NATIONAL INCOME ACCOUNTING

Measuring the Economy

Measurement

of aggregate economic activity helps answer such questions as:

How much output is being produced? What is it being used for? How much income is being generated? Whats happening to prices and wages?

What is National Income Accounting?

Measurement

of aggregate economic activity, particularly national income and its components It measures the indicators of national output/income; .e.g. GDP, GNP

What is National Income?

National income (also referred to as net national product) may be defined as a measure of the money value of the total flow of goods and services produced in an economy over a specified period of time. The owners of economic resources are engaged in earning incomes by allowing their resources to be used in producing goods and services. Changes in the incomes they receive indicate changes in the level of economic activity.

National income consists of the following: 1. Wage or salary those generated by labor; 2. Interest those generated by lenders of funds; 3. Rent those generated by owners of real state; 4. Profit those generated by the entrepreneurs; 5. Net factor income from abroad.

Important Terms Used in Measuring National Income

In measuring national income, an understanding of the following terms are important: 1. Gross Domestic Product (GDP) 2. Gross National Product (GNP) 3. Market Value 4. Value Added 5. Consumption 6. Investment 7. Consumer Durables 8. Government Expenditures 9. Net Factor Income from Abroad

GROSS DOMESTIC PRODUCTS

The GDP is a measure of the total flow of goods and services produced by the economy over a particular time period. The factors of production must be located in the domestic economy regardless of who owns these factors. The owners of the factors of production consist of citizens of the local economy and those of foreign countries.

Measurement Problems
Methods of calculating GDP entail measurement problems in accounting for all economic activity: Non-Market Activities- goods and services produced that are not sold/does not go through in a market or formal market sectors. Unreported Income market activities not reported to tax or census authorities. They are illegal activities like drug trafficking, prostitution,

GDP per Capita

GDP per capita: Total GDP divided by total population; average GDP GDP per capita is commonly used as a measure of a countrys standard of living Measures how much output or income was produced or received, on the average, by an individual in an economy Measures of per capita GDP tell us nothing about how GDP is actually distributed or used Useful for comparing the performance of a country overtime and a countrys performance relative to its neighbors

Per capita GDP

GDP GDP per capita population
Item GDP at constant (million pesos) Population (millions) 1990 720,700 62.0 1998 888,000 75.2 2002 1,046,100 81.8

Per capita GDP at constant prices

11,624.20

11,808.5

12,788.5

Real Versus Nominal GDP

Nominal GDP: The value of final output produced in a given period, measured in the prices of that period (current prices) Real GDP: The value of final output produced in a given period, adjusted for changing prices

Computing Real GDP

Inflation: An increase in the average level of prices of goods and services

Inflation tends to uncertain actual declines in real output

Base year: The year used for comparative analysis; the basis for indexing price changes

Inflation Rate

CPI t CPI t 1 Inflation Rate CPI t 1

Estimates of the CPI and Inflation Rate, 1990-98 Year

Consumer Price index (CPI) 62.7 75.6

Inflation rate (in percent) -20.6

1990 1991

1992
1993 1994 1995 1996 1997 1998

83.8
91.6 100.0 108.2 117.3 125.1 137.9

10.8
9.3 9,2 8.2 8.4 6.6 10.2

Computing Real GDP

The general formula for computing real GDP is:

nominal GDP in year t Real GDP in year t price index

price index

The price index represents a price level change as an index with a base of 100 100 percentage change
100

Computing Real GDP

2005
1. Nominal GDP (in billions) 2. Change in nominal GDP

2006

P12,456 P13,245 + P789

3. Change in the price level, 2005 to 2006

4. Real GDP in 2005 pesos 5. Change in real GDP

3.30%
P12,456 P12,822 + P366

P $13,245
103.3 100

Real GDP is the inflation-adjusted value of nominal GDP.

Changes in GDP: Nominal Versus Real

Increases in nominal GDP reflect higher prices as well as more output. Increases in real GDP reflect more output only.

Net Domestic Product

We wont be able to produce as much output next year unless we replace factors of production we use this year Depreciation: The consumption of capital in the production process; the wearing out of plant and equipment

Net Domestic Product

Net domestic product (NDP): GDP less depreciation

NDP GDP depreciation

The amount of output we could consume without reducing our stock of capital

Net Domestic Product

Investment: Expenditures on (production of) new plant, equipment, and structures (capital) in a given time period, plus changes in business inventories

Net Domestic Product

The distinction between GDP and NDP is mirrored in the difference between gross investment and net investment
Gross investment: Total investment expenditure in a given time period Net investment: Gross investment less depreciation

Net Domestic Product

The stock of capital the total collection of plant and equipment will not grow unless gross investment exceeds depreciation

GROSS NATIONAL PRODUCT

The

GNP is a measure of the market value of the final goods and services produced only by nationals or citizens of a country in a particular time period. This includes production within and outside of the country under consideration.

EXCLUSIONS FROM THE GNP

The

GNP is a measure of the total production of the economy for a specified year. It follows therefore, that the nonproductive transactions must be excluded.

Nonproductive transactions consist of the following: 1. Purely financial transactions and 2. Secondhand sales

1. 2. 3.

Purely financial transactions consist of the following: Public transfer payments Private transfer payments Buying and selling of securities.

Secondhand sales do not involve current production and so, they are excluded from the GNP.
Ex: when an appliance was bought last year, that transaction was included in last years GNP.

Public transfer payments those given by the government to individuals or households but which do not contribute to current production.
Ex: old-age pensions, welfare payments, and widows pensions.

Private transfer payments involve the transfer of funds from one private individual to another and which does not entail production. Ex: gift checks from friends or relatives

Buying and selling of securities do not directly involve current production. As such, they are excluded from the calculation of the GNP.

MARKET VALUE
Refers to the current price of goods and services produced in the economy. It is important because they facilitate computing for aggregate value of the various goods and services produced.

Ex: It would be difficult to determine the total value of 10,000 metric tons of fish and 50,000 cavans of rice. Computing will be easier if market values are assigned to commodities.
P5,000 for fish and P14,000 for rice.

VALUE ADDED
Refers to the difference between the value of goods produced and the cost of materials and supplies used in producing them. Ex: a newly constructed house is valued at P1 M. if the cost of materials and supplies used in constructing the house is worth P650 T, value added is equal to P350 T. The production of most goods and services involves a series of stages To accurately measure GDP we must distinguish between intermediate and final goods.

Value Added
Intermediate goods: Goods or services purchased for use as input in the production of final goods or services Value added: The increase in the market value of a product that takes place at each stage of the production process

Value Added in Various Stages of Production

Stages of Production
1. Farmer grows wheat, sells it to miller
2. Miller converts wheat to flour, sells it to baker

Value of Value Market Added Transactions

$0.12
0.28

$0.12
0.16

3. Baker bakes bagel, sells it to bagel store

4. Bagel store sells bagel to consumer Total

0.60
0.75 $1.75

0.32
0.15 $0.75

The value added at each stage represents a contribution to total output.

Two Ways to Calculate GDP

You

can compute the value of final output in one of two ways:

Count only market transactions entailing final sales and sum over all Count only the value added at each stage of production and sum over all

The Uses of Output

The

major uses of total output conform to the four sets of market participants:
Households consumption Business Firms investment Government government spending International participants net exports

CONSUMPTION
Refers to expenditures by consumers on final goods and services. the total amount spent by consumers on newly produced goods and services (excluding purchases of new homes, which are considered investment goods). Goods and services used by households are called consumption goods, which includes all household purchases made in product markets

CONSUMER DURABLES
Refers

to consumer goods, such as appliances and furniture, that is usually last for several years. Expenditures on consumer durables are meant not for current but for future satisfaction.

INVESTMENT
An

activity that uses resources now in such a way that they allow greater production in the future, and hence, greater consumption in the future. It includes output of capital goods, net change in business inventories, and residential construction. Investment goods are the plant, machinery, and equipment that we

INVESTMENT
Investment

are of two types:

1. Fixed investment a good that is purchased to be used in order to make other goods and services. Ex: equipment purchase. 2. Inventory investment are those used to increase the amount of inventories of finished products.

GOVERNMENT EXPENDITUES
Refers

to the sum of government payrolls and purchases, which is the cost of government output. Such expenditure are used for the day-to-day operations and projects of the government. Resources purchased by the public sector are unavailable for consumption or investment

NET FACTOR INCOME FROM ABROAD

This is the difference between the income earned by citizens who own resources used in the production process abroad and the income of foreigners who own resources used in the production process here in the Philippines. If the difference is positive, it means the residents of this country earn more from their transactions overseas compared to what foreigners earn from their transactions in this country.

Net Exports
Net

exports: The value of exports minus the value of imports

Exports: Goods and services sold to international buyers Imports: Goods and services purchased from international sources

APPROACHES TO NATIONAL INCOME ACCOUNTING

3 Approaches for measuring GDP

1. Expenditure/Product 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/Industrial Origin Approach measures GDP as the sum of value added at each stage of production (from initial to final stage)

PRODUCT APPROACH

Referred to as the expenditure approach, is also a way of estimating national income. It involves calculating the sum of all expenditures on final goods. The formula used in estimating national income using the product approach is:
GNP (PCE,GDI, GCE, NFIFA) Capital consumption allowances (Depreciation,Obsolescence,Accidental Damage) Net National Product (NNP) Indirect Taxes Subsidies National Income

To compute for the GNP using the product or expenditure approach:

GNP = C + I + G + (X-M) Where: GNP= Gross National Product C=Consumption (PCC) I=Investment G=Government Expenditure X=Exports M=Imports

Brief explanations of the terms used is required to a full understanding of the formula

PRIVATE (OR PERSONAL) CONSUMPTION EXPENDITURES (PCE)

Refers to the spending by households on the ff. types of goods: 1. Durable consumer goods 2. Nondurable goods such as candies, newspapers, toilet papers, soft drinks and ball pen. 3. Services such as those provided by teachers, architects, interior decorators and electrician.

GROSS DOMESTIC INVESTMENT(GDI)

These are expenditures for newly produced capital goods like machinery, equipment, tools, buildings, and additional inventory. Not included are transfers of papers assets and secondhand tangible assets.

DEPRECIATION This term refers to the reduction in value of asset through wear and tear.
NET NATIONAL PRODUCT This refers to the GNP less the part of the output needed to replace the capital goods worn out in producing the output.

INDIRECT TAXES
These are taxes such as sales, excise, and business property taxes, license fees and tariffs which firms treat as costs of producing product or service and pass on (full or partial) to buyers by charging them high prices.

SUBSIDIES
This is the payment of funds, goods, or services by a government, business, or household for which it receives no good or service in return.

INCOME APPROACH
Current production is made possible through the use of economic resources of land, labor, capital, and entrepreneurship. The owners of these resources receive earning in the form of rent, wages and salaries, interest and dividends, and profit. When the total amount of earning of the owners are aggregated into a single amount, the objective of determining the national income is achieved.

ESTIMATING DISPOSABLE INCOME

DISPOSABLE INCOME
That part of the national income that is available to household for consumption or savings, is referred to as disposable income. It is estimated by deducting from GNP all taxes, business saving, and depreciation; then adding government and other transfer payments and government interest payments.

GOVERNMENT TRANSFER PAYMENT Those that are made by the government to individuals for which the individuals perform no current service in return. Examples are retirement and gratuity payments and unemployment insurance.

Formula for estimating disposable income:

DI=GNP-(TBD)+(GTP+GIP) Where: DI=disposable income GNP=gross national product TBD=all taxes, business saving, and depreciation GTP=govt and other transfer payments GIP=government interest payments.

INDUSTRIAL ORIGIN APPROACH

It

measures national income by determining the sum of the market value of the total production of all major industries comprising the economy. The major industries consist of the ff:
1. agriculture, fisheries and forestries 2. Industrial sectors 3. Service sector

INDUSTRIAL ORIGIN APPROACH

The market value consist of the value added of the sector, the indirect taxes net of subsidies, and the capital consumption allowance for each sector. The sum of the market value of the total production of sectors is referred to as the Gross Domestic Product (GDP).

Add:

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

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