Welcome to the Welcome to the SessionSession

National Income National Income AccountingAccounting

National Income Accounting

National Income Accounting Defined Circular Flow of Economic Activity Measures of Output GDP/GNP/NDP/NNP/NI/DI/DPI Nominal GDP vs Real GDP GDP Per Capita Inflation and Price Index Interest Rate and Real Interest Rate Shortcomings of GDP as a Measure of Economic Well-Being

Measures of Output (Production)

National Income Accounting refers to the measurement of aggregate economic activity, particularly national income and its components.

Aggregate = Total or Gross

MARKETS FOR FACTORS OF PRODUCTION

MARKETS FOR GOODS AND SERVICES

FIRMS HOUSEHOLDS

Good and services bought

Good and services sold

Revenue (=GDP)

Spending (=GDP)

Inputs for Production

Land, labor and capital

Wages, rent, interest and profit (=GDP)

Flow of goods & services

Flow of money: Taka

Income (=GDP)

THE CIRCULAR FLOW DIAGRAM

Measures of Output (Production)

Gross Domestic Product is the total monetary value of final output produced within a nations borders in a given time period at current market prices

Gross Domestic Product is also referred to as

• Nominal Gross Domestic Product• Current Gross Domestic Product

Definition of GDP

The market value of good i (Vi) is equal to PiQi

GDP = sum of the market values of all final goods and services produced within the year.

n n

i i ii 1 i 1

GDP V P Q

Measuring Gross Domestic Product

The Expenditures Approach• C + I + G + (Xn) = GDP

The Flow of Income Approach• Households supply business with the factors of

production in return for payment in the form of wages, profits, rent, and interest

The Value Added Approach• Adds the increase in value at each stage of the

production and distribution process

GDP includes final goods and services only Final goods - goods and services that

are not purchased for the purpose of producing other goods and services or for resale Eg. Rice (final) and unhusked rice

(intermediate product)

Including intermediate goods and final goods will result in “double counting”.

Three Approaches for measuring GDP

1. Expenditure Approach (upper loop) – measures GDP as the sum of expenditures on final goods and services.

2. Income Approach (lower loop) – measures GDP as the sum of incomes of factors of production (wages, rent, interest and profit.

3. Value-added Approach – measures GDP as the sum of value added at each stage of production (from initial to final stage)

Expenditure Approach Uses the upper loop of the circular flow diagram. Example: Suppose the economy has only one

product, namely, rice.

Good Price per unit

Q sold Expenditure

Rice 20 1000 20,000

GDP 20,000

Income Approach Uses the lower loop of the circular flow diagram: sum of

payments to the various factors of production. Suppose that in the production of rice the sales and

expenses are as follows:

Sales P 20,000

Expenses:

Wages 8000

Rent 4000

Interest 2000

Total 14,000

Profit 6,000

GDP=Sum of Payments to factors

20,000 P 20,000

Value Added Approach Suppose that rice is the only final product of an economy:

It goes through several (3) stages of production.

Stage of Prod’nValue of

intermediate good

Value of Sales

Value-added

Farmer 12,000 12,000

Rice Miller -Milled Rice

12,000 15,000 3,000

Retailers - Rice 15,000 20,000 5,000

GDP= Total Value Added

20,000

Two Things to Avoid when Compiling GDP

Multiple counting Only expenditures on final products –

what consumers, businesses, and government units buy for their own use belong in GDP

Intermediate goods are not counted Used goods are not counted

Transfer payments Transfer payments are not payments for

currently produced goods and services When they are spent for final goods and services

they will go into GDP as consumer spending

Various Measures of Aggregate Economic Activity

GDP (Gross Domestic Product)- or + Net Factor Income

GNP- Depreciation

NNP - Indirect Business Tax National Income - RE + TP Disposable Income - Personal Tax Disposable Personal Income

Per Capita GDP

Per Capita GDP calculations attempt to give us additional information about how we are doing as an economy.

Per Capita GDP calculations may be a better measure of the standard of living.

• For citizens living in the same country over time• For comparing standards of living between citizens of

different countries

Per Capita Nominal GDP

Per capita GDP = --------------------------------GDP

Population

Per Capita Real GDP

Per capita real GDP = --------------------------------Real GDP

Population

To compare per capita GDP in one year with that of another year we have to correct for inflation. In other words, we really need to revise our formula

Nominal GDP and Real GDP

Real GDP = --------------------------------Nominal GDP

GDP Deflator

Nominal GDP measures the value of output in a given period in the prices of that period, or, as it is sometimes put, in current prices.

Real GDP measures changes in physical output in the economy between different time periods by valuing all goods produced in the two periods at the same prices, or in constant prices.

The GDP Deflator

Real GDP = --------------------------------Nominal GDP

GDP Deflator

GDP deflator is the ratio of nominal GDP in a given year to real GDP of that year.

Nominal Vs. Real GDP

Commodity

2007 NGDP

2008NGDP

2008RGDP

Rice 10 at 100 1000

15 at 150 2250

15 at 100 1500

Cloth 20 at 200 4000

25 at 225 5625

25 at 200 5000

5000 7875 6500

GDP Deflator= NGDP/RGDP= 7875/6500=1.21

Inflation and Prices

Inflation rate = --------------------------------Pt - Pt-1

Pt-1

Inflation is the rate of change in prices, and the price level is the accumulation of past inflations. If Pt-1 represents the price level last year and Pt represents today’s price level, then the inflation rate over the past year can be written as

Shortcomings of GDP as a Measure of National Economic Well-being

Problems of GDP Measurement Non Market Activities (Household

production) Imprecise Pricing of Govt. Activity Illegal production The underground economy Use of Resources to Avoid ‘Bad’ Treatment of leisure time Quality of Goods