This Power Point introduces students to national income principles

2. LECTURE OUTLINE
 Define National Income
 Explain the three methods of its calculation (income, expenditure and output
approaches)
 Identify, explain and interpret the different measures of national income (GNP, GDP,
NNP )
 Identify and explain market price, factor cost, added value, real GDP and GDP deflator
 Explain the problems associated with calculating national income
 Explain how the various measures of national income are used and the limitations of
each measure

3. WHAT IS NATIONAL INCOME?
 This is the total value of all incomes earned by the factors of production during a
year.
 This is found by adding up all the incomes (i.e. wages & salaries, interest, rent and
profit) of all factors of production that are used to produce intermediate goods as
well as final goods
 All transfer payments (i.e. payments for which no direct service is rendered e.g.
pensions, disability grant and social security payments)must be excluded to avoid
double counting.
 National income is measured by calculating the value of output produced within the
country over a 12-month period (i.e. GDP)

4. HOW IS GDP CALCULATED?
 There are three methods available to calculate GDP and ALL three SHOULD
render the same value:
 Product Method:
 Income Method
 Expenditure Method
 Product Method:
 This involves adding up the values of all goods and services produced by all industries in
the country.
 Income Method:
 This involves adding up all incomes earned by the factors of production that were used to
produce the goods and services in the country.

5. HOW IS GDP CALCULATED?

6. EXPENDITURE METHOD

7. CALCULATING GDP – EXPENDITURE
METHOD
 This involves adding up all money spent on final goods and services which is usually at
market prices.
 All money spent on final goods and services includes:
 Consumer Expenditure
 Government Expenditure (excludes transfer payments)
 Investment Expenditure
 Investment in Buildings , Equipment and Machinery
 Increase/Decrease in Inventories
 Net Exports of Goods and Services (Exports – Imports)

8. PRODUCT METHOD

9. CALCULATING GDP – PRODUCT
METHOD
 This involves adding up the value of goods and services produced (e.g. Dresses sold, food
sold, all items of clothing sold, manicures and pedicures, banking services, doubles sold
etc) in the country during the year.
 The various goods and services produced in a country are usually grouped into broad
categories that are obtained from an internationally agreed upon reference classification of
productive activities (i.e. International Standard Industrial Classification of All Economic
Activities (ISIC)).

10. AVERSION OF PROBLEMS IN CALCULATING
GDP USING THE PRODUCT METHOD
 Double Counting:
 This involves adding a value of a good or service twice.
 E.g. The flour used in doubles should not be counted as flour when it was sold as flour to
the doubles vendor and then as part of the doubles. Doing this will be double counting.
Instead the flour should be counted once and it is advisable to count it as part of the
finished good or service. This means if the doubles vendor used $0.75 worth of flour to
make the doubles and the vendor sells doubles at $4 each then the value of output
produced should not be $0.75 plus $4 instead it should be $4 as the $0.75 is already
included in the $4.
 An alternative way to avoid double counting is to count the value added at each stage of
production (recall the stages of production are: primary (raw materials being extracted),
secondary (combining the raw materials to make a finished good or service) and tertiary
(the distribution of good or service). This is called the Gross Value Added method.

11. AVERSION OF PROBLEMS IN CALCULATING
GDP USING THE PRODUCT METHOD
 Stocks or inventories issues:
 Stocks must be considered as valued added in the year they are used!!!
 Stocks/Inventories used in the production of goods and services that are incomplete at the
end of the year are treated as stocks/inventories when calculating GDP. Thus when the
product is completed the stocks/inventories which was already considered as GDP must
not be counted again in the final product.
 Stocks/Inventories used in products that are unsold at the end of the year must be treated
as partially finished goods and thus cannot be counted as part of the sold product
 Stocks/Inventories must be adjusted to take into consideration changes in prices that may
have occurred because there has not been any change in the amount of output.

12. AVERSION OF PROBLEMS IN CALCULATING
GDP USING THE PRODUCT METHOD
 Government services (e.g. Heath care and education) must be valued when calculating
GDP at what they cost to produce
 Ownership of Dwellings (i.e. Buildings and Houses) are valued at an imputted rental value
(i.e. An estimated rental value is used for the service)
 Taxes and Subsidies on Products are EXCLUDED from Gross Value Added. However
these are added to get GDP AT MARKET PRICES

13. INCOME METHOD

14. CALCULATING GDP – INCOME
METHOD
 This involves adding up the incomes generated from the production of goods and
services.
 This method assumes that the sum of the incomes generated is the same as the sum
of all values added because Sales Revenue – Cost of Purchases = Value Added
which is the payment for wages, salaries, rent, interest and profit

15. AVERSION OF PROBLEMS IN CALCULATING
GDP USING THE INCOME METHOD
 Stock Appreciation
 Gains in Firms’ Profits that are due to Stock/Inventory Appreciation must be deducted because
the increase in value is not a result of an increase in output but rather an increase in price
 Transfer Payments
 These are not included as these payments ARE NOT for contributing to the production of goods and
services.
 Direct Taxes
 These are INCLUDED in GDP calculations since the income paid for the production of goods and
services (i.e. GROSS SALARY OR GROSS WAGE) is what is needed when using the Income Method
 Taxes and Subsidies on Products
These are EXCLUDED in GDP calculations since these are not apart of the production process.

16. EXPLAINED

17. KEY TERMS
 GDP at market prices aka Nominal GDP:
 This is the value of output or income or expenditure in terms of the prices actually paid.
 This is obtained by adding the difference between Taxes on products and Subsidies on
products to Gross Value Added
 GDP at constant base year prices aka Real GDP
 This is the value of output or income or expenditure using a particular year prices. This year is
called the base year.
 Gross National Income (GNY):
 GDP at market prices + Net Income from abroad
 Difference between GDP and GNY
 GDP focuses on the value of domestic production while GNI focuses on the value of
incomes earned by domestic residents

18. KEY TERMS
 Net National Income (NNY):
 GNY – Allowance for Depreciation of Capital (i.e. Capital Consumption)
 Depreciation:
 The decline in value of capital equipment due to wear and tear
 Households’ Disposable Income (HDY):
 This is the income households have available to spend which is obtained after taxes are
deducted and benefits are added to personal income.
 HDY = GNY at market prices – Taxes paid by firms + Subsidies recd by firms – Depreciation
– Undistributed Profits – Personal Taxes + Benefits

19. KEY TERMS


20. USES OF NATIOANL INCOME
STATISTICS
 Changes in National Income can be used as an indicator of a change in the economic
welfare of a country’s population
 To compare different countries’ standards of living.
 In order to compare countries living standards real output per capita must be adjusted to take
into consideration the different currencies and the different needs and tastes of populations
within each country. This is done by adjusting for difference in price levels (i.e. purchasing
power parity).
 Government planning can occur:
 Since there is a connection in the short-term between real national income and the level of
employment as well as a connection between real national income and the level of inflation.

21. DIFFERENCE BETWEEN FULL
EMPLOYMENT AND NATIONAL INCOME
EQUILIBRIUM
 The Full Employment Level of National Income is the level of National Income at which
the economy is operating at its full capacity. This means that all available resources are
being fully utilised.
 National Income Equilibrium occurs when Aggregate Demand = Aggregate Supply