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Lecture 2: National Income Accounting

Lecture 2:

National Income Accounting

Reference - Chapter 5 

Learning Objectives 

      5.1 What gross domestic product (GDP) is, and how to measure it. 

          5.2  Other measures of a nation��s production of goods and services. 

              5.3  The distinction between nominal GDP and Real GDP 

                  5.4  The shortcomings of GDP as a measure of domestic output and well-being. 

                  National Income Accounting 

                  National income accounting is the technique used to measure the overall production of the economy and other related variables for the nation as a whole.  

                  Gross Domestic Product (GDP) 

                  GDP is the total market value of all final goods and services produced in a given year within the boundaries of a country.

                  • Japanese-owned factory in ON
                  • It is a monetary measure of the output of a nation

                  Three Approaches to Measure GDP 

                  1. Product Approach or Value Added    


                  1. Expenditures Approach
                  1. Income Approach 
                      1. Product or Value Added              Approach 

                    The product approach defines a nation��s GDP as the market value of final goods and services newly produced within a nation during a fixed period of time.  

                    • Example: 3 sofas ($500 each) and 2 PCs ($2000 each) versus 2 sofas and 3 PCs
                    • Avoid Multiple Counting 
                    • Include only final goods and ignore intermediate goods   altogether 
                    • Intermediate goods are goods and services that are purchased for resale or for further processing or manufacturing. 
                    • Final goods are goods and services that are acquired for final use by the purchaser, and not for resale or for further processing or manufacturing. 
                    • Avoid Multiple Counting by measuring and cumulating  only the value added at each stage. 
                    • Value added is the market value of the product sold by a firm, less the value of the products purchased and used by the firm to produce the product. 
                    • Example: Table 5-2
                    • GDP Excludes Non-Production Transactions 
                      1. Financial Transactions

                           - Public Transfer Payments

                                      - Private Transfer Payments

                                      - Stock-market Transactions

                  •    2)  Second-Hand Sales

                  2) Expenditures Approach 

                  The expenditures approach defines GDP as the sum of all the money spent in buying final goods and services.  

                  - GDP = Consumption (C) +

                          Gross Investment (Ig) +

                      Government Purchases (G) +

                      Net Exports (Xn) 

                  • Example: For Canada in 2002

                    GDP= $656.2+196.8+251.6+50.3=1154.9 

                    Personal Consumption Expenditures (C) 

                    C are the expenditures of households for durable and non-durable consumer goods and services. 

                    Gross Investment (Ig) 

                    Ig are the expenditures for newly produced capital goods and for additions to inventories.


                    • 1) All final purchases of machinery, equipment, and tools by businesses
                    • 2) All construction (residential construction as well as the construction of new factories, warehouses, and stores) 
                    • 3) Changes in inventories 
                    • Increases in inventories (unsold goods) are considered to be investment because they are unconsumed output.
                    • Positive and negative changes in inventories
                    • Positive inventories mean more output produced than was purchased, vice versa.
                    • Non-investment transactions- transfer of paper assets (stocks, bonds) or resale of tangible assets (houses, jewellery, boats). Investment has to do with the creation of new, physical capital assets – assets that create jobs and income.  The transfer (sale) of claims of existing capital goods does not create new capital.
                    • Gross investment includes investment in replacement capital and in added capital. 
                    • Net investment= Gross Investment- 


                    • Capital consumption allowance or depreciation is the amount of capital that is used up (consumed) in producing the GDP.

                    Government Purchases (G) 

                    G are the expenditures for goods and services that government consumes in providing public services. 

                    • include all government expenditures on final goods, investment goods, and all direct purchases of resources, including labour.
                    • does not include government transfer payments. 

                    Net Exports ( Xn) 

                    Net Exports (Xn) = Exports (X) –

                                                    Imports (M) 

                    -GDP records all spending on goods and services produced in Canada, including spending on Canadian output by people abroad (exports). 

                    - Canadians spend a great deal of money on imports- goods and services produced abroad. That spending shows up in some other nation��s GDP. So, we must subtract the value of imports from GDP to avoid overstating total production in Canada. 

                    - In 2002, net exports were a positive $50.3 billion. 

                    3) The Income Approach 

                    The income approach defines GDP in terms of the income derived or created from producing final goods and services. 

                    Net Domestic Income at factor cost =

                      Wages, Salaries, and Supplementary Labour Income+

                      Profits of Corporations and Govt. Enterprises before taxes +

                          Interest and Investment Income +

                      Net Income from Farms and Unincorporated Businesses +

                      Taxes less subsidies on factors of   production 

                      Net Domestic Income at market prices =

                            Net Domestic Income at factor cost +

                            Indirect taxes less subsidies 

                      Gross Domestic Product (GDP) at market prices =

                        Net Domestic Income at market prices +

                            Capital Consumption Allowances +

                            Statistical Discrepancy 

                      OTHER National Accounts 

                      Gross National Product (GNP) =

                            Gross Domestic Product (GDP) +

                            Net Investment from Non-residents

                            = 1154.9 – 84.9 = 1070

                      Example – The production of cars in the Honda factory in Alliston, Ontario is included in both Canadian GDP and  GNP. But GNP excludes profit sent to foreign shareholders of Honda, but this profit is included in Canadian GDP. 

                      Net Domestic Product (NDP) =

                                  GNP – Depreciation

                                                             = 1070–155 = 915 

                       Net National Income at Basic Prices (NNI)=


                          Taxes less subsidies on factors of production -

                                  Indirect taxes less subsidies 

                        = 915 – 53.8 – 84.4

                        = 776.8 

                      Personal Income = NNI – Undistributed Corporate Profits + Govt. Transfer Payments

                      = 776.8 – 49.0 +71.3

                      = 848.1 

                      Disposable Income = PI – PersonalTaxes

                                                        = 848 – 152.2

                                                         = 695.9 






                      Nominal GDP Vs Real GDP 

                      Price Index 

                      An alternative Method 

                      GDP Deflator 

                      Chain Weighted Index 

                      Shortcomings of GDP

                      • Measurement Shortcomings
                        • Non-Market Transactions
                        • The  Underground Economy
                        • Leisure
                      • Improved Product Quality
                      • Well-being Measure Shortcomings
                        • GDP and The Environment
                        • Composition and Distribution of Output
                        • Non-material Sources of Well-being

                      Income Approach 




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