National Income Accounting Lecture2

What is National Income? National income is defined as the total value of all goods and services produced within a country in a particular period usually 1 year.

National Income definition u The national income is a sum of monetary values that are ​​ obtained by individuals as a result of contributing to the production process Factors of production land labor capital entrepreneurial ability Factors of production rent wages interest profit Payment National income

The importance of computing National Income u

The Economy Income and Expenditure u For an economy as a whole, income must equal expenditure (aggregate demand) because: u Every transaction has a buyer and a seller. u Every dollar of spending by some buyer is a dollar of income for some seller. u This process can be seen using a Circular Flow Diagram.

The Circular-Flow income diagram (two sectors) Firms Households Market for Factors of Production Market for Goods and Services SpendingRevenue Wages, rent, and profit Income Goods & Services sold Goods & Services bought Labor, land, and capital Inputs for production

The Circular-Flow Income diagram National income(factors of production income) National output from goods and services

The Circular-Flow Income diagram (Four Sectors) ConsumersProducers Government Sector Taxation (T)Spending (G) External world Sector Imports (M)Exports (X) Consumption spending (C)

final Gross national product (GNP) :It is the total market value of all final goods and services produced within a country in a given period of time. Gross National Product

National Product National product :It is the total market value of all goods and services produced within a country in a given period of time.

What Is Counted and Not Counted in GNP? u What is counted in the GNP Non-Market Activities : Goods and services that are produced and consumed at home and that never enter the marketplace. u What is not counted in the GNP: u Transfer payments. For example, social security and pensions. u Unpaid and domestic activities. (example: If you cut your grass or paint your house…)

Methods of measuring GNP To avoid the double account of GNP we will use the value-added approach u Value-added Approach: u Value-added Approach: measures GNP as the sum of value added at each stage of production (from initial to final stage) V.A = value of sales – value of intermediate goods

Value Added Approach Value-addedValue of intermediate good Value of SalesStage of Production 0700Wheat Flour Bread National output Example1: Suppose that bread is the only final good of an economy: It goes through several (3) stages of production Suppose that bread is the only final good of an economy: It goes through several (3) stages of production.

Value Added Approach Value-addedValue of intermediate good Value of SalesStage of Production 0700Wheat 800Flour 1000Bread National output Example2: Suppose that there are three final products of an economy: It goes through several (3) stages of production. Wheat value :700  final product Sales :200  The rest is used in the production of flour Flour value:800  final product Sales :150  The rest is used in the production of bread which Bread value sales :1000

Expenditure Approach Expenditure Approach: measures GNP as the sum of expenditures on final goods and services. GNP =C + I + G + (X - M)

Direct and Indirect Taxes u Direct taxes – Direct taxes are applied to property, Tax liability cannot be passed onto someone else. (Example: income tax, business profit taxes..) u Indirect taxes – an indirect tax can be passed on from the designate to the final consumer.(example: VAT, consumption, production, import and export…)

Gross investment / Net investment u Gross investment represents additions to the stock of durable capital goods (buildings, equipment, inventories) during a year that increase production possibilities in the future. u Depreciation measures the amount of capital that has been used up in a year. u Net investment = gross investment - depreciation

Expenditure Approach Example: Suppose the economy has only one product, namely, rice. Expenditure Q sold Price per unit Good Rice 20000GDP

Income Approach Income Approach: measures GNP as the sum of incomes of factors of production (wages, rent, interest and profit). u Notice: we are computing GNP using the income approach.we need to add Indirect Taxes and Depreciation

Income Approach (continued) u GNP = rent + wages + interest + profit + indirect taxes + depreciation u GNP = National Income + indirect taxes + depreciation

u Example: Suppose that in the production of rice the sales and expenses are as follows: 20,000 20,000Sales Expenses: 8000 Wages Wages 2000 Rent Rent 1500 Interest Interest 6000 Profit Profit 1000 Indirect taxes 1500Depreciation 20,000 20,000 GNP=Sum of Payments to factors

Other Measures of Income u Gross Domestic Product (GDP) u Nominal and Real GDP u Personal Income u Disposable Personal Income

Gross Domestic Product (GDP) GDP is geographically focused, including only output produced within a nation’s borders regardless of whose factors are used GDP = GNP - Net external(foreign) income

Real and Nominal GDP u Nominal GDP the production values of goods and services at current prices. u Real GDP the production values of goods and services at constant prices.

Computing Real GDP u The general formula for computing real GDP is: u The price index represents a price level change as an index with a base of 100

Net Domestic Product Net domestic product (NDP): GDP less depreciation äThe amount of output we could consume without reducing our stock of capital

Personal Income u Personal income (PI): Income received by households before payment of personal taxes PI = NI – profits taxes – social security taxes – reserves +transfer payments

Disposable Personal Income All disposable income is either consumed or saved