National income accounting measures a country's total economic output and income. It uses Gross Domestic Product (GDP) and Gross National Product (GNP) to calculate the total value of final goods and services produced. GDP measures output within a country's borders, while GNP includes income from domestic and foreign sources. GDP can be calculated using either the income approach by adding up wages, profits, interest and rents, or the expenditure approach by adding consumption, investment, government spending, and net exports. Real GDP adjusts for inflation to measure output in constant prices.

1. National Income
Accounting &
Gross Domestic
Product

2. Chapter Objectives
• State why national income
accounting is important

3. Chapter Objectives
• State why national income accounting is
important.
• Define GDP, GNP, and NI.
• Calculate GDP in a simple example, avoiding
double counting.

4. Chapter Objectives
• Explain why GDP = C + 1 + G + (X - M).
• Distinguish between real and nominal values.
• State some limitations of national income
accounting.

5. Measures of Output
• National income accounting refers to a
set of rules and techniques that are used
to measure the national income of a
country.
• It refers to the measurement of
aggregate economic activity, particularly
national income and its components.

6. National Income Accounting
• Measuring Total Economic Output of
Goods and Services
–Gross Domestic Product (GDP) is the
total value of all final goods and
services produced in an economy in a
one-year period.
• It is the single most-used economic
measure.

7. National Income Accounting
• Measuring Total Economic Output of
Goods and Services
–Gross National Product (GNP) is the
aggregate final output of citizens and
businesses of an economy in one year.

8. National Income Accounting
• Measuring Total Economic Output of
Goods and Services
–GDP measures the economic activity
that occurs within a country.
–GNP measures the economic activity of
the citizens and businesses of a
country.

9. National Income Accounting
• Moving from GDP to GNP
–To move from GDP to GNP, net foreign
factor income is added to GDP.
–Net foreign factor income is the
income from foreign domestic factor
sources minus foreign factor incomes
earned domestically.

10. The Circular Flow
• The national income accounting identity is the
accounting equality of output and income.

11. The Circular Flow
Household Firms
(production

12. The Circular Flow
Goods
Household Firms
(production

13. The Circular Flow
Factor services
Goods
Household Firms
(production

14. The Circular Flow
nt
Factor services
Goods
Household Firms
(production

15. The Circular Flow
nt
Factor services
Goods
Household Firms
(production
al consumptio

16. The Circular Flow
nt
Factor services
Goods
Household Firms
(production
Financial mar ets
k
al consumptio

17. The Circular Flow
nt
Factor services
Goods
Household Firms
(production
Financial mar ets
k
al consumptio

18. The Circular Flow
nt
Factor services
Goods
Household Firms
(production
Government )G
Financial mar ets
k
al consumptio

19. The Circular Flow
nt
Factor services
Goods
Household Firms
(production
Government )G
Financial mar ets
k
al consumptio
Other countr
ies

20. Two Approaches to Calculating GDP
• The Income Approach
– The income approach is shown on the top half of
the circular flow.
– National income is the total income earned by
citizens and businesses in a country in one year.
– Firms make payments to households for supplying
their services as factors of production.

21. Two Approaches to Calculating GDP
• The Income Approach
– These factors are broken up into employee
compensation, rent, interest, and profits.
• Employee compensation is payments for labor such as
salaries and wages.
• Rents are payments for use of land and buildings.
• Interest includes payments for loans by households to
firms.
• Profits are payments to the owners of firms

22. Two Approaches to Calculating GDP
• The Expenditure Approach
– The expenditure approach is shown on the
bottom half of the circular flow.
– Specifically, GDP is equal to the sum of the four
categories of expenditures.

23. Two Approaches to Calculating GDP
• The Expenditure Approach
– Specifically, GDP is equal to the sum of the four
categories of expenditures.
GDP = C + I + G + (X - M)

24. Two Approaches to Calculating GDP
• The Expenditure Approach
– Consumption
• When individuals receive income, they can spend it on
domestic goods, save it, pay taxes, or buy foreign
goods.
• This is the largest and most important of the flows.

25. Two Approaches to Calculating GDP
• The Expenditure Approach
– Investment
• The portion of their income that individuals save leaves
the income stream and goes into financial markets.
• Business spending on equipment, structures, and
inventories is counted as investment.

26. Two Approaches to Calculating GDP
• The Expenditure Approach
– Government consumption and investment
• When individuals pay taxes, those taxes are either
spent by government on goods and services or are
returned to individuals in the form of transfer
payments.

27. Two Approaches to Calculating GDP
• The Expenditure Approach
– Government consumption and investment
• The connection drawn between the government and
the financial markets is there because if the
government runs a deficit, it must borrow from
financial markets to make up the difference.

28. Two Approaches to Calculating GDP
• The Expenditure Approach
– Net exports
• Spending on foreign goods escapes the system and
does not add to domestic production, thus spending on
imports are subtracted from total expenditures.
• Exports to foreign nations are added to total
expenditures.
• Exports to foreign nations are added to total
expenditures.
• These flows are usually combined into net exports.

29. Two Approaches to Calculating GDP
• Equality of Income and Expenditure
– Income and expenditures must be equal because
of the rules of double-entry bookkeeping.
– Profit is the balancing item.

30. Two Approaches to Calculating GDP
• Equality of Income and Expenditure
– The national income accounting identity allows
GDP to be calculated either by adding up all values
of final output or by adding up the values of all
earnings or income.

31. Using GDP Figures
• Comparing GDP Among Countries
– Per capita GDP is another measure often used to
compare nations' GDP.
• Per capita can be a poor measure of the various living
standards in various nations.

32. Using GDP Figures
• Comparing GDP Among Countries
– Per capita GDP is another measure often used to
compare nations' GDP.
• To get around the problems of per capita GDP,
economists use purchasing power parity, which adjusts
for different relative prices among nations before
making comparisons.

33. Using GDP Figures
• Economic Welfare Over Time

34. Using GDP Figures
• Real and Nominal GDP
– Nominal GDP is GDP calculated at existing prices.
– Real GDP is nominal GDP adjusted for inflation.
– Real GDP is nominal GDP adjusted for inflation.
• Real GDP is important to society because it measures
what is really produced.

35. Using GDP Figures
• Real and Nominal GDP
– Real GDP is nominal GDP adjusted for inflation.
• By dividing nominal GDP by the GDP deflator, we arrive
at real GDP.
Nominal GDP
Real GDP =
GDP deflator

36. GDP deflator
• The GDP deflator is a measure of the level of
prices of all new, domestically produced, final
goods and services in an economy.

37. Per Capita Real GDP
To compare per capita GDP in one year with that of
another year we have to correct for inflation. In other
words, we really need to revise our formula
Real GDP
Per capita real GDP = ----------------------
Population

38. Some Limitations of National Income
Accounting
• GDP measures market activity, not welfare.
– GDP does not measure happiness, nor does it
measure economic welfare.
• GDP measures market activity, not welfare.
– Welfare is a complicated idea, very difficult to
measure.

39. Some Limitations of National Income
Accounting
• Measurement Errors

40. Some Limitations of National Income
Accounting
• Measurement Errors
– GDP figures do not measure all market economic
activity.
– GDP figures do not measure the following market
activities:

41. Some Limitations of National Income
Accounting
• Measurement Errors
– GDP figures do not measure the following market
activities:
• Illegal drug sales.
• Under-the-counter sales of goods to avoid income and
sales taxes.
• Work performed and paid for in cash.

42. Some Limitations of National Income
Accounting
• Measurement Errors
– GDP figures do not measure the following market
activities:
• Unreported sales.
• Prostitution, loan sharking, extortion, and other illegal
activities.

43. Some Limitations of National Income
Accounting
• Measurement Errors
– Estimates of the size of the underground economy
range from1.5 to 20 percent of GDP.

44. Some Limitations of National Income
Accounting
• Measurement Errors
– A second type of measurement error occurs in
adjusting GDP for inflation.
• If the price and the quality of a product go up together,
has the price really gone up?

45. Some Limitations of National Income
Accounting
• Measurement Errors
– A second type of measurement error occurs in
adjusting GDP for inflation.
• Is it possible to measure the value of quality increases?

46. Some Limitations of National Income
Accounting
• Misinterpretation of Subcategories
– For example, the line between investment and
consumption is often fuzzy.

47. Some Limitations of National Income
Accounting
• Misinterpretation of Subcategories
– For example, the line between investment and
consumption is often fuzzy.
• Buying a steam iron would be consumption, and if it is
used to iron team T-shirts sold by a home business, it
would still be counted as consumption.

48. Some Limitations of National Income
Accounting
• Misinterpretation of Subcategories
– For example, the line between investment and
consumption is often fuzzy.
• Investment includes private housing units, but they do
not usually add to our stock of productive tools.

49. Some Limitations of National Income
Accounting
• Misinterpretation of Subcategories
– For example, the line between investment and
consumption is often fuzzy.
• Investment includes private housing units, but they do
not usually add to our stock of productive tools.
• The garages and spare bedrooms might if they are used
in an income-producing capacity.

50. Some Limitations of National Income
Accounting
• Misinterpretation of Subcategories
– Some social scientists have developed alternatives
to GDP such as the Gross Process Indicator (GPI).

51. Some Limitations of National Income
Accounting
• Misinterpretation of Subcategories
– Some social scientists have developed alternatives
to GDP such as the Gross Process Indicator (GPI).
• The GPI tries to measure pollution, education, health
concerns, as well as GDP.

52. GDP Is Worth Using Despite Its
Limitations
• National income accounting should be used
with sophistication.

53. GDP Is Worth Using Despite Its
Limitations
• It is a powerful economic tool that informs
average citizens about the direction the
economy is moving.

54. Thanks