2

MEASURING NATIONAL INCOME AND OUTPUT

Chapter Overview
Measuring National Income and Output

Introduction
The Concept of Income and Wealth(stock)

Circular Flow of Income in a 2,3, and 4sector economy

Gross Domestic Product (GDP) Three Approaches of Measuring GDP: Income, Expenditure and Output Other Measurement of National Income

The Purpose of Calculating National Income Difficulties in Estimating National Income Concepts of Income and Wealth in Islam

LEARNING OBJECTIVES:
After studying this chapter, you should be able to: 1. Distinguish the difference between income and wealth 2. Explain income flow in four-sector economy 3. Define the concepts of GDP, GNP, NNP, PI and DI 4. Calculate GDP using the three methods of national income accounting 5. State the importance of national income accounting and its limitation 6. Explain the problems in calculating national income 7. Explain the concept of income and wealth from the Islamic perspective

2.1

Introduction As we have seen in chapter one, one of the macroeconomic objective is to promote economic growth. Economic growth measures the change in the total value of goods and services produced in a given year compared to previous year. It shows the progress of the economy. In this chapter we will study in detail what constitute and how is economic growth measured and what the limitations are. You would have come across terms like gross domestic product (GDP), gross national product (GNP) in newspaper or other media and pondered what do they show and what is the implication. To understand these terms we will need to know the difference between income and wealth and how the economic operates from a simple two sector to a four sector economy.

Income is flow concept and Wealth is stock

2.2

The Concept of Income and Wealth (stock)

Income is the total payment to owners of the factors of production that is labour, land, capital and entrepreneur. It consists of wages and salaries, rent, interest, profits and income from self-employed. Income is a flow which will receive from time to time. It can be saved and invested or can be changed into wealth (assets). Wealth is stocks of economic goods which comprises of personal wealth (houses, cars and land), business wealth (machineries and factories) and social wealth (highways, schools, hospitals and libraries).

2.3

The Circular Flow of Income in a 2, 3, and 4-Sector Economy In the macroeconomic analysis, economy is divided into four sectors namely household, firms or private sector, the government or public sector and the rest of the world or international sector. These four sectors interact with each other. One way of looking at the economic interactions among the four sectors is to examine the circular flow of income. The circular flow of income describes the way in which a countrys economy flows backward and forward between the sectors in the economy. It shows how household and firm interact in the input market and the output markets. Circular flow of income shows GDP estimated either by product, income and expenditure method will result in the same estimate. To begin with we will focus on the two-sector economy then three and finally four sectors.

2.3.1. The two-sector economy A two-sector economy consists of only household and firms. The circular flow of income can be shown in the figure 2.1 below:

Figure 2.1: Circular flow of income in a two-sector economy Purchases of goods and services

Supply of Goods and Services FIRMS HOUSEHOLD

Supply of Labor, Capital, Land and Entrepreneur Wages, Interest, Rent and Profits Investment saving FINANCIAL INSTITUTION

The households are the owner of the factors of production and supply these factors to firms. Firms purchase these factors to produce goods and services. The bottom half of the diagram shows this flow of the factors of production and income earned by household in term of wages, rent, interest and profits The top half of the diagram shows the flow of the goods and services produced by firms for the household and the corresponding flow of money payments of goods and services from household to the firms. The circular flow of income illustrates the basic principles of 3 approaches of measuring Gross Domestic Product where the value of total outputs equals the value of total income equals total expenditure (explained in detail below). In this simple circular flow it is suffice to two explain in the following manner: Assuming firms produce goods and services with a total market value a total of RM500 million, they have to employ factors of production and make payments in terms of wages, interest, rent and profits to the respective owners. In other words the owners of factors of production will receive and income of RM 500 million. Household will incur a total expenditure of RM500 billion to purchase these goods and services. Here we can see that the GDP measured using product method = income method = expenditure method. The above illustration assumed that household spends all their income to buy good and services. But in everyday life, household does not spend all their income for consumption. They also save part of their income in financial institutions The money saved by household will be reinvested by the financial institutions through the firms and therefore injected back into the circular flow of income as private investment

2.3.2. The three-sector and four- sector economy A three-sector economy consists of household, firm and the government. The relationship between the three sectors can be explained using the following figure 2.2: Figure 2.2: The Circular flow of income in a four -sector economy Purchases of goods and services taxes taxes

FIRMS

GOVERMEMT Good and services wages, interest, rent, profit and transfer payments

HOUSEHOLD

Wages, Interest, Rent and Profits Investment FINANCIAL INSTITUTION Saving

Exports INTERNATIONAL TRADE

Imports

The Figure 2.2 shows that the in a three-sector economy household provides factor of production to the firms and the government. In return, households are rewarded with wages, interest, rents and profits. Besides this they also received payments from the government in the form of security benefit, welfare payments, pension and scholarship, which are called, transfer payments. Households use their income to buy goods and services from firm, pay taxes to the government and save in financial institutions., Firms on the other hand pay wages, rent, interest and profits and taxes to the government. The government collects taxes, from household and firms and makes payments when it purchases goods and services from firms, pays wages and salaries, interest and make transfer payments to household. These payments are also called government expenditure (G). In a four-sector economy another sector is added that is the international trade. International trade plays a role as an economy will export and imports goods and 5

services from the rest of the world. When a country exports it will receive income and when it imports it will have to make payments to the rest of the world.

CHECKLIST
At this point you should be able to:
Differentiate income and weath Identify two, three and four-sector economy

2.4

Explain the flow of income in all the four sectors of economy Gross Domestic Product (GDP) GDP is the sum of market value of all final goods and services produced in a country in a given year. There are four parts to this definition. The first refers to sum of market value. As goods and service produced are varied and have different measurement, for example rice is measured in kilogram (kg), a specific electrical item (hair dryer) in units, they cannot be added. By valuing them at market price we can get the total amount of goods and services produced in an economy. If the economy produces 100 kg of rice at price is RM4 per kg and 50 units of a specific electrical item (hair dryer) at price RM150, The total value of goods and services produce will be RM400 of rice plus RM7500 of the specific electrical item will be RM7900 in this economy. The next part is final goods and services. We have to differentiate between final goods and intermediate goods. Final goods are goods that are consumed by final user. Intermediate goods are goods that are used as component of a final good or service. Example of final goods is the amount of rice we consume or a car used by a family. Intermediate goods are car tires or sugar used to make ice-cream. To determine whether a good is a final good or intermediate we have to look at the use of it. In the calculation of GDP it is important to differentiate final good and intermediate good. A failure to do so will lead to double counting (this will be explained later) The third part is the produced in country. In the calculation of national income only goods and services produce in the country are take into account it does not matter if the firm is locally or foreign owned. For example The Coca-Cola Companys production in Malaysia is a part of Malaysians GDP estimate. On the other hand production of oil by PETRONAS in the middle east is not a part of Malaysias GDP estimated

The final part of the definition is the time factor.GDP is measured normally on yearly basis known as annual GDP data or can be measured on quarterly basis known as quarterly GDP data.

2.5

Three Approaches of measuring GDP: Income, Expenditure and Output GDP can be measured in three ways and will result in same value. The three methods are expenditure, income and product. In the first method GDP is calculated by adding the value of goods and services produced in the economy. In the process of producing these goods and services income is generated for households who provide factors of production in the form of wages, interest, rent and profits. Income method thus adds up the total income received by these households from productive activities only. The third method is expenditure method which adds up the total payment for goods and services purchased. The GDP can be calculated using three approaches namely: a) b) c) 2.5.1 The product method The expenditure method The income method The Product Method

Domestic product is the total consumer 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 goods and services produced by each firm (the final product), i.e. the production of every enterprise from the sole proprietor to the government. To avoid double counting and to eliminate intermediate goods from the measure of GDP , the calculation of GDP using the output method must be based on either of the following: i) ii) Taking into account only the total market value of all-final goods and services produced in the country. or Based on the value added approach Table 2.1 : Value-Added approach Participants FirmA Farmer(Paddy) Firm B Miller (Rice) Cost of material 0 150 Value of sales 150 250 Value added 150 100 7

Firm C Wholesaler Firm D Retailer Totals

250 300 700

300 400 1100

50 100 400

Table 2.1 shows that only value added or final output is considered in the GDP accounting. At each and every stage there are firms involve in production and distribution process which adds value to the product. If we were to calculate national income based on intermediate as well as final output, there would be double counting. Value added is the increase in value of the product as it moves from one process to another. Value added is calculated by subtracting the cost from the sales of the product. For example the miller buys rice from the paddy farmer at cost RM150 and mills it into flour to sell at RM250, the value added is RM150. Therefore if we use the value added method the amount that should be added to the GDP is ( RM150+ RM100+RM50+RM100) RM400. The other approach is to use final product value which is RM400 The sum of the value of all the goods and services produced by various sectors in economy in a given year is gross domestic product at market price (GDPmp). Table 2.2 shows the estimates of GDP using the product method that is by adding up the contribution of various sectors in the economy. Table 2.2 Hypothetical Example of GDP Estimates (Product- Method) 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. Agriculture, forestry and fishing Mining and quarrying (including petroleum) Manufacturing Construction Electricity, gas and water Transport, storage and communication Wholesale, retail trade, hotel and restaurants Finance, insurance, real estate and business services Government services Other services Gross Domestic product at market prices (GDP) 14,800 14,600 24,300 3,240 1,600 6,000 10,060 8,700 8,700 1,800 93,800

2.5.2

Expenditure Method The GDP can be measured by using expenditure method. In this method the total amount spent on goods and services and capital goods and stocks produced by an economy in that particular year is added.

When using expenditure method to calculate the GDP, we have to take all the expenditures incurred by the 4 sectors in the economy. The expenditure can be categorized as follows: i) Consumption (C) expenditure is made by household. It forms the largest component of national income. It comprises of all the expenditure on goods and services. Expenditure of can be on durable goods such as cars, electrical items and furniture and non durables such as food and clothing. Investment (I) expenditure includes investment on capital such as new plants, equipment, machinery and changes in inventory such as raw material, semi-finished goods or finished goods. Gross investment is the total amount spent on the purchase of goods and services and on replacing depreciated capital. Depreciated capital is the amount of wear and tear and obsolescence of the stock of capital. Net investment is the amount by which the capital stock increases . Net investment is calculated by: Gross Investment Depreciation = Net investment iii) Government expenditure (G) : government expenditure includes purchase of goods and services from firms spending on investment such as hospitals and schools and paying wages. However it is important to note that transfer payments that is cash transfer from government to household such as pension, subsidies are not included Net exports (X M) are net spending by the international sector. Firms buy and sell goods and services from other countries. When they sell it is known as exports and when they buy it is imports. Net exports is estimated by subtracting imports from exports

ii)

. iv)

Take note that GDP excludes non-production transactions such as second-hand sales. They do not contribute to current production. Suppose you sell your 2005 Proton Waja to your friend in 2011, this transaction will not be included in the 2011 GDP estimates because it is not current production. Change in business inventory is be counted in GDP. Firms are not sure how much they will sell from one period to another and sales often fluctuates.. To maintain the goodwill of their customers, firms need to be able to respond to the unforeseen increase in sales by keeping stocks of inventory. An increase in inventory reflects an increase in total production and should be added to GDP, and vice versa. Suppose inventories increased by RM10 million from December 31, 2010 and December 31, 2011, this means that the economy has produced RM10 million more output than was purchased in 2011. We need to account all output produced in 2011 as part of that years GDP, even though some of it remained unsold at the

end of the year. This increase in RM10 billion in inventories is included in the GDP estimates of year 2011.

Table 2.2 Hypothetical Example of GDP Estimates (Expenditure- Method) Particulars 1 2 3 4 5 6 7 8 Public expenditure Private expenditure Government expenditure Private investments Change in stocks Add : exports of goods and non-factor services Less : imports of goods and non-factor services Gross Domestic Expenditure at market price (GDE) Income Method RM million 12,980 43,500 9,000 23,000 680 78,840 -74,200 93,800

2.5.3

The next method is the income method. When income method is used we add the total money value of all incomes received by persons and enterprises of a country during the year. Such incomes may be in the form of income of individuals from employment (wages) and self-employed, the profits of firms and public corporation, rent on properties and interest earnings on capital borrowings. The income can be categories as follows: i) Compensation of employees is the largest income category. It consist of wages and salary ii) Rent consists of income payments received by households who supply land and property resources. Net Interest refers to money income payment flowing from private businesses to the suppliers of money capital. It is interest receive on loans made minus interest paid on borrowing. However interest payments by government are excluded from interest income. Corporate profit consists of three items. Firstly its the distributed profits which are paid to stockholders as dividend. Secondly, is the undistributed profits which are invested and increase the real assets of the investing business. Finally it is corporate income taxes which go to the government. Proprietors income consist of all the four categories mentioned above which cannot be divided into the categories above

iii)

iv)

v)

10

The sum of this income is called net domestic income at factor cost. It is at factor cost because we are adding all the earnings of factors of production. To get to market price as in the other two methods we have to add indirect taxes and deduct subsidies. Total income is the net figure as it includes net profits which exclude depreciation. To get gross estimates from the net domestic income we have to add depreciation. Table 2.3 shows the estimated of GDP using income method. Table 2.3 Hypothetical Example of GDP Estimates (Income- Method) Particulars 1 2 3 4 5 6 7 8 9 Compensation of employees Net interest Rental Income Corporate profits Proprietors income Indirect taxes Less subsidies Capital Consumption Gross domestic product at factor cost (GDI) RM million 55,100 2,300 1,400 13,000 9,100 7,000 2,400 12,800 98,300

By looking at the above examples, it can be seen that the estimates of GDPe same for all the three methods. Hence, GDP = GDE = GDI

CHECKLIST
At this point you should be able to:
Define Gross Domestic Product

2.6 2.6.1

Distinguish the value-added and final good in estimation of GDP Explain the composition of three approaches of estimating GDP Other Measurement of National Income Gross Domestic Product at factor cost.

11

When GDP is measured at market price it refers to the prices paid by the purchasers, which will include indirect taxes and do not include subsidies that are given to producers. Market prices do not give the real value of goods and services. The real value of goods and services are at the factor costs. Factor costs are the real prices earned by the sellers. To get GDP at factor cost (GDP fc ) indirect taxes are deducted and subsidies added to GDP at market price. (GDP mp ). GDP fc = GDP mp + subsidies indirect taxes 2.6.2 Gross National Product The next consideration is to get Gross Domestic Product. The difference between domestic product and national product is the net factor income (NFI) earned from abroad. This refers to the difference income earned by Malaysian-owned resources whether they are located in the country or abroad and income earned by foreign-owned resources in the country. Net factor income can either be positive or negative. If the net income from abroad is RM12 millions and the Gross Domestic Product is RM30 millions, then the Gross National Product (GNP) would be RM42 millions. GNP fc = GDP f + net factor income from abroad

2.6.3

Net National Income To get the net national income we have to consider gross private investment and net pirate investment. Gross private investment is the value of all newly produced capital goods, which includes residential investment, non-residential investment (e.g. new machinery and equipment) and changes in business inventories during the year., that is it includes both replacement and added investment. Net Private Investment refers to the added investment in the current year. To get the net private investment we deduct depreciation from gross private investment . Net Private Investment = Gross Private Investment capital depreciation To get the net national product (NNP) from gross national income we have to deduct depreciation NNP = GNP fc capital depreciation With this consideration we get Net national Income at Factor Cost which is also known as National Income. 12

Now, after studying the three methods of calculating the national income, take a break. Before we start the next section of this topic, you may spend a few minutes to write down the steps taken in calculating national income by using the three methods discusses earlier. You may try the practice questions given at the end of this chapter. 2.6.4 Personal Income (PI) Personal income is income received by household before tax. In the national income accounting there is income that is earned but not actually received by household such as social security contribution, corporate income taxes and undistributed profit. These are deducted to get personal income. On the other hand there is income which are not included in national income but are received by households, that is transfer payments. These have to be added to get personal income. Disposable income (DI) Disposable income is the amount of income which the household have can use they see fit. Disposable income is calculated by deducting personal tax. Table 2.5 shows a hypothetical example of other measurement of national income. It shows that from the GDP estimates other measurement that it GDP mp , GNP fc , NNP fc PI and DI can be estimated. Table 2.5 Hypothetical Example of Other Measure of National Income Item RM million 1 Gross Domestic Product at market price 98,300 (GDP mp ) 2 Less Indirect tax 7,000 3 Add Subsidies 2,400 4 Gross Domestic Product at factor cost 93,700 (GDP fc , ) 5 Factor income receive from abroad 5300 6 Factor income paid abroad 2000 7 Gross National Product at factor cost 97,000 (GNP fc ) 8 Less Depreciation 12,800 9 Net National Income (NNI) 84,200 10 Less social security contribution 200 Corporate taxes 180 Undistributed profits 220 11 Add transfer payment 1380 12 Personal Income (PI) 84,980 13 Less personal taxes 2600 14 Disposal Income (DI) 82,380

2.6.5

13

CHECKLIST
At this point you should be able to:
Define GNP, NNP, NI , PI DI

Explain the process of getting GNP, NNP, NI , PI DI Differentiate net investment and gross investment SELF-TEST QUESTIONS QUESTION 1 a) b) Explain the difference between income and wealth. Using examples, explain the difference between GDP and GNP.

QUESTION 2 The following table shows the national income data for a country. tem Gross Investment Government Expenditure Consumption expenditure Indirect Taxes Subsidies Exports Imports Depreciation Net Property Income From Broad EPF Contribution Transfer Payments Undistributed Profit Income Taxes RM million 1,500 2,000 3,000 500 600 1,100 1,000 400 200 50 100 200 150

Calculate the following: a) b) c) d) e) GDP at market price. GNP at factor cost. National income. Personal income. Disposable income.

14

QUESTION 3 The following data shows the values of economic activities in a country for 1993. Item Banking, Finance and Insurance Construction Agriculture Trade and retailing Education and health services Indirect taxes Subsidies Depreciation Net factor Income From Abroad Calculate: a) b) c) GDP at market price. GNP at factor cost National Income RM million 10,000 11,800 8,400 9,000 12,000 11,500 7,000 8,900 -5,600

SUGGESTED ANSWER QUESTION 1 a) Income refers to payments received by owners of factors of production, which include wages and salaries, rental income, profits and interest. Wealth is the stock of economic goods such as houses, shares, factory buildings, and land. b) GDP measures the total market value of all final goods and services produced in a country in a given year. It includes all goods and services produced by either domestic or foreign resources employed within the country. GNP measures the market value of all final goods and services produced by citizens of a country, regardless of where the output is produced. For example, the value of final goods and services produced by Indian workers working in Malaysia is counted in Malaysias GDP, but is excluded from Malaysias GNP. Likewise, the value of output produced by Malaysians working abroad is excluded in Malaysias GDP, but is included in Malaysias GNP.

15

QUESTION 2 Item Gross Investment Government Expenditure Consumption expenditure Exports - Imports (a) GDP mp - Indirect taxes + Subsidies GDP f.c Net Property Income From Broad (b) GNP fc - Depreciation (c) National Income - EPF Contribution + Transfer Payments - Undistributed Profit (d) Personal Income - Income Taxes (e) Disposable Income RM million 1,500 2,000 3,000 1,100 (1,000) 5,600 (500) 600 5,700 200 5,900 (400) 5,500 (50) 100 (200) 5,150 (150) 5,000

QUESTION 3 Item anking, Finance and Insurance Construction Agriculture Trade and retailing Education and health services (a) GDP m.p - Indirect taxes + Subsidies GDP f.c + Net factor Income From Abroad (b) GNP f.c - Depreciation (c) National Income RM million 10,000 11,800 8,400 9,000 12,000 51,200 (11,500) 7,000 46,500 (5,600) 85,100 (8,900) 76,200

16

National Income is used to achieve National Policy

2.7 a)

The Purpose of Calculating National Income To Measure the Rate of Growth of the Country

One reason for calculating the national income of GDP is to measure the rate of growth in a countrys economic activities from one year to another. The economic growth of a country can be indicated by the national income per head of the population (income per capita). To calculate the rate of economic growth, we need to calculate the real GNP using nominal income. The real GNP is GNP measured in the price of a fixed or base year while nominal GNP is measured in current prices and does not reflect the actual value of goods and services produced. i. Real GDP

Formula to calculate the real GNP:

Real GNP

= Price index year 0 Price index year 1

Nominal GNP year 1

Notes: Year 1 Year 0 GNP Year 1 Example Suppose the CPI of the current year is 103 and the nominal GNP is RM25,000 million. What is the real GNP? - Current year - Base year - GNP current year

17

Real GNP

= =

(100/103) x RM25,000 million RM24,271.84 million

ii.

Growth rate

The following formula is used to calculate the rate of growth:

Real GNP year 2 real GNP year 1 Real GNP year 1

100

g Real GNP year 2 Real GNP year 1

= = =

rate of economic growth Real GNP at current year Real GNP for the base year

If the real GNP of 1997 is 24,500 m and the real GNP of 1992 are 22,800m. What is the growth rate between 1992 and 1997?

g = iii.

= 7.5%

24,500 - 22,800 22,800

100

Per Capita Income

The per capita income refers to income receive per person in the country. It is calculated by dividing the GNP by the population in the country. Per capita income = GNP Population

Given GNP as RM 24,500 m and population 2.5m the per capita income is: Per capita income is 24,500 = 9, 800 2.5 On the average a person earns RM 9800 per year b) To Measure the Standard of Living of A Country

The national income is commonly measured in terms of income per capita of a country. In general, the higher is the income per capita over the years, the higher 18

the standard of living will be. A higher per capita would mean that the population is able to have a higher level of consumption. c) To Compare the Wealth of Different Countries

The national income figures can be used to compare the wealth of standard of living of different countries. To compare the wealth of country we have to compare the per capita income as a higher GNP does not really show the greater amount of wealth especially in countries with a high population. This is one of many other considerations before wealth can be measure between countries. d) To identify the Contribution of Various Sectors in the Country

We can identify the contribution of various sectors in the economy by using output in calculating national income. The output method of estimating GDP will show which sector is the main contributor and the one that needs to be focused. e) Assist the Government in Its Economic Planning

A successful government planning requires accurate figures-accurate figures upon which decision can be made. Therefore the National income figures can assist the government in designing future economic planning. For example, if the government has identified that the agricultural sector needs to be stimulated; it will then design some measures to achieve this objective, for example giving subsidies or other incentives to farmers to encourage production of agricultural products f) To indicate changes in the Distribution of Income

The national income figures help to indicate the distribution of income in the country. This can be done by examining the figures of wages, rent, interest and profit and its contribution to national income. As most of the population are wageearners the item compensation for employees must form the largest amount, if this is not the case than it will show that income is unequally distributed. g) To Show the Pattern of Government Expenditure

The government expenditures are included in the national income accounting using expenditure approach. The pattern of government expenditure such as on social benefits, education, and defense can be evaluated and be further adjusted if it is required.. 2.8 Difficulties in Estimating National Income

National income is a reasonably accurate and extremely useful measure of how well or how poorly the economy is performing. But it is extremely difficult to 19

measure and has several shortcomings as a measure of both total output and total utility. It may provide a false impression of a countrys well-being as it excludes certain factors, such as non-market transactions, the underground economy, the externalities, and the composition and distribution of output. a. The Necessity of Having to Make Arbitrary Definitions Arbitrary definitions must be made, for example: i) ii) Production includes paid goods and services but it excludes work done by a person for himself. Goods, which have a serviceable life of several years, are included in the national income at their full value of the year they are bought (with the exception of owner occupied houses/not rented out houses) Unpaid government services such as police services and education are included in the national output at cost.

iii)

b. Inadequate Information Data from which the national income figure is estimated contain incorrect and incomplete information (e.g. income tax returns). The value of the unmeasured black economy, which is economic activity kept hidden from the officialdom, may be very high. These incomes are not recorded in the national income statistics. c. The Danger of Double Counting Double counting of goods and services will exaggerate the value of GNP. All good and services produced in any given year must be counted once, but most products of through a series of production process before reaching the market. As a result, parts and components of a product are sold/bought many times which involves repeated calculations. Hence to avoid these calculations, GNP should include only the market value of final good and ignores those involving intermediate goods. Final goods are good and services purchased for final use and not for resale or farther processing. Intermediate goods are good and services purchased for further processing or manufacturing. Thus counting of intermediate goods involves double counting and hence will exaggerate the value of GNP. d. Non-Market Transaction National income counts only market transactions, it excludes certain unpaid activities, which do not take place in any market. For example, the services of homemakers, child rearing and the labor of carpenters who repair their own home are not counted in national income. Such transactions never show up in national 20

income, which measures only the market value of output. Consequently, national income understates a nations total output. e. The Underground Economy Embedded in our economy is a flourishing, productive underground sector. Activities such as gambling, prostitution, and illegal drugs are all final products whose values are determined in the market. However, they are not reported, so are not counted in national income accounting. Governments usually make an estimate of the size of this underground economy, thus national income data is not accurate.

2.9

CONCEPT OF INCOME AND WEALTH IN ISLAM The Concept of Income Payments to the owners of factors of production must be determined according to the Islamic rules (syariah laws) so as to promote justice in the allocation of resources. The Concept of Wealth In Islam, man is not the absolute owner of wealth, he is just a trustee who is given the responsibility to enrich the world and use the wealth given by Allah in the right way according to the syariah principles. Allah is the absolute owner of the universe. In order to carry out the responsibility as a trustee and act as a vicegerent of Allah, man should not manage the wealth only for his own self-interest. It should be directed towards the benefits of the mass as whole. As he aware of this responsibility as a Muslim, he should acquire wealth not to gain self-interest but to achieve al-falah (prosperity in this world and hereafter) Islam divides wealth into three main categories: a. b. c. individual wealth social wealth nations wealth

Each category of wealth must be managed according to the guidelines prescribed by Allah S.W.T. is the Quran and in the Prophets sunnah.

21

CHECKLIST
At this point you should be able to:
Explain the uses of national income accounting

Explain the problems in calculating national income accounting Explain the concept of income and wealth from the Islamic perspective.

2.10

Key Terms Income Gross Domestic Output Gross Domestic Product Gross Domestic Expenditure Gross National Product Net National Product Market Price Factor Cost Circular flow of Income Gross Investment Depreciation Disposable Income Double-counting Nominal GDP

Wealth Two-Sector Economy Three-Sector Economy Four-Sector Economy Final Good Intermediate Good Consumption Investment Government Expenditure Net Investment Net Exports Personal Income Real GDP

2.11

SUMMARY

Income is the total payment to the factors of production and it is a flow, it can be saved and invested. Wealth is stocks of economic goods, which consists of personal wealth, business wealth and social wealth. The circular flow of income explains how firms and household interact both in output market and input market. National income is the total payments received by the factors of production during a year. Gross national expenditure measures the amount spent on all final goods and services during a given period. Gross national product is the total market value of all final goods and services produced during a given period. National income can be calculated using three methods: income method, product method and expenditure method.

22

 When calculating the national income using the product method, we can either sum up the value added at each state of production or takes the value of final sales. National income includes only productive activities while non-productive activities such as gambling are not included. Real national income measures national income at fixed prices and nominal national income measures national income at current prices. GDP can be used to measure per capita income and the growth rate of a country. According to Islam, Allah is the absolute owner of wealth and an individual is a trustee. Man act as vicegerents of God (Khalifah) who is responsible to manage the wealth in the best possible ways as prescribed by Allah. The payment to factors of production is different in Islam compared to the conventional economics. Islam forbids interest. Owners of capital use them for investment by means of al-mudharabah and al -musyarakah.

PRACTICE QUESTIONS PART A: MULTIPLE-CHOICE QUESTIONS Answer the next two questions based on the data in this table. Year 2006 2007 1. GDP RM millions 125,970 146,800 Price Index 150 160

Real GDP growth rate in 2007 for this country is: 8.5 percent 9.3 percent 14.2 percent 24.3 percent If the population in 2006 is 15 millions, what is the nominal GDP per capita for 2006? RM 4,500 RM 5,599 RM6.117 RM 8,398 The purchase of machinery and equipment used in the production by firms is called consumption expenditures investment expenditures government expenditures net export

A. B. C. D.
2. A. B. C. D. 3. A. B. C. D.

23

4. A, B. C. D. 5. A. B. C. D. 6. A. B. C. D. 7. A. B. C. D. 8. A. B. C, D: 9. A. B. C. D. 9. A. B. C. D. 10. A. B. C. D.

Depreciation measures the interest rate charged by the central bank on over-night loans the stock of capital inventory build-up the rate at which capital wears out or becomes obsolete The difference between the value of a product at the final stage of production and the cost of materials purchased from other firms is the value added net input cost production profit gross input cost Nominal GDP will always equal real GDP if inflation is positive when prices are declining in the base year if intermediate goods are excluded The approach of computing GDP by adding up the amount of final goods and services produced in the economy during a given period is the Income approach Output approach Expenditure approach Circular approach The following is NOT included in Malaysia's GDP. EON's corporate profit Salary of a Malaysian Cabinet Minister SOGO's gross profit Wages earned by Malaysians in Brunei Indirect taxes include expenditure taxes sales taxes excise taxes All of the above Nominal GDP will always be greater than real GDP if nominal GDP is increasing and price level is unchanged. prices are decreasing, nominal GDP is increasing and price level is decreasing. prices are increasing. Suppose a used car dealer in Kajang purchases a used Proton car for RM20,000 and resells if for RM24,500. The effect on the country's GNP is GDP remains unchanged GDP increases by RM 24,500 GDP increases by RM 4,500 GDP decreases by RM 4,500

24

11. A. B. C. D.

The value of the housing services provided by the economy's owneroccupied houses is included in GDP and the estimated rental values of the houses is used to place a value on these housing services. included in GDP and the actual mortgage payments made on the houses is used to estimate the value of these rental services. excluded from GDP since these services are not sold in any market. excluded from GDP since the value of these housing services cannot be estimated with any degree of precision. Adding the market value of all final and intermediate goods and services in an economy in a given year would result in an amount less than GDP for that year an amount greater than GDP for that year the calculation of GDP for that year the calculation of Net Domestic Product (NDP) for that year

12. A. B. C. D.

13 A. B. C. D. 4. A. B. C. D. 15. A. B C. D. 16.

The value of chicken reared by a pensioner in his farm for his own consumption is excluded from the national income computation because it would involve double counting. there is no way of imputing value to such goods. the goods are not exchanged through the market. pensioners' activities should not be included. The total market value of all final goods and services produced within a period of time by Malaysians, refers to Net National Product Gross Domestic Product Gross National Product Net national Income If net factor income from abroad is negative total exports equal total imports. national income is less than personal income. GNP is lower than gross domestic product. GNP is greater than gross domestic product. Last year the Aisyah family earned RM70,000. This year their income is RM77,000. In an economy with an inflation rate of 8 percent, we can conclude that the Aisyahs nominal income and real income both increased and real income both decreased increased, but their real income decreased decreased, but their real income increased GDP may be defined as the market value of all final goods and services produced in an economy in a year all final and intermediate goods and services produced in an economy in a year

A. B. C. D. 17. A. B.

25

C. D. 18. A. B. C. D. 19. A. B. C. D.

all factors of production used in production of goods and services in an economy in a year total incomes distributed to producers and shareholders Real national product can be defined as national product valued at current price national product valued at real factor cost national product valued at unchanged prices from year to year national product valued in term of real value of money The unreported of illegal production of goods and services in the economy that is not counted in GDP is termed money laundering the underground economy net personal income indirect national income

20. A. B. C. D.

The largest component of GDP is personal consumption expenditure government spending net exports gross domestic private investment.

SHORT-ANSWER QUESTIONS QUESTION 1 a) Below is the income data for a country. Items Consumer expenditure Government expenditure Private investment Public investment Wages and salaries Rental income Net exports Taxes on expenditure Subsidies Direct taxes Net property income from abroad Capital consumption i) ii) iii) RM 210 000 14 500 60 100 40 000 100 000 28 000 2 800 56 000 7 000 8 000 3 400 42 000

Calculate the gross domestic product (GDP) at market price. Calculate national income. Give two (2) reasons why governments calculate national income.

26

b) i) ii)

Which of the following are counted in this year's GDP? Explain your answer in each case. A local car dealer sold a used car. Anita cooked meals for her family.

QUESTION 2 The following table shows GDP and price index for a country between 2000 and 2002. Assume that the year 2000 is the base year Year 2000 2001 2002 a) b) GDP (RM Millions) 30,000 40,000 48,000 Price Index 100 120 110

Calculate the real GDP for 2000, 20011 and 2002. Calculate the rate of economic growth based on the real GDP in 2002.

c) If the population in year 2002 is 40 millions, calculate the income per capita GDP for that year. QUESTION 3 The following table shows the national income data for an economy with a population of 10 million. Item Private consumption Public investment Corporate investment Net property income from abroad Government expenditure Increase in inventory Depreciation Gross profit from public enterprise Wages Taxes on expenditure Calculate: a) b) c) GDP at market prices GNP at market prices GNP at factor cost RM mill 101,500 17,980 44,850 -12,560 18,970 -3,800 15,000 -10,450 53,360 23,644

27

d) e)

National Income. National income per capita.

QUESTION 4 The following are extracts from the National Income accounting of a particular country. Items Imports Exports Private investment Government expenses Subsidies Indirect business taxes Private consumption Depreciation Change in stock Net factor payment abroad Wages and salaries a) Calculate: i) GDP at market price ii) iii) b) GNP at factor price National income RM million 25000 30000 1000 1000 500 1300 16000 500 1000 -8500 10500

Give 2 reasons why national income is calculated.

QUESTION 5 Output of various sectors in a hypothetical country is given in the following table. Sectors Construction Agriculture Mining Private investment Manufacturing Government services Wholesale and retailing Other services Taxes on expenditure Capital consumption Net factors income from abroad Subsidies RM (million) 350 320 125 200 400 220 150 170 80 50 140 65

28

Calculate: a) b) c) d) GDP at market price. GDP at factor cost. GNP at market price. National Income.

ESSAY QUESTIONS QUESTION 1 a) b) Briefly describe how GDP can be measured using the income approach and output approach. Explain four (4) reasons why national income is calculated.

QUESTION 2 a) Differentiate the concept of wealth from conventional and Islamic perspectives.

b)

Explain the circular flow model of income in two sector economy in detail and relate it with the throe approaches in calculating national income,

QUESTION 3 a) b) Explain four (4) problems in calculating national income. Using examples, differentiate between GDP and GNP.

29