National Income And Its Aggregates
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Overview 1. Why an economy’s total income equals its total expenditure or value added. 2. How gross domestic product (GDP) is defined and calculated. 3. Breakdown GDP into its four major components. 4. Distinguish between real and nominal GDP.
The Economy’s Income and Expenditure When judging whether the economy is doing well or poorly, it is natural to look at the total income that everyone in the economy is earning.
Gross Domestic Product •
•
Gross domestic product (GDP) is a measure of the income and expenditures of an economy. It is the total market value of all final goods and services produced within a country in a given period of time.
The Measurement of GDP Output is valued at market prices. It records only the value of final goods, not intermediate goods (the value is counted only once). It includes goods and services currently produced, not transactions involving goods produced in the past. It measures the value of production within the geographic confines of country.
What Is and What Is Not Counted in GDP? GDP includes all items produced in the economy and sold legally in markets. -Non-Market Activities: GDP does not include items produced and consumed at home that never enter the marketplace. -Underground Activities: It does not include items produced and sold illicitly, such as illegal drugs, smuggling etc.
The Economy’s Income and Expenditure •
For an economy as a whole, income must equal expenditure because: ◆ Every
transaction has a buyer and a seller. ◆ Every rupee of spending by some buyer is a rupee of income for some seller.
The Circular-Flow Diagram The equality of income and expenditure can be illustrated with the circularflow diagram.
The Circular-Flow (2) ProductionDiagram Revenue
Goods & Services bought
Consumption Spending
(3) Expenditure
The circular flow of income (2) Production
Factor Payments (Wages, rent, and profit)
Consumption of domestically produced goods and services (Cd)
(3) Expenditure
(1) Incomes
• The inner flow
The Circular Flow of Income ◆
The inner flow
◆
Withdrawals – net savings – net taxes – import expenditure
◆
Injections – investment – government expenditure – export expenditure
The circular flow of income
Factor payments
Consumption of domestically produced goods and services (Cd)
BANKS, etc
Net saving (S)
The circular flow of income
Investment (I)
Factor payments
Consumption of domestically produced goods and services (Cd)
BANKS, etc
Net saving (S)
The Circular Flow of Income ◆ The
inner flow
◆ Withdrawals
– net savings – net taxes – import expenditure ◆ Injections
– investment – government expenditure – export expenditure
The circular flow of income
Investment (I)
Factor payments
Consumption of domestically produced goods and services (Cd)
BANKS, etc
Net saving (S)
GOV.
Net taxes (T)
The circular flow of income
Investment (I)
Factor payments
Consumption of domestically produced goods and services (Cd)
Government expenditure (G) BANKS, etc
Net saving (S)
GOV.
Net taxes (T)
The Circular Flow of Income a)
The inner flow
b)
Withdrawals – net savings – net taxes – import expenditure
c) Injections – investment – government expenditure – export expenditure
The circular flow of income
Investment (I)
Factor payments
Consumption of domestically produced goods and services (Cd)
Government expenditure (G) BANKS, etc
Net saving (S)
GOV.
ABROAD
Import Net expenditure (M) taxes (T)
The circular flow of income
Investment (I)
Factor payments
Consumption of domestically produced goods and services (Cd)
Export expenditure (X)
Government expenditure (G) BANKS, etc
Net saving (S)
GOV.
ABROAD
Import Net expenditure (M) taxes (T)
The circular flow of income INJECTIONS
Investment (I)
Factor payments
Consumption of domestically produced goods and services (Cd)
Export expenditure (X)
Government expenditure (G) BANKS, etc
Net saving (S)
GOV.
ABROAD
Import Net expenditure (M) taxes (T)
WITHDRAWALS
National National income income accounts accounts
The 3 - methods of national income accounting
The circular flow of National income (2) Production
(1) Incomes
(3) Expenditure
3- Methods of Computing An Economy’s Income 1.
Resource Cost or Income Approach: Sum the total wages and profit paid by firms for resources (see the circular flow).
1.
Value Added or Production Method Sum the value added at each stage of production process
1.
Expenditure Approach: Sum the total expenditures by households (from the top portion of the circular flow).
Gross trading surplus of public sector Rs4627 m
0.7
Income from employment Rs400 354 m
62.3
Income from self-employment Rs70 116 m
10.9
Gross trading profits of companies Rs100 231 m
15.6
Rent Rs63 850 m
9.9
Other Rs3738 m
0.6
Total GDP Rs642 916 m
100.0
Percentage of GDP
Hypothetical Example
1. The Income Method
Manufacturing Rs137 006 m
21.3
Construction Rs33 748 m
5.3
Distribution, hotels, catering; repairs Rs. 93 091 m
14.5
Transport and communication Rs54 056 m
8.4
Banking, finance, insurance, etc. Rs89 500 m
13.9
Ownership of dwellings Rs47 814 m
7.5
Public administration and defence Rs38 244 m
5.9
Education and health Rs81 876 m
12.7
Other services Rs24 713 m
3.8
Total GDP Rs642 916 m
100.0
2. The Product Method
1.8 4.9
Percentage of GDP
Agriculture, forestry and fishing Rs.11 700 m Mining, energy and water supply Rs31 674 m
3. The Expenditure Method
Rs.million Consumers’ expenditure 473 509 Government final consumption 155 732 Gross domestic fixed capital formation (including new housing) 114 623 Value of physical increase in stocks and work in progress 2 917
Total domestic expenditure
746 781
plus Exports of goods and services
217 147
Total final expenditure less Imports of goods and services Statistical discrepancy
Gross domestic product at market prices less Taxes on expenditure plus Subsidies
Gross domestic product at factor cost plus Net property income from abroad
Gross national product (at factor cost) less Capital consumption (depreciation)
Net national product (national income)
963 928 −222 603 975
742 300 −108 484 9 100
642 916 9 652
652 568 −77 372
575 196
Gross National Product
€
The total market value of all final goods and services produced during a given period of time by the nation’s residents, regardless of the place produced.
National Income & Related Aggregates Four Important distinctions ◆
Between a Gross Concept and a Net Concept – GDP Vs NDP (Depreciation)
◆
Between a At Factor Costs Concept and a At Market Prices Concept – GNPfc Vs GNPmp (N Indirect Taxes)
◆
Between a At domestic Concept and a National Prices Concept - GDP Vs GNP (NFIA)
◆
Real and Nominal concept - Inflation
The Components of GDP 1. GDP (Y) is the sum of: – – – –
Consumption (C) Investment (I) Government Purchases (G) Net Exports (NX) or Exports minus Imports
Y = C + I + G + NX
The Four Components of GDP 1. Consumption (C): Is the spending by households on goods and services •
e.g. buying clothing, food, movie tickets
2. Investment (I): Is the purchases of capital equipment and structures, e.g. factory, houses, etc.
3. Government Purchases (G):Includes spending on goods and services by local, provincial and federal governments (e.g. roads, police, etc.). Does not include transfer payments, because it is not made in exchange for currently produced goods or services.
4. Net Exports (NX): Exports minus imports.
Real versus Nominal GDP 1. 2. 3.
GDP is the market value of the economy’s current production, referred to as Nominal GDP. Real GDP measures any given year’s total output in “constant” prices. An accurate view of the economy requires adjusting nominal to real GDP, using the GDP Price Deflator.
GDP Price Deflator 1. The GDP Price Deflator is a price index that uses a bundle of all final goods and services. –
It tells us the rise in nominal GDP that is attributable to a rise in prices.
1. Converting Nominal GDP to Real GDP: Real GDP200x =
(NominalGDP20xx ) RealGDP20xx = X 100 (GDPdeflator 20xx)
Real and Nominal GDP
Year
Price of Hot dogs
Quantity of Hot dogs
Price of Quantity of Hamburgers Hamburgers
2001
$1
100
$2
50
2002
$2
150
$3
100
2003
$3
200
$4
150
Sales Receipts and their Distribution Sector
Sales Receipts
Materials Allocation of Sales Receipts
Bakers
9,000
5,000
2,500
----
1,000
Machine Makers
1,000
400
500
----
100
----
Millers
5,000
1,900
9,000
----
700
600
Farmers 2,500
600
9,000
900
200
----
7,900
5,600
900
2,000
Total
17,500
Wages & Mixed Other Salaries Income of Income self Payments employed
Saved
500
1,100
Money Flow vs. Product Flow Farmer
Miller
Baker 5,000
1,000
2,500
Machine Maker Four Branches in the Economy: Farmers, Millers, Bakers, Machine Makers
The Economy’s Income and Expenditure When judging whether the economy is doing well or poorly, it is natural to look at the total income that everyone in the economy is earning.
Gross Domestic Product •
•
Gross domestic product (GDP) is a measure of the income and expenditures of an economy. It is the total market value of all final goods and services produced within a country in a given period of time.
The Measurement of GDP Output is valued at market prices. It records only the value of final goods, not intermediate goods (the value is counted only once). It includes goods and services currently produced, not transactions involving goods produced in the past. It measures the value of production within the geographic confines of country.
What Is and What Is Not Counted in GDP? GDP includes all items produced in the economy and sold legally in markets. -Non-Market Activities: GDP does not include items produced and consumed at home that never enter the marketplace. -Underground Activities: It does not include items produced and sold illicitly, such as illegal drugs, smuggling etc.
The Economy’s Income and Expenditure •
For an economy as a whole, income must equal expenditure because: ◆ Every
transaction has a buyer and a seller. ◆ Every rupee of spending by some buyer is a rupee of income for some seller.
The Circular-Flow Diagram The equality of income and expenditure can be illustrated with the circularflow diagram.
The Circular-Flow (2) ProductionDiagram Revenue
Goods & Services bought
Consumption Spending
(3) Expenditure
The circular flow of income (2) Production
Factor Payments (Wages, rent, and profit)
Consumption of domestically produced goods and services (Cd)
(3) Expenditure
(1) Incomes
• The inner flow
The Circular Flow of Income ◆
The inner flow
◆
Withdrawals – net savings – net taxes – import expenditure
◆
Injections – investment – government expenditure – export expenditure
The circular flow of income
Factor payments
Consumption of domestically produced goods and services (Cd)
BANKS, etc
Net saving (S)
The circular flow of income
Investment (I)
Factor payments
Consumption of domestically produced goods and services (Cd)
BANKS, etc
Net saving (S)
The Circular Flow of Income ◆ The
inner flow
◆ Withdrawals
– net savings – net taxes – import expenditure ◆ Injections
– investment – government expenditure – export expenditure
The circular flow of income
Investment (I)
Factor payments
Consumption of domestically produced goods and services (Cd)
BANKS, etc
Net saving (S)
GOV.
Net taxes (T)
The circular flow of income
Investment (I)
Factor payments
Consumption of domestically produced goods and services (Cd)
Government expenditure (G) BANKS, etc
Net saving (S)
GOV.
Net taxes (T)
The Circular Flow of Income a)
The inner flow
b)
Withdrawals – net savings – net taxes – import expenditure
c) Injections – investment – government expenditure – export expenditure
The circular flow of income
Investment (I)
Factor payments
Consumption of domestically produced goods and services (Cd)
Government expenditure (G) BANKS, etc
Net saving (S)
GOV.
ABROAD
Import Net expenditure (M) taxes (T)
The circular flow of income
Investment (I)
Factor payments
Consumption of domestically produced goods and services (Cd)
Export expenditure (X)
Government expenditure (G) BANKS, etc
Net saving (S)
GOV.
ABROAD
Import Net expenditure (M) taxes (T)
The circular flow of income INJECTIONS
Investment (I)
Factor payments
Consumption of domestically produced goods and services (Cd)
Export expenditure (X)
Government expenditure (G) BANKS, etc
Net saving (S)
GOV.
ABROAD
Import Net expenditure (M) taxes (T)
WITHDRAWALS
National National income income accounts accounts
The 3 - methods of national income accounting
The circular flow of National income (2) Production
(1) Incomes
(3) Expenditure
3- Methods of Computing An Economy’s Income 1.
Resource Cost or Income Approach: Sum the total wages and profit paid by firms for resources (see the circular flow).
1.
Value Added or Production Method Sum the value added at each stage of production process
1.
Expenditure Approach: Sum the total expenditures by households (from the top portion of the circular flow).
Gross trading surplus of public sector Rs4627 m
0.7
Income from employment Rs400 354 m
62.3
Income from self-employment Rs70 116 m
10.9
Gross trading profits of companies Rs100 231 m
15.6
Rent Rs63 850 m
9.9
Other Rs3738 m
0.6
Total GDP Rs642 916 m
100.0
Percentage of GDP
Hypothetical Example
1. The Income Method
Manufacturing Rs137 006 m
21.3
Construction Rs33 748 m
5.3
Distribution, hotels, catering; repairs Rs. 93 091 m
14.5
Transport and communication Rs54 056 m
8.4
Banking, finance, insurance, etc. Rs89 500 m
13.9
Ownership of dwellings Rs47 814 m
7.5
Public administration and defence Rs38 244 m
5.9
Education and health Rs81 876 m
12.7
Other services Rs24 713 m
3.8
Total GDP Rs642 916 m
100.0
2. The Product Method
1.8 4.9
Percentage of GDP
Agriculture, forestry and fishing Rs.11 700 m Mining, energy and water supply Rs31 674 m
3. The Expenditure Method
Rs.million Consumers’ expenditure 473 509 Government final consumption 155 732 Gross domestic fixed capital formation (including new housing) 114 623 Value of physical increase in stocks and work in progress 2 917
Total domestic expenditure
746 781
plus Exports of goods and services
217 147
Total final expenditure less Imports of goods and services Statistical discrepancy
Gross domestic product at market prices less Taxes on expenditure plus Subsidies
Gross domestic product at factor cost plus Net property income from abroad
Gross national product (at factor cost) less Capital consumption (depreciation)
Net national product (national income)
963 928 −222 603 975
742 300 −108 484 9 100
642 916 9 652
652 568 −77 372
575 196
Gross National Product
€
The total market value of all final goods and services produced during a given period of time by the nation’s residents, regardless of the place produced.
National Income & Related Aggregates Four Important distinctions ◆
Between a Gross Concept and a Net Concept – GDP Vs NDP (Depreciation)
◆
Between a At Factor Costs Concept and a At Market Prices Concept – GNPfc Vs GNPmp (N Indirect Taxes)
◆
Between a At domestic Concept and a National Prices Concept - GDP Vs GNP (NFIA)
◆
Real and Nominal concept - Inflation
The Components of GDP 1. GDP (Y) is the sum of: – – – –
Consumption (C) Investment (I) Government Purchases (G) Net Exports (NX) or Exports minus Imports
Y = C + I + G + NX
The Four Components of GDP 1. Consumption (C): Is the spending by households on goods and services •
e.g. buying clothing, food, movie tickets
2. Investment (I): Is the purchases of capital equipment and structures, e.g. factory, houses, etc.
3. Government Purchases (G):Includes spending on goods and services by local, provincial and federal governments (e.g. roads, police, etc.). Does not include transfer payments, because it is not made in exchange for currently produced goods or services.
4. Net Exports (NX): Exports minus imports.
Real versus Nominal GDP 1. 2. 3.
GDP is the market value of the economy’s current production, referred to as Nominal GDP. Real GDP measures any given year’s total output in “constant” prices. An accurate view of the economy requires adjusting nominal to real GDP, using the GDP Price Deflator.
GDP Price Deflator 1. The GDP Price Deflator is a price index that uses a bundle of all final goods and services. –
It tells us the rise in nominal GDP that is attributable to a rise in prices.
1. Converting Nominal GDP to Real GDP: Real GDP200x =
(NominalGDP20xx ) RealGDP20xx = X 100 (GDPdeflator 20xx)
Real and Nominal GDP
Year
Price of Hot dogs
Quantity of Hot dogs
Price of Quantity of Hamburgers Hamburgers
2001
$1
100
$2
50
2002
$2
150
$3
100
2003
$3
200
$4
150
Sales Receipts and their Distribution Sector
Sales Receipts
Materials Allocation of Sales Receipts
Bakers
9,000
5,000
2,500
----
1,000
Machine Makers
1,000
400
500
----
100
----
Millers
5,000
1,900
9,000
----
700
600
Farmers 2,500
600
9,000
900
200
----
7,900
5,600
900
2,000
Total
17,500
Wages & Mixed Other Salaries Income of Income self Payments employed
Saved
500
1,100
Money Flow vs. Product Flow Farmer
Miller
Baker 5,000
1,000
2,500
Machine Maker Four Branches in the Economy: Farmers, Millers, Bakers, Machine Makers
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