Lecturer Dr. Priscilla Twumasi Baffour; Department of ... · Lecturer Dr. Priscilla Twumasi Baffour; Department of Economics ... - Gross national product. - Net domestic product

College of Education

School of Continuing and Distance Education2014/2015 – 2016/2017

Lecturer Dr. Priscilla Twumasi Baffour; Department of EconomicsContact Information: [email protected]

Session Overview

• This session begins with the definition of concepts in nationalincome accounting such as gross domestic product, grossnational product, net domestic product, net national productamong others.

• In accounting for GDP, distinctions have to be made with regardsto intermediate and final goods, this the session discusses byfirst of all explaining the concept of value added. Afterwards, thesession discusses the three different approaches to measuringnational income which are the output, income and theexpenditure approaches.

• The session concludes with a discussion on the uses of nationalincome measure and the shortcomings associated with usingnational income as a measure of social welfare.

Priscilla T. Baffour Slide 2

Session Outline

• Definition of National income concepts.

- Gross domestic product.

- Gross national product.

- Net domestic product.

- Net national product.

• Value- added – definition and illustrations.

• Distinction between intermediate and final goods.

• Approaches of measuring national income.

• Shortcomings of national income measures

• National income and social welfare


Learning Outcome

• By the end of this session, you should be able to;

– Define the various national income concepts

– Define value- added and its significance.

– Distinguish between intermediate and final goods to avoiddouble counting when accounting for national income.

– Calculate value-added at each stage of the production

– Identify and distinguish between the various approachesof measuring GDP.

– Outline the shortcomings of national income measures

– Discuss the issues associated with using national income asa measure of social welfare.


Reading List

• Read Chapter 13 of John Sloman; Economics, 8th Edition(2011), Pearson

• Session Slides

• Watch video on session 2 ……………………..

• Any Other Economics text books available to students


Definition of Acronyms

To be discussed in the next 11 slides:

• Gross domestic product (GDP).

• Gross national product (GNP)

• Net domestic product (NDP)

• Net national product (NNP)


Gross Domestic Product (GDP)

Gross domestic product is the market value of all the final goods andservices produced within a country in a given time period.

This definition is in four parts: value produced, what is produced,where to produce and when to produce.

• Value produced is the market value expressed in monetary terms.

• What is produced is a full count of value of everything that isproduced and include only items that are traded in the market.That is, a good that is not produced for sale are not included inGDP calculation.

• Where to produce: only goods produced within a country.

• When to produce: during a given time period (usually a year).Priscilla T. Baffour Slide 7

Gross National Product (GNP)

Gross national product is the value of output produced using resources

(inputs of production) owned by nationals of a country (both domestically

and in the rest of the world) regardless of where they reside.

Algebraically,

• GNP= GDP + Net Factor Income Received from the rest of the world (NFIR)

• NFIR = INFC - IFDC

– INFC = Income accruing to factors of production owned by nationals of a country

who reside in the rest of the world.

– IFDC = Income accruing to factors of production owned by foreigners who reside

within the domestic country in question.


Net Domestic Product (NDP)/Net National Product (NNP)

Net domestic product is the market value of all the final goodsand services produced domestically within a country less what isrequired to maintain the value of the domestic economy’s capitalstock( that is depreciation or replacement investment).

NDP = GDP - Depreciation

Net national product measures the value of final goodsproduced and owned by nationals of a country (bothdomestically and from the rest of the world) less what isrequired to maintain the nation’s capital stock.

NNP = GNP - Depreciation.


Value Added

Value – added is the addition or increment in the valueof goods and services in the production process.

• Mathematically,

• Value-added = Market value of firm’s output -Market value of inputs used in producing the output.

Thus

• Value – added = Value of output - Intermediateconsumption (Cost of inputs)


Value Added

• Value –added shows the contribution of eachproduction unit process.

• Value-added is used in order to prevent doublecounting.– Double counting is an error that occurs when the value of

a transaction is counted more that once for variousreasons.

– Thus the inclusion of the same costs or benefits more thanonce in the belief that different measures are involved. Itinflates expenditure or income since the final figure isconsiderably more than what was spent or earned.


Value Added Illustration

Example 1:

Suppose a baker needs only flour to produce bread. Hepurchases flour as input worth GHC50 from the miller andthen by virtue of its productive activities, converts the flourinto bread and sells the bread for GHC70.

• In the illustration above:

Flour is an input (intermediate good) which costs GHC50,that is intermediate consumption.

Bread is the output which costs GHC70, that is value ofoutput.

• Hence, value-added becomes GHC70 - GHC50 = GHC20.


Value Added Illustration

Example 2:

• A fashion designer produces clothing at a total valueof GHC600. The textile manufacturer which producedthe cotton fabric used in producing the clothing soldit at a value of GHC350 to the fashion designer andthe farmer who produced the cotton yarn for thetextile manufacturer valued it at GHC230. Assumingthere are only three producers in the economy findthe accurate value of national output using thevalue-added method.


Value Added

• Solution too example 2

Priscilla T. Baffour

Good Market Price Value Added

Cotton yarn 230 230

Fabric 350 120

Clothing 600 250

Total 600

Slide 14

Intermediate and Final Goods

• The distinction between intermediate and final goods isanother way to avoid double counting.– Intermediate goods are partly finished goods which serve

as inputs to another firm’s production process and areused up in the production process.

– Final goods are goods purchased by the ultimate user,either in the form of consumer goods by households orcapital goods such as machinery purchased by firms.

After the distinction between intermediate and final goods,national output can be measured by summing the values ofall final goods in the economy.


APPROACHES TO MEASURING NATIONAL INCOME

Topic Two


Product Approach

This method sums up the value of output produced in a givenperiod of time to derive the value of total production (GDP)

There are two ways of calculating GDP under the productapproach:

1. Adding up the value added at each stage of production ofgoods and services, then summing up across all goodsproduced within the period.

2. Taking the value of the final good (clothing in example 2).

The product approach is also known as value-added, inventoryor output approach.


Expenditure Approach

• The expenditure approach measures expenditure on all finalgoods and services in an economy within a period of time.

• It measures GDP by using data on consumption expenditure(C), investment (I), government expenditure on goods andservices (G) and net exports (NX).Consumption expenditure is the largest component of total expenditureand includes expenditure by households on:

- Durable consumer goods: goods that last for a longer time e.g.laptops, cars etc.

- Non-durable consumer goods: lasts for a relatively short time forinstance food and clothing.

- Services: these are commodities whose production do not involvephysical materials. For instance health service, legal services.



Gross Domestic Investment (I):This includes expenditures on investment in capital by firms orbusinesses.The main types are:- Non- residential investment such as plants, machinery and

equipment by firms.- Residential investment such as offices, homes and new factories.- Changes in inventory including stocks. Expenditure on goods

produced presently but for future supply and sale. It constitutesboth planned and unplanned changes in business inventories. It isincluded in GDP calculation because the goods are produced in thecurrent (present) year.

Net investment = Gross investment - Depreciation.Gross investment = Net investment + Depreciation.



Government purchases of goods and services orgovernment expenditure (G):

This consists of spending by government on final goods andservices at the local, district, regional and national levels. Itcan be categorized under government consumption andgovernment investment.

It does not include government transfer payment such aswelfare, unemployment benefits and social securitypayments and interest on national debt.

• This is mainly because such transfer payments do notconstitute payments for currently produced goods andservices



• Net Exports (NX):

This constitutes expenditure to and from the rest of the world.

NX = Exports (X) - Imports (M).

X < M - Negative net exports.

X > M - Positive net exports.


Algebra of Expenditure Approach

• GDP = C + IG + G + (X – M).• GNP = GDP + NFIA• NDP = GDP – Depreciation.• NDP = C + IN + G + (X – M).• NNP = NDP + NFIAIf transactions are made by a country’s nationals regardless of where they reside then;• NNP = C + IN + G + (X – M)

• NI (National Income) = NNP – (Indirect business taxes + business transfer) + Subsidies + Statistical discrepancy.



Expenditures not in GDP:

– Spending and expenditure that is not on final goods and servicesis not recorded as part of GDP, hence spending on intermediategoods and services are not part of GDP.

– Spending on used goods and financial assets are also not part ofGDP.

– Used goods are not part of current year’s GDP because theyhave already been accounted for in the year they wereproduced.

– Financial assets like bonds and stocks make loans and notpurchases of physical and non-physical commodities hence notpart of GDP.



IllustrationConsider the values of the following components:C = GHC8668 I = GHC2054 G = GHC2338 X = GHC1304 M = GHC1991.

a. Find the value of the net exports.b. Using the expenditure approach, find the value of the GDP.

Solutions:

a. Net exports = exports (X) – imports (M) = GHC 1304 - GHC 1991 = - GHC 687.

b.

ITEM SYMBOL AMOUNT (GHC).

Consumption expenditure C 8668

Investment I 2054

Government expenditure G 2338

Net exports NX - 687

GDP Y 12373.


Income Approach

The main idea hear is to account for GDP by aggregating incomes that go to factors of production. Factor incomes can be grouped into:

– Compensation to employees (CTE) - salaries paid to households.

– Corporate profits before tax (CPBT) - income of large firms and corporations.

– Rental incomes (RI) - returns on land

– Net interest (NI) – payments by firms for borrowed funds.

– Unincorporated business profit and/or proprietor’s income (PI) –income from partnerships, sole proprietorships and cooperatives.

NDPFC =CTE + CPBT +RI +NI +PI

NNPFC = NDPFC +/- NFIA

National income (NI) = NNPFC +/- Statistical discrepancy.


Income Approach

National income measure and personal income;

Personal disposable income is the amount of personal income that isavailable to households to spend and /or save after paying for personalincome taxes.

• Mathematically,

PDI = Personal Income(PI) - Personal Income Tax

PDI = Personal Consumption (C) + Personal Savings (PS)

Note:

Personal income (PI) can be deduced from the national income (NI).

To derive PI, first deduct all items included in national income but notreceived by households and then add all incomes received byhouseholds but not included in national income


Calculation of Personal Income form National Income


Interpreting National Income

• NOMINAL AND REAL GDP/GNP VALUES

The summation of the value of goods and services producedin the economy gives the money value of national output isnominal national income or output.

Nominal gross national product (NGNP) measures thevalue of output in a given period in the prices of thatperiod.

Real gross national product (RGNP) measures the changesin the economy between different time periods by valuingall goods produced in the two periods at the same orconstant prices.


Importance of National Income Measure

National income measures are used to :

measure the sectoral contributions to economicgrowth. This paints a picture of which sectors andgrowing or shrinking in terms of their rates of growfor policy interventions if need be.

To measure the performance of an economy.

measure social welfare.

Plan in in the area of budgetary allocations.


Shortcomings of National Income Measures

• Certain production activities by their nature go unrecordedfor which reason they cannot be accounted for in nationalincome.– Underground production: Inability to measure illegal activities

although most of them are ordinary business activities thatproduce goods and services sold on the market that generatefactors incomes. For instance prostitution, drug trafficking amongothers.

– Household production: An enormous amount of production takesplace in homes but these are not accounted for. Households clean,washing, helping children with homework, cooking among othersbut these services are not transacted in markets. Therefore theyare not counted as part of GDP.


Shortcomings of National Income Measures

– Some of the nationals of a country who resideabroad are illegal residents hence all theiractivities are omitted and this underestimates thenational income value.

– It does not accurately account for improvementsin the quality of goods produced.

– There sometimes exist measurement errors.


National Income Measures and Social Welfare

An increase in real GNP although is a good measure ofeconomic growth does not necessarily make thesociety better off. This is because;

– Leisure time: Leisure which is an essential component ofwelfare is not capture in GNP.

– GNP measure is quantitative rather than qualitative,since it does not measure the improvements in the qualityof the products manufactured within the year.

– Environment quality: GNP does not reflect theenvironmental cost incurred in the production the goodsand services.


National Income Measures and Social Welfare

– Health and life expectancy: Good health and longlife do not show up directly in real GDP.

– Political freedom and social justice: A countrymight have a very large real GDP per capita buthave limited political freedom.


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Lecturer Dr. Priscilla Twumasi Baffour; Department of ... · Lecturer Dr. Priscilla Twumasi Baffour; Department of Economics ... - Gross national product. - Net domestic product