The macro economy

Unit 4
Chapter 15: National income statistics
Classroom task
• b Discuss the ways in which a government can redistribute income in a lower middle-income
country. [12]
• Knowledge and understanding
• • income inequality
• Analysis points
• • effects of a progressive income tax on redistribution of income
• • minimum wage – impact on wage rates, employment and the distribution of income • use of
transfer payments and direct state provision to reduce income inequality.
• Evaluation points
• • limited scope for using progressive income tax in middle-income countries
• • need for state to provide some essential services to protect low-income earners • policies to
reduce income inequality take time and tend to have had only a modest impact
• • judgment on which policy might be most effective in a middle-income country
National Income
• National income is a monetary value of country’s total output. People
earn income from producing the output. This income is then spent on
the output. This means that total output should equal total income
and total expenditure.
• A government measures a country’s total output to assess the
performance of the economy. An economy is usually considered to be
doing well if its output is growing at sustained rate.
 Concept of National income

Professor Simon Kuznets developed the concept of national

income systematically.
NI is defined as the method or technique used in
construction of total income of a nation at a particular
period of time.
It is expressed as:
NI= ∑ (Y1+Y2+Y3………..+Yn)
National income statistics provide a numerical measure of
an economy’s performance. In 1984, Richard Stone won
the Nobel Prize for economics for his work on the
development of national income statistics.
Concepts of NI from three different angles are:
 NI in terms of production of goods and services:
- NI is the market price of final goods and services produced in
the economy during a period of time. (a year)
 NI in terms of factor income:
- NI is the sum of total factor income earned by normal
residents of a country during a year as rewards for rending their
factor services.
 NI in terms of expenditure:
- NI is the sum of total final consumption expenditure (C),
investment expenditure (I) and government expenditure (G) in the
country during a period of time.
(a year)
Different concepts of NI
1. Gross domestic product:
The most widely used measure of national income is
known as gross domestic product (GDP). GDP is used by
economists, governments and international organizations
to assess what is produced, earned and spent in an
economy.
‘Gross’ means total, ‘domestic’ refers to the home
economy and product means ‘output’. So, for example,
Pakistan’s GDP is a measure of the total value of output
produced by the factors of production based in Pakistan in
a year.
Gross Domestic Product (GDP)
 It is a macroeconomic concept which is defined as the
market value of the final goods and services produced
within the domestic territory of a country during one year
by all factors of production.
There are both residents as well as foreign producers
produce within the domestic territory of a country.
Symbolically it is expressed as:
GDP= C+I+G+(X-M)
Where,
C= consumption, I= investment and changes in stocks
G= government expenditure, X= value of export, M= value
of import
2. Gross National Product/ Income (GNP/GNI)

GNP is the gross national product. Here, we have to

estimate the monetary value of all goods and services
produced by the residents of a country, no matter in which
part of the world they are.
Thus GNP is the market value of the final goods and
services produced by residents of a country during a period
of time (a year) including net factor income from abroad.
Contd.
GDP becomes GNP if net property income from abroad is
added to it.
Thus, it is expressed as:
GNP = GDP+ NPIA
= C+I+G + (X- M) + net factor or property income
from abroad
where X = Export, M = Import
NPIA= Net property income from abroad
cont.
NPIA is the income that the country’s residents earn on
their physical assets such as factories owned abroad and
foreign financial assets such as shares Minus(-) the returns
on assets held in the country but owned by foreigners. So
GNI gives a measure of the income of a country’s
residents.

NPIA may be +ve or –ve. If NPIA is +ve, GNP>GDP.

GNI.
Gross national income (GNI) is important measure because
it is included, by the United Nations in its Human
Development Index.
GNI also includes other sources of income that residents
receive from abroad and deducts other sources of income
that foreigners receive from the country.
Like, wages earned by workers who are resident in one
country but who work abroad for short periods.
Some tax revenue on products may be paid to other
countries and international organizations and some
production subsidies may be received by other
governments and international organizations.

Governments also measure gross national disposable

income. This includes income sent home to relatives by
people working abroad minus income sent by foreigners
working in the country to their relatives abroad.
Differences in countries’ GDP and GNI
Most countries’ GDP and GNI are relatively similar.
However, in the case of some countries, there is a clear
difference between their GDP and GNI. Some countries like,
Ireland, have a noticeably higher GDP than GNI.
 This is because foreign multinational companies (MNCs)
and foreign workers make an important contribution to the
output of these countries.
A major reason for the rapid rise in Ireland’s GDP in recent
years is its ability to attract foreign investment.
 However, foreign investment has also resulted in a net
outflow of profits and other income.
Some countries have a higher GNI than GDP because they
receive a net inflow of property income from abroad.
German firms, for example, have invested large amounts
in other countries in the past and now receive an inflow of
profits from their multinational companies operating in
other countries.
 A number of countries receive a significant inflow of
income from their citizens working abroad, for example
Nepal.
 Measurement of NI
There are three approaches to measure NI.
1. Expenditure method
It measures the national income as the aggregate of all final
expenditure made by the different agents of the economy
during a year.
It includes households’ consumption expenses, investment
expenses on capital goods, government expenses and net
export.
It is expressed as:
Gross domestic expenditure= C+I+G+(X-M)
Gross national expenditure= C+I+G+(X-M)+NFIA
2. Income method

This method is based on the estimation of income of various

factors of production.
Income method considers the payments made to all
productive resources of the country in the form of rent,
wages, interest and profit.
Thus it is the sum of all these incomes.
It is expressed as:
Gross domestic income= rents+ wages+ interest+ profit
along with indirect taxes and depreciation
Gross national income= GDI+ net factor income from abroad
3. Product/Output Method

According to this method, national income is measured in the

form of total output obtained from each economic sector:
Primary sector includes agro-products, fishery, forestry, and
others.
Secondary sector includes manufacturing, electricity, water
supply and others.
Tertiary sector includes banking, insurance, transport and
communication, defense, administration and other services. It
is expressed as,
GDP= total product of (primary+ secondary+ tertiary) sectors
Two methods of product method
The final output/ product method: the market value of
final goods and services at which consumers buy from
market is taken into consideration. For example, only the
total value of product like 100 units of TVs’ market price
$250000 is included in the calculation of NI.
Value added method: value added at different stages of
production.
When NI is calculated by using output method, we can use
either final product method or value added method in
order to avoid double counting.
For example, a car manufacturing firm buys components
costing $390 000 and uses them to make cars that it sells
for $480 000. The firm has added $90 000 to output.
The $390 000 has already been counted and then the $90
000 is added. Adding the value at each stage of production
should give the figure as the market value of the finished
product produced.
Difficulty in measuring NI

1. The first problem of measuring national income relates

to the non- monetary transaction such as services of house
wives, self consumed agricultural product, exchange of
goods between two different producers without the use of
money
The monetary value of these economic activities is not
included in NI, so the real nation income is not derived.
2. There may be the problem of double counting while
calculating NI because it's very difficult to distinguish
between final and intermediate goods.
3. The underground economy/ black economy consists of
illegal and undeclared transactions where goods and
services such as drugs, gambling, smuggling are traded.
Since these incomes are not included in NI, national
income seems to be less than the real income.
4. Due to the lack of required/ unreliable data on various
economic activities, calculation of national income has
become vary difficult task in developing countries.
5. National income is the monetary value of goods and
services. Money value depends on market price. The
problem of changing prices is one of the major difficulty to
measure accurate national income.
6. The transaction of second hand goods only changes the
ownership. Inclusion of such second hand sales in national
income overestimates the value of nation income.
7. Growth of public sector: larger the public sector larger
the degree of accuracy in measuring NI.
Significance of NI
1. Academic use: Academicians use it to test their theories
2. Government/firms/economists use it to forecast the
change in the economic conditions and use to determine
various policies such as monetary, fiscal, supply side
3. Use to achieve broad macroeconomic objectives such as
low and stable inflation, high and stable economic growth,
low unemployment, BOP equilibrium, sustainability issues.
4. Short and long term planning: Short term (current
demand, trend in demand), Long term (invest more in
capital, human resource)
5. To make comparison of NI within a country over a period
of time and among countries.
6. Comparison of standard of living and economic welfare
within a country over a period of time and among
countries.
Market prices and basic prices
Market price is the price charged to consumers. It includes
any taxes on products (indirect taxes) that have been
imposed and it deducts any subsidies that have been given
to producers.

Basic prices/ factor costs are the prices which would be

charged without government intervention and which equal
the reward paid to the factors of production for making the
output. To get basic prices, taxes on products are deducted
and subsidies on products are added.
For example, if a product which sells for $12 has a $2 tax
on it, the market price would be $12 but the basic price
would be $10.

A product that a producer would produce for $15 which is

subsidized at $4 per unit, will have a basic price of $15 but
a market price of $11.
Gross values and net values
GDP and GNP include gross investment. Gross investment
includes the output of capital goods both used to replace
existing capital goods that have worn out or become out of
date due to advances in technology and capital goods
required to expand capacity.
Net domestic product (NDP) and net national product
(NNI/NNP) only include net investment. Net investment
includes only the output of capital goods required to
expand capacity.
ACTIVITY 15.5
A country’s NNI at basic prices is $980 billion. Its net
property income from abroad is $60 billion, depreciation is
$30 billion, taxes on products (indirect taxes) are $40
billion and subsidies on production are $15 billion. What is
the country’s GDP at market
price? And GDP at Basic price?
Answer
$980 billion − $60 billion + $30 billion + $40 billion − $15
billion
 GDP at market prices = $975 billion

$980 billion − $60 billion + $30 billion - $40 billion + $15

billion

GDP at factor costs/basic prices= $ 925 billion

ACTIVITY 15.4
In a group, decide which of the following should be
included in measuring GDP by the income method:
• government subsidies to farmers
• the pay of civil servants
• the pay of nurses
• profits of firms
• state pensions.
Answer
The pay of civil servants, the pay of nurses and the profits
of firms should be included in the income method of
measuring GDP. This is because they are payments made
to factors of production in return for producing goods and
services.
 However, government subsidies to farmers and state
pensions should not be included as they are transfer
payments. Government subsidies to farmers should
increase output but that output will be measured by
farmers’ higher incomes (income method) and consumers’
higher spending on food (expenditure method)