IB Economics/Macroeconomics/Measuring National Income

Measuring National Income

Circular flow of income
Methods of measurement:

Income
Expenditure
Output

Distinction between

gross and net
national and domestic
nominal and real
total and per capita

GDP: Gross Domestic product is the total value of goods and services produced within the boundaries of a country regardless to nationality

GNP: Gross national product is the total amount of goods and services produced by means of production which are domestically owned in one years time.

Gross National Product (GNP) measures the economic output of a given nation.

GNP can be used to measure the increase in real national income over a given period of time.

Criticisms of GNP

1. Real national income excludes price changes. A short period rise in national income during an upswing of an economic cycle does not constitute economic development.

2. GNP does not factor in a change in the population of a given nation.

3. GNP does not reveal or factor in the negative externalities such as pollution.

4. GNP tells nothing about the distribution of a society's income.

5. Does not factor in other forms of measurement such as illegal markets, service

Circular flow of income

Household provides factor services and consumer spending to firms. Firms provide income and goods and services. Household income (Y) is spent on domestic firms’ output (O), country imports (M), taxes (T) to the government, and a portion is placed in the form of savings (S) in financial institutions, i.e. banks. T, S, and Ms are all termed leakages (L). These Ls are countered by injections (J) which is comprised of: government spending (G), investment expenditure (I), and export expenditure (X). Since L must always ultimately equal J it is a circular flow. Stock appreciation and discrepancies are taken into account too.

Methods of measurement- income, expenditure, output. There are three main ways of measuring a country's GDP:

Income: Income takes into account wages and salaries, rent, interest, self-employed income and adds up to make total domestic income.

Expenditure: Takes into account all spending in an economy. C+I+G+[X-M]

Output: Takes into account everything which is produced in an economy.

Problems with Measuring National Income

Transfer payments, payments made to students and pensioners even though they don't really help produce anything in the economy.
Non-market economy: If you build an extra wall in your house yourself the NY statistically stays the same but if you had paid a builder it would have risen, even though the work you have done has contributed to the total output of final goods and services in the economy.
Price changes
Parallel Economy: Many people work and is unrecorded by the authorities. This includes both black markets (selling illegal goods) and informal markets (selling legal goods illegally to circumvent price restrictions).
Self Sufficiency: In many poor countries food does not enter the market place. Food is grown for yourself in a subsistence manner thus the national income is lower than it should be.

Distinction between

Gross and Net: Net domestic product = GDP- depreciation
Domestic and national: GNP= GDP + net factor income. Many US Homes and Firms receive factor income from abroad.
Nominal and real: Nominal measures at the current value. Real takes into account inflation.
Total and per capita: Per capita is divided by a country's population.

Problems with using NY figures for a comparison between countries

Composition of Output : Does not show what this income is spent on for example Soviet Russia spent significant amounts on armaments in the cold war, however this does not improve the standard of living.
Composition of Expenditure: National income figures do not take into account what the incomes are spent on. For example heating in cooler countries adds nothing to standards of living; however, does contribute to national incomes.
Exchange Rate Distortions: Exchange rate conversions may not create an accurate representation of a populations relative purchasing power. Purchasing power parity may take this into account.
Unaccounted for Activity : Parallel markets, such as subsistence living and black market activity are not taken in GDP.
Distribution of Income: Doesn't take into account how this income is distributed.
Intangible additions to welfare: Doesn't take into account the ability to enjoy fresh air and have leisure time.
Externalities and environmental damage: Damage to the environment and pollution are not taken into account.