1. Measuring Domestic Output and National Income
Topic- 1.0

2. Learning objectives Importance of national income accounting
How gross domestic product (GDP) is defined and measured.
The relationships between GDP, net domestic product (NDP), national income (NI), personal income (PI), and disposable income (DI).
The difference between nominal GDP and real GDP.
Some limitations of the GDP measure.

3. Importance of NI accounting
National Income Accounting - measures the economy’s performance by measuring the flows of income and expenditures over a period of time.
Gives a picture of economic status/health of the country in comparison with other countries.
provides a basis for formulating appropriate public policies to improve the economic performance of the country.

4. Gross Domestic Product
Gross Domestic Product (GDP) is the monetary measure of the total market value of all final goods and services produced within a country in one year.
Market value = Quantity of all final goods and services multiplied by the market prices per unit of those goods and services
Final goods are consumption goods, capital goods & services that are bought by their final users, rather than the goods for resale or further processing or manufacturing

5. GDP excludes Intermediate Goods
GDP includes only the market value of final products (G) and services (S) by eliminating the value of any intermediate goods used in production of these final Gs & Ss. This is done to avoid double/multiple counting.
Intermediate goods are goods & services are semi- finished goods and goods which cannot be used independently; they are bought for resale for further processing or manufacturing.

6. Double counting
Double counting/Multiple counting could be avoided by cumulating only the value added at each stage
Value added is the market value of a firm’s product minus the value of the inputs the firm has bought from others
GDP is the value of what has been produced in the economy over the year, not what was actually sold. (use example in Table 24.2, page 481, McConnell)

7. Nonproduction Transactions are excluded such as:
Purely financial transactions
Public transfer payments, like social security or cash welfare benefits to some people
Private transfer payments, like student allowances or payments made to children by their parents
sale of stocks and bonds represent a transfer of existing assets. (However, the brokers’ fees are included for services rendered.)
Secondhand sales since they do not represent current output (However, any value added between purchase and resale is included, e.g. used car dealers).

8. Two Approaches to measure GDP
Income Approach (The sum of all incomes in a year)
Wages
Rental Incomes
Interest Incomes
Profits
Expenditure Approach
The Sum of the Money Spent to buy the Output i.e. goods and services in a year
(Illustration with circular flow diagram)
What is spent on a product is income to those who helped to produce and sell it.
This is an important identity and the foundation of the national accounting process

9. Expenditure Approach
GDP is divided into the categories of buyers in the market; household consumers, businesses, government, and foreign consumers/buyers
Personal Consumption Expenditures (C )
Durable Consumer Goods
Nondurable Consumer Goods
Consumer Expenditures for Services
Gross Private Domestic Investment (Ig)
Machinery, Equipment, and Tools
All Construction
Changes in Inventories

10. Gross investment & Net investment
Note: There is a distinction between Gross Investment and Net Investment
Gross Investment refers to all investment goods used up in producing output for a given year, plus any net additions to the capital stock i.e. machinery, equipment etc. In contrast net investment refers only to added capital/capital goods, therefore
Net Investment = Gross Investment – depreciation/wear and tear of capital

11. Expenditure Approach cont..
Government Purchases (G)
Expenditures for Goods and Services
Expenditures for Social Capital (schools, roads
Net Exports
Xn = Exports (X) – Imports (M)
Putting It All Together:
Total expenditure/spending = C+ Ig + G + Xn
GDP = C + Ig + G + Xn
GDP= $ , , = $13,841 in 2011

12. Income Approach to GDP
Demonstrates how the expenditures on producing final products are allocated to resource suppliers.
Compensation of employees includes wages, salaries, etc
Rents: payments for supplying property resources
Interest: payments from private business to suppliers of money capital
Corporate profits (CP): Earnings of owners of business corporations (CP is divided into dividends, corporate income taxes and undistributed corporate profits).

13. GDP Two Approaches- Comparison
Receipts
Expenditures Approach
Allocations
Income Approach
Personal Consumption (C)
$ 9734
Compensation
P$ 7874
Gross Private Domestic Investment (Ig)
2125
Rents 65
Government Purchases (G)
2690
Interest
603
Net Exports (Xn)
-708
Proprietor’s Income
1043
Corporate Profits
1627
Taxes on Production and Imports
1009
National Income
$12, 221
Less: Net Foreign Factor Income 96
Plus: Statistical Discrepancy 29
Consumption of Fixed Capital
1687
Gross Domestic Product
$ 13,841
$13,841

14. Net Foreign Factor Income (NFFI) earned
NFFI earned is the difference between the income earned by the citizen owned factors of production (resources) of the country (Botswana) used in foreign countries in a year minus income earned by foreign owned resources used in the country (Botswana) in a year.
NFFI earned in Botswana (it can be either positive or negative) is accounted in GDP. If it is positive, the income earned by the foreign-owned resources in Botswana is higher than the citizen-owned resources earned in other countries. If it is negative, income earned by citizen-owned resources in other countries is higher than the income earned by foreign-owned resources in the country.

15. GNP Gross National Product (GNP)
Measures the value of production by citizen supplied resources only, regardless of where the production takes place.
GNP = GDP + NFFI
Where
NFFI = income earned by citizens supplying resources abroad minus income earned by foreigners supplying resources in Botswana
NFFI is positive if income earned by citizens abroad is greater than income earned by foreigners in Botswana
Conversely, NFFI is negative if income earned by citizens abroad is less than income earned by foreigners in Botswana
From the example above,

16. The Income Approach Other National Accounts
Net Domestic Product (NDP)= GDP – depreciation allowance /consumption of fixed capital
National Income (NI): NDP - Statistical discrepancy +(-) net foreign factor income earned
Income earned by nationals domestically & abroad.
Personal Income (PI): NI – (Taxes on production and imports, social security contributions, corporate income taxes and undistributed corporate profits) + transfer payments
Income received (earned & unearned) by households
Disposable Income (DI): PI – personal taxes
DI = C + S

17. The Income Approach Gross Domestic Product (GDP)
Consumption of Fixed Capital
Net Domestic Product (NDP)
Statistical Discrepancy
Net Foreign Factor Income
National Income (NI)
Taxes on Production and Imports
Social Security Contributions
Corporate Income Taxes
Undistributed Corporate Profits
Transfer Payments
Personal Income (PI)
Personal Taxes
Disposable Income (DI)
$ 13,841
-1,687
$ 12,154
-29 96
$ 12, 221
-1009
-979
-467
-344
+2237
$ 11,659
-1,482
$ 10,177

18. Nominal Versus Real GDP
Nominal GDP – The total market value of all final G&S produced in a year. It is the output valued at current prices.
Real GDP – is the total value of the final G&S measured at base year prices/constant prices
Allows comparison of physical output between years.
GDP Price Index- a measure of the price (market value) of all goods and services included in GDP in a given year to the price of the same goods and services in a base year/reference year.

19. Nominal Versus Real GDP
GDP Price index in a given year = (Price of Market Basket in specific year/Price of Same Basket in Base Year)x100
E.g., from table, in year 2006 price of a basket containing pizza is P10.00
in year 2007 price of a basket containing pizza is P20.00
If 2006 is the base yr, then Price Index is = 100
In year 2007 Price Index is (20/10)x100 = 200
Real GDP = Nominal GDP/Price Index (in hundredths)
Real GDP (2006) = [(50/100)x100]=50
Real GDP (2007) = [(140/200)x100]=70
Real GDP (2008) = [(200/250)x100]=80

20. Calculating Real GDP (Base Year = 2006)
(1)
Units of output
(2)
Price of pizza (P)
(3)
Price Index (Year 1 = 100)
(4)
Unadjusted or Nominal GDP (P)
(5)
Adjusted or real GDP (P)
(6)
Real GDP (column 2 x P10)
(7)
2006 5 10
100 50
2007 7 20
200
140 70
2008 8 25
250 80
2009 30
300
2010 11 28
280
308
110

21. Real GDP alternative method
Gather data on physical outputs & their prices
Determine market value of output in successive yrs as if base yr price had prevailed (see column 6) previous slide
To get Price index for a given year divide nominal GDP by the real GDP for that year and multiplied by 100
Price index in 2007 = 140/70 X100 = 200

22. Circular flow of income – open economy
Domestic households/consumers and suppliers of resources
Abroad/Foreign sector
Exports & Imports
Government
Domestic producers/suppliers of goods and services

23. Circular Flow Revisited

24. Botswana’s National Accounts 05/06
Receipts
Expenditures Approach
Allocations
Income Approach
Personal Consumption (C) P
Compensation
Gross Private Domestic Investment (Ig)
5720.8
Rents
Government Purchases (G)
4969.6
Interest
Net Exports (Xn)
4666.2
Proprietor’s Income
Net errors & omissions
1629.4
Corporate Profits
Taxes on Production and Imports
National Income
Net Foreign Factor Income
Statistical Discrepancy
Consumption of Fixed Capital
Gross Domestic Product
P 22,672.1

25. Shortcomings/problems in the preparation of National Income Accounts
The accuracy of GDP figures is always questioned because of two sets of problems that arise in the estimation of GDP of a country
Conceptual problems
Practical problems

26. Shortcomings of GDP Double counting Informal sector activities
Non-marketed output and services – production made for household consumption, homemakers‘ services etc
Leisure – improves living conditions, but is not included
Improved Product Quality
Unrecorded economic activities
The Underground Economy
GDP and social and environment factors – harmful effects of pollution not subtracted from GDP
Composition and Distribution of the Output and income. GDP makes no difference between the quantity of output of guns or tractors.
Non-economic Sources of well-being – crime prevention not covered in GDP
(Each one of the above needs to be explained with details)