NATIONAL INCOME AND NATIONAL OUTPUT

The scoreboard for economic performance is the National Income accounting system. Simon
Kuznets developed the basic concepts and outlined the measurement procedures during the
1920’s.

Gross Domestic Product (GDP): market value of all final goods and services produced within
a country during a specific period, usually one year.

It measures the output of a country’s economy. It is an indication of the wealth or the stage of
development of the nation.

Economies produce different types of goods which need to be measured in different

measurement units, for example, solid goods (wheat, cloth, bread, etc.) are measured in pounds
or kilos, yards or meters, etc., liquids (milk, oil, etc.) are measured in gallons or liters, etc. Since
all these goods cannot be added together, all the goods are converted into market values and then
added.

WHAT COUNTS TOWARD GDP

1. Counts only FINAL goods (goods and services purchased by their ultimate or final users).
DOES NOT COUNT INTERMEDIATE goods (goods purchased for resale or for use in
producing another good or service).

2. Counts only CURRENT PRODUCTION i.e., only the goods and services produced during
the specified period. Examples: Annual GDP (Jan 1st – Dec 31st ) or quarterly GDP (Jan 1st –
March 31st ).
- Purchase of a used car (made in 2013) would not be counted in the GDP for 2018.
- However, if a used car dealer purchases a used car (made in 2012 for $800,000 refurbishes it
and sells it for $900,000 in 2018, the VALUE ADDED of $100,000 is included in the GDP for
2018.

3. Goods produced in a geographical area (inside the borders of a nation).

4. Includes goods that are transacted in an organized market structure.

EXCLUDED FROM GDP

1. ALL FINANCIAL TRANSACTIONS: They do not involve current production. e.g.

Purchases and sales of stocks and bonds DO NOT count because only ownership rights are
transferred.
- However, if a stockbroker made the purchase of stocks on your behalf and charges a
COMMISION FEE, this fee (the cost of a service rendered) is COUNTED IN CURRENT GDP.
2. ALL PRIVATE AND PUBLIC SECTOR INCOME TRANSFERS:
a. Aunt’s gift of $50,000 towards payment of school fee.
b. Social Security or welfare payments.
c. Student grants/bursaries.
3. NON-MARKET PRODUCTION: These are DO-IT-YOURSELF activities do not involve a
market production. Examples: a. mowing the lawn, b. painting the house.
4. UNDERGROUND ECONOMY: Market transactions that take place outside RECORDED
MARKET CHANNELS.
a. Some are UNREPORTED LEGAL market transactions just to evade taxes.
(eg. Robot/ illegal taxis in Jamaica.)
b. Some are ILLEGAL ACTIVITIES such as drug trafficking and prostitution.

REAL AND NOMINAL GDP

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Real GDP is calculated using the constant prices or base year prices. Real GDP is GDP adjusted
for changes in the price level.
Nominal GDP is calculated using current year prices. It is often referred as the money GDP.

GDP DEFLATOR
A price index that reveals the cost during the current period of purchasing the items included in
GDP relative to the cost during a base year. Because a base year is assigned a value of 100, as
the GDP deflator takes on values greater than 100, it indicates that prices have risen.

GDP Deflator = (Nominal GDP/Real GDP) x 100

PRICE INDEX

An index number which expresses the cost of a market basket of goods relative to its cost in
some base period.

Consumer Price Index (CPI)

A price index computed each month by the STATIN using a bundle that is meant to represent the
“market basket” purchased monthly by the typical urban consumer.

CPI in a given year = Cost of market basket of goods in given year x 100
Cost of market basket of goods in base year

Inflation rate in a given year = CPI in a given year – CPI in previous year x 100
CPI in previous year

LIMITATIONS OF GDP

1. GDP fails to count LEISURE and HUMAN COST associated with the production of goods
and services.
Example: One country attains US$20,000 per capita GDP. (GDP divided by population) with an
average work week of 30 hour. Another country attains the same US$20,000 per capita GDP
with an average work week of 50 hours. Internationally, both countries are recorded as having
the same GDP. HOWEVER, the first country is BETTER OFF because it produces MORE,
LEISURE or SACRIFICES LESS HUMAN COST.

2. GDP CANNOT ACCOUNT FOR PRODUCTIVE LOSS

When a natural disaster such as a hurricane or earthquake, occurs, goods that are
destroyed are not subtracted from GDP and there is no way to account for the loss in productive
capacity to the economy.
The REBUILDING that occurs after a natural disaster, however, is counted in GDP. For this
REASON, disasters like floods and earthquakes can actually end up INCREASING GDP.
ANOTHER EXAMPLE: Your textbook is stolen (DOESN’T AFFECT GDP). Replacing the text
book (counts towards GDP).

DOUBLE COUNTING
An accounting problem that occurs when measuring output. The problem is that final output is
made up of many stages. Hence, you must take care either to (A) include the extra value added at
each stage of production or (B) only record the value of FINAL outputs. Sales at intermediate
stages of production are not counted towards the GDP. (IMPORTANT TO NOTE when using
the OUTPUT METHOD to calculate the GDP).

GDP AND THE STAGES OF PRODUCTION

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Stages of Production Sales receipt at each Amount added to the
stage of production value of output

1. Farmer’s Wheat

$0.30 $0.30 Value added by farmer

2. Miller’s Flour

$0.65 $0.35 Value added by Miller

3. Baker’s Bread Wholesale

$0.90 $0.25 Value added by the Baker

4. Grocer’s Bread Retail

(Final good)

$ 1.00 $ 0.10 Value added by Grocer

TOTAL of value added = $1.00

THREE WAYS OF MEASURING GDP

I. THE EXPENDITURE APPROACH:

There are four (4) components: Personal Consumption Expenditure [C], 2. Gross Private
Domestic Investment [I], 3. Government Consumption [G], and 4. Net Exports [X – M].

GDP = C + I + G + X - M

1. Consumption [C]: There are three main categories; Durable goods, non-durable goods and
services.

2. Gross Private Domestic Investment [I] : refers to the purchase of new capital – housing,
plants, equipment and inventory. It includes expenditures for: replacements of machinery,
equipment and building worn out during the year, and net additions to the stock of capital goods.

3. Government Consumption and Investment [G]: includes expenditure by state and local Govt.
for final goods (eg. schools) and services (eg. military salaries).

4. Net Exports [X-M]: is the difference between Exports and Imports. This figure can be
positive or negative depending on the level of trade.

II. INCOME APPROACH

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Looks at GDP in terms of who receives it as Income. The four (4) components are National
Income, Depreciation, Indirect Taxes minus subsidies, and Net factor payments to the rest of the
world.

National Income includes income from employment, self-employment, profits and rent.

National income or the gross national income is the total income earned by all residents and
enterprises of a country over a specific period. You can also define national income as the total
value of all goods and services produced over a specific period of time. Now, there are several
methods of calculating national income. The three most common methods are the value-added
method, the income method, and the expenditure method. The value-added method focuses on
the value added to a product at each stage of its production.
National Income = C + I + G + (X – M)
Where,

C = Total consumption expenditure

I = Total investment expenditure
G = Total government expenditure
X – M = Export - Import

Income Method
The income method of calculating national income takes into account the income generated from
the basic factors of production. These include the land, labor, capital, and organization. And in
addition to income accrued from these factors of production, another important component of
income is mixed income. Now let’s discuss all these components in detail.

Rent from Land

Rent is the money you pay for the use of land. While calculating income, rent refers only to the
income earned from using any land. Rent paid for the use of machinery and other equipment is
not accounted for as rent.

Now in addition to rent, another form of income is royalty. Royalty is the amount you pay to an
individual or a company in exchange for the use of assets such as coal or gas.

Compensation for Labor

Compensation includes salaries and wages that you earn in exchange for the services and skills
that you provide for producing goods and services. It also includes travel allowances, bonuses,
accommodation allowances, and medical reimbursements.

In addition to wages and salaries, another important component of compensation is remuneration

in the form of social security schemes such as insurance, pensions, provident funds.

Interest on Capital
Interest refers to the charges you pay for using borrowed capital. Now, this includes the interest
paid when a company takes a loan for an investment. Similarly, when a family invests in a
property or a house, they take a loan from a bank and pay an interest for the same while repaying
the loan over a period of time. However, while calculating national income, economists consider
only the interest paid by production units.

Profits by Organizations
Profits refer to the money that organizations make while producing goods and services. Now
companies distribute the profits they make by paying income tax to the government and
dividends to shareholders. And the amount that is left over after paying tax and dividends is
called undistributed profit.

Mixed Income
Mixed income refers to the income of the self-employed individuals, farming units, and sole
proprietorships. Now, if you consider all these components of income, national income can be
represented as follows:

National Income = Rent + Compensation + Interest + Profit + Mixed income

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GDP (INCOME MEYTHOD) = NATIONAL INCOME + DEPRECIATION + (INDIRECT
TAXES - SUBSIDIES

An Indirect tax is charged on producers of goods and services and is paid by the consumer
indirectly. Examples of indirect taxes include VAT, excise duties (cigarette, alcohol tax) and
import levies (tax or fee or fine).
Description: In the case of indirect tax, the burden of tax can be shifted by the taxpayer to
someone else. Indirect tax has the effect to raising the price of the products on which they are
imposed. Customs duty, central excise, service tax and value added tax are examples of indirect
tax.
What is a Subsidy?
A subsidy is a benefit given to an individual, business, or institution, usually by the government.
It is usually in the form of a cash payment or a tax reduction. The subsidy is typically given to
remove some type of burden, and it is often considered to be in the overall interest of the public,
given to promote a social good or an economic policy. Subsidies come in various forms
including: direct (cash grants, interest-free loans, path) and indirect (tax breaks, insurance, low-
interest loans, accelerated depreciation, rent rebates). Furthermore, they can be broad or narrow,
legal or illegal, ethical or unethical. A rebate a partial refund to someone who has paid too
much for tax, rent, or a utility.

NATIONAL INCOME

Wages and Salaries xx

Rents xx

Profits xx

Interests Income xx

Total National Income xx

Add: (Indirect Taxes – Subsidies) xx

Net Domestic Product xx

Add: Depreciation xx

Gross Domestic Product xx

III. OUTPUT METHOD:

The output contributed by the various sectors (industries) of the economy is added to give
National Output. Industries include agriculture, manufacturing, etc. When calculating GDP by
this method it is necessary to avoid DOUBLE COUNTING. The economy is broken up into
various sectors. The money spent on making the goods (inputs) is taken away from the money
received from the sale of the goods (outputs) to give each sector’s Value added. TAKING
FINAL OUTPUT OR ADDING UP EACH SECTOR’S VALUE ADDED gives National
Income.

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 IMPORTANCE OF MAKING THE DISTINCTION
BETWEEN NOMINAL AND REAL GDP

A. NOMINAL GDP: GDP expressed at current prices. It is often called MONEY GDP.

B. REAL GDP: is GDP adjusted for changes in the price level. It uses constant prices.
Real Values eliminate the impact of change in the price level leaving only the
real changes in the size of an economic variable.

HOW DO ONE MAKE THE ADJUSTMENT FROM NOMINAL TO REAL GDP

We can use the GDP deflator together with nominal GDP to measure Real GDP.

GDP Deflator = Nominal GDP x 100

Real GDP

THE GDP DEFLATOR is a price INDEX that reveals the cost of purchasing the items included
in GDP during the period relative to the cost of purchasing these same items during the base
year.
Since the BASE YEAR is assigned a value of 100, as the GDP deflator takes on values greater
than 100 (the value in the base year) it indicates that prices have risen.

Growth Rate = Real GDP - Real GDP

(Real GDP) (in current year) (in base year)
_____________________________ X 100
Real GDP (in base year)

Year Nominal GDP (US $ Billion) GDP Deflator Real GDP (US $ Billion)
2002 $ 6,244 100 $ 6,244
2005 $ 7,246 107.5 ?

 Shows that between 2002 and 2005 Nominal GDP increased by 16 %.

 But when the 2005 GDP is deflated to account for price increases, we see that real
GDP increased by only 7.9 %.

GDP was designed to measure THE VALUE of the goods and services PRODUCED in the
MARKET SECTOR. In spite of its shortcomings and limitations REAL GDP is a
REASONABLY PRECISE measure of the rate of output in the market and how that output rate
is changing.
Adjusted for changes in prices, ANNUAL and QUARTERLY (Real) GDP data provide the
information required to track the performance level of an economy.
]

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GNP – A closely related measure to GDP is the total market value of all final goods and services
produced by the citizens of a country.

GNP = GDP + income received by citizens - income paid to foreigners

for factors of production for the contributions to
supplied abroad domestic output.

Factors influencing the size of the National Income:

 Natural resources.
 Nature of labour force.
 Amount of capital investment.
 Efficient utilization of resources.
 Political stability.
 Ability of the country to produce innovative ideas.
 Availability of foreign direct investment flows.

Uses of National Income Statistics:

 To measure the total income of a country.
 To measure the improvement in national wealth and the standard of living over-time.
 To compare the economic activity of different countries.
 To identify trends in consumer expenditure.
 To identify trends in industrial production.
 To assist government in its economic planning.

Factors influencing the size of the Gross Domestic Product (GDP)

 GDP and social welfare.
 GDP and environment.
 GDP and the underground economy.

RELATED INCOME MEASURES:

1. NET DOMESTIC PRODUCT = GDP – Depreciation

2. NET NATIONAL PRODUCT = GNP – Depreciation

3. NATIONAL INCOME = The total income payments to owners of human

(labour) and physical capital during a period. It
includes both DOMESTIC and FOREIGN
income earned by the nationals.

4. PERSONAL INCOME (GROSS INCOME) = The total income received by

individuals that is available for consumption,
saving and payment of personal taxes.

5. DISPOSABLE INCOME = Gross Income minus Taxes. It is income

available after personal taxes which can either
be spent on consumption or saved..

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