CHAPTER 2 NATIONAL INCOME (GDP and GNP) 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.
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).
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.
Lets have a 5 minutes break
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 RM800m • Income paid abroad RM200m • Income received from abroad RM180m Answer:The national income of country XYZ is as follows: RM800m 200m + 180m = RM780m
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) and contribution to SOCSO. 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 RM 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.
Value-added concept • To avoid double counting, calculation must be based on either one of the followings: • Measure only the total market value of all final goods and services produced in the country. OR b) Calculate national output based on the value added.
EXAMPLE: Firm Stage of Production Purchasing Selling Value ____ ________________ Price (RM)Price (RM)Added (RM) A Landowner sells trees - 100 100 to sawmill owner B Sawmill owner cut into 100 180 80 timber sheets to furniture manufacturer C furniture manufacturer 180 290 110 turns timber sheets into furniture and sells to retailer D retailer sells furniture to final 290 420 130 consumer TOTAL VALUE 570 990 420 Total value added = Total value of Sales – Cost of intermediate goods = 990 – 570 = 420
The concept of Market Price and Factor Cost • In most cases, Market Price (MP) > Factor cost (FC) Market Price = FC + indirect taxes – subsidies OR Factor Cost = MP – indirect taxes + subsidies
Output Approach The components are: RM The total value of final goods and services in the economy or the total sum of “value-added” of all industry or stage of production. = Gross Domestic Product at market price XXXX (GDP at mp) Income paid abroad xxx + Income received from abroad xxx = Gross National Product at market price XXXX (GNP at mp) Indirect taxes or taxes on expenditure xxx + Subsidies xxx = Gross National Product at factor cost XXXX (GNP at fc) Depreciation or capital consumption xxx = Net National Product at factor cost XXXX (NNP at fc OR NATIONAL INCOME)
iii) EXPENDITURE APPROACH • 4 components included here: a) Household or consumer expenditure on consumption goods, (C). b) Firm or producer expenditure of capital goods. Also known as gross investment or gross private capital formation (I). c) Government expenditure on goods and services, excluding transfer payment (G). d) Expenditure on exports and imports (X – M). Y = C + I + G + (X – M)
Gross vs Net Investment • Gross Investment is the expenditure on new construction, purchase on new equipment and change in stock • Net Investment is gross investment minus depreciation of capital. • Depreciation (capital consumption) is defined as an allowance that is put aside for machinery wears out and stocks used up due to its obsolete and deteriorated nature after being used for some time. Net Investment = Gross Investment – Depreciation of capital
Expenditure Approach The components include;RM the household expenditure (C), firm expenditure or gross investment (I) and government expenditure (G). + or – change in stock xxx =Total Domestic Expenditure at market price XXXX (TDE at mp) + Exports and Imports xxx =Gross Domestic Expenditure at market price XXXX (GDE at mp) Income paid abroad xxx + Income received from abroad xxx =Gross National Expenditure at market price XXXX (GNE at mp) Indirect taxes xxx + Subsidies xxx =Gross National Expenditure at factor cost XXXX (GNE at fc) Depreciation or capital consumption xxx = Net National Expenditure at factor cost XXXX (NNE at fc) (OR NATIONAL INCOME)
Few things to remember: • To change from market price to factor cost: minus indirect tax plus subsidies.
Few things to remember: • To change from Domestic to National value: plus or minus NPIFA • To change from Gross to Net value: minus capital consumption. • To change from NI to Personal Income (PI): plus transfer payment and any benefits minus any contribution (EPF, SOCSO) • To change from PI to DPI: minus income tax
Income ApproachGiven the information: RM million Total wages and salaries received 255,650 Total interest and dividends received 10,000 Total rent and imputed rent 80,880 Gross trading profits from companies 65,500 Total income of self-employed 33,700 Income paid abroad 54,345 Income received from abroad 76,680 Capital consumption 445 Find: i) GDP at factor cost ii) GNP at factor cost iii) NI
Answer: Income Approach RM million Total wages and salaries received 255,650 Total interest and dividends received 10,000 Total rent and imputed rent 80,880 Gross trading profits from companies 65,500 Total income of self-employed 33,700 GDI fc (GDP fc) 445,730 • Less income paid abroad (54,345) • Add income received from abroad 76,680 GNI fc (GNP fc) 468,065 • Less Depreciation on capital consumption (445)NNI fc 467,620
Output Approach RM million Agriculture, forestry and fishing 4,296 Mining and quarrying 6,700 Manufacturing 28,965 Construction 15,550 Services 13,220 Net exports 3,000 Appreciation in stock 2,000 Income paid abroad 15,432 Income received from abroad 17,66 Indirect taxes 599 Subsidies 333 Depreciation of capital 1,545 Compute the value for: i) GDP at market price ii) GNP at market price iii) GNP at factor cost iv) NI
Answer: Output Approach Agriculture, forestry and fishing 4,296 Mining and quarrying 6,700 Manufacturing 28,965 Construction 15,550 Services 13,220 Net exports 3,000 Appreciation in stock (2,000) GDP mp69,731 • Less income paid abroad (15,432) • Add income received from abroad 17,66 GNP mp 70,965 • Less indirect taxes (599) • Add subsidies 333 GNP fc 70,699 • Less depreciation (1,545)NNP fc (NNI) 69,154
Expenditure Approach RM million Total consumer expenditure (C) 50,000 Gross investment (I) 20,000 Government expenditure (G) 18,500 Add exports (X) 9,000 Less imports (M) ( 8,565) Change in stock 1,000 Net factor Income from abroad 250 Expenditure taxes 870 Subsidies 695 Capital consumption 2,750 Given the information above, calculate the values for: i) GDP at market price ii) GNP at market price iii) GNP at factor cost iv) NI
Answer: Expenditure ApproachRM million Total consumer expenditure (C) 50,000 Gross investment (I) 20,000 Government expenditure (G) 18,500 Add exports (X) 9,000 Less imports (M) ( 8,565) Change in stock 1,000 GDE mp (GDP mp) 89,935 • Less Income paid abroad (3,700) • Add income received from abroad 3,950 GNE mp (GNP mp) 90,185 • Less Indirect taxes (870) • Add subsidies 695 GNE fc (GNP fc) 90,010 • Less Depreciation (2,750) NNI fc (NI) 87,260
Uses and Importance of National Income • Useful in measuring the standard of living of a nation through estimating per capita income of the nation.
Uses and Importance of National Income • Useful in measuring the standard of living of a nation through estimating per capita income of the nation. • Time series comparison (year to year). Measuring growth of the economy.