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In this lesson, we discuss the meaning of national income and explore different approaches to measuring it, including the output approach, expenditure approach, and income approach.
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Principals of Economics Law class By Edward Gatwaza 12/03/2018 Lesson Eight
NATIONAL INCOME 8.1 Meaning • National income can be predictable if all accounts of data are collected and published by the government describing the various components of national income and output in the economy. • Gross National Product (GNP) is the total market value of all final goods and services produced by all citizens and residents of a country who are in and outside the country. • Gross domestic product (GDP) is the total market value of all final goods and services produced within a given period by factors of production located within a country. We shall define the difference shortly. Both and others mentioned below measure the social or national product of a country.
NATIONAL INCOME 8.2. Measuring Approaches • GNP can be measured in three ways Output Approach. • It is also called industry of origin approach and more commonly Value added Approach. Value added is the difference between the value of goods as they leave a stage of production and the cost of the goods as they entered that stage. Expenditure approach • It is a method of computing national production that measure the amount spent on all final goods during a given period.
Measuring Approaches Income approach • A method of computing the national product that measures the income-wages, rents, interest and profits received by all factors of production in producing final goods. • The three approaches can be demonstrated by the Circular Flow of Economic activities we saw at the beginning.
Circular Flow of Economic • In the circular flow, households sell factors of production and receive INCOMES. The sum of these incomes is the national income by income approach, which is marked as Flow no 1. • The firms use the factors of production to produce goods and services. The total value (final) or goods and services is given by Flow no 2. It is the PRODUCT approach. • In payment for the goods and services, households will use the income earned from selling factors to spend in the product market. It is Flow no 3. Which is EXPENDUTE, approach. The Broken line represents the monetary flow while the thick line represents the real flow.
8.3. Component of the Approaches Outputs Approach: it is the sum of the value added of different sectors in the economy. Suppose there is an economy made up of three sectors. Wheat cultivation , flour milling and a bakery. • Wheat farming produces 1,000 million RWF worth of goods • Flour milling 1,500 million of RWF • Bakery 2,000 million of RWF The national Product by output approach is not the sum of these. It is not RWF 4500. It is the sum of the value added.
Outputs Approach: • Wheat farming has added to the economy the whole of 1000 • Flour milling has added 1500-1000 or 500 RWF worth of goods • Baking has added 2000-1500 or 500 worth of goods to the economy. • The national product is therefore, in the hypothetical economy 2000 RWF. Note that it has the same value of the final goods.
The expenditure Approach The expenditure Approach is stated as follows: Y = C+I+G+X-G. Let us elaborate this, since we tend to use this more often. It is the value of all final goods and services. • Personal consumption expenditures (C) – Household spending on consumer goods. • Gross private domestic investment (I) – spending by firms and households on new capital: plant, equipment, inventory, and new residential structures. • Government consumption and gross investment (G) • Net exports (X-M) – net spending by the rest of the world, or exports (X) minus imports (M)
The expenditure Approach Expenditure categories: • Personal consumption expenditures (C) are expenditures by consumers on the following: • Durable goods: Goods that last a relatively long time, such as cars and household appliances. • Nondurable goods: Goods that are used up fairly quickly, such as food and clothing. • Services: The things that we by that do not involve the production of physical things, such as legal and medical services and education. • Investment refers to the purchase of new capital.
The expenditure Approach • Total investment by the private sector is called gross private domestic investment. It includes the purchase of new housing, plants, equipment, and inventory by the private (or non-government) sector. • Gross investment is the total value of all newly produced capital goods (plan, equipment, housing, and inventory) produced in a given period. • Government consumption and gross investment (G) counts expenditures by central and local governments for final goods and services. • Net exports (X-M) is the difference between exports (sales to foreigners of Rwanda- produced goods and services) and imports (Rwanda purchases of goods and services from abroad). The figure can be positive or negative.
Income Approach is as stated already. • Y = w+i+Π+r; where w are wages i interest , Π is profit, and r is rent. • Wages : Wages include all wages, salaries and benefits. • Interest: Includes the net interest paid by businesses to individuals. • Corporate Profits: Includes the net income of corporations whether paid as dividends or retained. • Rent: Includes all income from providing services of houses, land and buildings. • Income of Proprietors: For propriety businesses. It is difficult to separate out the components that correspond to wages, rent, interest, and profits, so the proprietors’ incomes are included in National Income as a total sum.
8.4. Aggregation • Three theories of aggregation are used. • National and domestic • This is why there is a distinction between Gross Domestic Product and Gross National Product. The difference is property income from abroad. GNP is the final value of goods and services by citizens of a country. Thurs the goods and services belonging to Rwandans, but were produced outside the country will be counted. Goods and services by foreigners in Rwanda will be reduced from our accounting. • Gross Domestic Product is the goods and services produced within the boundaries of a country. So in fact GDP is GNP minus Net property income from abroad. It is net because as said above we subtract what foreigners produced in Rwanda.
Aggregation • In is interesting to note that in developing countries GDP ends up being more than GNP. In developing countries GNP may be more than GDP. Why? In our countries there may be a lot of investment by foreigners such that income from abroad by Rwandans in less than income going to foreign countries from Rwanda. As a result, Net Property Income from abroad will be negative.
Gross and Net • Gross National Product is different from Net National Product (NNP). In Gross aggregate are estimates of depreciation. Thus the differences are allowances for depreciation. Net estimates are not very commonly used. However, when we talk of National Income we are often referring to NNP.
Market price and factor cost • The value of final goods and services are market price estimates. Thus to get factor cost from market price adjustment to be made is subtraction of indirect taxes. However, if there are subsidies in the economy we add them to market price estimates. GNPmp minus Net Indirect Taxes is GNPfc. It is Net because of the subsidies. The same adjustment should apply, from GDPmp to GDPfc. • Now recalling that National Product is equal to National Expenditure an is equal to National Income, and then the following identities are true GNP=GNI=GNE. For every aggregation there will be Domestic and mp and fc. For National Product alone there are GNP, NNP, GDP, NDP, GNPmp, GNPfc, NNPmp and NDPfc. • Example
In a hypothetical economy the following data was given in million of RWF. • indirect taxes 15 • imports 8 • buying of durable goods for home consumption 68 • buying of military uniforms 45 • exports 32 • depreciation 6 • property payments to foreign countries 12 • buying of non-durable goods for households 35 • subsidies 3 • property payments to foreign countries 5 • buying schools equipment 22 • gross domestic investment 45
Market price and factor cost Calculate • a) GNP at market price • b) GDP at factor cost • c) NNP at market price and • d) NDP at factor cost.
8.6. Problems of Measuring National Income National income accounting or measuring the social product is difficult. Most of the data are estimates. It is because of a number of problems: • Unpaid services. There are many activities in the economy that are not accounted for. For example the services of a housewife do not appear in national accounts. • Double counting. If in the example at the beginning we were to include the value of flour together with the value of bread in the baking industry then flour would have been counted twice. • Large subsistence economies. Many of our economies have large non-monetary production for owns consumption. National accountants have to estimate these activities.
Problems of Measuring National Income • Weak statistical base. The facilities and capacities to assemble reliable statistics make it harder to produce reliable estimates. • Depreciation. It is one of the most difficult items to estimate in an economy. It can be expected that the figures for depreciation are mere estimates. • Adjustment. Figures for all other adjustments are also not always easy to get and estimate. There are for instance property income, taxes and subsidies.
