National Income Accounting

Introduction National income accounting provides us with ex-post data about national income, it cannot explain the level and determinants of national income. The following identities are true for any level of income. In order to explain and predict the level of national income, models are constructed.

The flow of economic activities in a 2-sector economy Factor Market Product Market Factor services Goods & services Real Flow Consumers Factor Owners Firm Money Flow Factor Income Cost Revenue Expenditure The flow of economic activities in a 2-sector economy

GNP v.s. GDP Gross National Product (GNP) The total value at market prices of final goods and services produced by the citizens in an economy in a specified period. Gross Domestic Product (GDP) The total value at market prices of final goods and services produced within the domestic boundary of a territory in a specified period

GNP & GDP Flow concept Resale of existing houses  Sale of used cars / existing shares  Commission / Brokers’ fee  Imputed rents of owner-occupied dwellings  Capital gain is not income (Irving Fisher) Only the interest earned from the capital gain is considered as income

Real GNP & Nominal GNP & Per capita GNP Real GNP=(Nominal GNP/GNP Deflator)*100 Per capita GNP = GNP / Population size

Measurement of National Income Income Approach  NNP at factor cost OR National Income Output Approach  GDP at factor cost Expenditure Approach  GDP at market Prices

Expenditure Approach C+I+G+X-M GDP at market price - Indirect sales tax + Indirect subsidies  GDP at factor cost Net income from abroad GNP at factor cost Depreciation NNP at factor cost  Output Approach Factor Income-from abroad Factor Income paid abroad  Income Approach  W+I+R+P

NNP at factor cost - Retained profits Social insurance / Mandatory Provident Fund Direct business Tax + Transfer payments  Personal income Direct personal taxes Disposable personal income - Consumption = Saving

Income Approach W+I+R+P = NNP at factor cost Profits are stated net of depreciation / capital consumption allowances If the figures exclude net income from abroad, NDP at factor cost can be obtained. NDP at factor cost + Net income from abroad =

Output Approach The total value of the final goods and services produced by the primary / secondary / tertiary industries In order to avoid double counting, the value-added method is adopted to exclude intermediate goods. GDP at factor cost + Indirect Taxes – Indirect Subsidies = Distinguish between Indirect / Direct / Business / Personal Taxes

Expenditure Approach People spend their income. Thus, the total expenditure on final goods and services must be equal to the total value of final goods and services produced domestically. Any output that is not sold to consumers is bought by producers in the form of unintended inventory investment. C+I+G+(X-M) = Aggregate / Total expenditure

Expenditure Approach Private Consumption Expenditure (C) Gross Investment Expenditure (I) Firms : plant (in progress) / unused raw materials Households : residential building Inventory investment : intended unintended (reduce information cost) - gross domestic fixed capital formation* - change in stocks & work in progress *gross national fixed capital formation GNP at market prices Government Expenditure (G) roads/education/medical & health services/law & order/public works/… salary to civil servants, NOT transfer payments at the cost to taxpayers, NOT at market prices Net Exports (X-M) the value of imports is included in C, I, G, X Exports include domestic exports & re-exports

Items excluded from National Income Accounting Second-hand goods Intermediate goods Non-marketed goods / services Volunteer work / Housework Unreported / Illegal market transactions

Merits & Uses of National Income Statistics Reflecting & comparing the standards of living of different countries Per capita real GNP  standard of living Providing information to the government and firms for economic planning Reflecting the economic growth of a country % change in real GNP over a period of time

Limitations of National Income Statistics Factors that may understate the standard of living / the welfare Exclusion of the value of leisure Same Q produced with fewer working hours  higher welfare Exclusion of non-marketed / unreported transactions

Limitations of National Income Statistics Factors that may overstate the standard of living / the welfare Undesirable Side-effects of Production Air pollution / traffic congestion /… Understate the real / social costs to society  externality /divergence between social costs & private costs

When comparing economic performances using national income statistics, Price Level use real GNP  eliminate the effect of inflation Size of Population  use per capital GNP Income Distribution more even distribution  higher welfare Composition of National income more consumption, less national defence  higher welfare Exchange Rates expressed in the same currency whether the exchange rates reflects the purchasing power of the 2 currencies

Inflation A general and sustained increase in the prices of all goods and services GNP deflator / GDP deflator Consumer Price Index (CPI) Producer Price Index (PPI) When constructing price indices different weighting will be given to different commodities reflecting their relative importance on the consumers’ expenditure A base year is chosen during which the economy experiences no economic crisis

Calculating a Price Index Item Expenditure 1991 Weight Prices Price Relatives 1992 Transport 1000 10 15 100 Clothing 2000 20 Housing 3000 30 500 650 130 Food 4000 40 200 220 110

Calculating a Price Index (cont’d) Price Index in 1991 =0.1*100+0.2*100+0.3*100+0.4*100 =100 Price Index in 1992 = The general price level in 1992 has increased by % Only persistent increase in the price indices implies inflation

Consumer Price Indices Only consumer goods are included Persistent increase in the CPI implies an increase in the cost of living unless there is a compensating rise in money income CPI(A), CPI(B), HSCPI are constructed to measure the change in the cost of living of different income groups since they have different consumption patterns. Different weights are assigned to different categories of goods to reflect their relative importance.

Uses of the CPI In the following table, the real income is increasing, this implies that the standard of living is also increasing for a typical citizen Year CPI Nominal income Real income 1991 90 7650 8500 =(7650/90)*100 1992 Base year 100 8820 = 1993 105 9555 9100

Limitations of the CPI Only consumer goods are included  CANNOT reflect the inflation rate accurately Change in consumption pattern  the weights are fixed  misleading Change in quality of goods  CPI due to better quality  overstate inflation Possibility of Substitution  overstate the impact of inflation if consumers substitute cheaper goods for dearer goods

Implicit GNP Deflator To measure inflation, this is a better indicator as it has a wider coverage of commodities Year GNP deflator Inflation Rate between …. 1990 90 1991 100 1991 &1992 [(121-100)/100]*100% = 21% 1992 121

Unemployment Working Population OR Labour Force Un-employment Rate Working Population=Employed+Unemployed+Self-employed Un-employment Rate =(Unemployed/Labour Force)*100% Under-employment Rate

Method of Analysis Endogenous variable the value of the variable is determined inside the model ( x, y) Exogenous variable the value of the variable is determined by forces outside the model ( m, c) any change is regarded as autonomous

C C C Y Y Y C I I Y Y Y C=f(Y) C=a C=a+cY C=a+c’Y C=c*Y I=f(Y) I=I* I=I*+iY