National Income Accounting

BA-2103

Macroeconomics

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 National Income Accounting

Section-A
Study Item # 1

National Income Accounting

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 National Income Accounting

Reference Books

Rudiger Dornbusch and Stanley Fischer

Macroeconomics
(Sixth Edition)
McGraw Hill, Inc.

N. Gregory Mankiw
Macroeconomics
(Seventh Edition)
Worth Publishers, Inc.

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Discussion Questions

1. Write short notes on “GDP, GNP” and distinguish between “GDP and GNP”.
2. Explain the rules of computing GDP.
3. Distinguish between “Nominal GDP” and “Real GDP”. Which one is a “Better”
indicator? Why?
4. Explain the “Income-Expenditure Circular Flow” with example.
5. Explain “Stock and Flows” from the case study “Stock and Flows” and relate it with
“GDP Calculation”. Why “Current GDP” is a Flow?
6. Describe the “Components” of demand.
7. Write short note on “Disposable Income”.
8. Prove that-in a “Simple Economy” without govt. and foreign sector “Savings” will
always be equal to “Investment”.
9. Prove that-in a “Complex Economy” including government and foreign sector –the
“Gap” between domestic “Savings” and “Investment” will be distributed among
“foreign” and “Government” sector.
10. Write short notes on “Budget Deficit/Surplus” and “Trade Deficit/Surplus”.
11. Write short notes on “CPI and unemployment rate”.
12. Explain your ideas about the trend in labour force participation from the case study on
“Trends in labour force participation”.

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“It is a capital mistake to theorize before one

has data. Insensibly one begins to twist facts
to suit theories, instead of theories to fit facts”
– Sherlock Holmes

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1. Write short notes on “GDP, GNP and distinguish between “GDP and
GNP”

Gross Domestic Product (GDP) is the dollar value of all final goods and
services produced within an economy in a given period of time.

To obtain gross national product (GNP), we add receipts of factor income

(wages, profit, and rent) from the rest of the world and subtract payments of
factor income to the rest of the world.
GNP = GDP + Factor Payments from Abroad - Factor Payments to
Abroad
Whereas GDP measures the total income produced domestically, GNP
measures the total income earned by nationals (residents of a nation).

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2. Explain the rules of computing GDP

1) To compute the total value of different goods and services, the

national income accounts use market prices.
Thus, if:
$0.50 $1.00

GDP = (Price of apples  Quantity of apples)

+ (Price of oranges  Quantity of oranges)
= ($0.50  4) + ($1.00  3)
GDP = $5.00
2) Used goods are not included in the calculation of GDP.
3) The treatment of inventories depends on if the goods are stored or if they spoil.
If the goods are stored, their value is included in GDP. If they spoil, GDP remains
unchanged. When the goods are finally sold out of inventory, they are considered
used goods (and are not counted).
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2. Explain the rules of computing GDP

4) Intermediate goods are not counted in GDP– only the value of
final goods. Reason: the value of intermediate goods is already
included in the market price. Value added of a firm equals the
value of the firm’s output less the value of the intermediate goods
the firm purchases.

5) Some goods are not sold in the marketplace and therefore don’t
have market prices. We must use their imputed value as an estimate
of their value. For example, home ownership and government services.

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3. Distinguish between “Nominal GDP” and “Real GDP”. Which one is a “Better”
indicator? Why?

The value of final goods and services measured at current prices is

called nominal GDP. It can change over time, either because there is a
change in the amount (real value) of goods and services or a change in
the prices of those goods and services.
Hence, nominal GDP Y = P  y, where P is the price level and y is real
output—and remember we use output and GDP interchangeably.

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3. Distinguish between “Nominal GDP” and “Real GDP”. Which one is a “Better”
indicator? Why?

Real GDP or, y = YP is the value of goods and services measured using
a constant set of prices.

This distinction between real and nominal can also be applied to other
monetary values, like wages. Nominal (or money) wages can be denoted
by W and decomposed into a real value (w) and a price variable (P).
Hence, W = nominal wage = P • w
w = real wage = w/P
This conversion from nominal to real units allows us to eliminate the
problems created by having a measuring stick (dollar value) that
essentially changes length over time, as the price level changes.
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Let’s see how real GDP is computed in our apple and

orange economy.
For example, if we wanted to compare output in 2009 and output
in 2010, we would obtain base-year prices, such as 2009 prices.
Real GDP in 2009 would be:
(2009 Price of Apples  2009 Quantity of Apples) +
(2009 Price of Oranges  2009 Quantity of Oranges).
Real GDP in 2010 would be:
(2009 Price of Apples  2010 Quantity of Apples) +
(2009 Price of Oranges  2010 Quantity of Oranges).
Real GDP in 2011 would be:
(2009 Price of Apples  2011 Quantity of Apples) +
(2009 Price of Oranges  2011 Quantity of Oranges).
Note that 2009 prices are used to compute real GDP for all three
years. Because prices are held constant from year to year,
real GDP varies only when the quantities produced vary. 11
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4. Explain the “Income-Expenditure Circular Flow” with example

Two ways Total income of everyone in the economy

of viewing GDP Total expenditure on the economy’s
output of goods and services
Income $
Labor
Households Firms
Goods
Expenditure $
For the economy as a whole, income must equal expenditure.
GDP measures the flow of dollars in the economy.
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5. Explain “Stock and Flows” from the case study “Stock and
Flows” and relate it with “GDP Calculation”. Why “Current GDP”
is a Flow?

“Case Study: Stocks and Flows”

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6. Describe the “Components” of demand

Y = C + I + G + NX

Total demand Investment

for domestic is composed spending by
output (GDP) of businesses and
households Net exports
or net foreign
Consumption Government demand
spending by purchases of goods
households and services

This is the called the national income accounts identity.

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7. Write short note on “Disposable Income”

Personal Disposable Income (PDI) is the level of income

available for consumption & saving by household
PDI = GDP + net factor income from abroad + transfers –
taxes – depreciation – retained earnings
Output, Income & Spending
Assumptions:
No taxes & transfer payments (GDP = NI);
PDI = GDP; No depreciation (GDP = NDP)
Gross investment = Net investment

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8. Prove that-in a “Simple Economy” without govt. and foreign sector

“Savings” will always be equal to “Investment”

Simple Economy (no government & foreign trade) The demand

for output (GDP) is composed of
Y=C+I ------ (1)
Household receives whole of national income as disposable
income
Y=S+C ------ (2)
Combining identities 1 & 2, we can have
C+I=Y=S+C ------ (3)
The left-hand side = the components of demand
The right-hand side = the allocation of income

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8. Prove that-in a “Simple Economy” without govt. and foreign sector

“Savings” will always be equal to “Investment”

C + I = Y = S + C ------ (3)
Subtracting consumption from both sides, we find the
relation between S & I
I = Y – C, S = Y – C
I=Y–C=S
S=I ------ (4)
Thus in an economy without government & foreign trade,
investment is identically equal to saving

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9. Prove that-in a “Complex Economy” including government and foreign sector –

the “Gap” between domestic “Savings” and “Investment” will be distributed among
“foreign” and “Government” sector

Introducing government & foreign trade:

The demand for output (GDP) is composed of
Y = C + I + G + NX ------ (5)
Household pays taxes and receives transfers in addition to
national income
So, the relation between YD & output (GDP) is
YD = Y + TR – TA ------ (6)

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9. Prove that-in a “Complex Economy” including government and foreign sector –

the “Gap” between domestic “Savings” and “Investment” will be distributed among
“foreign” and “Government” sector

YD, in turn, is allocated to C & S,

YD = C + S ------ (7)
Combining identities 6 & 7, we can find
YD = Y + TR – TA & YD = C + S
C + S = YD = Y + TR – TA ------ (8)
or, C + S = Y + TR – TA
or, C = Y + TR – TA – S
or, C = YD – S = Y + TR – TA – S ------ (9)

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9. Prove that-in a “Complex Economy” including government and foreign sector –

the “Gap” between domestic “Savings” and “Investment” will be distributed among
“foreign” and “Government” sector

C = Y + TR – TA – S ------(9)
Putting the value of C in (5), we can find
Y = C + I + G + NX ------ (5)
Y = (Y + TR – TA – S) + I + G + NX
or, Y – Y + S – I = G + TR – TA + NX
or, S – I = (G + TR – TA) + NX ------ (10)
Thus we have four separate components which constitutes
the equilibrium in economy

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10. Write short notes on “Budget Deficit/Surplus” and “Trade

Deficit/Surplus”

S – I = (G + TR – TA) + NX ------ (10)

Budget Deficit/Surplus = G + TR – TA

Trade Surplus/Deficit = NX

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11. Write short notes on “CPI and unemployment rate”

The Consumer Price Index (CPI) turns the prices

of many goods and services into a single index
measuring the overall level of prices. The Bureau
of Labor Statistics weighs different items by
computing the price of a basket of goods and
services produced by a typical customer. The CPI
is the price of this basket of goods relative to the
price of the same basket in some base year.

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Let’s see how the CPI would be computed in our

apple and orange economy.

For example, suppose that the typical consumer buys 5 apples and 2
oranges every month. Then the basket of goods consists of 5 apples
and 2 oranges, and the CPI is:

CPI = ( 5  Current Price of Apples) + (2  Current Price of Oranges)

( 5  2009 Price of Apples) + (2  2009 Price of Oranges)

In this CPI calculation, 2009 is the base year. The index tells how
much it costs to buy 5 apples and 2 oranges in the current year relative
to how much it cost to buy the same basket of fruit in 2009.
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11. Write short notes on “CPI and unemployment rate”

The labor force is defined as the sum of the employed and

unemployed, and the unemployment rate is defined as the
percentage of the labor force that is unemployed.
The labor-force participation rate is the percentage of the adult
population who are in the labor force.

Unemployment Rate = Number of Unemployed  100

Labor Force

Labor-Force Participation Rate = Labor Force  100

Adult Population
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12. Explain your ideas about the trend in labour force

participation from the case study on “Trends in labour force
participation”.

“Case Study: Trends in Labor-Force participation”

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• Coming Up : Study Item # 2: Income and Spending

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