Measuringthe

Economy

CHAPTER 9

Daniel James Caballero y Dineros

MEASURES OF INCOME AND OUTPUT Whenever one sector is using their money for the purchase of others’ output, it becomes an income of that sector vice versa. Thus, in this simplified economy, we can easily compute for national income. For instance, ABC Company produces product M worth Php4,000 using the equipment hired from Mr. Dela Cruz which the latter received a total income of Php3,000 after paying Mang Ambo who regularly maintains the equipment. Another company, XYZ Company, provides product N worth Php3,000 using the expertise and skills of Mr. Santos and Mr. De Guzman who in return receives 1,500 each.

The household sector is composed of four individuals – Mr. Juan Dela Cruz, Mang Ambo, Mr. Santos and Mr. De Guzman who spend their income for the basic needs provided by ABC and XYZ Company in the following manner:

Mr. Dela Cruz spends Php1,500 for product M and another Php1,500 for product N

Mang Ambo purchases Php500 worth of product M and Php500 worth of product N

Mr. Santos also purchases the goods he needs from company ABC and XYZ worth of Php750 of product M and Php750 of product N

Mr. De Guzman is spending just the same amount as Mr. Santos

Adding the Financial Sector Into the Model It’s unrealistic to assume that the household sector consumes every peso of income earned on goods and services. A portion of it is saved in some financial institutions. This situation is likely true with the business leakage from the circular flow or sometimes called as an outflow. In the same manner, both sector spend most of their income on investment. Investment is considered an injection in the circular flow. Consider as an example that part of money or income of both sectors that were saved in some financial institutions, which in turn lend this fund to individuals or invested in some profitable business. In some cases of foreign investment, it may be considered as an injection into the economy for it brings employment and productions. However, most of these foreign investors send back their profit to their own country and this manifest a leakage from our economy. This process is called as “profit repatriation”

Adding the Government Sector Into the Model The government sector plays a vital role in our economy. The government imposes a variety of taxes to support a wide range of budgetary programs. Both household and business sectors are oblige to pay their corresponding taxes. Therefore tax is a leakage in the circular flow. On the other hand, the government spends its income generated out of the taxes of the mentioned sectors on salaries of public servants and capital expenditure on road construction, repair of bridges, establishments of public hospitals, schools and etc. Hence, government expenditure or spending is an injection into the circular flow.

Adding the Overseas Sector Into the Model Philippines has an “open economy”. A certain percentage of the Philippine consumption is made up of goods and services produced overseas while some products are being exported to other countries. Importation is a leakage in the circular flow. This is because the money that has been used to pay the imports does not circulate back or into the economy On the contrary, exportation of goods and services are considered as an injection into the circular flow. This is because receipts of the sales of the product return to the economy. Hence, an increase in exports result to the increase of the national income

In this “four-sector” circular flow model, an outflow or leakage is that part of income that leaks the circular flow and causes to slow down the rate of movement on the income. This includes savings, taxes, and imports. On the contrary, inflows or injections allow the flow of income to rise within a certain economy. It includes the investments, government expenditure, and proceeds from goods and services to other countries.

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1

4

3

7

65

10

9 8

11

121

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Household Business

1. Goods and Services2. Factors of Production (land, labour, capital entrepreneur)

3. Factors of Payment (rent, wage, interest profit)4. Payment of Purchase of Goods and Services

5. Imports6. Taxes7. Savings

8. Financial Sector9. Government Sector10. Overseas Sector

11. Investment12. Government Expenditure13. Payment of PurchaseCircular Flow of Income

Some economies use mathematical equation in expressing the effect of inflows and outflows on the circular flow and national income. As mentioned earlier, the household sector either consumes or saves money. That is,

Y = C + Swhere:

Y = incomeC = consumptionS = savings

The same is true with the business sector, where firms spend their money either on the production that is consumed in the period it was produced or on investment.

Therefore,Y = C + I

where: Y = expenditure or total spendingC = the production that is consumed in the period it was producedI = investment

Combining the two equations will give us:Y = C + S and Y = C + I

Cancelling consumption or the C’s,I = S

Hence, spending by the business sector equals income received by the household sector. That is, national income depends on the level of consumption by household sector, and the level of investment by the business sector.

As mentioned earlier, the government also spent its income through government expenditure and government spending. This act of spending is an injection into the circular flow. Hence,

Y = C + I + G

Going back to the circular flow model, import is considered as leakage while export is injection to the economy.

Y = C + I + G + (X - M)

Remember that the circular flow model is just a framework that explain how each sector work in performing complex economic activities.

THE GROSS NATIONAL PRODUCT (GNP) Nobody has cleared the discovery of the gross national product, the name Simon Kuznet comes into view for is path-breaking work on GNP. The concept of GNP opened to the systematic understanding of how economy performs on a macro level. Since then, the gross national product has become the most basic tool in measuring the economy The gross national product (GNP), therefore, is the sum of the market values of all goods and services produced. It is also the sum of the money value of consumption, investment, government purchases of goods and services, and net exports. In defining the GNP, value is a measurement in the monetary terms, which is the value of goods and services, usually in market price, in peso.

Activities that are Excluded in theGNP Computation

We defined GNP as the sum of all final goods and services. Hence, its only the value of the goods and services should be counted, and those values of intermediate goods which are a part of final product are excluded. Similarly, the value of goods and services must be counted only once. An approach in estimating the value of final product is the value added. The next slide will show the overestimate in the GNP if we count the intermediate value and not just the value added.

Hypothetical Value-Added Data

Items SalesReceipts

Cost of Intermedia

teProducts

Value- Added

Eraser 5 0 5

Wood 8 -5 3

Lead 12 -8 4

Pencil 25 -12 14

50 -25 25

To avoid double counting of products, the value of goods and services must be counted only once (value-added approach). Value-added is the difference between the value of goods and the cost of the materials and supplies used in production. Non-productive transactions should also be excluded from the GNP computation (ex. Financial transactions, second-hand sales & underground economy). Public transfer payments are those given by the government to individuals or households but does not contribute production in return for them (ex. Old age pension & welfare payments). Private transfer payments involve funds from a private individual to another and which is not part of the production. (ex. Gift cheques from friends/relatives) Some of these transaction were earned years ago, hence, these do not contribute to the current production. This will only result to double counting so it will be included in the present GNP accounting.

For example: The income of a father of a student amounting Php120,000 which is included in the 2004 GNP, and sums of Php30,000 to the total allowance of the student for the same period. If the student’s allowance is counted for 2004 GNP, an overstatement shall occur because it was already recorded as part of the father’s income. Re-sale or second-hand sale transactions were also excluded in the GNP calculation. All products produced in 2004 were measured in in 2004 GNP even if some of the product were not sold in the same year. Hence, such unsold products should not be included in year 2005 GNP calculation. Another activity that is excluded in the GNP computation is the so-called underground economy. Underground economy has two kinds:

1. Activities that are illegal (i. e. Illegal drug trade); and

2. Activities that are legal but unrecorded for tax purposes (i. e. Services of doctors, lawyers, tutors who produces valuable services but might escape the net of national input statisticians)

Computing the Gross National ProductProduct or Expenditure Approach How do we really go about measuring the GNP? Economist have several approaches in measuring the GNP. One is the product or expenditure approach. There are 4 major components in measuring the GNP:

Personal Consumption Expenditure of goods and services. This constitute the largest share of the nation’s output.

Government Spending. It is the sum of expenditures incurred by the government. This includes salaries and wages of public servants and daily operations.

Net Exports (Export-Import). This is the difference between exports and imports. A negative net export is derived when imports are greater than exports. A positive net export occurs when exports is greater than the imports.

Summing up these components will give a rise to the GNP. The table below shows the major components of GNP expenditure approach.

Household or Personal Consumption Expenditure (C) + Gross Domestic Capital Formation (I) + Government Purchase of Goods and Services (G) ± Net Export (Export-Import) + Statistical Discrepancy = Gross Domestic Product (GDP) + Net Factor Income from Abroad = Gross National Product - Depreciation Allowance = Net National Product - Indirect Income Taxes - Subsidies = National Income

Gross National Product (Expenditure Approach)

In the circular flow model, investment is done by the business sector. But with no introduction into the government sector in the model, the government invest as well. Investment is an expenditure on new capital goods. This consist an addition to the national stock of building, equipment and inventories. The government also provides basic services like education, health, and etc. This is called Government consumption expenditure which is separated from personal consumption expenditure .Not all of the government’s spending is included in the GNP computation. This includes government on transfer payments, which are payments from the government to the individuals. (ex. disability payments, veteran’s benefits) Net exports is the difference between exports and imports. In some cases, products produced at home are sometimes sold to other countries (exports). And in some of the goods materials in production are brought abroad. (import)

Industrial Origin Approach It is another method in computing the GNP. It measures GNP by determining the sum of the market value of the total production of all the major industries comprising the economyGross National Product

(Industrial Origin Approach) Agriculture, Fisher and Forestry Sector

+ Industry SectorMiningManufacturing, ConstructionElectricity, Gas and Water

+ Service SectorTransportation, Communication & StorageTrade, FinanceOwner Dwelling and Real EstateService (Private & Government)

Equals : Gross Domestic Product Less International Factor Income Equals : Gross National Product Less Net Indirect Taxes & Depreciation Allowance Equals : National Income

Income Approach Still, another method in computing the GNP is the Income Approach as shown in Table 26. in our circular flow, recall that the household sector receives earning fro the business sector as payment for the economic resources. A component for this approach includes all income received as the owner of economic resources known as factor payments. Part of the factor payments include wages and salaries to labour, rent paid for allowing the use of one property, profits and dividends paid to capital. In reality, it is not only the household sector that has income. Government, too, has an income generated mainly from the so-called government owned and controlled corporation.

Gross National Product(Income Approach)

Compensation of EmployeesPrivate Compensation of EmployeesPublic Compensation of Employees

Entrepreneurial and Property IncomeGovernment Income from entrepreneurial propertyCorporate Income

Corporate TaxCorporate Savings

National Income+ Depreciation+ Indirect Business Tax (IBT)- Subsidies= Gross National Product (GNP)

Philippine GNP Actual Account Table 27 presents the Gross National Products accounts in actual numbers/data of the Philippine GNP economy. The right side of the component of expenditure approach. It measures the flow of the product which is usually represented by economic symbols: C for personal expenditure, I for gross domestic investment, G for government purchases of goods and services, and X for net exports. The left side shows the components of industrial origin approach. Note that each approach adds up to exactly the same Gross National Product. This is because whatever income the consumers receive out of the payment of factors of production, they spend it on goods and services produced by the other sector.

Net factor income from abroad refers to the difference between the net income earned by the citizens who earned resources used in the production process abroad and the income of foreigners who own resources used in the production process here in the PH. Whereas, depreciation allowance refers to the decline in the value of an asset has been worn out a period of time. Indirect tax refers to tax imposed on goods before they reach consumers who ultimately pays for them not as a tax but as part of the purchase price to which it is added. On the other hand, subsidies refer to the payment of funds, goods, or services by government, business, or household for which it receives no goods or services in return.

Gross National Product By Industrial Origin and

By Expenditure Approach(At Current Prices)

1. Agriculture, Fishery & Forestry742,112

2. Industrial Sector 1,542,240A. Mining and Quarrying

53,032B. Manufacturing

1,116,163C. Construction

217,699D. Electricity, Gas, & Water

155,3463. Services Sector

2,559,098A. Transpo., Commun., and Storage

370,228B. Trade

680,762C. Finance

215,136D. Owners’ Dwellings and Real Estate

293,750E. Private Services

605,719F. Goverment Services

393,503 Gross Domestic Product

4,843,450Net Factor Income From Abroad

352,454

Gross National Product 5,195,904

GROSS NATIONAL PRODUCT BY INDUSTRIAL ORIGINAt Current Price(in million pesos)

GROSS NATIONAL PRODUCT BY EXPENDITUREAt Current Price(in million pesos)

1. Personal Consumption Expenditure 3,343,973

2. General Government 488,795

Consumption Expenditure3. Gross Domestic Capita Formation

825,484A. Fixed Capital Formation

802,172B. Increase in Stacks

23,3124. Exports of Goods and Services 2,432,6815. Less: Imports of Goods and 2,434,672

Non-Factor Services6. Statistical Discrepancy

187,419Expenditure on Gross Domestic Product

4,843,430Net Factor Income From the

352,434Rest of the World

Expenditure on Gross National Product 5,195,504

GNP versus GDP The distinction between two measurements of economic performance is based on the differences in counting production by foreigners in a country and by citizens outside the country, such that, there are some cases where final goods and services are part of GDP but not of GNP, or vice versa. For instance, production by foreigners within a particular country is part of GDP but not of GNP and that production of citizens outside their country is included in the GNP but not in GDP. Thus, GNP is the sum of market value of all goods and services produced by a citizen of a country during a given time regardless of their physical location, while GDP if the sum of all final goods and services produced within the country.

Generally, we use the price to determine the market value of goods and services. However, considering the price differ over time, it is not usually appropriate to use variant yardsticks of measurement. This is because in the case of inflation, prices tend to increase, needless to say, GNP at current price increases, based on the fundamental equation.

GNP = price x quantity Thus, in order to deal with the ambiguity of using price as measurement for market value of goods and services, macroeconomist have categorized GNP into real and nominal GNP. Nominal GNP is the sum of all goods and services at current price. This is obtained simply by multiplying the number of final goods and services by the prevailing market price.

Real GNP versus Nominal GNP

Thank you for Listening. . .

Daniel James D. Caballero

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