NATIONAL ECONOMY AND
INCOME NALYSIS
NATIONAL INCOME ACCOUNTING
LACTURE NOTES II
Definition: National Income Accounting
What is National Income Accounting?
Is the set of rules and techniques for measuring
the total flow of output produced and the total
incomes generated by this production.
Definition: National Income Accounting
Recall the concept of the circular flow of income:
the amount of expenditure in the economy must
equal the value of output sold; which must then
be equal to the income paid to the owners of the
factor inputs.
This identity between expenditure, output and
income is so important that it is worth stating
explicitly.
Expenditure Output Income
Definition: National Income Accounting
cont…
This implies that the total value of output produced
can be calculated in any of three separate ways, each
of which would necessarily give the same answer.
Income method/Approach
1.Income Method
This method look at the value of total incomes generated in
the process production.
It measures the total incomes earned by the factors of
production involved in the production of goods and
services in one year. These include:
Wages + salaries (compensation of employees including
income of the self employed)…(W)
includes wages and salaries paid by businesses and
government to workers as well as all other benefit
payments by employers such as payments towards
social security, pension funds and health insurance.
Income method/Approach cont….
Operating surplus which include Profits, Rent and
interest…………(R)+(I)+(P)
(R) are net rents received by landlords. Rents are paid
by households, businesses and government.
(I) incomes include interest payments households
receive on their bank deposits or bonds
(P) Profit can be classified into proprietors' income and
corporate profits.
Proprietors' incomes are their reported net profits.
Corporate profits are corporations' net earnings after
business expenses. Corporate profits are divided into
corporate income taxes, distributed dividends and
retained (undistributed) profits
Income method/Approach cont…
Provision for Depreciation / Capital
consumption……(D)
Capital Consumption Allowances: are the total costs of
the wear and tear or depreciation of the capital stock ie
machinery, tools, plants, roads, buildings, trains, railways
etc within an economy usually within a given year.
Income approach gives GDP at factor costs because
calculations are based on factor payments,
i.e. GDP(FC) = W + P + R + I + D
Income method/Approach cont…
Factor costs: are the actual production costs of
goods and services. Factor costs are the costs of all
the factors of production such as labor , capital,
energy, that are used to produce a given quantity of
output in an economy.
Thus the term GDP at factor cost refers to the total
final output of all final goods and services produced
within the national frontiers of a country which
based on the actual costs of production.
Expenditure Method/Approach
2.Expenditure Approach
The approach measures the total amount of domestic
spending by consumers, firms, government and
foreigners.
Expenditure Approach consists of:-
Consumption (C)
Investment (I)
Government Purchases (G)
Net Exports (Xn = X - M)
Expenditure Method/Approach cont….
C=Households' spending on durable and non-durable
goods and services.
G=Government purchases include spending by all levels
of governments on finished goods and services.
All government transfers are excluded.
I=Gross Private Domestic Investment include all final
purchases of tools, equipment, and machinery by
businesses, all (private) construction including new
homes, and changes in inventory
Note: Purchase of stocks and bonds and depositing
money in a bank are not considered as investment.
Expenditure Method/Approach cont….
(X – M) = Net Export :The difference between a country's
sales to other countries (exports) and its purchases from
other countries (imports).
These components give:
GDPMP = C + I + G + (X - M)
The GDP is valued at market prices because it contains
some elements of indirect taxes less subsidy by the
government.
Subsidies: are government expenses that are provided to business
firms, or farmers to pay their production costs or to reduce prices for
consumers. Subsidies are deducted because they impose expenses on
government budgets instead of contributing revenues.
Expenditure Method/Approach cont….
Market prices: are the prices at which goods and
services are sold in various markets to households
and firms.
GDP at market price therefore refers to the total
value of all final goods and services produced within
the national frontiers of a country that are valued at
market prices.
Output /Value Added Method
3.Output /Value Added Method
The approach measures the total money value of
goods and service produced by summing the value
of goods and services by an industry and deducting
the costs of goods and services.
It sums the net value of the output produced at
each stage of production by all the firms in the
economy (sales revenue less payments for
intermediate goods)
Output /Value Added Method
cont….
EXAMPLE
The farmer purchases seed for Tshs 40 from seed
producer.
The farmer produces wheat and sells the wheat to the
mill at 400 Tshs.
The mill produces wheat flour and sells to the bakery
at Shs.620/=
The bakery produces bread and sell it at 1000/=
Output /Value Added Method
cont….
The gross output value is as follows:
The value of farmer's seed ----T.shs. 40/=
Value of farmers wheat---------Tshs. 400/=
Value of flour----------------------Tshs 620/=
Value of bread--------------------Tshs. 1000/=
Total--------------------------Tshs. 2060/=
Output /Value Added Method
cont….
Total Value Added
Farmer's Value Added = 400- 40 = 360
Mill's Value Added = 620- 400 = 220
Bakery's Value Added = 1000 - 620 = 380
Total Value Added = 960
In the country like Tanzania, national income can be
given as:
VA = VA agriculture + VA. industries + VA. mining
+ etc.
Note that, value added method is used in order to
avoid a problem of double accounting.
Output= Income= Expenditure
The three approaches should arrive at the same
answer.
Consider the following Table
Output= Income= Expenditure
Sales Inter. Value Added Wages & Profit
Revenue Goods Salaries
Bakers $2000 $1000 $1000 $700 $300
Millers $1000 $500 S500 $250 $250
Farmers $500 - $500 $300 $200
Value Added Total
Final Exp. $2000
$2000 Incomes
$2000
Output= Income= Expenditure cont…..
Expenditure approach
Determines aggregate demand, or Gross National
Expenditure, by summing consumption/production of
final goods (bread produced by baker in our case which is
sold at Tsh 2000)
Value added Approach
Using the output or value-added approach, we must sum
the value-added at each stage of production,
it sums the net value of the output produced by all the
firms in the economy (sales revenue less payments
for intermediate goods:1000+500+500=2000)
Output= Income= Expenditure cont…..
Income approach
In our example, is the summation of wages and
profits,
Adding the factor incomes paid will also give the
same measure of national output
(700+300+250+250+300+200).
All three approaches should, in theory, give us the
same answer (2000 Tsh in our case).
In reality they are slightly different due to some
measurement error.
Other National Accounts
GDP at mp = GDP at fc+ Indirect taxes -Subsidies
GDP at fc = GDP at mp - Indirect Taxes + Subsidies
GNP = GDP +Net Income (Income from abroad -
Income paid abroad)
NDP (Net Domestic Product)= GDP - Depreciation
( capital consumption)
National income per capita = national income ÷
population size
Income per person is an indicator of the standard of
living
Other National Accounts cont…..
Personal Income (PI) = NI - Social security
contributions – Corporate income taxes
- undistributed corporate profits + Transfer payment
DI (Disposable Income) =PI - Personal taxes
Other National Accounts cont…
National Income at Constant and Current Prices
In order to make comparisons of national account
of two periods, it is necessary to make sure that the
same unit of measurement is used, i.e. there's a
need to express national accounts in the same set of
prices.
GDP can increase from one year to the next for two
reasons:
1. More goods and services are produced,
2. Prices have increased (inflation)
Other National Accounts cont…
To determine whether there has been an increase in
volume of goods/services (which determines the
welfare of the people), we therefore value the
national output (GDP) at constant prices so as to
correct the effects of inflation.
Other National Accounts cont…
Real and Nominal GDP
National income at current prices is the final good
and services valued at the prevailing prices.
Whereas national income at constant prices is the
final good/services valued at a base year prices.
Constant prices remove the changes or effects of
inflation by valuing the output of all the years in the
period in question using a chosen year's price (the
base year)
Other National Accounts cont…
Therefore:
Nominal GDP measures the value of the economy’s
production of goods and services in current prices
(i.e., prices in the current year)
Real GDP measures the value of the economy’s
production of goods and services in terms of a constant
set of prices (ex. taking 1992 as a base year)
Real GDP shows how the economy’s overall
production of goods and services changes over time,
eliminating the effects of price inflation.
Example: Nominal Vs Real GDP
–An increase in GDP 1950-1951 is a result of changes in
BOTH price and production (table below)
1950 nominal GDP 1951 nominal GDP
100 coats x $60 = $6000 150 coats x $80 = $12,000
100 radios x $40 = $4000 120 radios x $20 = $2400
Total = $10,000 Total = $14,400
Consider 1950 as the base year: then, whenever we
calculate real GDP we use the prices from 1950.
To determine real GDP for 1951, we use the quantities
produced in 1951 and the base year prices from 1950
(150 coats x $60)+ (120 radios x 40) = $13,800
Example: Nominal Vs Real GDP cont….
The increase in GDP (1950 – 51) includes ONLY
changes in production, because prices are held
constant at their 1950’s levels.
Note that: Economists are more interested in the
CHANGE in real GDP rather than the LEVEL of
real GDP
Other National Accounts cont…
GDP Deflator
This is a price index which measures the rise in
nominal GDP attributable to inflation.
GDP Deflator is defined as Nominal GDP
Real GDP
For example, if in the year 2000 nominal GDP
was Tshs.6.8 trilion and real GDP was Tshs. 5.9
trilion (valued in 1992 prices); then GDP deflator
is calculated to be
Other National Accounts cont…
GDP Deflator = 6.8 =1.1525
5.9
The GDP deflator for the base year (1992) has a
value of 1.00, then the average price level of all
goods and services included in GDP rose by
15.25%(1.1525 - 1= 0.1525) between 1992 and 2000.
By definition, Real GDP is equal to
Nominal GDP
GDP Deflator
Shortcomings of Using GDP in
Measuring National Income
GDP doesn’t measure some very useful output because
it is unpaid (homemakers’ services, parental child care,
volunteer efforts, home improvement projects).
GDP doesn’t measure improvements in product quality .
GDP doesn’t measure improved living conditions as a
result of more leisure.
GDP makes no value adjustments for changes in the
composition of output or the distribution of income.
Shortcomings of Using GDP in
Measuring National Income cont…
Per capita GDP may give some hint as to the relative
standard of living in the economy; but GDP figures do
not provide information about how the income is
distributed.
The Underground Economy
Illegal activities are not counted in GDP
GDP and the environment:
The harmful effects of pollution are not deducted
from GDP (oil spills, increased incidence of cancer,
destruction of habitat for wildlife etc).
