National Income Accounting DD

8/8/2019 National Income Accounting DD

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National IncomeNational Income

Accounting Accounting


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National income accountingNational income accounting

(NIA)(NIA)is the measurement of indicators of is the measurement of indicators of national output/income; .e.g. GDP,national output/income; .e.g. GDP,GNPGNP


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C ircular flow diagramC ircular flow diagram

summarizes the transactions betweensummarizes the transactions betweenthe different economic agentsthe different economic agents

agents: households, firms (business),agents: households, firms (business),government, and foreigners (rest of government, and foreigners (rest of the world)the world)


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C ircular flow diagramC ircular flow diagram

A ssumption A ssumption: : TheThe economyeconomy isis composedcomposed of of householdshouseholds andand firmsfirms onlyonlyHouseholdsHouseholds: : ownown factorsfactors of of production,production,consumeconsume goodsgoods andand servicesservices. .FirmsFirms:: hirehire factorsfactors of of productionproduction toto produceproducegoodsgoods andand servicesservices. .


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FIGURE 8.1. Circular flow diagram. The diagram above represents the transactions between

firms and households in a simple economy.In the upper loop, the arrow emanating from firms to households represents the sale by firms of goods and services to households. On the other hand, the arrow from households to firmsrepresents the payments.

n the lower loop, the arrow originating from the households to the firms shows that firms hirelabor and capital from households in order to produce goods and services. The arrowemanating from the firms indicates their payments for the use of the factors of production.

factor payments

(wages, interest, rent, profit)

factor services

goods and services

payments for goods and services

HOUSEHOLDSFIRMS


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MA RKETS FORFA CTORS OFPRODUCTION

MA RKETS FORGOODS A ND

SERVICES

FIR M S HOUSEHOLDS

Good andservices

bought

G ood andservices sold

Revenue(=G DP)

Spending(=G DP)

Inputs for

Production

Land, labor and capital

Wages, rent,interest andprofit (= G DP)

Flow of goods & services

Flow of money: pesos

Income (= G DP)

THE CIRCUL A R FLOW DI A GR AM


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W ith government andW ith government and

foreign agentsforeign agentsNeed to account for :Need to account for :

a.a. Government purchases of goods and services.Government purchases of goods and services.

b.b. Government payments for factor servicesGovernment payments for factor services(wages, rent, interest).(wages, rent, interest).

c.c. Transfer paymentsTransfer payments between different agents.between different agents.d.d. Firms and households pay taxes toFirms and households pay taxes to

government.government.e.e. Taxes paid on income, property, goods andTaxes paid on income, property, goods and

services.services.f.f. Transactions with the foreign sector.Transactions with the foreign sector.


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Transfer paymentsTransfer payments

Transfer paymentsTransfer payments are transactionsare transactionswherein one party is not obliged towherein one party is not obliged todeliver a good or service in return fordeliver a good or service in return forthe payment.the payment.Examples: retirement benefits,Examples: retirement benefits,unemployment benefits, scholarships,unemployment benefits, scholarships,and donationsand donations ..


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Transactions with foreignTransactions with foreign

sectorsectorIncludes sales of goods and services,Includes sales of goods and services,assets, and transfersassets, and transfersExportsExports -- sales of domesticallysales of domesticallyproduced goods to other countriesproduced goods to other countriesImportsImports -- goods bought from othergoods bought from othercountriescountries


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Measurement of economy s output:Measurement of economy s output:T

he Gross Domestic Product (GDP)T

he Gross Domestic Product (GDP)

The GDP measures theThe GDP measures the market valuemarket value of allof all finalfinalgoods and services produced within an economy ingoods and services produced within an economy ina given period.a given period.GDP only measures current production.GDP only measures current production. TransferTransferpaymentspayments and transactions involving goodsand transactions involving goodsproduced in other periods are not included in theproduced in other periods are not included in thecalculation of GDP.calculation of GDP.

GDP is usually expressed in the currency of aGDP is usually expressed in the currency of aparticular country,particular country, e.g.Indiane.g.Indian rupee and it indicatesrupee and it indicatesmarket value of the goods and servicesmarket value of the goods and services


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Definition of GDPDefinition of GDP

TheThe marketmarket valuevalue ofof goodgood i i (V(V ii)) isisequalequal toto PP ii QQ iiGDPGDP == sumsum ofof thethe marketmarket valuesvaluesofof allall finalfinal goodsgoods andand servicesservicesproducedproduced withinwithin thethe yearyear ..

! !

! ! n n

i i ii 1 i 1

G V Q


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GDP includes final goodsGDP includes final goods

and services onlyand services onlyFinal goodsFinal goods - - goods and services that aregoods and services that arenot purchased for the purpose of producingnot purchased for the purpose of producing

other goods and services or for resaleother goods and services or for resale EgEg. Rice (final) and. Rice (final) and unhuskedunhusked rice (intermediaterice (intermediate

product)product)

Including intermediate goods and finalIncluding intermediate goods and finalgoodsgoods both willboth will result in double counting .result in double counting .


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3 Approaches for3 Approaches for

measuring GDPmeasuring GDP1 .1 . Expenditure A pproachExpenditure A pproach (upper loop)(upper loop)

measures GDP as the sum of expendituresmeasures GDP as the sum of expenditures

on final goods and services.on final goods and services.2.2. Income A pproachIncome A pproach (lower loop)(lower loop) measuresmeasuresGDP as the sum of incomes of factors of GDP as the sum of incomes of factors of production (wages, rent, interest andproduction (wages, rent, interest and

profit.profit.3.3. Value Value--added A pproachadded A pproach measures GDP asmeasures GDP asthe sum of value added at each stage of the sum of value added at each stage of production (from initial to final stage)production (from initial to final stage)


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Ex penditure ApproachEx penditure Approach

Uses the upper loop of the circular flowUses the upper loop of the circular flowdiagram.diagram.

Example: Suppose the economy hasExample: Suppose the economy hasonly one product, namely, rice.only one product, namely, rice.

GoodGood Price perPrice perunitunit

Q soldQ sold Ex penditureEx penditure

RiceRice 2020 1 0001 000 20,00020,000GDPGDP 20,00020,000


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Income ApproachIncome ApproachUses the lower loop of the circular flow diagram: sum of paymentsUses the lower loop of the circular flow diagram: sum of paymentsto the various factors of production.to the various factors of production.Suppose that in the production of rice the sales and expenses are asSuppose that in the production of rice the sales and expenses are asfollows:follows:

SalesSales P 20,000P 20,000Expenses:Expenses:

WagesWages 80008000Rent Rent 40004000

Interest Interest 20002000TotalTotal 14,00014,000

Profit Profit 6,0006,000GDP=Sum of Payments toGDP=Sum of Payments tofactorsfactors

20,00020,000 P 20,000P 20,000


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Value Added Approach Value Added Approach

Suppose that rice is the only final product of anSuppose that rice is the only final product of aneconomy: It goes through several (3) stages of economy: It goes through several (3) stages of

production.production.

Stage of Stage of Prod nProd n Value of Value of

intermediateintermediategoodgood

Value of Value of SalesSales

Value Value--addedadded

FarmerFarmer --paddypaddy 1 2,0001 2,000 1 2,0001 2,000Rice M illerRice M iller --M illedM illedRiceRice

1 2,0001 2,000 15 ,00015 ,000 3,0003,000

RetailersRetailers -- RiceRice 15 ,00015 ,000 20,00020,000 5 ,0005 ,000GDP= Total ValueGDP= Total Value A

dded A

dded

20,00020,000


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Notes of the 3 approachesNotes of the 3 approaches

The expenditure approach, income approach, and the valueThe expenditure approach, income approach, and the value- -added approach all come up with the same estimate of theadded approach all come up with the same estimate of theGDP. They areGDP. They are equivalent equivalent approaches.approaches.In the income approach,In the income approach, profit profit is also considered a payment is also considered a payment to the entrepreneur. So the incomes are ( 1 ) wages, (2) rent,to the entrepreneur. So the incomes are ( 1 ) wages, (2) rent,(3) interest, and (4) profit. Profit adjusts to make the sum(3) interest, and (4) profit. Profit adjusts to make the sumequal to the final value of the good.equal to the final value of the good.In the value added approach, only the value added in eachIn the value added approach, only the value added in eachstage of production are included. If we add the value of stage of production are included. If we add the value of intermediate product with the value of the final product, weintermediate product with the value of the final product, we

commit the sin of doublecommit the sin of double- -counting.counting.A t each stage of production, the value A t each stage of production, the value- -added is equal toadded is equal towages, interest, rent, and profit. Therefore the value of thewages, interest, rent, and profit. Therefore the value of thefinal product is likewise the same of all payments to thefinal product is likewise the same of all payments to thefactors of production.factors of production.


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Additional Topics Additional Topics

GDP vs GNPGDP vs GNPReal vs current GDPReal vs current GDPInterInter--country comparisons of GDPcountry comparisons of GDP Convert to international currency like USConvert to international currency like US

dollarsdollars Convert to per capita measuresConvert to per capita measures


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THE N A TION A L A CCOUNTS OF THETHE N A TION A L A CCOUNTS OF THE

PHILIPPINESPHILIPPINES

same principles as above but need to makesame principles as above but need to makeadjustments in order to accommodate theadjustments in order to accommodate therealities in modern economiesrealities in modern economiesEx penditure approachEx penditure approach

GDPGDP = C + G + I + X= C + G + I + X M+M+ SDSD

SD = Statistical discrepancySD = Statistical discrepancy


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Ex penditure ApproachEx penditure ApproachCC -- spending of households and private nonspending of households and private non- -profit institutions onprofit institutions ongoods and servicesgoods and services NonNon--durablesdurables - - goods and services that are consumed rapidlygoods and services that are consumed rapidly Durable goodsDurable goods - - that last for a longer period of timethat last for a longer period of timeII -- investment spending of domestic agents. Its major componentsinvestment spending of domestic agents. Its major componentsare changes inare changes in Fixed CapitalFixed Capital andand Changes in StocksChanges in StocksGG -- government s payments for the salaries of its workforce as well asgovernment s payments for the salaries of its workforce as well aspurchases of goods and servicespurchases of goods and services pp used for the government s day toused for the government s day today operations and projects.day operations and projects.XX -- the spending of the rest of the world on goods and nonthe spending of the rest of the world on goods and non- -factorfactorservices produced in the countryservices produced in the country

MM -- the country s purchases of goods and nonthe country s purchases of goods and non- -factor servicesfactor servicesfrom the rest of the world.from the rest of the world.SDSD -- accounts for accounting and reporting errors in the accounts.accounts for accounting and reporting errors in the accounts.Needed to ensure that GDP value from all approaches are the sameNeeded to ensure that GDP value from all approaches are the same


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The distinction between GDP andThe distinction between GDP and

GNPGNPGNP = GDP +GNP = GDP + Net Factor Income fromNet Factor Income fromthe Rest of the Worldthe Rest of the World (NFIRW)(NFIRW)NFIRWNFIRW -- measures the differencemeasures the differencebetween the earnings of between the earnings of IndianIndianresidents in other countries andresidents in other countries and

foreign residents inforeign residents in India.India.


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Nominal and Real GDPNominal and Real GDP

GDP at current prices or nominal GDPGDP at current prices or nominal GDP - - GDPGDPmeasured using the prices of the year for which it ismeasured using the prices of the year for which it iscalculatedcalculatedNominal GDP can be a misleading indicator of Nominal GDP can be a misleading indicator of changes in output or income because it alsochanges in output or income because it alsoembodies changes in the prices of goods andembodies changes in the prices of goods andservices.services.Real GDP or GDP at constant pricesReal GDP or GDP at constant prices || measures themeasures thetotal value of output using the prices of a selectedtotal value of output using the prices of a selectedyear (the base year).year (the base year).Real GDPReal GDP is betteris better for analysis overtime because it for analysis overtime because it eliminates the effects of price changeseliminates the effects of price changes


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GDPGDPyearyear 11 = ( 1 00) ( 5 0) + ( 1 00) ( 1 00) = 15 ,000= ( 1 00) ( 5 0) + ( 1 00) ( 1 00) = 15 ,000GDPGDPyearyear 22 = ( 1 00) ( 5 0) + ( 1 00) ( 1 00) = 15 ,000= ( 1 00) ( 5 0) + ( 1 00) ( 1 00) = 15 ,000

In practice, calculating real GDP using the previousIn practice, calculating real GDP using the previousapproach is a tedious process becauseapproach is a tedious process because so so manymanygoods and services are produced in an economy.goods and services are produced in an economy.Can simplify the calculation process by using theCan simplify the calculation process by using theGDP deflator.GDP deflator.

GDP deflatorGDP deflator - - aa price indexprice index that allows us tothat allows us toconvert nominal GDP into realconvert nominal GDP into real GDP.GDP.


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R eal GDPR eal GDP

N ominal G DPReal G DP 00.G DP deflator

!


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Inflation R ateInflation R ate

1

1

Inflation Rate t t

t

CPI CPI

CPI !


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GDP per capitaGDP per capita

M easures how much output or income wasM easures how much output or income wasproduced or received, on the average, by anproduced or received, on the average, by anindividual in an economyindividual in an economy

Useful for comparing the performance of a countryUseful for comparing the performance of a countryovertime and a country s performance relative to itsovertime and a country s performance relative to itsneighborsneighbors

GG r c it

l ti n!


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GNP for cross country comparisonsGNP for cross country comparisons

Convert a country s GNP to US dollars,Convert a country s GNP to US dollars,or some common currency, by usingor some common currency, by usingthe country s exchange ratethe country s exchange rateWhen comparing income acrossWhen comparing income across

countries, it also makes sense to usecountries, it also makes sense to useper capita estimatesper capita estimates pp eliminateseliminatesdifferences in population size.differences in population size.


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PPP A djusted GNPPPP A djusted GNP

PPPPPP purchasing power paritypurchasing power parityGNP is adjusted to account for the fact GNP is adjusted to account for the fact that 1 USD when spent in one countrythat 1 USD when spent in one countrydoes not buy the same quantity of does not buy the same quantity of goods when spent in another countrygoods when spent in another country E.g.E.g. India, perIndia, per capita GNP (in USD) =capita GNP (in USD) =

1 0001 000 per capita GNP (PPP adjusted, in USD) =per capita GNP (PPP adjusted, in USD) =

3,5 003,5 00


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Personal Disposable IncomePersonal Disposable Income

P ersonal disposable incomeP ersonal disposable income represents therepresents theincome that households are free to spend orincome that households are free to spend or

save.save.It excludes the components of nationalIt excludes the components of nationalincome that do not accrue directly toincome that do not accrue directly tohouseholds, examplehouseholds, example- - undistributed profit.undistributed profit.

It also includes a few items that are not part It also includes a few items that are not part of national income but nonethelessof national income but nonethelessinfluence the amount of income that influence the amount of income that households canhouseholds can spend Examplespend Example- -P ension.P ension.


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Some Limitations of GDP orSome Limitations of GDP or

GNP as measures of growthGNP as measures of growthIgnores income distributionIgnores income distributionIgnores environmental degradationIgnores environmental degradationDoes not include activities that do not Does not include activities that do not go through the formal markets sectorsgo through the formal markets sectorsDoes not include illegal activities likeDoes not include illegal activities likedrug trafficking,drug trafficking, blackblack market market transaction.transaction.

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National Income Accounting DD