National Income Accounting (NIA)

1. National Income Accounting (NIA) Tragakes 2011, pp. 219-226 C. Bordoy UWC Maastricht

2. Measuring economic activity • It involves measuring the national income or output of an economy. Also referred to as NIA. • Why do we want to measure national income / value of aggregate output? • To assess performance over time • To make comparisons with other economies • As a basis for policy making C. Bordoy UWC Maastricht

3. In Microeconomics: quantity • In Macroeconomics: (monetary) value, as we need to add up quantities of output of many different goods and services. Value = quantity x price • Level of aggregate output= aggregate output= value of aggregate output. C. Bordoy UWC Maastricht

4. CFM: the value of aggregate output produced is equal to the total income generated in producing that output, which is equal to the expenditures made to purchase that output. • ‘National income’ and value of aggregate output sometimes used interchangeably. • There are three ways to measure the value of aggregate output. C. Bordoy UWC Maastricht

5. Expenditure approach. Measures total amount of spending to buy final goods and services. • Intermediate goods are not counted. • Four components: • Consumption spending (C): all purchases by households on final g&s in a year (excludes housing). • Investment spending (I) includes: • Spending by firms on capital goods • Spending on new construction • Changes in inventories C. Bordoy UWC Maastricht

6. Government spending (G): spending by governments within a country (national, regional, local). • Purchases of factors of production • Investment by governments (public investment), usually on capital goods: roads, airports, hospitals, schools,…). • Net exports, ie, exports minus imports (X-M). C + I + G +(X – M) = GDP C. Bordoy UWC Maastricht

7. GDP: the market value of all final goods and services produced in a country over a time period (usually a year). • Remarks on Investment: • Investment is carried out also by governments, but included under G. • Investment in capital includes only spending on physical capital, thus excluding: • Investments in human capital • Investments in natural capital C. Bordoy UWC Maastricht

8. Income approach. It adds up all income earned by the factors of production within a country over a time period. National income = wages+rent+interest+ profits ≠ GDP In order to calculate GDP, some adjustments need to be made to national income. C. Bordoy UWC Maastricht

9. Output approach. Measures the value of each good and service produced in the economy over a time period (a year) and then sums them up to obtain the total value of output produced. It calculates the value of output by economic sector, such as agriculture, manufacturing, transport, banking, etc. This is then added up to obtain the value of output for the entire economy. . C. Bordoy UWC Maastricht

10. GDP and GNI/GNP • In the real world, the value of output is not always equal to the total income generated in producing that output: • Output produced by factors of production owned by foreigners (a US multinational in India that remits its profits to the US). Does this profit count as Indian or US income? • A Spanish worker in Germany that sends a large part of his income to his family in Spain). Should this income be counted as Spain’s or Germany’s income?

11. Domestic (GDP) means that output has been produced by factors of production within the country, regardless of who owns them. • National (Gross National Income/Product) means that the income is the income of the residents in that country, regardless where this income comes from. • Profit remitted to US: included in Indian GDP but part of US’ GNI, as it is income received by US’ residents. • Value of output produced by Spanish worker is included in Germany’s GDP but his income sent to Spain is part of Spain’s GNI.

12. GNI or GNP is the total income received by the residents of a country. It is equal to the value of all final g&s produced by the factors of production supplied by the country’s residents regardless where they are located. • GNI = GDP + Income from abroad – income sent abroad

13. Nominal and real • Nominal value is value measured in terms of prices that prevail at the time of measurement. • If nominal GDP increases in a year, the increase may be due to • changes in the quantities of output produced or • changes in the prices of g&s or • changes in both. We are interested in knowing how much the quantity of output has increased, so we need a measure of GDP that is not influenced by price changes.

14. Real value is a measure of value that takes into account changes in prices over time. It allows us to make meaningful comparisons over time in the value of any variable that is measured in money terms. • Nominal GDP (GNI) is measured in terms of current prices and it does not account for changes in prices. • Real GDP (GNI) is a measure of economic activity that has eliminated the influence of changes in prices.

15. Total and per capita • Per capita=per person or per head. • GDP per capita = Total GDP / total population. • Why are per capita measures important: • Different population sizes accross countries

16. Population growth. Changes in the size of GDP per capita depend on the relationship between growth in total GDP and growth in population: • If total GDP increases faster than the population, then GDP per capita increases. • If population increases faster than GDP, then GDP per capita decreases.

17. Gross and net • The term ‘gross’ is related to spending to produce capital. • Physical capital has a finite life. Within a year, some of the capital goods become worn out and are thrown away. This worn out capital is called depreciation. • Total/Gross investment = Replacement of worn out capital goods (depreciation) + New additions of capital goods (net investment). • Gross inv = depreciation + net investment

18. GDP = C + I + G + (X-M), where I=gross investment. Therefore: • NDP = GDP - depreciation

19. Evaluation of national income statistics GDP and GNI are used to make comparisons among countries and over time and we use them as a measure of standards of living. However, they have two problems: • NI statistics do not accurately measure the true value of output produced in an economy. • Standards of living depend on a variety of factors which are not measured by NI statistics.

20. Why GDP/GNI do not accurately measure output • Non-marketed output: output of g&s that is not traded in the market and does not generate any income. Example: one’s own work on repairing one’s home. • Output sold in underground (informal=parallel) markets. Goods are traded in markets and generate income but they go unrecorded and are not included in the statistics. It includes: • Legal g&s (reselling a good at a higher price when there is a price ceiling, a plumber not reporting income to avoid paying taxes) C. Bordoy UWC Maastricht

21. Illegal g&s, such as drugs. • Quality of g&s are not accounted for. Technological advances often permit improved products to be sold at lower prices. This provides consumers with benefits which do not show up in statistics. • Negative externalities nor the depletion of natural resources are accounted for. They reduce society’s well-being but is not reflected in GDP/GNI. • Differing domestic price levels C. Bordoy UWC Maastricht

22. Consider two countries with GDP per capita=$1000 producing only one identical good Country A has a greater purchasing power (the quantity of g&s that can be bought with money) than country B, and thus a higher standard of living than the population of country B. If differences in price levels across countries are not accounted for, conclusions about standards of living are misleading. Solution: to convert GDP/GNI values using special exchange rates (purchasing power parities). C. Bordoy UWC Maastricht

23. Why GDP/GNI cannot accurately measure standards of living • They do not consider the composition of output (weapons, education, health…). One country may have a lower per capita GDP than another but higher levels of merit goods provision. • They cannot reflect achievements in levels of education, health and life expectancy, with a great impact on standards of living. The Human Development Index is a better measure. • No information on the distribution of income and output. C. Bordoy UWC Maastricht

24. They do not take into account increased leisure. The average number of hours worked per week has increased in many countries, with the number of leisure hours increasing. This contributes to higher standards of living, but is not accounted for in GDP/GNI. • They do not account for quality of life factors, such as: crime rate, well-functioning institutions, , degree of political freedom,… C. Bordoy UWC Maastricht