Presentation 2 national income

Measuring National Output and National Income

Is it because of the resources they have - Japan hardly has any natural resources Is is because of the money they have - paper money can be made Is is due to the real wealth they generate. - what then is real wealth. Why are countries rich or poor

Real Wealth or Income Real wealth is the wealth generated by a country in terms of the goods and services it produces. Paper money is nominal wealth and goods and services generated is real wealth.

National Income Accounting National income accounting – a set of rules and definitions for measuring economic activity in the aggregate economy – that is, in the economy as a whole. National income accounting is a way of measuring total, or aggregate production.

National income accounting includes the following concepts : Gross Domestic Product (GDP) and Gross National Product (GNP) Net National Product or Net National Income (NNP) GDP/GNP at market price and factor cost Personal income (PI) and Personal Disposable income (PDI) Personal Consumption Expenditure and Personal savings Real and Nominal Income Per capita income (PCI)

Gross Domestic Product Gross domestic product (GDP) is the current market value of the total final goods and services produced within a given period by factors of production located within a country. The term final goods and services refers to goods and services produced for final use. Intermediate goods are goods produced by one firm for use in further processing by another firm. These are not used in the computation of GDP.

Value Added Value added is the difference between the value of goods as they leave a stage of production and the cost of the goods as they entered that stage. In calculating GDP, we can either sum up the value added at each stage of production, or we can take the value of final sales. We do not use the value of total sales in an economy to measure how much output has been produced .

Value Added Value Added in the Production of an Automobile Stage Of Production Value at End of Each Stage of Production Value Added by Each Stage of Production (1) Iron and other raw materials $ 600 $ 600 (2) Pig iron and other processed materials 1,200 600 (3) Steel ingots, etc 2,400 1,200 (4) Sheet steel, etc 5,500 3,100 (5) (6) (7) Automobile parts Assembly Automobile delivered at showroom 8,000 11,500 16,900 46,100 2,500 3,500 5,400 16,900

GDP Versus GNP GDP is the value of output produced by factors of production located within a country . (deals with location) Gross National Product (GNP) measures the o utput produced by a country’s citizens , regardless of where the output is produced . (deals with ownership of resources) GNP = GDP + value of goods & services produced by the country’s owned resources abroad – value of goods & services produced by foreign resources in the country GNP= GDP + NFIA (Net Factor Income Earned From Abroad)

Calculating GDP GDP can be computed in two/three ways: The expenditure approach : A method of computing GDP that measures the amount spent on all final goods and services during a given period. (Y= C+I+G+(X-M) ) The income approach : A method of computing GDP that measures the income—wages, rents, interest, and profits—received by all factors of production in producing final goods. (Y = W+R+I +P ) The Output/ Value added approach : In some cases value of final output generated or value added by each producer is taken as a method to compute national income (Y= value of final goods & services/value added in the primary, secondary and tertiary sectors)

The circular flow of income: The inner flow Firms Households Factor Services Goods and services Price of goods and services Factor payments

Factor payments Consumption of domestically produced goods and services (C d ) The circular flow of income WITHDRAWALS INJECTIONS Investment ( I ) Government expenditure ( G ) Export expenditure ( X ) BANKS, etc Net saving ( S ) GOV. Net taxes ( T ) ABROAD Import expenditure ( M )

The Income Approach National income is the total income earned by the productive resources owned by a country’s citizens. The income approach to GDP breaks down GDP into four components: GDP mp = national income + depreciation + ( indirect taxes – subsidies ) + net factor income from rest of the world + other National Income = Compensation of employees +Proprietors income + Corporate profits + Net interest + Rental income

The Income Approach Components of GDP, 1999: The Income Approach BILLIONS OF DOLLARS PERCENTAGE OF GDP Gross domestic product 9,299.2 100.0 National income 7,469.7 80.3 Compensation of employees 5,299.8 57.0 Proprietors’ income 663.5 7.1 Corporate profits 856.0 9.2 Net interest 507.1 5.5 Rental income 143.4 1.5 Depreciation 1,161.0 12.5 Indirect taxes minus subsidies 689.7 7.4 Net factor payments to the rest of the world 11.0 0.1 Other  32.2  0.3 Source: See Table 17.2.

From GDP to Disposable Income GDP, GNP, NNP, National Income, Personal Income, and Disposable Personal Income, 1999 DOLLARS (BILLIONS) GDP 9,299.2 Plus: receipts of factor income from the rest of the world + 305.9 Less: payments of factor income to the rest of the world  316.9 Equals: GNP 9,288.2 Less: depreciation (capital consumption allowance)  1,161.0 Equals: net national product (NNP) 8,127.1 Less: indirect taxes minus subsidies plus other  675.5 Equals: national income 7,469.7 Less: Undistributed profits  485.7 Less: social insurance payments  662.1 Plus: personal interest income received from the government and consumers + 456.6 Plus: transfer payments to persons +1,011.0 Equals: personal income 7,789.6 Less: personal taxes  1,152.0 Equals: disposable personal income 6,637.7 Source: See Table 17.2.

From GNP to NNP Net national product equals gross national product minus depreciation; a nation’s total product minus what is required to maintain the value of its capital stock. Capital consumption allowance (depreciation) represents the amount of depreciation and obsolescence in the GNP. NNP = GNP – Depreciation (capital consumption allowance)

From NNP to National Income (NI) Alternative measures Total productive resource costs of the goods and services produced by the economy The income earned by the owners of productive resources in producing GDP NI = NNPmp – (Indirect business taxes + Subsidies) + statistical discrepancy = NNPfc

National income accounting: a summary GNP (and GNI) at market prices GDP at market prices NYA C X - Z I NYA G NNP at market prices Deprec'n National Income or NNP at factor cost Net Indirect taxes Wages and salaries Self- employment Profits, rents

From GDP to Personal Income Personal income is the total income of households. Transfer payments A payment of money in return for which no current goods or services are produced The current income received by persons from all sources: Wages, salaries, proprietors’ incomes, rental income, interest income, dividend income, and transfer payments = (national income) - (undistributed corporate profits) – (social security payments) + interest income received from the government and households +Transfer payments).

From Disposable Personal Income to Personal Saving Personal Consumption Exp. = PDI – Personal savings Personal Savings = PDI – Personal Consumption Exp. Disposable Personal Income and Personal Saving, 1999 DOLLARS (BILLIONS) Disposable personal income 6,637.7 Less: Personal consumption expenditures  6,268.7 Interest paid by consumers to business  194.8 Personal transfer payments to foreigners  26.6 Equals: personal saving 147.6 Personal savings as a percentage of disposable personal income: 2.2% Source: See Table 17.2.

Disposable Personal Income and Personal Saving Disposal personal income is the personal income minus personal taxes. The personal saving rate is the percentage of disposable personal income that is saved. If the personal saving rate is low, households are spending a large amount relative to their incomes; if it is high, households are spending cautiously.

GDP at market and factor price GDP at Market price = GDP at factor cost + Indirect Taxes – subsidies GDP at factor cost = GDP at Market price - Indirect Taxes + subsidies

GDP Plus: receipts of factor income from the rest of the world Less: payments of factor income to the rest of the world Equals: GNP Less: depreciation (capital consumption allowance) Equals: net national product (NNP) Less: indirect taxes minus subsidies plus other Equals: national income (NNP at factor cost) Less: Undistributed profits Less: social security payments Plus: personal interest income received from the government and consumers Plus: transfer payments to persons Equals: personal income Less: personal taxes (Income tax, wealth tax, etc) Equals: disposable personal income Less Personal consumption expenditures Interest paid by consumers to business Personal transfer payments to foreigners Equals: personal saving

GDP by Expenditure method Four major components Consumption Investment Net exports Government GDP = C+I +G + (X-M)

Personal Consumption Expenditures (C) Personal consumption expenditures ( C ) are expenditures by consumers on the following: Durable goods : Goods that last a relatively long time, such as cars and appliances. Nondurable goods : Goods that are used up fairly quickly, such as food and clothing. Services : Things that do not involve the production of physical things, such as legal services, medical services, and education.

Gross Private Domestic Investment (I) Investment refers to the purchase of new capital. Total investment by the private sector is called gross private domestic investment . It includes the purchase of new housing, plants, equipment, and inventory by the private sector.

Gross Private Domestic Investment Nonresidential investment includes expenditures by firms for machines, tools, plants, and so on. Residential investment includes expenditures by households and firms on new houses and apartment buildings. Change in inventories computes the amount by which firms’ inventories change during a given period. Inventories are the goods that firms produce now but intend to sell later.

Gross Private Domestic Investment Remember that GDP is not the market value of total sales during a period—it is the market value of total production. The relationship between total production and total sales is: GDP = final sales + change in business inventories

Gross Investment versus Net Investment (G) Gross investment is the total value of all newly produced capital goods (plant, equipment, housing, and inventory) produced in a given period. Depreciation is the amount by which an asset’s value falls in a given period. Net investment equals gross investment minus depreciation. capital end of period = capital beginning of period + net investment

Government Consumption and Gross Investment Government consumption and gross investment (G ) counts expenditures by federal, state, and local governments for final goods and services.

Net Exports (X-M) Net exports (EX – IM) is the difference between exports and imports. The figure can be positive or negative. Exports (EX) are sales to foreigners of U.S.-produced goods and services. Imports (IM) are U.S. purchases of goods and services from abroad).

Exclusions of Used Goods and Paper Transactions GDP ignores all transactions in which money or goods change hands but in which no new goods and services are produced.

Calculating GDP: Some Examples Selling your two-year-old car to a neighbor does not add to GDP. Selling your car to a used car dealer who then sells your car to someone else for a higher price, adds to GDP. The value of the dealer's services is added to GDP.

Calculating GDP: Some Examples Selling a stock or bond does not add to GDP. The stock broker's commission from the sales does add to GDP.

Calculating GDP: Some Examples Social security payments, welfare payments, and veterans' benefits, are not included in GDP – transfer payments Only the cost of transferring is included in GDP.

Calculating GDP: Some Examples The work of unpaid housespouses does not appear in GDP calculations. GDP only measures market activities so unpaid value added is not included in GDP.

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

The Circular Flow Goods Other countries Financial markets Government Firms (production) Household Taxes Factor services Savings Imports Government Spending Wages, rents, interest, profits Exports Investment Personal consumption

Nominal versus Real GDP Nominal GDP is GDP measured in current dollars , or the current prices we pay for things. Nominal GDP includes all the components of GDP valued at their current prices. When a variable is measured in current dollars, it is described in nominal terms .

Changes in the Price Level Nominal GDP The market value in current rupees/dollars of the total goods and services currently produced by the economy GDP implicit price deflators An index that converts GDP from current-dollar/rupee figures to constant-dollar/rupee figures, taking into account some changes in the quality of various products Real GDP The gross domestic product as expressed in constant rupee/dollars terms

Calculating Real GDP A Three-Good Economy (1) (2) (3) (4) (5) (6) (7) (8) GDP IN GDP IN GDP IN GDP IN YEAR 1 YEAR 2 YEAR 1 YEAR 2 IN IN IN IN PRODUCTION PRICE PER UNIT CURRENT YEAR YEAR 1 YEAR 2 CURRENT YEAR YEAR 1 YEAR 2 YEAR 1 YEAR 2 PRICES PRICES PRICES PRICES Q 1 Q 2 P 1 P 2 P 1 x Q 1 P 1 x Q 2 P 2 x Q 1 P 2 X Q 2 Good A 6 11 $.50 $ .40 $3.00 $5.50 $2.40 $4.40 Good B 7 4 .30 1.00 2.10 1.20 7.00 4.00 Good C 10 12 .70 .90 7.00 8.40 9.00 10.80 Total $12.10 $15.10 $18.40 $19.20 Nominal GDP in year 1 Nominal GDP in year 2

Exhibit 3: A Price Index (base year = 2000) Price of Bread Price of Bread in Current Year in Base Year Price Index Year (1) (2) (3) = (1)/(2)x100 2000 $1.25 $1.25 100 2001 1.30 1.25 104 2002 1.40 1.25 112 For base year 2000, we divide the base price of bread by itself, $1.25 / $1.25  price index for 2000 equals 1  100 = 100  the price index in the base year is always 100. The price index for 2001 is $1.30 / $1.25 = 1.04, which when multiplied by 100 = 104, and for 2002 it is 112. Thus, the index is 4% higher in 2001 than in the base year, and 12% higher in 2002 than in the base year.

Per Capita GDP/GNP Per capita GDP or GNP measures a country’s GDP or GNP divided by its population. Per capita GDP is a better measure of well-being for the average person that its total GDP or GNP.

Changes in Population Size Real per capita disposable income The best measure of the average amount of goods and services received per person Per capita disposable income adjusted for changes in the price level Provides measure of changes in the standard of living

Per Capita GDP/GNP http://www.indexmundi.com/g/r.aspx?c=mr&v=67 Per Capita GNP for Selected Countries, 1998 COUNTRY U.S. DOLLARS COUNTRY U.S. DOLLARS Switzerland 40,080 Portugal 10,690 Norway 34,330 Argentina 8,970 Denmark 33,260 South Korea 7,970 Japan 32,380 Czech Republic 5,040 United States 29,340 Brazil 4,570 Austria 26,850 Mexico 3,970 Germany 25,850 Turkey 3,160 Sweden 25,620 South Africa 2,880 Belgium 25,380 Colombia 2,600 France 24,940 Jordan 1,520 Netherlands 24,760 Romania 1,390 Finland 24,110 Philippines 1,050 United Kingdom 21,400 China 750 Australia 20,300 Indonesia 680 Italy 20,250 Pakistan 480 Canada 20,020 India 430 Ireland 18,340 Rwanda 230 Israel 15,940 Nepal 210 Spain 14,080 Ethiopia 100 Greece 11,650 Source: The World Bank Atlas, 2000.

GDP as a Measure of Economic Welfare Types of goods and services produced Nature of goods being produced eg consumer goods, military goods or other public goods Treatment of durable goods Contribution of services from durable goods (eg cars, washing machines, refrigerator, etc) in subsequent years are not included in the GDP computation. External or social costs Pollution, environmental degradation are not costed into the GDP Value of leisure Working hours, holidays and vacation time are not considered in GDP computation

Value of Nonmonetary Transactions GDP for the most part takes into account only currently produced goods and services supplied through monetary transactions The underground economy is the part of an economy in which transactions take place and in which income is generated that is unreported and therefore not counted in GDP.

Limitations of the GDP Concept Society is better off when crime decreases, but a decrease in crime is not reflected in GDP. An increase in leisure is an increase in social welfare, not counted in GDP. Nonmarket and domestic activities are not counted even though they amount to real production.

Limitations of the GDP Concept GDP accounting rules do not adjust for production that pollutes the environment. GDP has nothing to say about the distribution of output. Redistributive income policies have no direct impact on GDP. GDP is neutral to the kinds of goods an economy produces.

International Comparisons of GDP Purchasing power parity The number of units of currency needed in one country to buy the same amount of goods and services that 1 unit of currency will buy in another country =

Presentation 2 national income

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