National Income Accounting

Depression—Surprise!

• After being blind-sided by the Great Depression, policymakers decided that they needed measures of economic activity.

• A Keynesian economist, Simon Kuznets, was charged with establishing the methodology for this in the late 1930s.

• Kuznets later received the Nobel Prize for his efforts.

Macroeconomics and national income accounts

• GDP and its measurement

• Output approach, income approach and expenditure approach

• The components of GDP

• From GDP to GNP to National Income

• How good an indicator of a country’s living standards is GDP?

National income accounting

• National income accounting is about measuring economic activity

• One of the most comprehensive measures of a country’s economic activity is the value of total production of its final goods and services, called national product

• The rate of economic growth is an important indicator of a country’s economic performance (although a high growth rate does not necessarily lead to less poverty)

Gross Domestic Product

• Gross Domestic Product (GDP) is the most widely reported measure to indicate a country’s economic performance

• GDP is the market value of all final goods and services produced in a nation during a specific period of time, usually a quarter or a year

Gross National Product

• Gross National Product (GNP) is the market value of all final goods and services produced by nationals (e.g. UK citizens) wherever they are located.

• GDP/GNP are expressed in monetary terms, thus rely on the markets to establish the relative values of goods and services

GDP vs. GNP

• Gross Domestic Product (GDP) is the total value of final goods and services produced during a given period within the geographic boundaries of a country regardless of by whom. The goods and services are produced domestically.

• Gross National Product (GNP) is the total value of final goods and services produced during a given period by the citizens of a country no matter where they live. The goods and services are produced by the “nationals” of the country.

GDP and Circular Flow

Points to remember when measuring GDP...

(a) Secondhand transactions are not included (since merely exchanges of previously produced goods)

(b) Private or public transfer payments are not counted (e.g. unemployment insurance benefits – not made in exchange of a service => no new production)

(c) Only final goods, intermediate goods not included (e.g. bread yes, flour no)

=> If any of these items were included in the calculations, the measurement of economic activity would be subject to ‘double-counting’

(d) Excludes financial transactions since these do not reflect production.

Three different ways of measuring GDP1. Output approach

2. Income approach, and

3. Expenditure approach

1. Output approach

This may be measured as the total output of final goods and services. This uses the concept of value added.

Value added: difference between the value of a good as it leaves a stage of production and the costs of that good as it entered that stage.

Summing the ‘value-added’ of the different stages of production gives the total value of economic activity.

GDP as Valued-Added

Measuring value added

Stage of production Value of Sales Value Added

1 – Oil Drilling $0.50 $0.50

2 – Refining $0.65 $0.15

3 – Shipping $0.80 $0.15

4 – Retail Sale $1.00 $0.20

Total Value Added $1.00

2. Income Approach

GDP may be measured as the total income earned by the factors of production (i.e. land, labour and capital) derived from producing the output => sum of factor incomes.

Factors of Production and their Remuneration

1.Land: Rent

2.Labour: Wages and Salary

3.Capital: Interest

4.Entrepreneur:: Profit

GDP= Rent+ Wages and Salary + Interest + Profit

3. Expenditure Approach

GDP may be measured by using the expenditure on total output. It is measured initially at market prices, including indirect taxes such as VAT but excluding subsidies. This approach provides a very useful identity Y = C + I + G + (X – M)

C= Consumption Expenditure by Household Sector

I= Investment Expenditure by Firms

G= Government Expenditure

X-M= Net Expenditure by Rest of the World

• The income and expenditure measures are expressed in monetary terms at the market prices that prevail (i.e. at current prices or in nominal terms)

• Nominal GDP (p x q) can grow because of three reasons:– Output (q) rises and prices remain unchanged

– Prices (p) rise and output remains unchanged

– Both output and prices rise

• In order to control for price changes GDP can be calculated using a base set of prices. The real measures can then be obtained by deflating GDP by a relevant price index.

What Increased?

Three Key Price Indexes

• Consumer Price IndexConsumer Price Index (CPI)(CPI)

• Producer Price Index (PPI)Producer Price Index (PPI)

• GDP Deflator (GDP Price Index or GDPPI)GDP Deflator (GDP Price Index or GDPPI)

Composition of CPI

The Expenditure approach is important for highlighting linkages between macroeconomic indicators ….

Component parts of expenditure based GDP

• UK GDP (Y), 2003 estimated (billion) = £1,099.4a) Consumption expenditure (C) = £951.4

(on durables, non-durables, services)

b) Investment (I) = £175.8 (stock-building, capital formation, housing)

c) Government expenditure (G) = £231.7 (roads, health, education, but not transfer payments)

d) Exports of goods and services (X) = £276.0

e) Imports of goods and services (M) = £308.4

(C, I,G have import component, thus M needs to be subtracted from economic activity)

National Accounts Identity

(1) Y = C + I + G + X - M

Gross domestic product or ‘grossly deceptive product’?

• Non-market transactions– The ‘care’ economy (underestimation of housewives/husbands work)– Subsistence agriculture

• Distribution, nature and quality of goods produced

• Leisure time

• The hidden economy– Illegal activities

– Informal sector

• Economic ‘bads’ – No distinction between green and polluting industries

• This list of omissions suggests that GDP figures are a dubious guide to the quality of life in different countries

• Nevertheless GDP per capita is used as a broad indicator of living standards

• Examples of alternative measures:– HDI (weighted average of life expectancy,

education and income)

Other national accounts• GDP + Net Factor Income (NFI) = GNP• Net National Product (NNP) = GNP - Depreciation

(depreciation: estimate of the capital worn out by producing GDP)• National Income: total income earned by the owners of

resources, including wages, rents, interest and profitsNI = NNP - indirect taxes [taxes on goods sold, e.g. VAT]

• Personal Income: total income received by households that is available for consumption, saving and the payment of personal taxes

• Personal disposable Income (PDI): Personal Income minus personal income taxes plus transfer payments received by individuals PDI = PI – income taxes + transfers

CDS: Current Daily StatusCWS: current Weekly StatusUPSS: Usual Principal and Subsidiary Status

Employment and Unemployment in India

Growth versus Development

• Economic growth may be one aspect of economic development but is not the same

• Economic growth:– A measure of the value of output of goods and services

within a time period

• Economic Development:– A measure of the welfare of humans in a society

Development

• Development incorporates the notion of a measure/measures of human welfare

• As such it is a normative concept – open to interpretation and subjectivity

• What should it include?

Development

• Levels of poverty– Absolute poverty

– Relative poverty

• Inequality• Progress – what

constitutes progress?

Our definitions of progress may be highly subjective. What has progress brought to native tribes people across the globe?Title: Navajos refuse casino riches. Copyright: Getty Images, available from http://edina.ac.uk/eig

Poverty in India

Poverty Line in India

As per the Tendulkar Committee Report, the national poverty line at 2004-5 prices was a monthly per capita consumption expenditure of:

Rupees 446.68 in rural areas, and Rupees 578.80 in urban areas in 2004-5

Economic Growth vs. DevelopmentIncome Inequality

• Using measures of economic growth can give distorted pictures of the level of income in a country – the income distribution is not taken into account.

• A small proportion of the population can own a large amount of the wealth in a country. The level of human welfare for the majority could therefore be very limited.

But this could be just around the corner!Copyright: chinagrove, http://www.sxc.hu

This might be a common picture……Copyright: unseenob, http://www.sxc.hu

Income Inequality: Gini Index

According to HDR 2011, inequality in India for the period 2000-11 in terms of the income Gini coefficient was 36.8.

India’s Gini index was more favourable than those of comparable countries like South Africa (57.8), Brazil (53.9), Thailand (53.6), Turkey (39.7), China (41.5), Sri Lanka (40.3), Malaysia (46.2), Vietnam (37.6), and even the USA (40.8), Hong Kong (43.4) and Argentina (45.8).

Human Development Index (HDI)

• HDI: A socio-economic measure• Focuses on three dimensions of human welfare:

Longevity – Life expectancyKnowledge – Access to education, literacy ratesStandard of living – GDP per capita: Purchasing

Power Parity (PPP)

Other Measures?