National Income Accounting – Lecture 1 Comprehensive Notes

1.0 Introduction

  • National income = monetary value of the flow of final goods & services produced within an economy over a specific period (usually 1 year).
  • Purpose: gauges the nation’s “wealth” & guides policy.
  • Key accounting identities/concepts to master:
    • GDPGDP / GDEGDE / GDIGDI (domestic, gross, market–price measures)
    • GNPGNP / GNEGNE / GNIGNI (national, gross, market–price measures)
    • NNPNNP / NNENNE / NNINNI (national, net of depreciation)
    • Per–capita income = National IncomePopulation\dfrac{National\ Income}{Population} ; proxy for average living standards.

1.1 Approaches for Estimating National Income

  • Three mutually‐consistent methods:
    • Expenditure Approach ⇒ sum of outlays by households, firms & government (plus external sector adjustments).
    • Income Approach ⇒ sum of factor earnings (wages, rent, interest, profit, etc.).
    • Product / Output / Value-Added Approach ⇒ sum of value added across primary, secondary & tertiary sectors.
  • Because of double-entry nature of the economy each approach must yield the same total when measurement is perfect.

1.2 Circular Flow of Income & Equality of the Three Approaches

  • Households supply factors ⇒ receive incomes (Income approach).
  • Firms buy factors ⇒ produce goods/services (Product approach).
  • Households spend incomes buying firms’ output (Expenditure approach).
  • Hence Income=Output=Expenditure.\text{Income} = \text{Output} = \text{Expenditure}.
  • Simple circular-flow excludes taxes, savings, gov’t, trade, but identity still holds after adding them.
  • Exam tip: If data for all three approaches are provided, each calculation must reconcile to the same GDP.

1.3 Items Excluded from National Income

  • Sales of Used Goods ⇒ already counted when first produced.
  • Trading of Financial Assets (T-bills, stocks, bonds) ⇒ merely swaps of ownership; no new production.
  • Government Transfer Payments (e.g. LEAP, pensions, unemployment benefits) ⇒ payments without current output.
  • Intermediate Products ⇒ counted only in final good to avoid double counting (e.g. wheat → flour → bread ⇒ only bread enters GDP).
  • Incomes from Illegal Activities ⇒ excluded where activity is unlawful (context-specific; e.g., prostitution excluded in Ghana but legal in Netherlands).

1.4 Usefulness of National / Per-Capita Income Estimates

  • Assess sectoral performance (e.g., Ghana’s agriculture share = 34 % in 2005).
  • International growth comparisons (2015: China ≈ $9,000\$9{,}000 vs USA ≈ $55,000\$55{,}000 per-capita).
  • Economic planning tool (contrast Nigeria vs South Korea; Ghana vs Malaysia trajectories).
  • Guide for foreign investors ⇒ higher per-capita income ⇒ larger purchasing power.
  • Track domestic living standards over time (per-capita rise from $1,000\$1{,}000 in 2004 to $2,300\$2{,}300 in 2015 implies better welfare, ceteris paribus).

1.5 The Expenditure Approach

  • Formula for open economy GDP at market price:
    GDEmp=C+I+G+(X−M)GDE_{mp}=C+I+G+(X-M)
  • Components:
    • Household consumption CC ⇒ durable, non-durable, services.
    • Firm investment II ⇒ machinery, buildings, inventories (∆stocks added if positive, subtracted if negative).
    • Government expenditure GG ⇒ capital, recurrent & investment outlays.
    • Net exports X−MX-M ⇒ exports minus imports.

1.5.1 Gross National Expenditure (GNE)

  • Adjusts for factor income flows:
    GNE<em>mp=GDE</em>mp+Factor income received abroad−Factor income paid abroadGNE<em>{mp}=GDE</em>{mp}+\text{Factor income received abroad}-\text{Factor income paid abroad}
    or GDEmp±net property income from abroad.GDE_{mp}\pm \text{net property income from abroad}.

1.5.2 GNE at Factor Cost

  • Remove indirect taxes, add subsidies to reveal true producer value:
    GNE<em>fc=GNE</em>mp−indirect taxes+subsidies=GNEmp±net taxesGNE<em>{fc}=GNE</em>{mp}-\text{indirect taxes}+\text{subsidies}=GNE_{mp}\pm \text{net taxes}
    where net taxes=subsidies−indirect taxes\text{net taxes}=\text{subsidies}-\text{indirect taxes}.

1.5.3 Net National Expenditure (NNE)

  • Deduct depreciation (capital consumption allowance):
    NNE<em>fc=GNE</em>fc−depreciationNNE<em>{fc}=GNE</em>{fc}-\text{depreciation}

1.5.4 Per-Capita Income

  • Per Capita Income=NNEfcPopulation\text{Per Capita Income}=\dfrac{NNE_{fc}}{Population}
Worked Example (abbreviated from pages 23-26)
  • Data given (household spending, investment, gov’t spending, trade, taxes, subsidies, factor income flows, depreciation).
  • Computations:
    1. GDEmp=$116,800GDE_{mp}=\$116{,}800
    2. GNEmp=$120,900GNE_{mp}=\$120{,}900 (adding net +$4,100+\$4{,}100 factor income).
    3. GNEfc=$118,500GNE_{fc}=\$118{,}500 (subtract taxes 6,7006{,}700, add subsidies 4,3004{,}300).
    4. NNEfc=$116,000NNE_{fc}=\$116{,}000 (less depreciation 2,5002{,}500).
    5. Per-capita with population 4 000 ⇒ $29\$29 per head.

1.6 Product / Output / Value-Added Approach

  • Add value added of each production sector, exclude intermediate goods & trade items:
    GDPmp=Primary+Secondary+TertiaryGDP_{mp}=\text{Primary}+\text{Secondary}+\text{Tertiary}
  • Sectoral definitions:
    • Primary (agriculture): farming, fishing, hunting, quarrying.
    • Secondary (manufacturing): convert raw inputs (e.g., Toyota Co., GHACEM).
    • Tertiary (services): communication, transport, education, tourism, health, etc.
  • No need for export/import figures because focus is on production, not spending.

1.6.1 Gross National Product (GNP)

  • National vs domestic adjustment:
    GNP<em>mp=GDP</em>mp+earnings of nationals abroad−earnings of foreigners at home=GDPmp±net factor income abroadGNP<em>{mp}=GDP</em>{mp}+\text{earnings of nationals abroad}-\text{earnings of foreigners at home}=GDP_{mp}\pm \text{net factor income abroad}

1.6.2 & 1.6.3 GNP at Factor Cost & NNP

  • GNP<em>fc=GNP</em>mp−indirect taxes+subsidiesGNP<em>{fc}=GNP</em>{mp}-\text{indirect taxes}+\text{subsidies}
  • NNP<em>fc=GNP</em>fc−depreciationNNP<em>{fc}=GNP</em>{fc}-\text{depreciation}
Worked Example (pages 32-35)
  • Summed sector outputs:
    • Primary = $78,300\$78{,}300
    • Secondary = $21,000\$21{,}000
    • Tertiary = $56,400\$56{,}400
    • GDPmp=$155,700GDP_{mp}=\$155{,}700
  • Net factor income abroad = −$4,700-\$4{,}700 ⇒ GNPmp=$151,000GNP_{mp}=\$151{,}000
  • Taxes 2,5002{,}500, subsidies 2,8002{,}800 ⇒ GNPfc=$151,300GNP_{fc}=\$151{,}300
  • Depreciation 2,5002{,}500 ⇒ NNPfc=$148,800NNP_{fc}=\$148{,}800
  • Population 3 000 ⇒ per-capita ≈$49.6\approx\$49.6

1.7 The Income Approach

  • Sums factor earnings:
    • Employee compensation (wages & salaries, bonuses, allowances).
    • Rents.
    • Royalties (for mineral/oil extraction, quarrying).
    • Interest on capital (physical capital, not cash).
    • Profits
    • Proprietors’ income (self-employed, unincorporated businesses).
    • Corporate profits (distributed dividends + undistributed retained earnings).
  • Gross Domestic Income at factor cost:
    GDIfc=Wages+Rent+Royalties+Interest+Proprietors Income+Corporate Profits+Dividends+Undistributed Profits+Other Factor EarningsGDI_{fc}=Wages+Rent+Royalties+Interest+Proprietors\,Income+Corporate\,Profits+Dividends+Undistributed\,Profits+Other\,Factor\,Earnings
  • Exclusions: transfer payments, black-market incomes, exports & imports (latter are expenditure items).
  • Indirect taxes & subsidies belong to market–price conversions, not income totals.
Worked Example (pages 39-41)
  • GDIfc=$88,700GDI_{fc}=\$88{,}700
  • GNI<em>fc=GDI</em>fc+net factor income=88,700+4,300−7,800=$85,200GNI<em>{fc}=GDI</em>{fc}+\text{net factor income}=88{,}700+4{,}300-7{,}800=\$85{,}200
  • Depreciation 3,6003{,}600 ⇒ NNIfc=$81,600NNI_{fc}=\$81{,}600
  • Population 5 000 ⇒ per-capita $16.32\$16.32

1.8 Measuring Price Changes: Real vs Nominal GDP

  • Nominal GDP ⇒ values current output at current prices.
  • Real GDP ⇒ values current output at constant base-year prices (e.g., 2005 dollars) ⇒ isolates quantity changes.
  • GDP Deflator (implicit price index):
    GDP Deflator=Nominal GDPReal GDP×100\text{GDP Deflator}=\dfrac{\text{Nominal GDP}}{\text{Real GDP}}\times100
  • Inflation between two years:
    \text{Inflation %}=\dfrac{\text{Deflator}{t}-\text{Deflator}{t-1}}{\text{Deflator}_{t-1}}\times100
    Example (2009–2010): [(111.0−109.7)/109.7]×100=1.2%[(111.0-109.7)/109.7]\times100=1.2\%
  • Called “deflator” because dividing nominal GDP by deflator removes price effects: Real GDP=Nominal GDPGDP Deflator/100Real\ GDP = \dfrac{Nominal\ GDP}{GDP\ Deflator/100}
  • Alternative explicit price indices: Consumer Price Index (CPI).

1.9 Problems in National Income Accounting

  • Double counting ⇒ solved via value-added & excluding second-hand goods.
  • Non-market activities (house helpers, home tutors) ⇒ underestimation.
  • Data unavailability/unreliability ⇒ informal sectors, tax evasion, poor record keeping.
  • Depreciation measurement challenges ⇒ different methods, uncertainty ⇒ NNP rarely published.
  • Subsistence agriculture (common in developing nations) ⇒ output not marketed, leads to understatement.

1.10 Criticisms of Per-Capita Income as Welfare Measure

  • Composition of Government Spending ⇒ lavish/profligate outlays inflate GDP but not welfare.
  • Differences in Working Conditions ⇒ richer countries often safer, healthier workplaces; raw income ignores this qualitative factor.
  • Environmental Damage Costs ⇒ GDP omits negative externalities (polluted air/water), overstating welfare.
  • Poor Data Collection ⇒ especially acute in developing countries; weak statistics mislead comparisons.
  • Income / Resource Distribution ⇒ high per-capita may mask severe inequality; small elite can skew average (e.g., resource-rich Gulf states).

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