National Income Accounting Lecture 2 National Income Accounting

National Income Accounting The circular flow of income and expenditure Definition of national income Measurement of National Income The Expenditure Approach The Components of GDP The Factor Payments Approach The Value Added Approach

Economy’s Income & Expenditure Gross Domestic Product (GDP) Measures the total income of everyone in the economy Measures the total expenditure on the economy’s output of goods and services For an economy as a whole Income must equal expenditure Every transaction has a buyer and a seller If someone pays someone else Ghc100 to mow a lawn, the expenditure on the lawn service (Ghc100) is exactly equal to the income earned from the production of the lawn service (Ghc100).

Economy’s Income & Expenditure Circular-flow diagram: Describes all transactions between all households and firms in a simple economy

Circular Flow diagram Assumptions Markets Households Firms Goods and services Factors of production Households Spend all of their income Firms Pay rewards (wages, rent, profit) to resource owners

The Circular-Flow Diagram

The Circular Flow Diagram GDP can be calculated by: Adding up total purchases of households (expenditure) Or, Adding up total income of earned by households

The Circular Flow Diagram Model unrealistic, however Limitations?

The Circular Flow Diagram Model unrealistic, however Limitations Omits Savings Taxes Government purchases

The Measurement of GDP Gross domestic product (GDP) Market value of all final goods and services produced within a country in a given period of time

The Measurement of GDP “GDP is the market value…” “Cannot compare apples and oranges”. Market prices - reflect the value of the goods What is a limitation of the use of market prices in calculating GDP? Do increases in total market values always indicate increases in production of goods and services in an economy?

The Measurement of GDP “… of all…” All items produced in the economy And sold legally in markets Would goods like land, stocks or bonds be included in GDP? Why? Excludes some items Produced and sold illicitly Examples? Produced and consumed at home

The Measurement of GDP “… final…” Value of intermediate goods is already included in the prices of the final goods Why is this important?

The Measurement of GDP “… goods and services…” Tangible goods & intangible services Books, shoes, etc Haircut, music concert, etc

The Measurement of GDP “… produced…” Goods and services currently produced Sale of new vs. used car

The Measurement of GDP “… within a country…” Goods and services produced domestically Include output produced by foreigners Exclude output produced by nationals in a foreign country

The Measurement of GDP “… in a given period of time” A year or a quarter

Discussion questions What contributes more to GDP- production of an economy car or a luxury car? Why? Explain why an economy’s income must equal its expenditure GDP does not include the value of used goods that are resold. Why would including such transactions make GDP a less informative measure of economic well-being? A few years ago, Ama paid Ghc500 to put together a record collection. Today, she sold her albums at a garage sale for Ghc100. How does this sale affect GDP? A farmer sells wheat to a baker for Ghc2. The baker uses the wheat to make bread, which is sold for Ghc3. What is the total contribution of these transactions to GDP?

Next Class Approaches to measurement of GDP Expenditure Approach Factor Payments Approach Value-Added Approach