1. National Income Accounting
Lecture 3

2. Outline Measurement of national income Other measures of Income
Value-Added Approach
Factor Payments (or Income) Approach
Other measures of Income
GNP, NNP, National Income, Personal Income, Disposable income
Nominal and real measures
Limitations of the national income concept

3. Other Approaches to GDP
The Value-Added Approach
The Factor Payments/ Income Approach

4. The Value-Added Approach
In the Expenditure approach,
Count goods and services only when sold to final users
In Value-added approach,
Add up each firm’s contribution to a product as it is produced
A firm’s contribution to a product is called its value added

5. The Value-Added Approach to GDP
The revenue a firm receives minus the cost of the intermediate goods it buys
GDP
Sum of value added by all firms in the economy

6. Illustrating the Value-Added Approach
Ghc2.25
(notebook paper)
Ghc1.00
(Wood Chips)
Ghc1.50
(raw paper)
Ghc3.50
(Notebook paper)
Ghc5.00
(Notebook paper)
Lumber mill
Paper mill
Office Supplies Manufacturer
Wholesaler
Retailer
Production of a ream of notebook paper:
Ghc( ) = Ghc5

7. Another Illustration: Value Added Approach
Suppose there are 5 stages in getting a suit manufactured and into the hands of a final consumer
Stage of Production
Sales Value of Materials or Product
Value- Added
Firm A, Sheep ranch 60
Firm B, wool processor
100
Firm C, suit manufacturer
125 40
Firm D, Clothing wholesaler
175 25
Firm E, retailer
250 50
Total Sales value
710 75
Value added (total income)

8. The Factor Payments/ Income Approach
Payments to the owners of resources that are used in production
GDP Calculation
Sum of factor payments earned by all households in the economy

9. The Income Approach Domestic Income There are four (4) components
Total income earned by residents and businesses in an economy
There are four (4) components
Employees compensation
Rents
Interests
Profits

10. The Factor Payments Approach
Compensation to employees
Wages and salaries paid to individuals
Fringe benefits
Makes up a largest proportion of national income

11. The Factor Payments Approach
Rents
Income received by households from properties that they own
Income received by firms from properties that they own form part of profits
Rent component of GDP may be small if depreciation is high in a particular year

12. The Factor Payments Approach
Interest
The income that private businesses pay to households that have lent the business money e.g. purchase of stocks
Interests paid to firms also show up in profits

13. The Factor Payments Approach
Profits
The amount that is left over after compensation to employees, rents and interest have been paid out

14. Other Approaches to GDP
Why use more than one method to calculate GDP?
Measurement errors

15. Problems With GDP Quality changes The underground economy
Nonmarket production

16. Quality Changes
Analysts record an increase in GDP only if there is an increase in the quantity of a good or service produced
New pen that lasts four times longer than previous version should cost 4 times as much!
GDP analysts record some quality changes (cars, computers); not all
Reason: Budget constraints
GDP underestimates the true growth in output from year to year

17. The Underground Economy
Some production hidden from government
Illegal (drugs, prostitution)
Tax avoidance
Underestimation of true production in economy

18. Non-Market Production
Excluded
Housecleaning
Sewing
Lawn mowing
Child rearing
Whenever non-market transactions become market transactions, GDP will rise, even though total production is the same
Over last century, much production shifted from home to market
Parenting to day care
Home-cooked food to takeout
Talking to a friend to therapy
Neighbour watching your house to alarm system
Real GDP increases although production has not
Exaggerate growth in GDP over time

19. Other measures of national income

20. Gross vs. Net concepts Depreciation
The decrease in the value of a capital good over time
Wear and tear on economy’s stock of capital
Examples?

21. GDP vs. NDP Gross Domestic Product (GDP) Net Domestic Product (NDP)
Total output produced within a country
Net Domestic Product (NDP)
Total output produced within a country, minus depreciation

22. Market Price vs. Factor cost
Recall expenditure = income assumption
Prices paid by consumers revenue received by producers
Why?
Taxes and subsidies
Taxes imply producer receives less than consumer pays
Subsidies imply producers receive more than consumer pays

23. Market Price vs. Factor Cost
To convert the value at factor cost to the value at market prices, we must:
Add indirect taxes and subtract subsidies
The expenditure approach values goods at market prices; the income approach values them at factor cost

24. Measures of Income More complete picture Gross National Product (GNP)
Net National Product (NNP)
National Income
Personal Income
Disposable Personal Income
Largest to Smallest

25. Other measures of Income
Gross National Product (GNP)
Total output of goods and services produced by nationals
Excludes production by foreigners within domestic economy; includes production by nationals in foreign country.

26. Other measures of income
Net Factor income from abroad
= Output by nationals abroad - Output by foreigners
Ghana GNP = Ghana GDP + Net factor income from abroad
Question (True/False)
When a Nigerian businessman builds a factory in Ghana; his production is part of Ghana’s GDP, but not Ghana’s GNP. Why?

27. Other measures of Income
Net National Product (NNP)
Total production by a nation’s residents minus losses from depreciation
National Income
Total income earned by a nation’s residents.
Differs from NNP by statistical discrepancy
Market price vs. factor cost

28. Other measures of Income
Personal Income
Income received by households and businesses
Excludes retained earnings
Includes income from Transfer payments
PI= NI – retained earnings + transfer payments

29. Other measures of Income
Disposable Personal Income
Income that households and businesses have left over after paying taxes
= Personal income- personal taxes

30. Relationship between various measures of income

31. Real versus Nominal GDP
Total spending rises from one year to the next
Economy - producing a larger output of goods and services
And/or goods and services are being sold at higher prices
Nominal GDP
Production of goods and services
Valued at current prices

32. Real versus Nominal GDP
Real GDP
Production of goods and services
Not affected by changes in prices
From nominal GDP to real GDP….

33. Table 2 Real and Nominal GDP
What is true about real GDP and nominal GDP in the base year?

34. Real vs. Nominal GDP
Nominal GDP uses current prices to place a value on economy’s output
Real GDP uses base-year prices to place a value on economy’s output

35. Real vs. Nominal GDP True/False
If Nominal GDP is rising, real GDP must also be rising. Why?

36. GDP
GDP – “the best single measure of the economic well-being of a society”
Economy’s total income
Economy’s total expenditure
Larger GDP
Good life, better healthcare
Better educational systems
Measure our ability to obtain many of the inputs into a worthwhile life

37. GDP
GDP – not a perfect measure of well-being. Why not?

38. GDP Doesn’t include Nothing about distribution of income Leisure
Value of almost all activity that takes place outside markets
Chef, child care-taker, etc
Quality of the environment
Nothing about distribution of income

39. International differences: GDP & quality of life
Rich countries - higher GDP per person
Better
Life expectancy
Literacy
Internet usage
Poor countries - lower GDP per person
Worse

40. GDP and the Quality of Life
The table shows GDP per person and three other measures of the quality of life for twelve major countries.

41. International differences: GDP & quality of life
Low GDP per person
More infants with low birth weight
Higher rates of infant mortality
Higher rates of maternal mortality
Higher rates of child malnutrition
Less common access to safe drinking water
Fewer school-age children are actually in school

42. International differences: GDP & quality of life
Low GDP per person
Fewer teachers per student
Fewer televisions
Fewer telephones
Fewer paved roads
Fewer households with electricity

43. Sample Questions What is nominal GDP for 2005 and 2010?
Calculate real GDP for 2005 and 2010, using 2005 as the base year.

44. Sample Questions
Consider an economy that produces only chocolate bars. In year 1, the quantity produced is 3 bars and the price is Ghc4. In year 2, the quantity produced is 4 bars and the price is Ghc5. In year 3, the quantity produced is 5 bars and the price is Ghc6. Year 1 is the base year.
What is the nominal GDP for each of these years
What is the real GDP for each of these years?
What is the % growth rate of real GDP from year 1 to year 2?

45. Take-Home Exercise
One day, Barry the Barber collects $400 for haircuts. Over this day, his equipment deteriorates in value by $50. Of the remaining $350, Barry sends $30 to the government in sales taxes, takes home $220 in wages, and retains $100 in his business to add new equipment in the future. From the $220 that Barry takes home, he pays $70 in income taxes. Based on this information, compute Barry’s contribution to the following measures of income:
Gross domestic product
Net national product
National income
Personal income
Disposable personal income

46. Next Class The price level and inflation
Measuring the rate of inflation
The construction of the consumer price index (CPI)/retail price index (RPI)
GDP deflator
Unemployment
Definition and Measurement