Lecture 4

1. Lecture 4 National Income Accounting _Pt 3

2. National Income Accounting_Pt 3 Other measures of Income • GNP, NNP, National Income, Personal Income, Disposable income Nominal and real GDP • Calculations Limitations of the national income concept

3. Other measures of Income Largest to Smallest More complete picture • Gross Domestic Product (GDP) • Gross National Product (GNP) • Net National Product (NNP) • National Income • Personal Income • Disposable Personal Income

4. Other measures of Income:Gross Domestic Product Gross Domestic Product (GNP) • Total output of goods and services produced within nation’s borders • Excludes production by Ghanaians beyond domestic economy; includes production by foreigners in domestic country.

5. Other measures of Income:Gross National Product Gross National Product (GNP) • Total output of goods and services produced by nationals • Excludes production by foreigners within domestic economy; includes production by nationals in foreign country.

6. Other measures of income:Gross National Product Net Factor income from abroad = Output by nationals abroad - Output by foreigners • Ghana GNP = Ghana GDP + Net factor income from abroad Question (True/False) • When a Nigerian businessman builds a factory in Ghana; his production is part of Ghana’s GDP, but not Ghana’s GNP. Why? • Under what circumstance could a country’s GDP be equal to its GNP?

7. Net National Product • “Gross” stands for the fact that GDP/GNP accounts do not take “depreciation” into account. • Depreciation: The wear and tear down of machinery, tools, equipment, infrastructure used up in the production process.

8. Other measures of Income:Net National Product Net National Product (NNP) • Total production by a nation’s residents minus losses from depreciation Hence:NNP = GNP – depreciation NDP = GDP – depreciation Question • Difference/similarity between NDP and NNP?

9. Other measures of Income:National Income National Income • Total income earned by a nation’s residents in the production of goods and services, less depreciation • National National Income= NNP

10. Difference between NDP at Market Price and at Factor Costs National Product at factor cost • Includes payments made to factors of production National Product at market price • Market value of all final goods and services Market price includes indirect taxes (sales tax, excise duty, customs duty) • Income in the form of taxes is NOT factor income Therefore, NDP (factor costs)= NDP (market price) – indirect taxes + subsidies

11. Other measures of Income:Personal Income Personal Income • Income received by households and businesses Excludes: • retained earnings • Incomes that businesses have earned but have not paid out to owners Includes • interest income that households receive from their holdings of government debt • income from Transfer payments

12. Other measures of Income:Disposable Income Disposable Personal Income • Income that households and businesses have left over after paying taxes = Personal income- personal taxes

13. Relationship between various measures of income

14. Real versus Nominal GDP Total spending rises from one year to the next • Economy - producing a larger output of goods and services • Or goods and services are being sold at higher prices • Or both

15. Real versus Nominal GDP Nominal GDP • Production of goods and services • Valued at current prices Real GDP • Production of goods and services • Not affected by changes in prices Mathematical Illustration • From nominal GDP to real GDP….

16. Real and Nominal GDP

17. Real and Nominal GDP

18. Real and Nominal GDP

19. GDP Deflator • The GDP deflator is calculated as follows: • The GDP deflator is a measure of the price level calculated as the ratio of nominal GDP to real GDP times 100. • It tells us the rise in nominal GDP that is attributable to a rise in prices rather than a rise in the quantities produced.

20. GDP Deflator Reflects the prices of goods and services, but not the quantities produced • Quantities of goods and services in a country rise over time but prices remain the same • Effect on nominal and real GDP? GDP deflator? • Prices rise over time but quantities stay the same • Effect on nominal and real GDP? GDP deflator?

21. GDP Deflator Reflects the prices of goods and services, but not the quantities produced • Quantities of goods and services in a country rise over time but prices remain the same • Both nominal and real GDP rise together • GDP deflator is constant • Prices rise over time but quantities stay the same • Nominal GDP rises and real GDP stays the same • GDP deflator rises GDP deflator reflects what is happening to prices, not quantities

22. GDP Deflator Numerical Example contd.

23. Real and Nominal GDP • What is true about real GDP and nominal GDP in the base year? • How is the GDP deflator interpreted? • GDP deflator of 171- the average price in the economy increased by 71% between 2001 and 2002 • GDP of 240- the average price level in the economy increased by 140% between 2001 and 2003 • Percentage changes in GDP deflator from year to year gives indication of inflation rates.

24. Real vs. Nominal GDP Nominal GDP uses current prices to place a value on economy’s output Real GDP uses base-year prices to place a value on economy’s output

25. Real vs. Nominal GDP True/False • If Nominal GDP is rising, real GDP must also be rising. Why/ not?

26. GDP as a measure of Economic well-being GDP – “the best single measure of the economic well-being of a society” What are some limitations of use of GDP as measure of individuals’ well-being in a country?

27. GDP PER CAPITA and ECONOMIC WELL-BEING GDP per capita = __GDP__ Population • GDP per persontells us the income and expenditure of the average person in the economy; • Commonly used as a measure of the economic well-being of a society.

28. GDP PER CAPITA and ECONOMIC WELL-BEING • Higher GDP per person generally indicates a higher standard of living; • YET GDP is not a perfect or sufficient measure of the happiness or quality of life and needs to be complimented by other measures.

29. GDP as a measure of Economic well-being “GDP does not allow for the health of our children, the quality of their education, or the joy of their play. It does not include the beauty of our poetry or the strength of our marriages, the intelligence of our public debate or the integrity of our public officials. It measures neither our courage, nor our devotion to our country. It measures everything, in short, except that which makes life worthwhile…..” (Senator Robert Kennedy, 1968)

30. GDP PER CAPITA and ECONOMIC WELL-BEING • Why is GDP not a perfect or sufficient measure of the happiness or quality of life? 1. It is just an average number that does not reflect the inequalities in the distribution of income. 2. It is simply an indicator of purchasing power and as such does not necessarily capture a series of quality of life factors that contribute to well-being such as • The value of leisure. • The value of a clean environment. • The value of almost all activity that takes place outside of markets, such as the value of the time parents spend with their children and the value of volunteer work.

31. GDP and the Quality of Life The table shows GDP per person and three other measures of the quality of life for twelve major countries.

32. International differences: GDP & quality of life Rich countries - higher GDP per person • Better • Life expectancy • Literacy • Internet usage Poor countries - lower GDP per person • Worse • Life expectancy • Literacy • Internet usage

33. GDP as a measure of Economic well-being A large GDP can help us to lead a good life! GDP does not measure the health of our children • …But nations with large GDP can afford better health care for their children! GDP does not measure the quality of our education • …But nations with larger GDP can afford better education systems! GDP does not measure the beauty of our poetry • …But nations with larger GDP can afford to teach more of their citizens to read and enjoy poetry! GDP does not take into account our intelligence, integrity, courage, wisdom or devotion to country • …But these laudable attributes easier to foster when people less concerned about affording basic necessities of life

34. The Indicators Criteria of Well-being • Measure of Economic Welfare (MEW) • Genuine Progress Indicator (GPI) • Human Development Index (HDI) “longevity, knowledge, and a decent standard of living” • Gender-related Development Index (GDI) • Human Poverty Index

35. “Take-home” Question 1 What is nominal GDP for 2005 and 2010? Calculate real GDP for 2005 and 2010, using 2005 as the base year.

36. “Take-home” Question 2 Consider an economy that produces only chocolate bars. In year 1, the quantity produced is 3 bars and the price is Ghc4. In year 2, the quantity produced is 4 bars and the price is Ghc5. In year 3, the quantity produced is 5 bars and the price is Ghc6. Year 1 is the base year. • What is the nominal GDP for each of these years • What is the real GDP for each of these years? • What is the % growth rate of real GDP from year 1 to year 2?

37. “Take-Home” Question 3 One day, Barry the Barber collects $400 for haircuts. Over this day, his equipment deteriorates in value by $50. Of the remaining $350, Barry sends $30 to the government in sales taxes, takes home $220 in wages, and retains $100 in his business to add new equipment in the future. From the $220 that Barry takes home, he pays $70 in income taxes. Based on this information, compute Barry’s contribution to the following measures of income: • Gross domestic product • Net national product • National income • Personal income • Disposable personal income

38. Announcements Answer Take home questions 2 and 3 in on slides 36 and 37 respectively as your assignment. Submit in class (typed and printed with your IDs) on Friday, 4th March 2016) No submissions would be received later after the lecture on the submission date.