PBBS 214 Principles of Economics II Macro Lecture

PBBS 214: Principles of Economics II (Macro) Lecture 2 National Income – Measurement and Uses Michael Insaidoo

Learning Objectives Lecture 3 After completing this lecture, you will: § Understand the measurement of national income § Also understand the various approaches involved in the measurement of national income § Understand the uses of national income § Understand the problems associated with the measurement of national income

Defining National Income Lecture 3 § National Income is the monetary value of final goods and services produced by citizens (nationals) of a country during a period of time usually one year § Goods can be final and intermediate § Final goods are those goods that do not enter into further stage of processing or reselling. Example is sugar cane which is sold to consumers and chewed § Intermediate goods are those goods that go into further processing or resale before consumption. Example is sugar cane which is processed into sugar by a sugar factory

Approaches of Measurement of National Lecture 3 Income There are three approaches in the measurement of national income which are: § Income Approach § Product or Output Approach § Expenditure Approach The three approaches results in identical or same results due to the circular flow of income

The Circular Flow of Income Lecture 3 § The Circular Flow of Income makes it possible for the national income to be measured using three approaches which gives the same results Assumptions 1) The economy is made up of two sectors – household sector and business sector 2) There is no role of saving and investment in the economy 3) The role of government and foreign sector is not captured 4) There is free flow of economic activities or resources

The Circular Flow of Income cont…. Lecture 3

The Circular Flow of Income cont…. Lecture 3 § Factor Market – Firms exchange money for the services provided by the households, that is wages – payments for labour services, interest on capital, rent for land profit for enterprise (entrepreneurship) • These represents incomes received by factors of prodn • The summation of these incomes gives national income § Product Market – Households exchange money for goods and services produced by firms. The summation of the values of goods and services produced by Firms gives National Product (Output). § The summation of expenditure by Households on

The Circular Flow of Income cont…. Lecture 3 goods and services gives the National Expenditure § From the diagram, one can conclude that National Income = National Product (Output) = National Expenditure

Income Approach Lecture 3 § This refers to the sum of all final incomes generated by the factors of production § Labour – wages, salaries, commissions etc. § Land – rent, royalties etc. § Capital – interest etc. § Entrepreneurship – Profits from businesses § Must be noted that only factor services that generates income is accounted for § Gifts, transfer payments, unemployment benefits etc are excluded

Income Approach cont…. Lecture 3 § Undistributed profits of business enterprises are added to that period’s national income § The summation of all these incomes gives Gross Domestic Income at factor cost (GDYf) § The subtraction or addition of net factor income from abroad (YA) to (GDYf) gives Gross National Income at factor cost (GNYf) = (GDYf) (+) or (-) (YA) § Gross National Income (GNYf) minus depreciation (dep) gives Net National Income at factor cost (NNYf) or National Income (NY). (GNYf) – (dep) = (NNYf)

Usefulness/Advantages of Income Lecture 3 Approach § It shows the functional distribution of income. This approach makes it possible to ascertain the incomes earned by the various factors of production § It provides income for Income tax planning. The income data provided by this approach forms the basic data for income tax planning. These are normally used to determine the income tax rates

Problems of the Income Approach Lecture 3 § § § Difficulties in ascertaining all factor incomes Problem of transfer payments Fringe benefits – payments of income in kind Owner-occupied houses Difficulty in estimating net factor income from abroad

Product (Output) Approach Lecture 3 § This approach sums up the market value of final goods and services of the productive sectors of the economy within a year § The productive sectors are the Agricultural, Industrial and Services sectors § Two ways of arriving at total product, either we sum up the values added at intermediate levels of production or the value of all final goods and services § Value Added is the difference between the gross value of a product and the raw materials that have gone into production

Product (Output) Approach cont…. Lecture 3 § The summation of monetary values of goods and services produced during the year gives Gross Domestic Product (GDP) at market prices § GDP at market prices plus or minus net factor income from abroad (YA) gives Gross National Product (GNP) at market prices. (GNP) = (GDP) (+) or (-) (YA) § Markets prices are inflated by the effect of indirect taxes and deflated by subsidies § Therefore, GNP at market prices must be converted to (GNPf) at factor cost by subtracting indirect taxes and adding subsidies

Product (Output) Approach cont…. Lecture 3 § When depreciation (dep) is subtracted from (GNPf), Net National Product at factor cost (NNPf) is obtained which is identical to National Income (NY) § (NNPf) = (GNPf) - dep

Final Goods and Value-Added methods Lecture 3 Stages of Production Sale Value in GHȼ Cost of Intermediate Goods Value-Added in GHȼ Maize 10 Corn Dough -0 18 10 -10 8 Kenkey 22 (Value of Final Goods) 50 -18 (Total cost of intermediate goods) 28 4 (Sum of value-added at each stage) 22 Total § Final goods method record value of kenkey (GHȼ 22) which is the same as 50 – 28. On the other hand, value added method sums up values added at each stage (22)

Usefulness/Advantages of Product Lecture 3 (Output) Approach § Knowledge of contribution of each sector. This approach allow an economy to know the contributions of each sector and sub-sectors § It indicates structural changes that are occurring in an economy. This approach enables an economy to know if there are changes in the output composition of the economy

Problems of Product (Output) Approach Lecture 3 § Difficulty in valuation of goods and services produced and consumed § Non-inclusion of some personal services § Double or multiple counting

Expenditure Approach Lecture 3 § This approach sums up final expenditures of macroeconomic sectors of a nation § For this purpose, the economy is divided into four spending sectors namely Households’ consumption (C), Firms’ private domestic investment (I), Government spending on final goods and services (G) and foreign sector – net exports (X – M) § The summation of all expenditures by these sectors gives the Gross Domestic Expenditure (GDE) at market prices which is equivalent to Gross Domestic Product (GDP) at market prices

Expenditure Approach cont…. Lecture 3 § Symbolically GDE = C + I + G + (X – M) § GDE plus or minus net factor expenditure from abroad or net factor income from abroad (YA) gives Gross National Expenditure at market prices (GNE) § (GNE) = (GDE) + or – YA § (GNE) at market prices minus indirect taxes and plus subsidies gives (GNE) at factor cost § (GNE) at factor cost minus depreciation (dep) gives Net National Expenditure at factor cost (NNE) which identical to National Income (NY). § (NNE) = (GNE) – (dep)

Usefulness/Advantages of Expenditure Lecture 3 Approach § Knowledge of various expenditure levels. This approach enables the economy to know the expenditure levels of the macroeconomic sectors, this helps in planning § Changing pattern of private consumption. This approach also allows an economy to know the extent of changing patterns of private consumption § Idea of expansion of productive capacity of the economy. This approach indicates the level of private domestic investment thus knowing the level of expansion of productive capacity

Problems of Expenditure Approach Lecture 3 § Difficulties in estimating exports and imports values. Under invoicing and over invoicing makes it extremely difficult to determine the actual value of net exports § Double or multiple counting. This happens when a unit of expenditure is counted more than once. To eliminate this, only expenditure on final output is counted § Lack of adequate statistics on expenditure levels. Many people do not keep accurate data on their expenditure levels, making it difficult to get accurate levels of expenditure

Nominal and Real National Income Lecture 3 § Nominal Income is the same as National Income at prices prevailing in a particular year of computation. It is also referred to as National Income at current prices § In order to eliminate price level changes or inflation from the national income data, it is converted into real value § Real National Income is also the same as National Income at constant prices § It reflects the real volume of goods and services produced

Nominal and Real National Income cont…. Lecture 3 § Real Nat. Inc = Nom Nat. Income × Base Yr. Price Index Current Yr. Price Index § Real Nat. Inc = Nom Nat. Income × 100 Current Yr. Price Index § Price Index is an index number that shows the weighted average prices of a ‘baskets of goods’ changes over time § GDP deflator measures the price level obtained by dividing the nominal GDP by the real GDP

Nominal and Real Gross Domestic Lecture 3 Product (GDP) § Real GDP = Nominal GDP × Base Yr. Price Index Current Yr. Price Index § Real GDP = Nominal GDP × 100 Current Yr. Price Index § Income Per Capita (PY) – This the national income divided by the population

General Problems encountered in Lecture 3 Measuring National Income § § § Double or Multiple Counting Non-marketed goods and services Inadequate statistical data Difficulty in estimating depreciation value Difficulty in getting accurate information from abroad

Uses of National Income Data Lecture 3 § Knowledge of the performance of the economy § Calculation of rate of growth of output in the economy § Indication of Sectoral contribution of the productive sectors § Information on the structural change of the economy § Knowledge of the various expenditure levels § Useful for income tax planning § Computation of income per capita figure § Guide for potential investors § For inter-temporal and international comparison of

Uses of National Income Data cont…. Lecture 3 economic performance

Measurement of Economic Welfare of a Lecture 3 Country § Economic welfare or wellbeing is the volume of the real goods and services enjoyed by each citizen of a nation § If the volume is high, then economic welfare is high all things being equal and vice versa § Again if the volume is high, then there is a high standard of living all things being equal and vice versa § Standard of living is inversely related to cost of living, if cost of living is high, standard of living is low all things being equal and vice versa § Again amount of leisure (entertainment, recreation) enjoyed by citizens enhances economic quality of life

Use of Income per capita statistic as a Lecture 3 measure of economic welfare § Generally countries use the Income per Capita (YP) statistic for measuring economic welfare § Thus a high YP statistic indicates that citizens enjoy a high volume of goods and services and hence an increase in their welfare all things being equal and vice versa

Problems of using Income per capita statistic Lecture 3 as a measure of economic welfare Income distribution is not taken into account Leisure is not taken account of Product quality might be poor Composition of output – probably a chunk will be military goods § Externalities are not taken account of. Pollution, traffic jams are not accounted for whilst positive externalities like education etc are also not taken account of § §

Use of Income Per Capita (Data) for Int’l Lecture 3 Comparison of Economic Welfare § Generally the income per capita statistic is used to compare economic welfare of countries § Thus if country A has a higher per capita income than country B, it is taken that country A enjoys a higher economic welfare than country B § There is however problems with this comparison

Problems of Using Income Per Capita (Data) Lecture 3 for Int’l Comparison of Economic Welfare Differences in currencies Differences in quality of goods and services Differences in composition of goods ands services Differences in the level of non-marketed goods and services § Differences in the level of enjoyment of leisure § Differences in Income Distribution q. The World Bank and UNDP developed the Human Development Index (HDI) in 1990 to address these problems. HDI combines income per head with § §

Problems of Using Income Per Capita (Data) Lecture 3 for Int’l Comparison of Economic Welfare cont measures of life expectancy, adult literacy, health provision, education, leisure time and so on