2: Measuring National Income and Output

National income definitions

National income
- The total payments received by the factors of production in a country during a year
- Payment received due to productive activities
- It can also be measured using product, expenditure and income approach
- The 3 approaches will result in the same total amount of economic wealth – GDP
- !!!! The key concept in national income accounting is GDP.

2.1 Circular flow of income in a 2, 3, and 4-sector economy

A circular flow of income, product and expenditure is a model built to simplify the economic
transactions and businesses going on amongst various economic groups in the economy

In any economy, there are four economic groups involved in the economic activities.
i. Household (private sector)
ii. Firm
iii. Government (public sector)
iv. Foreigners (international sector)

These 4 groups interact in a variety of ways, many involving either the receipt or payment of income

A. A case of two factor (the simple economy)

In simple economy, the economy consist of just 2 kind of economic agents

HOUSEHOLD
- Own all factors of production
- Spend all income by buying all final goods and services (G&S)

FIRM
- Hire factors of production from household
- Sell goods and services to households
- Pay any profit made to households

1ST flow – Services of economic resources. A flow of factor services of economic resources from the
household sector to the business sector.

2ND flow – Factor income (Y). Payment for the factors of production in the form of wages, rent, interest
and profits. All of these are paid using money. Households use these incomes to buy goods and
services from the firms. Collectively these rewards are called income and we use the letter Y to
represent them.
3RD flow – Spending on goods and services (C/E). The expenditure made by the households. Assuming
none of the income is saved, the total expenditure on these goods and services will be the same as the
total income previously earned by them. Therefore income is equal to expenditure.

4TH flow – Goods and services (Q). The flow of final goods and services from the business sector to the
household sector. The value of this final goods and services in terms of money is exactly equal to the
total expenditure spent on them. Here the expenditure is equal to the product or output produced by the
firm sector.

Therefore the value of the national income (Y) is equal to the values of the national product (Q) and the
national expenditure (E).

There are 2 types of flow between these groups:

 A real flow. Households own factor services, which they hire out to firms. Firms use these
factor services to manufacture goods and services
 A money flow. Households receive payments for their services (income) and use this money
to buy the output of firms

3 (C/E)

4 (Q)
FIRM
HOUSEHOLD
1

2 (Y)

Not all income, which flows from households, is passed onto firms. Part of household income is
withdrawn from the circular flow of income (CFY), i.e. consumers put aside for part of their current
income for future spending: SAVING (S).

Savings here consider as leakage. A leakage is a flow from CFY&E, it represent money coming out.

Also, firms sell not all of current output, to household. Inflows into the CFY are called investment i.e.
expenditure by firms on plant, buildings, machinery or addition to stocks.

Investment here consider as injection. An Injection is a flow into the CFY&E. It represents money
coming in.
 CONSUMPTION {C}

HOUSEHOLD FIRMS

INCOME {Y}

LEAKAGES INJECTION

SAVING = S INVESTMENT = I

Thus we can conclude that Y from firms to household is equal to consumer spending (C) plus savings
(S).

Y=C+S

From firm, payment for factors of productions (Y) equal receipts from the sale of goods and services
(C) plus investment (I).

Y=C+I

From above 2 equations, we can safely conclude that injection equal to leakage

I=S

From the circular of flow diagram we can conclude that

i. Factor incomes must equal to household spending since we assume that all income is
spend
ii. The value of production or output must equal to total spending on G&S since we assume
that all goods are sold
iii. The value of output must equal to the value of household incomes

EXPENDITURE = INCOME = OUTPUT

 iv. The diagram also indicates 3 ways in which the total level of productive activity could be
measured over a period:

 We could measure the total amount of G&S produced over the period. This is called the
output approach

 We could measure the total amount of domestic spending by consumers, firms, government
and foreigners over a period. This is called expenditure approach.

 We could measure the total incomes earned by the factors of production involved in the
production of G&S over a period. This is called income approach.

GDP & GNP

GDP
- Refers to the market value of final output produced within the country over a twelve-month
period
- Exclude intermediate goods and goods produced by Malaysian abroad
- Include output produced by non-residents working in the country

GNP
- Final G&S produced by Malaysians regardless where they are
- Exclude output produced by foreign workers
- Include output produced by Malaysians working oversea

MARKET PRICE & FACTOR COST

Market price

- Prevailing price in the market through the forces of demand and supply
- Price that consumers have to pay
- Include indirect taxes but excludes subsidies given to the producers
- Market price do not give the real value of G&S
- The real value of G&S are at the factor costs

Factor cost

- Real price earned by the sellers

- Income earned by all factors of production
- Exclude the indirect taxes but includes the subsidies received by the producers from
the government
- The difference between national income at market price and national income at factor cost
arises from indirect taxes and subsidies
2.2 3 approaches of measuring GDP: income, expenditure, output

Expenditure approach

- the total amount of domestic spending by consumers, firms, government and foreigners over a
period.
- the expenditures of the 4 economic sector will be included under this method
- expenditures made by the 4 economic sector of the economy can be categorized as follows

i. consumption (C)

- Household expenditure/ money spent on durable good, non durable good & services

ii. investment (I)

- expenditures by firms/producers on new capital plants, equipment, machinery, new residential

structure and changes in inventory
- change in inventory which is the net change in spending for unsold finished goods and raw
materials, can either be increased (+) @ decline (-)
- Investment does not include the transfer of paper asset (stocks, bond) or the resale of
tangible asset (house, jewelry, boat)
- Investment has to do with the creation of new capital assets that create jobs and income

iii. government (G)

- government purchases of G&S expenditure

- exclude transfer payment because they do not represent newly produced goods and
services and merely transfer government receipts to certain households

v. net export (X-M)

- net spending by the international sector

- M are subtracted from export because GDP measures only domestic economic activity, so
sales of foreign good must be removed

The steps:

1. GDPmp = C + I + G + (X-M) + CHANGE IN STOCK/INVENTORY

2. GDPfc = GDPmp – INDIRECT TAXES + SUBSIDIES

 Indirect tax

- taxes levied as a percentage of the price of goods sold and therefore collected as part of the
firm’s revenue
- firms treat such taxes as production cost, i.e. general sales taxes, excise taxes, custom duties,
business property taxes and license fees
 - indirect taxes are not income payments to suppliers of resources but firms will collect and send
it to the government
- these taxes are includes in the price, but are not income for individuals.

 subsidy

- a payment of funds ( @ goods and services) by a government, firm or household for which it
receives no good or service in return.
- When made by a government, it is a government transfer payment

3. GNPmp = GDPmp + NET FACTOR INCOME FROM ABROAD

(income received from abroad – income paid abroad)

4. GNPfc = GNPmp – INDIRECT TAX + SUBSIDY

= GDPfc + NET FACTOR INCOME FROM ABROAD
(income received from abroad – income paid abroad)

5. NNPfc@NI = GNPfc – DEPRECIATION

 Depreciation

- @ consumption of fixed capital @ capital consumption allowance @ capital

consumption
- an estimate of the amount of capital worn out or used up (consumed) in producing the GDP /
by each year
- it is the portion of GDP that is set aside to pay to the ultimate replacement of those capital
goods, it is a cost of production and thus included in the gross value of output

6. PI = NNPfc + TRANSFER PAYMENT – EPF – SOCSO – INSURANCE –

RETAINED EARNINGS – CORPORATE TAX

7. DI = PERSONAL INCOME – PERSONAL INCOME TAX

Example

Table 1: Calculation national income using the expenditure approach

COMPONENTS RM MILLION
PUBLIC CONSUMPTION 20000
PRIVATE CONSUMPTION 30500
PUBLIC INVESTMENT 10600
PRIVATE INVESTMENT 15000
CHANGE IN STOCK 150
G&S EXPORTED 1000
G&S IMPORTED 700
NET PAYMENTS ABROAD 100
INDIRECT TAXES 200
SUBSIDIES 500
DEPRECIATION 50
EPF 200
TAX ON PERSONAL INCOME 400
TRANSFER PAYMENT 100
SOCIAL SECURITY 100
RETAINED EARNINGS 10
INSURANCE PREMIUM 100
CALCULATE:

1. GDPmp
2. GNPmp
3. GDPfc
4. GNPfc
5. NNPfc
6. PI
7. DI
SOLUTIONS

1. GDPmp = C + I + G + X-M + CHANGE IN STOCK/INVENTORY

= 20000 + 30500 + 10600 + 15000 + 150 + (1000 – 700)
= 76550

2. GNPmp = GDPmp + (INCOME RECEIVED FROM ABROAD – INCOME PAID ABROAD)

= 76550 + 100
= 76650

3. GDPfc = GDPmp – INDIRECT TAX + SUBSIDY

= 76550 – 200 + 500
= 76850

4. GNPfc = GNPmp – INDIRECT TAX + SUBSIDIES

= 76650 – 200 + 500
= 76950

5. NNPfc = GNPfc – DEPRECIATION

= 76950 – 50
= 76900
= National income

6. PI = NNPfc + TRANSFER PAYMENT – EPF – SOCSO – INSURANCE – RETAINED

EARNINGS – CORPORATE TAX
= 76900 + 100 – 200- 100 – 100 – 10
= 76590

7. DI = PERSONAL INCOME - PERSONAL INCOME TAX

= 76590 – 400
= 76190
Product / output approach

- total value of goods and services and investment goods (including additions to stock) produced
by the country during the year
- it can be measured by adding the value added of the G&S produced by each firm (final
product)
- in Malaysia, economy sectors can be divided into:

i. agriculture, forestry & fish

ii. mining & quarrying
iii. construction
iv. manufacturing
v. energy & water supply
vi. transport & communication
vii. banking, finance & insurance
viii. trade & retailing
ix. public administration
x. national defense
xi. education & health services
xii. other services

The steps:

1. GDPmp = THE SUM OF ALL THE VALUE OF GOODS AND SERVICES

PRODUCED BY ECONOMIC SECTORS

2. GDPfc = GDPmp – INDIRECT TAXES + SUBSIDIES

3. GNPmp = GDPmp + NET FACTOR INCOME FROM ABROAD

(income received from abroad – income paid abroad)

4. GNPfc = GNPmp – INDIRECT TAX + SUBSIDY

= GDPfc + NET FACTOR INCOME FROM ABROAD
(income received from abroad – income paid abroad)

5. NNPfc@NI = GNPfc – DEPRECIATION

6. PI = NNPfc + TRANSFER PAYMENT – EPF – SOCSO – INSURANCE –

RETAINED EARNINGS – CORPORATE TAX

7. DI = PERSONAL INCOME - PERSONAL INCOME TAX

Example

Table 2: Calculation national income using the product/output approach

COMPONENTS RM
MILLION
14828
AGRICULTURE, FORESTRY & FISHING
MINING AND QUARRYING (INCLUDING 14644
PETROLEUM)
MANUFACTURING 24307
CONSTRUCTION 3240
ELECTRICITY, GAS & WATER 1697
TRANSPORT, STORAGE & COMUNICATION 6079
WHOLESALE, RETAIL TRADE, HOTEL & 10068
RESTAURANTS
FINANCE, INSURANCE, REAL ESTATE AND 8733
BUSINESS SERVICES
GOVERNMENT SERVICES 8768
OTHER SERVICES 1831
IMPUTED BANK SERVICE CHARGES 4804
3458
IMPORT DUTIES
INDIRECT TAX 4000
SUBSIDIES 3000
NET PROPERTY INCOME FROM ABROAD 3000
CAPITAL CONSUMPTION 5000
CALCULATE:

1. GDPmp
2. GNPmp
3. GDPfc
4. GNPfc
5. NNPfc
6. PI
7. DI
SOLUTIONS

1. GDPmp = 14828 + 14644 + 24307 + 3240 + 1697 + 6079 + 10068 + 8733 + 8768 + 1831
- 4804 + 3458
= 89391

2. GDPfc = 89391– 4000 + 3000

= 88391

3. GNPfc = 88391+ 3000

= 91391

4. NNPfc = 91391- 5000

= 86391

Income approach

- the national income account method that measure GDP by adding all income received by all
factors of production in producing final good
- such income may be in the form income of individuals from employment and self-employed,
the profits of firm and public corporation, rent on properties and interest earning of factors of
production.
- It is the sum of 5 items

i. Compensation of employee
- includes wages and salaries

ii. Proprietor’s income

- the income of unincorporated businesses
- consist of the net income of sole proprietorship, partnership & other unincorporated businesses

iii. Corporate profit

- earning of owners of corporation
- divided to DISTRIBUTED & UNDISTRIBUTED
- distribute and undistributed are added under GDPmp
- only undistributed is minus under PI (distributed profit (exclude dividen)-ignore)
- 3 categories

a) corporate income taxes

 these taxes are levied on corporations’ net earnings
 flow to the government
 undistributed to household

b) dividends
 these are the part of corporate profits that are paid to the corporate stockholders
 distributed to the households
 c) undistributed corporate profits @ retained earnings
 these are money saved by corporations to be invested later in new plants and
equipment
 undistributed to household

iv. Net interest

- interest paid by businesses to the suppliers of money capital
- includes the interest household receive on saving deposits, certificates of deposit (CDs) and
corporate bond
- interest paid by households and by the government is not counted in GDP because it is not
assumed to flow from the production of goods and services.

v. rental income

- the income received by property owners in the form of rent

The steps:

1. GDPmp = COMPENSATION OF EMPLOYEE + PROPRIETORS; INCOME +

CORPORATE PROFIT + NET INTEREST + RENTAL INCOME +
DEPRECIATION + INDIRECT TAXES – SUBSIDIES - NET FACTOR
INCOME EARNED FROM ABROAD (income received from abroad –
income paid abroad) + NET FACTOR PAYMENT TO THE REST OF THE
WORLD @ NET FOREIGN FACTOR INCOME (payment of factor income
to the rest of the world – receipt of factor income from the rest of the
world)

!!!!! Depreciation must be added to calculate GDP by income approach because we want to measure
all income, including income that results from the replacement of existing plant and equipment.

2. GDPfc = GDPmp – INDIRECT TAXES + SUBSIDIES

3. GNPmp = GDPmp + NET FACTOR INCOME FROM ABROAD

(income received from abroad – income paid abroad)

4. GNPfc = GNPmp – INDIRECT TAX + SUBSIDY

= GDPfc + NET FACTOR INCOME FROM ABROAD
(income received from abroad – income paid abroad)

5. NNPfc@NI = GNPfc – DEPRECIATION

6. PI = NNPfc + TRANSFER PAYMENT – EPF – SOCSO – INSURANCE –

RETAINED EARNINGS (undistributed corporate profits) – CORPORATE
TAX
7. DI = PERSONAL INCOME - PERSONAL INCOME TAX
Example

Table 3: Calculation national income using the income approach

COMPONENTS RM
MILLION
4004.6
COMPENSATION OF EMPLOYEES
PROPRIETORS’ INCOME 473.7
CORPORATE PROFIT 542.7
NET INTEREST 409.7
RENTAL INCOME 27.7
INDIRECT TAXES 233
SUBSIDIES 320.1
RECEIPTS OF INCOME FROM THE REST OF 167.1
THE WORLD
PAYMENT OF FACTOR INCOME TO THE REST 178.6
OF THE WORLD
DEPRECIATION 715.3
CORPORATE TAXES 348.4
SOCIAL SECURITY CONTRIBUTIONS 626
TRANSFER PAYMENT 963.4
EMPLOYMENT PROVIDENT FUND 233
PERSONAL TAXES 742.1
CALCULATE:

1. GDPmp
2. GNPmp
3. GDPfc
4. GNPfc
5. NNPfc
6. PI
7. DI
SOLUTIONS

1. GDPmp = 4004.6 + 473.7 + 542.7 + 409.7 + 27.7 + 233 - 320.1 - 167.1 + 178.6 + 715.3
= 6098.1

2. GDPfc = 6098.1 – 233 + 320.1

= 6185.2

3. GNPfc = 6185.2 + 167.1 – 178.6

= 6173.7

4. NNPfc = 6173.7 – 715.3

= 5458.4

5. PI = 5458.4 – 348.4 – 626 + 963.4 – 233

= 5214.4

6. DI = 5214.4 – 742.1
= 4472.3

Other National Accounts

NDPmp = GDPmp – DEPRECIATION

NDPfc = GDPfc – DEPRECIATION

NNPmp = GNPmp – DEPRECIATION

NNPfc = GNPfc – DEPRECIATION

NNImp = GNPmp – DEPRECIATION

NNIfc = GNPfc – DEPRECIATION

NNIfc = NDPmp – DEPRECIATION

2.3 Personal income, disposable income, per capita income, nominal and real income

Formula as explain above !

 Personal Income

- includes all income received whether earned or unearned by household

- subtract the income that is earned but not received by household i.e. social security taxes (payroll
taxes), corporate income taxes and undistributed corporate profits
- add the income that is received but not earned such as social security payments, welfare payment,
disability and education payment to veteran and private pension payment ( this transfer payment
must be added to obtain PI)

 disposable income

- The amount of income that households actually have to spend or save after payment of
personal taxes
- personal taxes consists of personal income taxes, personal property taxes and inheritance taxes

 per capita income

- refers to the average income per head of population

- used as index of change in the standard of living of a country
- formula:

Per capita income = National income / Total population

 nominal income

- Income unadjusted for the effects of inflation or deflation, and stated in the currency in which it is
earned or
- The part of a salary or wage paid out in cash not including benefits such as subsidized meals or
transportation.
- NOMINAL GNP, is measured in current price

NOMINAL GNPcy = PIcy X REAL GNPcy

PIby

NOMINAL GDPcy = PIcy X REAL GDPcy

PIby

NOMINAL GNPPER CAPITA = NOMINAL GNP

POPULATION

 real income

- Income of an individual, organization, or country, after taking into consideration the effects of
inflation on purchasing power.
- Also called real wages.
 - For example, if you received a 2% salary rise over the previous year and inflation for the year was
1%, then your real income only rose 1%. Conversely, if you received a 2% raise in salary and
inflation stood at 3%, then your real income would have shrunk 1%.
- REAL GNP, is GNP measured in the price of a fixed or base year

REAL GNPcy = PIby X NOMINAL GNPcy

PIcy

REAL GDPcy = PIby X NOMINAL GDPcy

PIcy

2.4 Uses of national income statistic

1 Standard of living comparison

The GNP and GDP statistics are used to measure the standard of living where a higher per capita
GDP would indicate higher standard of living in a country
Eg country with higher standard of living:- USA, UK CANADA & JAPAN
Eg country with lower standard of living:- MYANMAR, VIETNAM & CAMBODIA

2 Economic performance over time

The GDP figure is used to view the development overtime and it gives a basis to compare the level
of output of the nation from year to another.
if national income improved steadily over the past years, shows a stable economy with improved
productivity
National income data also represent whether the economic performance of a nation is growing,
stagnant or declining

3 National planning
National Income data are used to do economic planning for future economic periods with
the assumption that future will carry trends from past.
Important tool for the government to formulate its short term and long term economic planning
Important tool for the government to forecast future developments based on current economic
performance
To draft the country’s ‘Malaysian Development Plan’ for a five year period

4 Sectoral contribution
National income data are used to calculate the contribution from each sector to the economy.
enable us to know which sector contributes the most to the economy

5 Economic policy
To formulated future economic policies with using the national incomes estimates

6 Inflationary & deflationary gaps

National income data provided the information of purchasing power of money
This helps government implement anti-inflationary or anti-deflationary measure to stabilize the value
of money

7 National expenditure
National incomes estimates provides information for consumption and investment expenditure and
 as well as reasonable depreciation to maintain capital stock

8 Public sector
National income figures enable us to know the relative performance of both the public and private
sector through the pattern of expenditure
If most of the activities are performed by the state, shows public sector is playing a dominant role in
a centrally planned economy

9 Distribution of income
To analyze the distribution of income national income data will be useful.
Indicate changes in income distributions among different sectors and factor of production

10 Comparison between countries

Compare the wealth of different countries

11 To measure a country’s growth rate

Income data are needed to compute country’s growth rate

GNP GROWTH RATE = REAL GNPt – REAL GNPt-1 * 100

REAL GNPt-1

12 Taxable capacity
From the national income figures, gov. can gauge the taxable capacity of its working
population
2.5 Problems in measuring / calculating national income

PRACTICAL PROBLEMS CONCEPTUAL PROBLEMS

1. Problem of illiteracy 1. Arbitrary definition
Small producer in 3rd world are illiterate Inclusion or exclusion of certain items in national
Produce for self consumption and not for the market income accounting will cause confusion
Records are not kept of their productive activities
Fail to provide accurate information to gov.
2. Problem of expertise 2. Problems of estimation
Lack of professionals to estimate national income In some countries they use their domestic currency
data with minimum error to measure the national income where as some
countries use US dollars to measure national
income.
such as statisticians, researchers, programmers and Since there is no standard unit of measurement it
analysts leads to inconsistency.
3. Lack of sophisticated machinery 3. Problem of double accounting
To compute national income data in organize Implies the possibility of intermediate goods being
included in the national income data more than once
Such as advanced computers or programs This is where the output of one production process
becomes input to another process leading to
double counting the value of the good. To avoid this
problem the added value at
each production process is used to calculate the
national income figure.
4. Problem of inaccessibility 4. Problem of stock appreciation
Normally in poor countries which certain areas in The increase of stock value due to the inflation
their countries remote and isolated and totally known as stock appreciation
inaccessible
However the economic activities occurs in this area In national income accounting, stock appreciation
should be recorded, without that data the national must be deducted because the increase in the
income data will not be accurate. general price level does not reflect the real increase
in physical stocks or tangible assets.
5. Problem of false information 5. Problem of measuring quality
For eg. Businessman and other self employed Quality of the goods is of equal importance as well
people usually under-estimate their earnings as the quantity. But how to measure?
primarily to evade paying high taxes
This will lower the national income figure of the The price not reflects the quality of the goods!
country and not accurate Because the distortion of prices due to subsidies
and indirect taxes
6.Problem of non-monetized sector 6. Problem of multi occupation
There is large number of a non-monetized sector Nowadays people get to be engaged in a number of
especially in the 3rd world countries and does not economic activities and not included in national
reach the market income
Lead to difficulties in calculating the national income Eg. Full time employer do part time job at night by
driving taxi