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Explain the difference between the three main methods of calculating national income - by income, by expenditure and by output.  What are the strengths and weaknesses of each method of measurement?


Accounting definitions:

W.  Beckerman NationalIncomeandEmployment RR750 B3

The  New Palgrave  - national income, - social accounting

R.  and G. Stone National Income and Expenditure RR786 S1


Economic Trends RRPer22

Calculating growth rates:

Any elementary stats book.

National income is the value of all goods produced in the economy that are final goods (i.e. not used up for producing something else). As there are two sectors in the economy - productive and household, several measures can be made that reach to roughly the same national income figure and then an average estimate can be calculated. Wages and profits reach household sector from productive sector and private consumption is returned. Value added measures the flow that leaves productive sector, national income measures the amount received by households and final demand(or expenditure) is the amount reaching the productive sector again.

In theory all these measures should be the same. In the reality an item called statistical discrepancy must often be used to average out the errors.

National expenditure method includes the consumers expenditure (not on houses as they are durable goods and included in fixed capital formation). This is equal to the personal disposable income (PDI)-savings. General government final consumption is the second item. It is the current consumption to be precise, no loans, transfer payments an expenditure by government institutions(harbours) is included as this simply transfers the same money from one sector to other or is included in later year GDP calculations or other sectors in this account. Gross domestic fixed capital formation is the value of houses and other durables formed during a year; and value of physical increases in stocks and work in progress are also included. Export values are added as they are actually produced in a country, but will not increase the country's stock of assets. Same way imports are subtracted.

Basically this all was the value of final goods, thus for example if steel is produced, but then used up for producing cars, its value is not counted. PDI can be obtained from tax returns.

Output method (or production method, industry of origin method) measures the value added of each industry. It is hard to calculate (done by taking the final output of an industry and subtracting inputs or counting all the payments made to the factors of production by that industry). It is useful as the final expenditure can be broken down to show the industry of origin, so nowadays actually most of the accounts are shown as value added ones. This helps to anticipate unemployment in different sectors, etc. But actually the calculations often have to be income or expenditure bases and we have very limited information on some sectors as no-one collects the data. Manufacture is the biggest sector (oil), but it is declining, services sector increases. Adjustment for financial services(interest payments) must be allowed and special care must be taken to prevent double counting.

Income method measures the incomes received by different factors of production (Land, Labour, Capital, Entrepreneurs). It is different by its source from the other two methods and thus helps to make the calculations of the national product more accurate by giving it a different source. It is easy to calculate again from the income tax receipts.

National income method includes the income from employment and from self-employment; gross trading profits of companies, public corporations and general govn enterprises; rent and the imputed charge for the consumption of non-trading capital(benefits from living own houses) and stock appreciation(gain in value).

National Income has severe limitations. There is often no sector by sector breakdown, variations and linkages among components exist, it is difficult to measure and some of the measures can only be guesswork. Different national incomes per head(because the size of population differs) exist, so GDP figures do not provide an accurate overview. Inflation and the GDP deflator differ and are hard to measure (as RPI only measures consumer spending whereas GDP also includes government and trade). Non-monetary transactions(black market) can influence the GDP in some countries(growing own food, in Kenya 25% allowance is made, in developed countries negligible). Tax evasion and black market conditions differ, leisure time is important (UK has longest working week and biggest working population although developing countries might have even more).

International comparisons are even more difficult as the exchange rates fluctuate after 1971, prices and inflation differ in different countries, transport costs must be included, there are different levels of  subsistence economy and the govn expenditure patterns differ. Most of all the data is not meant for national income accounting, it is a by-product of other institutions and can thus be inadequate in several cases.

Define gross national product, national income and gross domestic product.  What is the distinction between current and real terms of these entities?

Gross national product (GNP) is the total income earned by the domestic citizens regardless of the country in which their factors production are located. National income (net national product) is the GNP minus the capital that is consumed(depreciation) during the year.

Gross domestic product shows the output produced in a country regardless of their owner.

Real terms are adjusted to inflation (the general rise in prices) by using a GDP deflator, for example. Real term values help to compare the value of national output over time eliminating the monetary effects of inflation. Current terms show the value of national product in today's prices(thus including inflation). It is the value that can be calculated straight by using the above three methods.

Construct charts showing the time paths of real gross domestic product, and the real value of output of manufactured goods, since 1960.  Calculate the rate of growth of real GNP from 1979, 1981 and 1983 to 1989 and to 1991. 

Real domestic product and the value of manufacturing in index numbers 1990=100

From Year \ To year

89 - 552440


79 - 434274



81 - 419183



83 - 444040



When discussing growth rates, is there any reason why we should take one starting point rather than another? Explain why savings are identically equal to investment in accounting terms.  Is national income a good measure of national welfare?

It is easier to use a round year figure for calculation of the growth rates (i.e. 1990) just for the convenience. Also govn. tends to restart calculations from the recession, so growth looks bigger.

Savings and investment are the same thing in accounting as the savings are defined as the money left in the business after all costs + profits have been paid/distributed. This money must be used up for something, so there is an investment in cash etc.

GNP is used in several cases to asses the welfare. Main shortcoming is that this measure does not take into account the population size and growth. So we tend to use GNP per head more often.

Still, the externalities like pollution and congestion are not taken into account. So the country that produces more, but everybody are sick because the non-existence of pollution reducing equipment, appears to have higher GNP than the country that spends on pollution filters.

Home produced goods and non-market activities can not be shown in GNP. These include the work of housewives. Subsistence sector (growing for own sake) can also contribute considerably to the national welfare in less developed countries. This does not show in GNP calculations.

It is hard to calculate the contribution of several public services. Soviet system used not to count them at all as they are not producing anything tangible. Service sector output is also calculated in a welfare orientated manner (i.e. how much people benefit), but more correct figure could be achieved by cost-of-input calculations.

Perhaps one of the most important measure the GNP shields is the income inequality. Oil-producing countries often report huge GNP-s, but in reality this is earned by very few people and most live in poverty. The welfare there is worse than in countries reporting smaller GNP, but where the poverty level is much smaller.

Leisure and working conditions are not counted in GNP. UK has one of the longest working weeks, this definitely decreases welfare in the UK compared to the other European countries. Much the same way if GNP-s were internationally compared in different countries by using the current exchange rate a very distorted picture is achieved as the price level is actually different, so Estonians can by with their crowns much more in Estonia than in the UK when they would change their crowns to pounds. Thus purchasing power parity calculations of GNP are more accurate (i.e. comparing the cost of same basket of goods in different countries and adjusting the GNP figures accordingly).

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