Lecture 4

Macroeconomics I

Topic: MEASURING DOMESTIC OUTPUT, NATIONAL INCOME

Lecturer: Ing. Dennis Nchor, Ph.D.

[email protected]
Topics
• NATIONAL INCOME ACCOUNTING
• Gross Domestic Product
• Avoiding Multiple Counting
• Omitting Non-production Transactions
• TWO APPROACHES TO GDP MEASURING: SPENDING AND INCOME
• Expenditures Approach
• Income Approach
• Three Adjustments to Balance the Accounts
• OTHER NATIONAL ACCOUNTS
• PROBLEM OF COMPARISON: REAL VERSUS NOMINAL GDP
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Why National Income Accounting

There are three main functions of national income accounting:

1. It helps to measure the overall level of production in the economy in
a particular timeframe.
2. System of a national accounting allows us to compare the national
accounts in chosen period of years.
3. National accounts provide us with information that serve as a basis
for planning, designing and pursuing macroeconomic policies.

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Gross Domestic Product
• Gross Domestic Product (GDP) including goods and services
produced by domestic and foreign resources operating within
geographical boundaries of a country, measures aggregate
output.
• GDP is measured as the total market value of all final goods
and services produced within a country in a particular year.

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National Income Accounting Identity
• The equality of output and income is an accounting identity
in the national income accounts.
• The identity can be seen in the circular flow of income in an
economy.

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 Measuring
Domestic
Output, National
Income

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Two Approaches to Measuring GDP
• Expenditures approach sees GDP as the sum of all
expenditures in purchasing that output.
• Income approach measures GDP as the entire income
derived from the production of that output.
• The money spent to purchase this year`s GDP = all the
income created from the production of this year‘s GDP

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Expenditure and Income Approaches to GDP

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1. Expenditures Approach
• Sum up all spending - personal expenditures on consumption
(C), gross private domestic investment (Ig), government
purchases (G), and net exports (NX) – spent on final goods
and services.
• The GDP equation: GDP = C + Ig + G + NX

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Consumption
• Personal Consumption Expenditures (C) is also called “consumption
expenditures by households,”.
• That term covers households’ expenditure on durable consumer goods,
non-durable consumer goods and consumer expenditures for services.

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Investment
• Business spending on equipment, structures, and inventories is
counted as part of gross private investment (I). It includes changes in
inventories.
• Net Private Investment is obtained by deducting depreciation from
gross private investment.
• Depreciation is the reduction in the value of an asset due to wear and
tear.
• Another term for depreciation is fixed capital consumption
expenditure.

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Government Expenditure

• Government purchases (G) of goods and services include

items such as national defense expenditures, costs of roads by
state and local governments as well as salaries of government
employees
• It does not include government transfer payments because
they merely transfer government receipts to certain
households and generate no production of any sort.

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Net Exports
• Net Exports account for domestic purchases of foreign goods
(Imports) and foreign purchases of domestic goods (Exports)
• Expenditure on exports (X) is added while expenditure on imports (M)
is subtracted
• NX = Exports – Imports
• NX can be >, <, or = 0

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 Calculating GDP through the expenditure approach

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The Income Approach
The sum of incomes from factors of production is equal to National Income (NI).
NI is the total income of the country’s citizens, irrespective of the place (country)
they are working
1. Compensation of employees (wages)
2. Rents
3. Interest
4. Proprietors’ income.
5. Corporate profits (corporate income tax, dividends and undistributed profit)

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Compensation of Employees
• By far the largest share of national income
• It includes wages and fringe benefits earned by workers

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Rent

• Rents consist of the income received by the households and

businesses that supply property resources.
• They include the monthly payments tenants make to
landlords and the lease payments corporations pay for the use
of office space.

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Interest
• Interest consists of the money paid by private businesses to
the suppliers of loans used to purchase capital.
• It also includes such items as the interest households receive
on savings deposits, certificates of deposit (CDs), and
corporate bonds.

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Profit
• Profit is broken down into two accounts: proprietors’
income (sole proprietorships, partnerships, and
unincorporated businesses) and corporate profits.
• Proprietors’ income flows to the proprietors.

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Corporate Profits

• Corporate profits are the earnings of corporations. Corporate profits are sub-
divided into three categories
1. Corporate income taxes. These taxes are levied on corporations’ profits.
2. Dividends. These are the part of after-tax profits that corporations choose to pay
out, or distribute, to their stockholders or shareholders.
3. Undistributed corporate profits (retained earnings)-Any after-tax profits that are
not distributed to shareholders are saved, or retained, by corporations to be
invested later in new plants and equipment.

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Net Foreign Factor Income

• Net foreign factor income is the difference between income nationals

gain from supplying resources abroad and the income that foreigners
gain by supplying resources within the country.
• Net foreign factor income is added to GDP to get National Income. It
can be negative or positive

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Consumption of Fixed Capital or Depreciation

• It is the allowance for capital that has been “consumed” in producing

the year’s GDP.
• It is the portion of GDP that is set aside to pay for the ultimate
replacement of capital goods.

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Indirect Business Taxes

• Certain taxes on businesses, such as sales taxes, less offsetting

business subsidies.
• These taxes place a wedge between the price that consumers pay for a
good and the price that firms receive

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 Calculating GDP through the Income Approach

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The difference between expenditure and income
approaches

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 NI → GDP
Three Adjustments required to move from NI to GDP
To derive GDP from NI, make the following three adjustments
1. Add depreciation or consumption of fixed capital.
2. Add indirect business taxes.
3. Add net foreign factor income.

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 NI -> GDP

• How to derive GDP from

national income

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 GDP → NDP

• Net domestic product is GDP adjusted for depreciation.To

derive NDP, subtract depreciation from GDP.
• Since it is so hard to measure depreciation in the real world,
economists use capital consumption allowance rather than
depreciation.

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 GDP -> NDP

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 NDP → NI
To derive NI from NDP, subtract the following from
NDP
1. Net foreign factor income
2. Indirect business taxes

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 NDP -> NI

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 NI → PI

To derive Personal Income (PI) from NI,

1. Subtract corporate income taxes
2. Subtract undistributed corporate profits
3. Subtract social security taxes
4. Add transfer payments.

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 NI -> PI

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 PI → DI

• To move from personal income (PI) to disposable income

(DI) all types of personal taxes (personal income taxes) must
be subtracted.
• Disposable income is divided between consumption (C) and
savings (S) by households: DI = C + S

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 PI -> DI

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 Example 1: GDP,
NDP, NI, PI, and DI

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Example 2

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 Please try to
calculate GDP using
the Expenditure and
income approaches

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Measuring 1. Avoid multiple counting
GDP 2. Omit non-production transactions
accurately
Avoiding Double Counting

• Gross domestic product includes only the market value of

final goods.
• It doesn’t involve intermediate goods neither re-sold
products.

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Omitting Non-production Transactions

1. Purely financial transactions

-Public transfer payments.
-Private transfer payments.
-Security transaction
2. Second-hand sales.

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Problems of GDP Measurement

There are major criticisms of the GDP measure:

1. Omits non-market goods and services
2. No accounting for “bads” such as crime and pollution
3. No correction for quality improvements
4. Unreported Incomes
5. Double counting

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