Lecture NATIONAL INCOME- CONCEPTS MEASUREMENT
Income is the money earn or paid as a reward for the resources owned. • For example: A worker earn income in the form of monthly payment.
Instead, What is National Income?
National Income • is defined as: the total value of final outputs which comprises of goods and services produced by a country for a particular period of time, usually a year.
as: total income earned by resources owners, that is: rents, wages, interest and profit. • Tucker, defined national income
National Income: is the total amount of money that factors of production earnedduring a year. This includes mainly payments of: wages, rents, profits and interest of capital.
NATIONAL INCOME = NATIONAL PRODUCT = NATIONAL EXPENDITURE (NI = NP =NE)
Or NI = National Product (NP) • The national product refers to the value of output produced by an economy during the course of a year. Or NI = NP = National Expenditure • refers to the value of money spent on goods and services in the economy in a year.
Factor Market Product Market Factor services Goods & services Real Flow Consumers Factor Owners Firm Money Flow Factor Income Cost Revenue Expenditure The flow of economic activities in a 2-sector economy
GDP and GNP • GDP = Gross Domestic Product, is the value of all final goods and services produced by all sectors of the economy the citizens or foreign sectors within a country. • GNP = Gross National Product, is the value of all final goods and services produced by all citizens of a country (within a country or abroad).
Final Goods and Services • 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.
Real GNP & Nominal GNP & Per capita GNP • Real GNP=(Nominal GNP/GNP Deflator)*100 • Per capita GNP = GNP / Population size
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.
Exclusions from GDP • GDP ignores all transactions in which money or goods change hands but in which no new goods and services are produced.
GDP Versus GNP • GDP is the value of output produced by factors of production located within a country. Output produced by a country’s citizens, regardless of where the output is produced, is measured by gross national product (GNP).
CONCEPTS OF NATIONAL INCOME • Gross National Product: It is the total measure of the flow of goods and services at market value resulting from current production during a year in a country, including net income from abroad. • GNP at Market Prices: When the total output produced in one year is multiplied by their market prices prevalent during that year in a country, plus net income from abroad, it is called GNP at Market Prices. • GNP at Factor Cost: It is the sum of the money value of the income accruing to the various factors of production in one year in a country. GNP at Factor Cost = GNP at market prices – Indirect Taxes + Subsidies.
CONCEPTS OF NATIONAL INCOME • Net National Product (NNP): NNP is GNP net of depreciation. NNP = GNP – Depreciation. • NNP at Market Prices: Net value of final goods and services evaluated at market prices: NNP at Market Prices = GNP at Market Price – Depreciation. • NNP at Factor Cost: Net output evaluated at factor prices. NNP at Factor Cost = NNP at Market Prices – Indirect Taxes + Subsidies (or) = GNP at Market Prices – Depreciation – Indirect taxes + Subsidies
CONCEPTS OF NATIONAL INCOME • Domestic Income or Product: Income generated or earned by the factors of production within the country from its own resources is called domestic income or domestic product. Domestic Income = National Income – Net Income earned from abroad. • Personal Income: Personal Income is the total income received by the individuals of a country from all sources before direct taxes. Personal Income = National Income – Undistributed Corporate Profits – Profit Taxes – Social Security Contributions + Transfer Payments + Interest on Public Debt.
CONCEPTS OF NATIONAL INCOME • Disposable Income: income that accrues after direct taxes have actually been paid. Disposable Income = National Income – Business Savings – Indirect taxes plus Subsidies – Direct Taxes on Persons – Direct Taxes on Business – Social Security Payments + Transfer Payments + Net Income from abroad. • Real Income: Real income is national income expressed in terms of a general level of prices of a particular year taken as base. Real NNP = Current Year NNP x Base year Index / Current Year Index. • Per Capital Income: The average income of the people of a country in a particular year is called per capital income for that year. Per capita income = national income / population.Real per capita income = real national income / population.
CONCEPTS OF NATIONAL INCOME • Nominal GDP • Value of output measured at actual prices (current rupee output) • Does not correct for inflation Nominal GDP = Current year Quantities x Current year Prices • Real GDP • Value of output based on prices of some base period (“constant” rupee output) • eliminates effect of inflation Real GDP = Current year Quantities x Base year Prices GDP Deflator = Nominal GDP x 100 Real GDP
CONCEPTS OF NATIONAL INCOME GDP Deflator = Nominal GDP • 100 Real GDP 1992 GDP Deflator = 127• 100 = 100.0 127 1994 GDP Deflator = 160 • 100 = 111.9 143
CONCEPTS OF NATIONAL INCOME Change in GDP Deflator (Inflation) from 1992 to 1994: = (1994 Deflator - 1992 Deflator) • 100 1992 Deflator = (111.9 - 100.0) • 100 = 11.9% 100.0
PRICE INDEX • A price index (plural: “price indices” or “price indexes”) is a normalized average (typically a weighted average) of • prices for a given class of goods or services in a given region, during a given interval of time. It is a statistic designed to help to compare how these prices, taken as a whole, differ between time periods or geographical locations. • Price indices have several potential uses. For particularly broad indices, the index can be said to measure the economy's price level or a cost of living. More narrow price indices can help producers with business plans and pricing. Sometimes, they can be useful in helping to guide investment. Some notable price indices include: • Consumer price index • Producer price index • GDP deflator
Consumer Price Index • A consumer price index (CPI) is a measure estimating the average price of consumer goods and services purchased by households. A consumer price index measures a price change for a constant market basket of goods and services from one period to the next within the same area (city, region, or nation). • It is a price index determined by measuring the price of a standard group of goods meant to represent the typical market basket of a typical urban consumer.
Producer Price Index • A Producer Price Index (PPI) measures average changes in prices received by domestic producers for their output. It is one of several price indices. • Its importance is being undermined by the steady decline in manufactured goods as a share of spending. • The Producer Price Index (PPI) program measures the average change over time in the selling prices received by domestic producers for their output.
GDP Deflator • The GDP deflator (implicit price deflator for GDP) is a measure of the level of prices of all new, domestically produced, final goods and services in an economy. In most systems of national accounts the GDP deflator measures the ratio of nominal (or current-price) GDP to the real (or chain volume) measure of GDP. The formula used to calculate the deflator is: Dividing the nominal GDP by the GDP deflator and multiplying it by 100 would then give the figure for real GDP, hence deflating the nominal GDP into a real measure.
The GDP deflator is utilized as a measure of shifts in the prices of goods and services that are produced in a given country. It is understood that the GDP deflator can help provide a more accurate picture of the current status of the gross domestic product within the country. Because the GDP deflator is understood to be an example of an implicit price deflator for GDP, economists consider calculating this economic indicator as an essential component in ascertaining the current strength or weakness of the country’s economy.
Circular Flow of Income Model: The basic circular flowmodel provides a general picture of the interactions in terms of : income, output and expenditureamong all sectors in an economy.
Circular Flow of Income Economic Models 3 types: • A 2-sector model of circular flow - Comprises of ‘Households’ and ‘Firms’ sectors • A 3-sector model of circular flow - Comprises of ‘Households’ , ‘Firms’ and ‘Government’ sectors • A 4-sector model of circular flow - Comprises of ‘Households’, ‘Firms’, ‘Government’ and ‘Foreign’ sectors
The 2-sector circular flow of national income and expenditure Y = C+I Expenditure, C on goods & services HOUSEHOLDS FIRMS Income,Y Wages, rent, interest, profit Factor payment
Assumptions in a 2 – sector Circular Flow model • All income received by households will entirely be spend on consumption. • The households in the market will entirely purchase all goods and services produced by firms. • Therefore, total income = total expenditure = total output
The 3 sector circular flow of national income and expenditure Y = C+I+G Net Taxes Net Taxes G. Expenditure G. Expenditure GOVERNMENT Expenditure, C Financial Institutions FIRMS HOUSEHOLDS Income,Y
Assumptions in a 3–sector Circular Flow model • C: households is assumed to spent only a portion of their income on consumption. Part of it as savings in financial institutions and for paying taxes. • I: Investors are getting loans for capital investment thus produced goods and services in an economy. • G: Government expenditure will be made based on tax revenue collected. • t: when government sector is included in the model; tax revenue (t) will be collected (from households – personal income tax, and from firms – corporate income tax).
The concept of disposable income The household income (Y) that can be spent by households will now be lesser after deducting the tax portion (t) paid to government. It is now called as: disposable income (Yd). Yd = Y – t. and Disposable NI = NI – t.
The 4-sector circular flow of national income and expenditure Net Taxes Net Taxes G. Expenditure G. Expenditure GOVERNMENT Expenditure, C Financial Institutions HOUSEHOLDS FIRMS Income,Y Y = C+I+G+(X-M) FOREIGNERS
Assumptions in a 4 –sector Circular Flow model • Households now supply resources to both domestic and foreign markets. Households also consume both local and imported goods. • Firms purchased capital goods and engaged foreign workers from abroad to help them produce more new goods and services. They also exports goods and services produced to abroad or overseas. • Government involves either directly or indirectly with foreign sector. They may import as well as exports goods and services to abroad.
Methods of Measuring National Income NI can be measured using 3 common approach: • Income approach • Output approach • Expenditure approach Irrespective of which approach used in calculating NI, will give us the same value
i) INCOME APPROACH • National Income is the total money values of all incomes received by productive persons and enterprises in the country during the year. • It is the total income of all factors of production including the income of self-employed person, labourers, capital and land (L,L,K,E)
“Transfer Payment” • should not be included in calculating NI to avoid double counting problem. • Transfer payment refers to income received without any direct contribution to the production of goods and services. • is simply transferred from one group or people to another; without the recipients adding any value to production or volume of goods and services in the country.
e.g; Transfer Payment • Pensions • Welfare benefits • Scholarships • Unemployment benefits • Sale of a second-hand goods e.g. an existing house • Allowances to housewife • Interest on national debt
Example1: • En. Ahmad previously was a self-employed man with an income of RM1, 500. He later quit from business become an employee of a manufacturing company and earn a salary of RM3, 200 per annum. In closing down his business, he had to dismiss two assistants, each previously receiving a salary of RM700 and RM800 respectively. Each of the assistants subsequently now received social security benefits (unemployment benefit) worth RM300 per month. What is the net change in national income? The change in national income as a result of this was: • Previously self-employed RM1, 500 • Presently employed + RM3, 200 • Dismissal of 2 assistants RM1, 500 __________ Net Increase of NI is: + RM 200 Social security benefit is an example of transfer payment, so is not included in the calculation of national income.
Total Domestic vs Total National Income • Total Domestic Income is the total income earned within a territorial or geographic boundary. • It includes income earned by its citizens as well as its non-citizens i.e. foreign workers residing or working in the country. • Total National Income is the total income earned by citizens of the country irrespective whether the citizens reside / working in the country or outside the country (abroad). • It will exclude all income earned by foreign workers in the country.
Example 2: Given the following data, find the national income of country XYZ; • Domestic Income Rs 800m • Income paid abroad Rs200m • Income received from abroad Rs 180m Answer:The national income of country XYZ is as follows: Rs800m 200m + 180m = Rs 780m
Personal Income vs Personal Disposable Income • Personal Income is the gross receipt of income regardless of its source. It can come from productive and non-productive sources (transfer payment). And minus the contribution to Employees Provident Fund (EPF). Thus it is totally different from gross earning of factor income (GDI or GNI). • Personal Disposable Income is gross personal income less by the personal income tax paid.
Income Approach The components of this approach include: Wages and salaries Rs xxx Interest and dividends xxx Rent and imputed rent xxx Profits: distributed and undistributed profits, xxx income of self-employed xxx = Gross Domestic Income (at factor cost) XXXX Income paid abroad xxx + Income received from abroad xxx = Gross National Income XXXX Depreciation or capital consumption xxx = Net National Income XXXX (OR NATIONAL INCOME)
ii) OUTPUT APPROACH • Also known as Product Approach. • National Income (=GNP) is equivalent to the money value of all goods and services produced by all sectors in the country during a year.
The problem of double counting: • To avoid double counting, we only sum-up all the “value-added” of each sectors or at each stage of production to give us the national income value.