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MEASURING NATIONAL INCOME AND OUTPUT

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LEARNING OUTCOMES

At the end of this chapter, you should be able to:

Describe the circular flow of income in two-, three- and four-sector economies
Identify the concepts of measuring national income
Measure national income by using the three approaches
Distinguish between personal income and disposable income
Distinguish between nominal income, real income, per capita income, and growth rate
Describe the uses of national income statistics
Elaborate on the problems in measuring national income

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COMPONENTS OF MACROECONOMICS

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CIRCULAR FLOW OF INCOME

Circular flow of income is an economic model depicting how money flows through the economy.
It describes the movement of factors of production and factors of payment.

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CIRCULAR FLOW OF INCOME (cont.)

The flow of factors of production from households to firm and the flow of goods and services from firms to household are matched by equivalent flows of money—firms paying income to households (Y) and households paying the firms for consuming the goods and services (C).

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CIRCULAR FLOW OF INCOME (cont.)

The government collects taxes from households and firms. The government also makes payments. It buys goods and services from firms, pays wages and interest to households, and makes transfer payments to households.

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CIRCULAR FLOW OF INCOME (cont.)

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CONCEPTS OF NATIONAL INCOME

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CONCEPTS OF NATIONAL INCOME (cont.)

Market Price

Market price refers to the current price in the market through the forces of demand and supply.
Market prices are the actual price paid by the consumers.

Factor cost is the price of output that is valued based on the cost of factors of production.
Therefore, factor cost is known as actual price earned by producers or sellers.

Factor Cost

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CONCEPTS OF NATIONAL INCOME (cont.)

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CONCEPTS OF NATIONAL INCOME (cont.)

Gross National Income

The term of gross national income means the value of national income has been associated by the value of depreciation.

Net National Income

The term of net national income means the value of national income has been adjusted by the value of depreciation or net national income is gross national income minus depreciation.

NDP at market price = GDP at market price – Depreciation value

NNP at market price = GNP at market price – Depreciation value

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CONCEPTS OF NATIONAL INCOME (cont.)

Personal Income (PI)

Personal income is the real income earned by households before they pay personal income taxes.

Disposable Personal Income (DPI)

Disposable personal income is the income available for personal consumption expenditure and personal saving (after minus tax).

PI = National income + Transfer payments – Corporate income taxes – Retained earnings – Employee’s Provident Fund (EPF) – Social security contributions (SOCSO) – Insurance premium

DPI = Personal income – Personal income tax

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METHODS OF MEASURING INCOME

The accurate meaning of national income is commonly referred to as the concepts of gross domestic product (GDP).
GDP is the total market value of all final goods and services produced within a given period of time by factors of production located within a country.
The GDP can be computed in three ways:
Income approach
Expenditure approach
Product or Output approach

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METHODS OF MEASURING INCOME (cont.)

Since the income approach, expenditure approach and product approach are the three methods of measuring the same thing, they must thus be identical.
This can be expressed as accounting identity:

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METHODS OF MEASURING INCOME (cont.)

Income Approach

The income approach measures national income by looking at the GDP from the perspectives of sum of incomes received from the production of the output.

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METHODS OF MEASURING INCOME (cont.)

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METHODS OF MEASURING INCOME (cont.)

National Income (NI) = NDPfc + Net Factor Income Abroad

Personal Income (PI) = National income + Transfer Payments Corporate Income Taxes – Retained/Undistributed Earnings –Employee’s Provident Fund (EPF) – Social Security Contributions (SOCSO) – Insurance Premium

Disposable Personal Income (DPI) = Personal Income – Personal Income Tax

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METHODS OF MEASURING INCOME (cont.)

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METHODS OF MEASURING INCOME (cont.)

Expenditure Approach

Expenditure approach measures national income by looking at the GDP from the perspectives of total spending on the final goods and services.

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METHODS OF MEASURING INCOME (cont.)

GNPmp = GDPmp + Net Factor Income Abroad

GNPfc = GNPmp + Subsidies – Indirect Taxes

National Income (NI) = GNPfc – Depreciation

Personal Income (PI) = National income + Transfer Payments – Corporate Income Taxes – Retained/Undistributed Earnings –Employee’s Provident Fund (EPF) – Social Security Contributions (SOCSO) – Insurance Premium

Disposable Personal Income (DPI) = Personal Income – Personal Income Tax

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METHODS OF MEASURING INCOME (cont.)

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METHODS OF MEASURING INCOME (cont.)

Output Approach

Under Output or Product or Value Added Approach, national income is measured by adding up the net value of all the goods and services produced in the country, sector by sector during a year.

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METHODS OF MEASURING INCOME (cont.)

GNPfc = GDPfc + Net Factor Income Abroad

National Income (NI) = GNPfc – Depreciation

Personal Income (PI) = National income + Transfer Payments – Corporate Income Taxes – Retained/Undistributed Earnings –Employee’s Provident Fund (EPF) – Social Security Contributions (SOCSO) – Insurance Premium

Disposable Personal Income (DPI) = Personal Income – Personal Income Tax

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METHODS OF MEASURING INCOME (cont.)

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NOMINAL INCOME VS REAL INCOME

Nominal Income

Nominal income is the national income that is measured in the current price level.
Any change in nominal income reflects the combined effects of change in quantity and change in price level.

Real Income

Real income refers to the national income that is measured at a constant price or in a base year.
By comparing the value of production in the two years at the same prices, the changes in real income reflects only the changes in real output.

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NOMINAL INCOME VS REAL INCOME (cont.)

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NOMINAL INCOME VS REAL INCOME (cont.)

Per Capita Income

GDP per capita is often used as an indicator of living standards.
Per capita income refers to average income per head of population.

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NOMINAL INCOME VS REAL INCOME (cont.)

Growth Rate

Growth rate is the percentage change in quantity of goods and services produced from one to another.

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USES OF NATIONAL INCOME

(1) Standard of living indicators

Standard of living reflects the individuals’ welfare because it shows how much goods and services can be consumed by each individual in a country. It can be measured by GDP per capita.

(2) Government planning and policies

The available statistics of national income can guide the policy makers in planning for the future. From the national income data, the government can view the historical trends and performance of economic sectors.

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USES OF NATIONAL INCOME (cont.)

(3) Sectoral contributions

An economy consists of various economic activities. Hence, with the available statistics of national income data, the study of the economic sectors can tell us the relative importance of various parts of the economy and whether these change with time relatively. It is also useful in the context of the analysis of specific problems of an economy.

(4) International comparisons

With the national income statistics, we not only can compare the absolute size of one economy relative to another, but compare how well-off the average individual is in each country.

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PROBLEMS OF MEASURING NATIONAL INCOME

(1) Problems of non-monetized sector

The existence of a large number of non-monetized activities in these countries, especially in the agricultural sector makes the computation of the national income more difficult.

(2) Underground economy

Official GDP estimates may not take into account the underground economy, in which transactions contributing to production, such as illegal trade and tax-avoiding activities, are unreported, causing GDP to be underestimated.

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PROBLEMS OF MEASURING NATIONAL INCOME (cont.)

(3) Non-market transactions

There are many productive works done in the economy but they are not paid. Food grown in backyard plots, home repairs, clothes made at home, and any other do-it-yourself goods and services that people make or do for themselves, their families or their friends are not counted in GDP.

(4) Problems of expertise and modern machinery

The lack of professionals such as statisticians, researchers, programmers and analysts is a major problem in third world countries.

(5) Problems of double counting

Double counting in national income will appear when both values of final goods and intermediate goods are included.

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