Chapter Seven: National Income Accounting

CHAPTER SEVEN
NATIONAL INCOME
ACCOUNTING
National income account
 Is an accounting record of the level of
economic activities of an economy
 is a measure of aggregate output, income and
expenditure in an economy
Its importance:
 To know economic performance of country
 To observe the long run trend of the economy
 To formulate economic policies
Gross Domestic Product(GDP) and Gross
National Product(GNP)
GDP
is the market of currently produced final goods and services
that are produced within in the country’s borders(boundary)
during a given period of time, usually one year.
GNP
is the market value of currently produced final goods and
services that are produced by domestically owned factors of
production during a given period of time
It measure the total output or income generated by domestic
residents’ factors of production irrespective of where these
resource are used.
Cont…
GNP = GDP + NFI
NFI- net factor income
NFI = factor income received from abroad - factor
income received by foreigners from domestic
economy
NFI can be positive, negative or zero
NFI>0,then GNP>GDP
NFI<0,then GNP<GDP
NFI=0, then GNP=GDP
Problems associated with measuring GDP
The problems:
 Double counting
To avoid this problem we should take
o The market value of final g+s
o The value added at each stage of production
 Don’t include non-productive transactions…transfer payments
 Failing to measure non-marketed outputs since they have no
market price
-government production of public goods
-households output which produced for home consumption purpose
- Leisure activities such as the satisfaction obtained from
recreational activities doesn’t included in GDP
Cont…..
 It is difficult to measure outputs in the informal
sector
-the informal sector is that part of the economy which
consists of activities or output that are never report
to tax and other gov’t authorities. It include both
legal(sealing tela, tej,…) and illegal(like drug
dealing) activities
 Distribution of income across household is not
included in GDP
 Cost of environmental damage is not counted in
GDP.
Measuring GDP and GNP
Three methods:
1. Product approach/value added approach
2. Expenditure approach
3. Income approach
1. Product approach
 Calculated by adding the market value of goods
and services produced by each sector of the
economy i.e. agriculture, service and industry
Cont…
2.Expenditure Approach
GDP is measured by adding all spending on final final
goods and services produced in the country
The expenditures made on the final goods and services
of country can be divided into four categories.
These are
I. Personal consumption expenditure
II. Gross domestic private investment expenditure
III. Government spending on goods and services
IV. Net export
Cont…
I. Personal consumption expenditure(C)
 Expenditure made by households to purchase final g+s
for consumption purpose
 They are divided into three:
1. Durable consumer goods- are those goods that can be
used for longer period of time such as cars, TV,…
2. Non-durable consumer goods- are those goods that
can be used/consumed for shorter period of time such as
food, fuel,…
3. Services- include education, haircut, transport,
health service….
Cont…
II. Gross domestic private investment expenditure(I)
 Expenditure by private sectors for investment purpose
GI= Net Inv’nt + depreciation(consumption of fixed
asset)
 Includes three types of expenditures
1. Business investment expenditure/business fixed
investment on machinery, equipment
2.Construction expenditure-expenditure on
residential and non residential constructions
3.All increase in inventories-these is unsold output
currently produced by firms and counted in GDP as if
they were purchased by the firms’ themselves
Cont…
III. Government spending on goods and services(G)

 Expenditure by local and federal government
 NB:All expenditures made by government will not
be counted.
Eg. Public transfer payments like pension and interest
payments on the country’s debt will not be counted
Cont…
IV. Net export(NX)
 It means export (X)mines import(M)
 Imported goods are not our country's output,
these we can not include them in GDP
calculation
GDP = C+I+G+NX
Cont…
3. Income Approach
 GDP is measured by adding all incomes
earned by domestic factors of production to
produce goods and services
 These factors of production are labor, land ,
capital, and entrepreneurship
Cont…
These payments includes:\
i. Compensation of employees: the reward for labor. i.e.
Wages and salaries
ii. Rental income: the reward for land
iii. Proprietor’s income/ profits/: income earned by
entrepreneurs.
iv. Interest income: the reward for capital
v. Depreciation: allowance of capital consumption
A portion of capital goods used in the production
process that wear out or used up in the current production
process
vi. Indirect business taxes: like excise and sales tax
GDP = i + ii+ iii+ iv+ v + vi
Nominal and Real GDP
Nominal GDP
Is monetary value of currently produced final outputs
measured at current market price
Is GDP measured at current market price
Is not useful to compare country’s economic
performance through time
Real GDP
it is the value of currently produced g+s at constant
price. or it is measure of GDP at constant price
It is calculated by dividing the nominal GDP by price
index
Real GDP = (nominal GDP/price index)x 100
Cont…
Eg. The Ethiopian nominal GDP and the CPI for the
year 1985 and 1986 was given below. Calculate
the real GDP and the economic growth?
Year nominal GDP CPI real GDP
1985 26,671.40 849.9 3138.18
1986 28,328.90 858.9 3298.28
Economic growth = RGDPt – RGDPt-1 x 100

RGDPt-1
5.1 %
Other social account
• Net domestic product (NDP): it is the measure of the
total value of the economy without impairing the future
production capacity of the economy.
NDP = GDP – Depreciation
• National Income (NI): is the total income earned by our
factors of production irrespective of where they are used.
NI = NDP + NFI – indirect business tax
• Personal income: income earned by persons or hhs.
PI = NI – [social security contribution + corporate
income tax + retained corporate profit] + [public transfer
payments + net interest on government debt]
• Personal disposable income(Yd): home take money
Yd = PI – personal taxes
Yd = c +s
Income inequality and Distribution
GDP and GNP doesn’t indicate how the total output
currently produced is distributed in the economy
The distribution of income measured in two
measures
i. Functional distribution of income
 refers to the distribution of national income to
owners of factors of production, i.e. labor,
land, ...
ii. Personal distribution of income
 Shows the distribution of national income to
individual families
Cont…
The sources of income inequalities in country can
be :
i. Differences Wealth
ii. Differences Ability
iii. Discrimination: which leads to difference in
opportunities for achievements.
iv. Differences in education, energy and motivation
v. Differences in human capital and investment
choices
GDP and Informal sector
 Informal sector of the economy is part of the economy
which consists of activities that are never reported to
government authorities
 These activities can be legal or illegal
 GDP doesn’t usually include these activities due to lack
of information
 Tax evasion is usually thought to be the major incentive
for a person to participate in the informal sector.
 When the size of informal sector is large , the GDP
understates the performance of the economy

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CHAPTER SEVEN

III. Government spending on goods and services(G)

1985 26,671.40 849.9 3138.18

1986 28,328.90 858.9 3298.28

Economic growth = RGDPt – RGDPt-1 x 100

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