CHAPTER 2 NATIONAL INCOME (GDP and GNP) MEASUREMENT

What is income?

Income is the money earn or paid as a reward for the resources owned. For example: A worker earn income in the form of monthly payment.

What is National Income? Instead, What is National Income?

National Income is defined as: the total value of final outputs which comprises of goods and services produced by a country for a particular period of time, usually a year.

Tucker, defined national income as: total income earned by resources owners, that is: rents, wages, interest and profit.

National Income: is the total amount of money that factors of production earned during a year. This includes mainly payments of: wages, rents, profits and interest of capital.

NATIONAL INCOME = NATIONAL PRODUCT = NATIONAL EXPENDITURE (NI = NP =NE)

Or NI = National Product (NP) The national product refers to the value of output produced by an economy during the course of a year. Or NI = NP = National Expenditure refers to the value of money spent on goods and services in the economy in a year.

GDP and GNP GDP = Gross Domestic Product, is the value of all final goods and services produced by all sectors of the economy the citizens or foreign sectors within a country. GNP = Gross National Product, is the value of all final goods and services produced by all citizens of a country (within a country or abroad).

Circular Flow of Income Model: The basic circular flow model provides a general picture of the interactions in terms of : income, output and expenditure among all sectors in an economy.

Circular Flow of Income Economic Models 3 types: A 2-sector model of circular flow - Comprises of ‘Households’ and ‘Firms’ sectors A 3-sector model of circular flow - Comprises of ‘Households’ , ‘Firms’ and ‘Government’ sectors A 4-sector model of circular flow - Comprises of ‘Households’, ‘Firms’, ‘Government’ and ‘Foreign’ sectors

The 2-sector circular flow of national income and expenditure Y = C+I Expenditure, C on goods & services HOUSEHOLDS FIRMS Income,Y Wages, rent, interest, profit Factor payment

Assumptions in a 2 – sector Circular Flow model All income received by households will entirely be spend on consumption. The households in the market will entirely purchase all goods and services produced by firms. Therefore, total income = total expenditure = total output

Financial Institutions The 3 sector circular flow of national income and expenditure Y = C+I+G Net Taxes Net Taxes G. Expenditure G. Expenditure GOVERNMENT Expenditure, C Financial Institutions FIRMS HOUSEHOLDS Income,Y

Assumptions in a 3–sector Circular Flow model C: households is assumed to spent only a portion of their income on consumption. Part of it as savings in financial institutions and for paying taxes. I: Investors are getting loans for capital investment thus produced goods and services in an economy. G: Government expenditure will be made based on tax revenue collected. t: when government sector is included in the model; tax revenue (t) will be collected (from households – personal income tax, and from firms – corporate income tax).

The concept of disposable income The household income (Y) that can be spent by households will now be lesser after deducting the tax portion (t) paid to government. It is now called as: disposable income (Yd). Yd = Y – t. and Disposable NI = NI – t.

Financial Institutions The 4-sector circular flow of national income and expenditure Net Taxes Net Taxes G. Expenditure G. Expenditure GOVERNMENT Expenditure, C Financial Institutions HOUSEHOLDS FIRMS Income,Y Y = C+I+G+(X-M) FOREIGNERS

Assumptions in a 4 –sector Circular Flow model Households now supply resources to both domestic and foreign markets. Households also consume both local and imported goods. Firms purchased capital goods and engaged foreign workers from abroad to help them produce more new goods and services. They also exports goods and services produced to abroad or overseas. Government involves either directly or indirectly with foreign sector. They may import as well as exports goods and services to abroad.

Lets have a 5 minutes break

Methods of Measuring National Income NI can be measured using 3 common approach: Income approach Output approach Expenditure approach Irrespective of which approach used in calculating NI, will give us the same value

i) INCOME APPROACH National Income is the total money values of all incomes received by productive persons and enterprises in the country during the year. It is the total income of all factors of production including the income of self-employed person, labourers, capital and land (L,L,K,E)

“Transfer Payment” should not be included in calculating NI to avoid double counting problem. Transfer payment refers to income received without any direct contribution to the production of goods and services. is simply transferred from one group or people to another; without the recipients adding any value to production or volume of goods and services in the country.

e.g; Transfer Payment Pensions Welfare benefits Scholarships Unemployment benefits Sale of a second-hand goods e.g. an existing house Allowances to housewife Interest on national debt

Example1: En. Ahmad previously was a self-employed man with an income of RM1, 500. He later quit from business become an employee of a manufacturing company and earn a salary of RM3, 200 per annum. In closing down his business, he had to dismiss two assistants, each previously receiving a salary of RM700 and RM800 respectively. Each of the assistants subsequently now received social security benefits (unemployment benefit) worth RM300 per month. What is the net change in national income? The change in national income as a result of this was: Previously self-employed  RM1, 500 Presently employed + RM3, 200 Dismissal of 2 assistants  RM1, 500 __________ Net Increase of NI is: + RM 200 Social security benefit is an example of transfer payment, so is not included in the calculation of national income.

Total Domestic vs Total National Income Total Domestic Income is the total income earned within a territorial or geographic boundary. It includes income earned by its citizens as well as its non-citizens i.e. foreign workers residing or working in the country. Total National Income is the total income earned by citizens of the country irrespective whether the citizens reside / working in the country or outside the country (abroad). It will exclude all income earned by foreign workers in the country.

Example 2: Given the following data, find the national income of country XYZ; Domestic Income RM800m Income paid abroad RM200m Income received from abroad RM180m Answer: The national income of country XYZ is as follows: RM800m  200m + 180m = RM780m

Personal Income vs Personal Disposable Income Personal Income is the gross receipt of income regardless of its source. It can come from productive and non-productive sources (transfer payment). And minus the contribution to Employees Provident Fund (EPF) and contribution to SOCSO. Thus it is totally different from gross earning of factor income (GDI or GNI). Personal Disposable Income is gross personal income less by the personal income tax paid.

Income Approach The components of this approach include: Wages and salaries RM xxx Interest and dividends xxx Rent and imputed rent xxx Profits: distributed and undistributed profits, xxx income of self-employed xxx = Gross Domestic Income (at factor cost) XXXX  Income paid abroad xxx + Income received from abroad xxx = Gross National Income XXXX  Depreciation or capital consumption xxx = Net National Income XXXX (OR NATIONAL INCOME)

ii) OUTPUT APPROACH Also known as Product Approach. National Income (=GNP) is equivalent to the money value of all goods and services produced by all sectors in the country during a year.

The problem of double counting: To avoid double counting, we only sum-up all the “value-added” of each sectors or at each stage of production to give us the national income value.

Value-added concept To avoid double counting, calculation must be based on either one of the followings: Measure only the total market value of all final goods and services produced in the country. OR b) Calculate national output based on the value added.

EXAMPLE: Firm Stage of Production Purchasing Selling Value ____ ________________ Price (RM) Price (RM) Added (RM) A Landowner sells trees - 100 100 to sawmill owner B Sawmill owner cut into 100 180 80 timber sheets to furniture manufacturer C furniture manufacturer 180 290 110 turns timber sheets into furniture and sells to retailer D retailer sells furniture to final 290 420 130 consumer TOTAL VALUE 570 990 420 Total value added = Total value of Sales – Cost of intermediate goods = 990 – 570 = 420

The concept of Market Price and Factor Cost In most cases, Market Price (MP) > Factor cost (FC) Market Price = FC + indirect taxes – subsidies OR Factor Cost = MP – indirect taxes + subsidies

Output Approach The total value of final goods and services in the The components are: RM The total value of final goods and services in the economy or the total sum of “value-added” of all industry or stage of production. = Gross Domestic Product at market price XXXX (GDP at mp)  Income paid abroad xxx + Income received from abroad xxx = Gross National Product at market price XXXX (GNP at mp)  Indirect taxes or taxes on expenditure xxx + Subsidies xxx = Gross National Product at factor cost XXXX (GNP at fc)  Depreciation or capital consumption xxx = Net National Product at factor cost XXXX (NNP at fc OR NATIONAL INCOME)

iii) EXPENDITURE APPROACH 4 components included here: a) Household or consumer expenditure on consumption goods, (C). b) Firm or producer expenditure of capital goods. Also known as gross investment or gross private capital formation (I). c) Government expenditure on goods and services, excluding transfer payment (G). d) Expenditure on exports and imports (X – M). Y = C + I + G + (X – M)

Gross vs Net Investment Gross Investment is the expenditure on new construction, purchase on new equipment and change in stock Net Investment is gross investment minus depreciation of capital. Depreciation (capital consumption) is defined as an allowance that is put aside for machinery wears out and stocks used up due to its obsolete and deteriorated nature after being used for some time. Net Investment = Gross Investment – Depreciation of capital

Expenditure Approach The components include; RM the household expenditure (C), firm expenditure or gross investment (I) and government expenditure (G). + or – change in stock xxx =Total Domestic Expenditure at market price XXXX (TDE at mp) + Exports and  Imports xxx =Gross Domestic Expenditure at market price XXXX (GDE at mp)  Income paid abroad xxx + Income received from abroad xxx =Gross National Expenditure at market price XXXX (GNE at mp)  Indirect taxes xxx + Subsidies xxx =Gross National Expenditure at factor cost XXXX (GNE at fc)  Depreciation or capital consumption xxx = Net National Expenditure at factor cost XXXX (NNE at fc) (OR NATIONAL INCOME)

Few things to remember: To change from market price to factor cost: minus indirect tax plus subsidies. DIRECT TAXES INDIRECT TAXES Personal Income Tax Business/ Corporate Tax Profit Tax Expenditure or Consumption Tax Custom duties Export Tax Import Tax Tariff Services Tax

Few things to remember: To change from Domestic to National value: plus or minus NPIFA To change from Gross to Net value: minus capital consumption. To change from NI to Personal Income (PI): plus transfer payment and any benefits minus any contribution (EPF, SOCSO) To change from PI to DPI: minus income tax

Lets Try Some Exercises

Income Approach Given the information: RM million Total wages and salaries received 255,650 Total interest and dividends received 10,000 Total rent and imputed rent 80,880 Gross trading profits from companies 65,500 Total income of self-employed 33,700 Income paid abroad 54,345 Income received from abroad 76,680 Capital consumption 445 Find: i) GDP at factor cost ii) GNP at factor cost iii) NI

Answer: Income Approach RM million Total wages and salaries received 255,650 Total interest and dividends received 10,000 Total rent and imputed rent 80,880 Gross trading profits from companies 65,500 Total income of self-employed 33,700 GDI fc (GDP fc) 445,730 Less income paid abroad (54,345) Add income received from abroad 76,680 GNI fc (GNP fc) 468,065 Less Depreciation on capital consumption (445) NNI fc 467,620

Output Approach RM million Agriculture, forestry and fishing 4,296 Mining and quarrying 6,700 Manufacturing 28,965 Construction 15,550 Services 13,220 Net exports 3,000 Appreciation in stock 2,000 Income paid abroad 15,432 Income received from abroad 17,66 Indirect taxes 599 Subsidies 333 Depreciation of capital 1,545 Compute the value for: i) GDP at market price ii) GNP at market price iii) GNP at factor cost iv) NI

Answer: Output Approach Agriculture, forestry and fishing 4,296 Mining and quarrying 6,700 Manufacturing 28,965 Construction 15,550 Services 13,220 Net exports 3,000 Appreciation in stock (2,000) GDP mp 69,731 Less income paid abroad (15,432) Add income received from abroad 17,66 GNP mp 70,965 Less indirect taxes (599) Add subsidies 333 GNP fc 70,699 Less depreciation (1,545) NNP fc (NNI) 69,154

Expenditure Approach RM million Total consumer expenditure (C) 50,000 Gross investment (I) 20,000 Government expenditure (G) 18,500 Add exports (X) 9,000 Less imports (M) ( 8,565) Change in stock 1,000 Net factor Income from abroad 250 Expenditure taxes 870 Subsidies 695 Capital consumption 2,750 Given the information above, calculate the values for: i) GDP at market price ii) GNP at market price iii) GNP at factor cost iv) NI

Answer: Expenditure Approach RM million Total consumer expenditure (C) 50,000 Gross investment (I) 20,000 Government expenditure (G) 18,500 Add exports (X) 9,000 Less imports (M) ( 8,565) Change in stock 1,000 GDE mp (GDP mp) 89,935 Less Income paid abroad (3,700) Add income received from abroad 3,950 GNE mp (GNP mp) 90,185 Less Indirect taxes (870) Add subsidies 695 GNE fc (GNP fc) 90,010 Less Depreciation (2,750) NNI fc (NI) 87,260

Uses of National Income

Uses and Importance of National Income Useful in measuring the standard of living of a nation through estimating per capita income of the nation.

Uses and Importance of National Income Useful in measuring the standard of living of a nation through estimating per capita income of the nation. Time series comparison (year to year). Measuring growth of the economy.

Uses and Importance of National Income Useful in measuring the standard of living of a nation through estimating per capita income of the nation. Time series comparison (year to year). Measuring growth of the economy. Comparison between two or more countries can be made.

Uses and Importance of National Income Useful in measuring the standard of living of a nation through estimating per capita income of the nation. Time series comparison (year to year). Measuring growth of the economy. Comparison between two or more countries can be made. Able to know and analyze the contribution made and performance by each production sector in the economy and thus taken ample step for rectification

Uses and Importance of National Income Useful in measuring the standard of living of a nation through estimating per capita income of the nation. Time series comparison (year to year). Measuring growth of the economy. Comparison between two or more countries can be made. Able to know and analyze the contribution made and performance by each production sector in the economy and thus taken ample step for rectification Useful in measuring inequalities in the distribution of income.

Uses and Importance of National Income Useful in measuring the standard of living of a nation through estimating per capita income of the nation. Time series comparison (year to year). Measuring growth of the economy. Comparison between two or more countries can be made. Able to know and analyze the contribution made and performance by each production sector in the economy and thus taken ample step for rectification Useful in measuring inequalities in the distribution of income. Useful in revealing the expenditure pattern of a country.

Uses and Importance of National Income Useful in measuring the standard of living of a nation through estimating per capita income of the nation. Time series comparison (year to year). Measuring growth of the economy. Comparison between two or more countries can be made. Able to know and analyze the contribution made and performance by each production sector in the economy and thus taken ample step for rectification Useful in measuring inequalities in the distribution of income. Useful in revealing the expenditure pattern of a country. Useful in measuring the level and pattern of investment.

Uses and Importance of National Income Useful in measuring the standard of living of a nation through estimating per capita income of the nation. Time series comparison (year to year). Measuring growth of the economy. Comparison between two or more countries can be made. Able to know and analyze the contribution made and performance by each production sector in the economy and thus taken ample step for rectification Useful in measuring inequalities in the distribution of income. Useful in revealing the expenditure pattern of a country. Useful in measuring the level and pattern of investment. Balance of payments pattern.

Uses and Importance of National Income Useful in measuring the standard of living of a nation through estimating per capita income of the nation. Time series comparison (year to year). Measuring growth of the economy. Comparison between two or more countries can be made. Able to know and analyze the contribution made and performance by each production sector in the economy and thus taken ample step for rectification Useful in measuring inequalities in the distribution of income. Useful in revealing the expenditure pattern of a country. Useful in measuring the level and pattern of investment. Balance of payments pattern. National income as an indicator of success or failure of national planning.

Gross and Net Investment Gross investment is the total amount spent on purchases of new capital and on replacing depreciated capital. Net investment is the change in the stock of capital and equals gross investment minus depreciation.

Economic Growth eº = GDP1 – GDP0 X 100 eº = rGNP1 – rGNP0 X 100 GDP0 Higher economic growth shows higher economic activities and performance.

Real GNP: Real GNP = Price Index0 X Nominal GNP1 Price Index1 Nominal GNP is the current value of GNP according to the price in that particular year, in which might has experience a price rise from previous years because of inflation. Real GNP or GDP shows a better value of measurement for comparison purposes, because it has deflate the value from the problem of inflation.

The Difference between nominal and real income Nominal Income would be the actual wage or salary that is earned currently. The Nominal Gross Domestic Product measures the value of all the goods and services produced expressed in current prices. Nominal GDP of Malaysia for the year 2001 is RM334.6b

The Difference between nominal and real income Nominal Income would be the actual wage or salary that is earned currently. The Nominal Gross Domestic Product measures the value of all the goods and services produced expressed in current prices. Nominal GDP of Malaysia for the year 2001 is RM334.6b Real Income would be the income that has been deducted with the reduction in the “purchasing power” that the wage or salary has in the market place (i.e. rate of inflation is 3%). Real Gross Domestic Product measures the value of all the goods and services produced expressed in the prices of some base year. Real GDP of Malaysia for the year 2001 is RM210.5b

per capita income is defined as their total personal income divided by the number of people in the country. often used as a measure of the wealth of the population of a nation, particularly in comparison to other nations. usually expressed in terms of a commonly-used international currency such as the Euro or United States dollar. Malaysia’s per capita income for the year 2001 is US$3,392 or RM12,867.

2 major problems in measuring national income i) PRACTICAL PROBLEMS a) Problem of illiteracy b) Problem of expertise c) Problem of inaccessibility d) Lack of sophisticated software machineries. e) Problem of false information

ii) CONCEPTUAL PROBLEMS a) Arbitrary definition b) Problems in estimating the value of depreciation, imputed rent, etc. c) Problem of double counting d) Problem of measuring quality

THANK YOU Have A Nice Day!