National Income Accounting Welcome to the Session National Income Accounting

National Income Accounting National Income Accounting Defined Circular Flow of Economic Activity Measures of Output GDP/GNP/NDP/NNP/NI/DI/DPI Nominal GDP vs Real GDP GDP Per Capita Inflation and Price Index Interest Rate and Real Interest Rate Shortcomings of GDP as a Measure of Economic Well-Being

Measures of Output (Production) National Income Accounting refers to the measurement of aggregate economic activity, particularly national income and its components. Aggregate = Total or Gross

MARKETS FOR GOODS AND SERVICES MARKETS FOR FACTORS OF PRODUCTION Revenue (=GDP) Spending (=GDP) MARKETS FOR GOODS AND SERVICES Good and services sold Good and services bought HOUSEHOLDS FIRMS Land, labor and capital Inputs for Production MARKETS FOR FACTORS OF PRODUCTION Income (=GDP) Wages, rent, interest and profit (=GDP) Flow of goods & services Flow of money: Taka THE CIRCULAR FLOW DIAGRAM

Measures of Output (Production) Gross Domestic Product is the total monetary value of final output produced within a nations borders in a given time period at current market prices Gross Domestic Product is also referred to as Nominal Gross Domestic Product Current Gross Domestic Product

Definition of GDP The market value of good i (Vi) is equal to PiQi GDP = sum of the market values of all final goods and services produced within the year.

Measuring Gross Domestic Product The Expenditures Approach C + I + G + (Xn) = GDP The Flow of Income Approach Households supply business with the factors of production in return for payment in the form of wages, profits, rent, and interest The Value Added Approach Adds the increase in value at each stage of the production and distribution process

GDP includes final goods and services only Final goods - goods and services that are not purchased for the purpose of producing other goods and services or for resale Eg. Rice (final) and unhusked rice (intermediate product) Including intermediate goods and final goods will result in “double counting”.

Three Approaches for measuring GDP Expenditure Approach (upper loop) – measures GDP as the sum of expenditures on final goods and services. Income Approach (lower loop) – measures GDP as the sum of incomes of factors of production (wages, rent, interest and profit. Value-added Approach – measures GDP as the sum of value added at each stage of production (from initial to final stage)

Expenditure Approach Uses the upper loop of the circular flow diagram. Example: Suppose the economy has only one product, namely, rice. Good Price per unit Q sold Expenditure Rice 20 1000 20,000 GDP

Income Approach Uses the lower loop of the circular flow diagram: sum of payments to the various factors of production. Suppose that in the production of rice the sales and expenses are as follows: Sales P 20,000 Expenses: Wages 8000 Rent 4000 Interest 2000 Total 14,000 Profit 6,000 GDP=Sum of Payments to factors 20,000

Value of intermediate good Value Added Approach Suppose that rice is the only final product of an economy: It goes through several (3) stages of production. Stage of Prod’n Value of intermediate good Value of Sales Value-added Farmer 12,000 Rice Miller -Milled Rice 15,000 3,000 Retailers - Rice 20,000 5,000 GDP= Total Value Added

Two Things to Avoid when Compiling GDP Multiple counting Only expenditures on final products – what consumers, businesses, and government units buy for their own use belong in GDP Intermediate goods are not counted Used goods are not counted Transfer payments Transfer payments are not payments for currently produced goods and services When they are spent for final goods and services they will go into GDP as consumer spending

Various Measures of Aggregate Economic Activity GDP (Gross Domestic Product) - or + Net Factor Income GNP - Depreciation NNP - Indirect Business Tax National Income - RE + TP Disposable Income - Personal Tax Disposable Personal Income Indirect Business Taxes are primarily sales taxes and excise taxes; subsidies include payments such as those made to farmers Earnings not received include social security taxes and corporate profits not paid out as dividends Receipts not earned include Social Security Benefits plus other government transfer payments

Per Capita GDP Per Capita GDP calculations attempt to give us additional information about how we are doing as an economy. Per Capita GDP calculations may be a better measure of the standard of living. For citizens living in the same country over time For comparing standards of living between citizens of different countries

Per Capita Nominal GDP GDP Per capita GDP = -------------------------------- Population

Per capita real GDP = -------------------------------- Population To compare per capita GDP in one year with that of another year we have to correct for inflation. In other words, we really need to revise our formula Real GDP Per capita real GDP = -------------------------------- Population

Nominal GDP and Real GDP Nominal GDP measures the value of output in a given period in the prices of that period, or, as it is sometimes put, in current prices. Real GDP measures changes in physical output in the economy between different time periods by valuing all goods produced in the two periods at the same prices, or in constant prices. Nominal GDP Real GDP = -------------------------------- GDP Deflator

The GDP Deflator GDP deflator is the ratio of nominal GDP in a given year to real GDP of that year. Nominal GDP Real GDP = -------------------------------- GDP Deflator

Nominal Vs. Real GDP Commodity 2007 NGDP 2008NGDP 2008RGDP Rice 10 at 100 1000 15 at 150 2250 15 at 100 1500 Cloth 20 at 200 4000 25 at 225 5625 25 at 200 5000 5000 7875 6500 GDP Deflator= NGDP/RGDP= 7875/6500=1.21

Inflation and Prices Inflation rate = -------------------------------- Inflation is the rate of change in prices, and the price level is the accumulation of past inflations. If Pt-1 represents the price level last year and Pt represents today’s price level, then the inflation rate over the past year can be written as Pt - Pt-1 Inflation rate = -------------------------------- Pt-1

Shortcomings of GDP as a Measure of National Economic Well-being Problems of GDP Measurement Non Market Activities (Household production) Imprecise Pricing of Govt. Activity Illegal production The underground economy Use of Resources to Avoid ‘Bad’ Treatment of leisure time Quality of Goods