National Income National Income AnalysisAnalysis

National Income- National Income- MeaningMeaning It is a sum total of factor incomes It is a sum total of factor incomes

accruing to normal residents of a accruing to normal residents of a country within an accounting year.country within an accounting year.

ThThee concept of National Income concept of National Income can be explained from three sides can be explained from three sides – –

I) ProductionI) Production

II) Income andII) Income and

III) ExpenditureIII) Expenditure

DEFINITIONS DEFINITIONS

Central Statistical Organization: - Central Statistical Organization: - “National Income is the sum total of factor “National Income is the sum total of factor incomes earned by the normal residents of a incomes earned by the normal residents of a country in the form of wages, rent, interest country in the form of wages, rent, interest and profit in an accounting year”.and profit in an accounting year”.

Prof. Kuznets: - Prof. Kuznets: - “The sum total of the “The sum total of the market value of final goods and services, market value of final goods and services, produced by normal residents of a country in produced by normal residents of a country in one year is known as national product.”one year is known as national product.”

Circular flow diagramCircular flow diagram

summarizes the transactions summarizes the transactions between the different economic between the different economic agents agents

agents: households, firms agents: households, firms (business), government, and (business), government, and foreigners (rest of the world) foreigners (rest of the world)

Circular flow diagramCircular flow diagram

Assumption: The economy composed Assumption: The economy composed of households and firms only of households and firms only

Households: own factors of production, Households: own factors of production, consume goods and serviceconsume goods and service

Firms: hire factors of production to Firms: hire factors of production to produce goods and servicesproduce goods and services

FIGURE 8.1. Circular flow diagram. The diagram above represents the transactions between firms and households in a simple economy.

In the upper loop, the arrow emanating from firms to households represents the sale by firms of goods and services to households. On the other hand, the arrow from households to firms represents the payments.

n the lower loop, the arrow originating from the households to the firms shows that firms hire labor and capital from households in order to produce goods and services. The arrow emanating from the firms indicates their payments for the use of the factors of production.

factor payments

(wages, interest, rent, profit)

factor services

goods and services

payments for goods and services

HOUSEHOLDSFIRMS

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: pesos

Income (=GDP)

THE CIRCULAR FLOW DIAGRAM

Transfer paymentsTransfer payments

Transfer payments – are Transfer payments – are transactions wherein one party is transactions wherein one party is not obliged to deliver a good or not obliged to deliver a good or service in return for the payment. service in return for the payment.

Examples: retirement benefits, Examples: retirement benefits, unemployment benefits, unemployment benefits, scholarships, and donationsscholarships, and donations..

Concepts/Aggregates of Concepts/Aggregates of National IncomeNational Income Gross Domestic Product at Market Price (GDPGross Domestic Product at Market Price (GDPMPMP) )

Gross National Product at Market Price (GDPGross National Product at Market Price (GDPMPMP))

Net National Product at Market Price (NNPNet National Product at Market Price (NNPMPMP))

Net Domestic Product at Market Price (NDPNet Domestic Product at Market Price (NDPMPMP))

Gross Domestic Product at Factor Cost (GDPGross Domestic Product at Factor Cost (GDPFCFC))

Gross National Product at Factor Cost (GNPGross National Product at Factor Cost (GNPFCFC))

Net National Product at Factor Cost (NNPNet National Product at Factor Cost (NNPFCFC))

Net Domestic Product at Factor Cost (NDPNet Domestic Product at Factor Cost (NDPFCFC)) Factor Income From Net Domestic Product Factor Income From Net Domestic Product

Accruing to Private SectorAccruing to Private Sector Private IncomePrivate Income Personal IncomePersonal Income

Basic Concepts -Basic Concepts -

Domestic and National ConceptsDomestic and National Concepts

1.Domestic Income = National Income – NFYA1.Domestic Income = National Income – NFYA

2. National Income = Domestic Income + NFYA2. National Income = Domestic Income + NFYA Market Price and Factor Cost ConceptsMarket Price and Factor Cost Concepts

1.1. Market Price = Factor Cost + NITMarket Price = Factor Cost + NIT

2.2. Factor Cost = Market Price – NIT Factor Cost = Market Price – NIT Gross and Net ConceptsGross and Net Concepts

1.1. Gross Product = Net Product + DepreciationGross Product = Net Product + Depreciation

2.2. Net product = Gross Product – Net product = Gross Product – DepreciationDepreciation

Definition of GDPDefinition of GDP

The market value of good i The market value of good i (V(Vii) is equal to P) is equal to PiiQQii

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

n n

i i ii 1 i 1

GDP V P Q

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

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

(intermediate product)(intermediate product)

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

Approaches for measuring Approaches for measuring National IncomeNational Income

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

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

3.3. Expenditure ApproachExpenditure Approach – measures GDP – measures GDP as the sum of expenditures on final as the sum of expenditures on final goods and services.goods and services.

Value Added MethodValue Added Method

STEPS –STEPS –

Classification of Productive Classification of Productive EnterprisesEnterprises

Calculation of Value AddedCalculation of Value Added

1.1. Value of OutputValue of Output

2.2. Value of Intermediate ConsumptionValue of Intermediate Consumption Calculation of Domestic IncomeCalculation of Domestic Income Calculation of National IncomeCalculation of National Income

Value Added ApproachValue Added Approach

Suppose that rice is the only final product of an economy: Suppose that rice is the only final product of an economy: It goes through several (3) stages of production.It goes through several (3) stages of production.

Stage of Prod’nStage of Prod’nValue of Value of

intermediaintermediate goodte good

Value of Value of SalesSales

Value-Value-addedadded

Farmer - PalayFarmer - Palay 12,00012,000 12,00012,000

Rice Miller -Milled Rice Miller -Milled RiceRice

12,00012,000 15,00015,000 3,0003,000

Retailers - RiceRetailers - Rice 15,00015,000 20,00020,000 5,0005,000

GDP= Total Value GDP= Total Value AddedAdded

20,00020,000

Cautions Regarding Value Added Cautions Regarding Value Added

1) Value of intermediate goods is 1) Value of intermediate goods is not included in Product Method.not included in Product Method.

2) Value of second hand goods is 2) Value of second hand goods is not included in product method.not included in product method.

3) Imputed rent is included in this 3) Imputed rent is included in this method.method.

Income MethodIncome MethodSTEPSSTEPS Classification of Productive Classification of Productive

EnterprisesEnterprises Classification of Factor IncomeClassification of Factor Income1.1. Compensation of Employees (COE)Compensation of Employees (COE)

2.2. Operating Surplus (O.S.)Operating Surplus (O.S.)

3.3. Mixed IncomeMixed Income Calculation of Domestic Income Calculation of Domestic Income Calculation of National IncomeCalculation of National Income

Income ApproachIncome Approach

ITEMS SYMBOLS VALUE

Compensation of Employees

COE 1,093,800

Operating Surplus OS 2,215,100

Depreciation D 357,200

Net Indirect Taxes NIT 356,600

Gross Domestic Product GDP 4,022,700

Cautions Regarding Income Cautions Regarding Income MethodsMethods Windfall gainsWindfall gains Income from illegal activitiesIncome from illegal activities Transfer earningsTransfer earnings The sale and purchase of second The sale and purchase of second

hand goods hand goods Imputed value of services Imputed value of services

Expenditure MethodExpenditure MethodSTEPSSTEPS Identification and classification of Identification and classification of

Economic Units incurring Final Economic Units incurring Final ExpenditureExpenditure

Classification of Final ExpenditureClassification of Final Expenditure1.1. Final Consumption ExpenditureFinal Consumption Expenditure

2.2. Final Investment ExpenditureFinal Investment Expenditure Calculation of Domestic IncomeCalculation of Domestic Income

NDPNDPFCFC = Private Final = Private Final Consumption Expenditure + Consumption Expenditure + Government Final Consumption Government Final Consumption Expenditure + Gross Domestic Expenditure + Gross Domestic Capital Expenditure (Gross Fixed Capital Expenditure (Gross Fixed Capital Formation + Change in Capital Formation + Change in Stock) + Net Exports (Exports – Stock) + Net Exports (Exports – Imports)- Dep.-NITImports)- Dep.-NIT

Calculation of National Calculation of National IncomeIncome

Cautions Regarding Cautions Regarding Expenditure MethodExpenditure Method Only final expenditure is included Only final expenditure is included

in national income.in national income. Expenditure on shares and bonds Expenditure on shares and bonds

are not included.are not included. Expenditure on second hand Expenditure on second hand

goods is not included in national goods is not included in national income.income.

Expenditure on transfer payments Expenditure on transfer payments is not included in national income.is not included in national income.

Nominal and Real GDP Nominal and Real GDP

GDP at current prices or nominal GDP -GDP at current prices or nominal GDP - GDP GDP measured using the prices of the year for measured using the prices of the year for which it is calculatedwhich it is calculated

Nominal GDP can be a misleading indicator of Nominal GDP can be a misleading indicator of changes in output or income because it also changes in output or income because it also embodies changes in the prices of goods and embodies changes in the prices of goods and services. services.

Real GDP or GDP at constant prices Real GDP or GDP at constant prices measures the total value of output using the measures the total value of output using the prices of a selected year (the base year). prices of a selected year (the base year).

Real GDP better for analysis overtime because Real GDP better for analysis overtime because it eliminates the effects of price changes it eliminates the effects of price changes

Real GDPReal GDP

Nominal GDPReal GDP 100.

GDP deflator

Inflation RateInflation Rate

1

1

Inflation Rate t t

t

CPI CPI

CPI

GDP per capitaGDP per capita

Measures how much output or income was Measures how much output or income was produced or received, on the average, by an produced or received, on the average, by an individual in an economy individual in an economy

Useful for comparing the performance of a Useful for comparing the performance of a country overtime and a country’s country overtime and a country’s performance relative to its neighborsperformance relative to its neighbors

GDPGDP per capita

population

Per Capita GNI Per Capita GNI Poverty rate

Myanmar b 217 26.6

Nepal 250 30.9

Cambodia 350 34.7

Lao PDR 390 33.5

Bangladesh 440 49.8

Viet Nam 540 19.5

Pakistan 600 32.6

India 620 26.1

Sri Lanka 1010 22.7

Indonesia 1140 18.2

Philippines 1170 30.0

China 1500 3.1

Thailand 2490 9.8

Malaysia 4520 7.5

Korea, Rep. of 14000 3.6

Taiwan 14770 0.8

Singapore 24760 0.0

PER CAPITA GROSS NATIONAL INCOME, 2004 (US$)

Some Limitations of GDP or Some Limitations of GDP or GNP as measures of growthGNP as measures of growth

Ignores income distributionIgnores income distribution Ignores environmental degradationIgnores environmental degradation Does not include activities that do Does not include activities that do

not go through the formal markets not go through the formal markets sectorssectors

Does not include “illegal” activities Does not include “illegal” activities like drug trafficking, prostitution, like drug trafficking, prostitution, moonlightingmoonlighting