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National Income

National income accounting
is the measurement of indicators
of national output/income; .e.g.
Ackleys Definition:
.. Sum of all individual incomes

Broomans Definition:
..sum of total final expenditure by the
residents of the country

Samuelsons Definition:
.. Measure of overall annual flow of goods
and services in an economy.
Circular flow diagram

summarizes the transactions between the different

economic agents

agents: households, firms (business), government,

and foreigners (rest of the world)
Circular flow diagram

Assumption: The economy

composed of households and
firms only
Households: own factors of
production, consume goods and
Firms: hire factors of production
to produce goods and services
Revenue Spending
(=GDP) (=GDP)
Good and
services sold


Land, labor
Inputs for
and capital
Production MARKETS FOR
Income (=GDP)
Wages, rent,
interest and
profit (=GDP)
Flow of goods & services

Flow of money: pesos

With government and
foreign agents
Need to account for :
a. Government purchases of goods and
b. Government payments for factor
services (wages, rent, interest).
c. Transfer payments between different
d. Firms and households pay taxes to
e. Taxes paid on income, property, goods
and services.
f. Transactions with the foreign sector.
Transfer payments

Transfer payments are transactions wherein one

party is not obliged to deliver a good or service in
return for the payment.
Examples: retirement benefits, unemployment
benefits, scholarships, and donations.
Transactions with foreign
Includes sales of goods and services, assets, and
Exports - sales of domestically produced goods to
other countries
Imports - goods bought from other countries
Measurement of economys output:
The Gross Domestic Product (GDP)

The GDP measures the market value of all

final goods and services produced within
an economy in a given period.
GDP only measures current production.
Transfer payments and transactions
involving goods produced in other periods
are not included in the calculation of GDP.
GDP is usually expressed in the currency of
a particular country, e.g., Pakistan
PKR.indicates the market value of the
goods and services
Definition of GDP

The market value of good i (Vi) is equal to PiQi

GDP = sum of the market values of all final goods
and services produced within the year.

n n
i Qi
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) or unhusked rice
(intermediate product)

Including intermediate goods and

final goods will result in double
3 Approaches for
measuring GDP
1. Expenditure Approach measures
GDP as the sum of expenditures
on final goods and services.
2. Income Approach measures GDP
as the sum of incomes of factors
of production (wages, rent,
interest and profit.
3. Value-added Approach measures
GDP as the sum of value added at
each stage of production (from
initial to final stage)
Expenditure Approach

Example: Suppose the economy

has only one product, namely, rice.

Good Price Q sold Expenditure

Rice 20 1000 20,000
GDP 20,000
Income Approach
sum of payments to the various factors of
Suppose that in the production of rice the
sales and expenses are as follows:

Sales P 20,000
Wages 8000
Rent 4000
Interest 2000
Total 14,000
Profit 6,000

GDP=Sum of 20,000 P 20,000

Payments to
Value Added Approach
Suppose that rice is the only final product
of an economy: It goes through several (3)
stages of production.

Value of
Stage of Prodn intermedi Value Value-
ate good of added
Farmer - Palay 12,000 12,000
Rice Miller 12,000 15,000 3,000
-Milled Rice
Retailers - Rice 15,000 20,00 5,000
GDP= Total Value 20,000
Notes of the 3 approaches
The expenditure approach, income approach,
and the value-added approach all come up
with the same estimate of the GDP. They are
equivalent approaches.
In the income approach, profit is also
considered a payment to the entrepreneur. So
the incomes are (1) wages, (2) rent, (3)
interest, and (4) profit. Profit adjusts to make
the sum equal to the final value of the good.
In the value added approach, only the value
added in each stage of production are
included. If we add the value of intermediate
product with the value of the final product, we
commit the sin of double-counting.
At each stage of production, the value-added is
equal to wages, interest, rent, and profit.
Therefore the value of the final product is
likewise the same of all payments to the
factors of production.
The distinction between
GNP = GDP + Net Factor Income from the Rest of
the World (NFIRW)
NFIRW - measures the difference between the
earnings of Pakistani residents in other countries
and foreign residents in the Pakistan
The distinction between GDP
and GNP

Gross Domestic Product GDP 4,022,700

Net Factor Income from the NFIRW 267,500

Rest of the World

Gross National Product GNP 4,290,200

Nominal and Real GDP
GDP at current prices or nominal GDP -
GDP measured using the prices of the
year for which it is calculated
Nominal GDP can be a misleading
indicator of changes in output or income
because it also embodies changes in the
prices of goods and services.
Real GDP or GDP at constant prices
measures the total value of output using
the prices of a selected year (the base
Real GDP better for analysis overtime
because it eliminates the effects of price
Table 8.5



Ice Cream 100 100

Buko Pie 100 100

Ice Cream 50 100

Buko Pie 100 200

Ice Cream 5,000 10,000

Buko Pie 10,000 20,000
NOMINAL GDP 15,000 30,000
GDPyear 1 = (100) (50) + (100) (100) =
GDPyear 2 = (100) (50) + (100) (100) =
In practice, calculating real GDP using
the previous approach is a tedious
process because there are so many
goods and services are produced in an
economy. Can simplify the calculation
process by using the GDP deflator.
GDP deflator - a price index that allows
us to convert nominal GDP into real
GDP. (note: price index to be defined
Real GDP

Nominal GDP
Real GDP 100.
GDP deflator
GDP per capita

Measures how much output or income was

produced or received, on the average, by an
individual in an economy
Useful for comparing the performance of a
country overtime and a countrys
performance relative to its neighbors

GDP per capita
Personal Income and DPI

Personal Income:
PI= NI- (corporate profit tax+ undistributed
corporate profits+ contribution to social security +
transfer payments)

Disposable Personal Income:

DPI= PI- direct taxes
Personal Disposable Income

Personal disposable income

represents the income that
households are free to spend or save.
It excludes the components of
national income that do not accrue
directly to households.
It also includes a few items that are
not part of national income but
nonetheless influence the amount of
income that households can spend.
Some Limitations of GDP or
GNP as measures of growth
Ignores income distribution
Ignores environmental degradation
Does not include activities that do not go through
the formal markets sectors
Does not include illegal activities like drug
trafficking, prostitution, moonlighting
National Income

Net National Product:

NNP= GNP-( Depreciation)


NI= NNP+ Government subsidies ( Indirect taxes+

Transfer Payments- statistical discrepancy)
Different Concepts of NI
National Income:
NI= NNP+ Government subsidies (Indirect taxes+ Transfer
Payments+/- statistical discrepancy)

Personal Income:
PI= NI- (corporate profit tax+ undistributed corporate
profits+ contribution to social security + transfer payments)

Disposable Personal Income:

DPI= PI- direct taxes

Difference between GDP Factor Cost and at Market Price

GDP(fc)= GDP(MP) Indirect Taxes+ Subsidies

GDP at Factor cost means, money value of everything produced
in a country, without counting Government's role in it. i.e.
indirect tax and subsidies.
Real vs Nominal GDP
Using the current prices to value current production is
known as nominal GDP
Real GDP values goods and services in any given year by
using the prices of a set base period
Nominal GDP

nominal GDP 1997 = (.45)(475) + (1100)(70) + (7)(380) = $ 79,873.75

nominal GDP 1998 = (.48)(510) + (1050)(85) + (8)(390) = $ 92,614.80
nominal GDP 1999 = (.50)(500) + (1000)(100) + (9)(400) = $103,850
From 1997 to 1999 nominal GDP has increased by

Real GDP
Now let's calculate real GDP, using 1998 as the base
real GDP 1997 = (.48)(475) + (1050)(70) + (8)(380) = $
real GDP 1998 = (.48)(510) + (1050)(85) + (8)(390) = $
real GDP 1999 = (.48)(500) + (1050)(100) + (8)(400) =
From 1997 to 1999 real GDP has increased by
Shortage of Statistical Data
Lack of trained manpower
Free Services
Demonetized Goods
Ignorance and Illiteracy
Price Fluctuation