Adigrat University Department of AcFn Macroeconomics 2019

2. National Income Accounting

2.1. Introduction

National income accounting system is a systematic recording of the economic performance of a

nation with in a given period of time. It can be done (compiled) at different levels depending on
the administrative structure of the country.

a. Gross Domestic Product GDP and Gross National Product GNP

GDP: The most comprehensive available measure of the size of an economy is the gross
domestic product (GDP). GDP is the total market (money) value of all final goods and services
produced in a country during a specified period of time, usually a year. It includes the production
of both factories of the country and foreign-owned factories in the country. It includes only
newly produced goods and services within the borders of the country. Goods produced by
Ethiopians working in other countries are not part of GDP of the Ethiopia. They are part of
the other countries’ GDP. Goods and services produced by foreigners working in Ethiopia are
part of GDP of Ethiopia.

GNP: It is defined as the total market value of all final goods and services produced by
nationals of a country in one year regardless of the place of the production. In case of Ethiopian
GNP, it includes goods produced by Ethiopians working abroad and excludes goods produced in
Ethiopia by foreigners. To measure total output accurately, all goods and services produced in a
given year must be counted once, but not more than once. GNP and GDP include only the
market value of final goods and services and ignore transactions involving intermediate
goods.

Final goods are those goods and services which are being purchased for final use and not for
resale or further processing or manufacturing. Transactions involving intermediate goods, on the
other hand, refer to purchases of goods and services for further processing and manufacturing or
for resale.

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2.2. Approaches of Measuring National Income (GDP/GNP)

There are different approaches adopted by different economists such as:

1. Traditional approach,
2. Keynesian approach and
3. Modern approach

1. Traditional Approach
a. Fishers definition: Fisher stated that national dividend or income consists solely of
services as received by ultimate consumers whether from their material or from their human
environment. From this definition fisher adopts consumption as the basis of national income.
However, it has the following short comings:
 Net consumption cannot be estimated easily;
 The value of services rendered by consumer durables year after year cannot be
measured ; and
 Consumer durables also keep on changing hands and therefore the change of
ownership also creates difficulties.
b. Marshal’s definition: Marshal argued that the labor and capital of country acting on its
natural resources produce annually a certain net aggregate of commodities, material and
immaterial, including services of all kind. This is the true net national income or revenue of
the country or national dividend. Hence, according to Marshal,:

 All types of goods and services which are produced, whether they are brought to the market
or not, are included in the national income;

 The cost of wear and tear of the machinery should be deducted from the total value of these
goods and services. The reminder could be the national income. That is why marshal has
used the term net; and

 Income from abroad has also to be taken into account while computing the national
income.

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However, goods and services produced in a country are so numerous that it is not easy to make
out a correct estimate of the total production. There is the difficulty of double counting which
implies that a particular commodity (as a raw material as well as finished product) may get
included in the national income.

c. Pigou’s definition: He stated that National income is that part of the objective income of
the commodity including of course, income derived from abroad, which can be measured in
money. The main points of this definition are :
 Only goods and services exchanged for money are included in the national income and
 Income earned from investment in foreign countries has also to be counted while
computing national income.
However, the distinction between goods and services exchanged for money and those not
exchanged for money are not real. Moreover, services rendered to one self or the number of
family or friends without any payment are not to be included in the national income.

2. Keynesian Approach: He stated that there are three approaches that can be used to
compute national income. These are:
A. Expenditure Approach
B. Income Approach
C. Sale – Minus - Cost Approach

A. Expenditure Approach

National income, According to this approach, is equal to total consumption expenditure and total
investment expenditure. It can be expressed as:

Y=C+I ……………………………………………. 2.0

Where:
Y= National income
C= Consumption expenditure
I= Investment expenditure

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B. Income Approach

National income, according to this approach, is the total income of all factors of production. It
can be expressed as under:

Y= F+EP …………………………………………….. 2.1

Where F is the payments received by owners of factors of production and EP represents

entrepreneurial profits.

C. Sale – Minus-Cost Approach

National income, according to this approach, is equal to the total sale of proceeds in user cost. It
can be expressed as under:

Y=A-U ……………………………………………2.2

Where A is gross national product and U is aggregate user cost.

3. Modern Approach

Modern approach has considered the concept of national income in its three aspects:

a. Product aspect (output)

b. Income aspect and

c. Expenditure aspect.
It is assumed that there is fundamental identity among the three aspects. It is viewed national
income as a flow of output, income and expenditure. When goods are produced by firms the
owners of various inputs receive income in the form of wages, profits, interest, remaining is
saved. The amount saved by the households is mobilized by the produces for investment
spending. Thus, there is a circular flow of production, income and expenditure. These three flows
are always equal per unit of time. Hence:
Total Output = Total Income = Total Expenditure

……………………………………………….. 2.3

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a. Output Approach

This is the method of measure of GDP/GNP by adding up the market value of output of all firms
in the country. In this method of measuring GDP/GNP, it is important to include only final goods
and services in order to avoid double counting. Double counting will arise when the output of
some firms are used as the inputs of other firms. There are two possible ways of avoiding double
counting. These are:

 Taking only the value of final goods and services and

 Taking the sum of the value added by all firms at different stages of production.
Example2.0: This example will enable you to compute the gross domestic product of a country
using output approaches:
Sector Value of output (in million birr )
1.Agriculture and allied activities 8000
 forestry 1000
 Agriculture 1500

 Fishing 5500
2.Industry 12,200
 mining and quarrying
 large and medium scale manufacturing 1200
 electricity and water 5000
 construction 4000
2000
3.distribution 20,000
 banking and insurance 10,000
 Defense 2250

 Education 3250

 Health 2000

 Other services 2000

4.capital consumption allowance 6200

5. Net income from abroad 4000

GDP is calculated, given information in the above table, as:

GDP= 8000+ 12200+20000= 40200 (Taking only the value of final goods and services method)

Sum of Value Added Methods

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It is necessary to use value added method to avoid double counting. Value added is the market
value of firm’s output less the value of the inputs purchased from others. Thus, the summation of
the values added by all firms in the economy will give as GNP of the economy in the specific
period of time.

Example 2.1: This example helps you to identify the method of computing GDP using the sum
of value added method. A farmer produces oil seeds and sells it to edible oil
factory for birr 10,000. The oil factory uses the oil seeds to produce edible oil,
which it sells to retailers for birr 15,000 Retailers buy the oil and sell it for birr
24,000 using the value added method compute the value of the final product.
Answer: Let’s summarizes the stages of production as follows:

Stages of production Value of output Cost of intermediate goods Value added

Farmer 10000 0 10000

Oil factory 15000 10000 5000

Retailers 24000 15000 9000

Total 24000

Note that the sum of value added is equal to the final value (24000)

b. Expenditure Approach

We must add up all types of spending of final goods and services to determine GDP using
expenditure approaches. Expenditures can be categorized into 4 groups depending on who buys
the goods or services:

 personal consumption Expenditure (C)

 Gross private Investment (Ig)
 Government purchase of goods and services (G)

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 Net export (NE)
Personal consumption Expenditure(C): It includes expenditures by households on durable
goods like cars, refrigerators, video records, automobiles etc, non-durable goods like bread, beer,
cigarettes, pencil, tea etc. and for services like barber, restaurant, lawyer, mechanics etc.

Gross private Investment (Ig): It refers to all investment spending by business firms.
Investment includes all purchases of machinery, equipment and tools by business enterprise, all
construction like building of a new factory and change in inventories. Investment also includes
residential construction. This is because like factories, residential house are income-earning
assets. That means they can be rented to yield money income as a return.

Gross private investment includes added investment and depreciation. If we take only the added
investment, which has occurred in the current year, then we get net private investment.
Net private investment = Gross private investment – depreciation
………………………………………………… 2.4

Where: depreciation is the allowance made for tear and wear out of capital.

Government purchases of goods and services (G): It includes all government spending at
different layers of the government like at federal, state and local, on final goods and services.
However, it excludes all government transfer payments because such payments don’t reflect
current production.
Net export NE:
NE = Export –Import ………………………………………2.5

Spending by foreigners in a certain country may contribute just as spending by the citizens.
Hence, we have to add the value of net export in determining GNP. On the other hand, the value
of import (produced a broad and do not reflect productive activity of a country) should be
subtracted. Net export is the difference between the amounts by which foreigner spending on a
certain country and the amount by which citizens spending on foreign country. In other words,
net export is the difference between export and import.

Hence, the value of gross domestic product of any economy is given as:
GDP = C + Ig + G + NE ………………………………… 2.6

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A country may own resources in foreign country, which leads to a flow of income from a broad
in to the country, denoted by I1, resources owned by foreigners in a country may lead to outflow
of income to a broad from the country, denoted by I 0 the difference between income inflow (I 1)
and income outflow (I0) is known as net factor income from abroad:

Net I = I1 – I0 ……………………………………………………………………………2.7

Hence, the relationship between GNP and GDP is given as:

GNP = GDP + net income from a broad

GNP = GDP + (I1 – I0 ) …………………………………… 2.8
Note that:
 when I1 > I0 , GNP exceeds GDP
 when I1 = I0 , GNP equals GDP
 when I1 < I0 , GNP is less than GDP

Example2.2: This example will help you to develop the skill of computing GNP and/or GDP
using the following hypothetical data of a certain country answer the questions
below.

No Expenditure Items Value ( in Billion Birr)

1 Capital consumption allowance (depreciation) 1220
2 Personal consumption expenditure 6320
3 Government spending on goods and services 5000
4 Transfer payment 650
5 Income earned by foreigners in the country 500
6 Net investment 5780
7 Income earned by citizens a broad 800
8 Export 500
9 Import 750

GDP and GNP, given information in the above table, can be calculated as:
GDP= C + Ig + G + NE
= C + net investment + depreciation + G + NE
Where:
GNP = Gross national product
C= personal consumption expenditure

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Ig = Gross private investment
G= Government purchases of goods and services
NE = net export
GDP = 6320 + 5780+ 120+5000+500-750
GDP = 18070 billion birr
GNP = GDP + (I1 – I0) = 18070 +800-500 = 18370 billion birr

c. Income Approach

Payments received by all citizens of the country that have contributed in the current year
production, according to this method, are added to get gross national product. Hence, Gross
Domestic Product using income approach includes compensation to employees, rent, interest,
profit, depreciation and indirect business tax and subsides.

Compensation to employees (w): It includes wages and salaries and their supplements like
employer’s contributions in social security, pension, health and welfare funds, which are paid by
business firms and government to suppliers of labor.

Rents (R): are payments to households that supply property resources.

Interest (I): refers to payments by private firms to household which supply capital. However,
interest payment made by government is excluded.

Profit (Π): includes proprietors’ income (profit of unincorporated business) and corporate profit.
Proprietors’ income refers to the net income of sole proprietors, partnerships and cooperatives.
While corporate profits include corporate income taxes (part flow to government), dividends
(part divided to stock holders) that are payment flow to households and undistributed corporate
profits that are retained as corporate earnings.

Depreciation (capital consumption allowance) (D): The annual payment, which estimates the
amount of capital equipment used up in each year’s production, is called depreciation. It
represents a portion of GNP that must be used to replace the machinery and equipment used up
in the production process.

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Indirect business tax (IBT: The government imposes indirect taxes on business firms. These
taxes are treated as cost of production. Therefore, business firms add these taxes to the prices of
the products they sell. Indirect business tax includes sales taxes, excise taxes and custom duties
etc. Therefore, GDP and GNP using income approaches are given as follows:

GDP = C+ R+ I+ II+ D+ IBT – Subsidy

GNP=GDP + Net Income from Abroad …………………………. 2.9

Example 2.3: In this example, you will learn the skill of computing GNP and/or GDP using income
approach using the following hypothetical data of a certain country answer the question
below.
No Types of income Amount (in billion birr)
1 Compensation of employees 10,800
2 Proprietor’s income 400
3 Rental income 600
4 Corporate profit 4000
5 Net interest 170
6 Deprecation 1600
7 Indirect business taxes 200
8 Income earned by foreigners in the 500
country
9 Income earned by citizens abroad 800
1. Compute GDP using income approach
2. Compute GNP using income approach
Answer:
1. GDP using income approach is determined as follows:
GDP = C + R +I + II + D + IBT
GDP = 108100+ 600+ 170 + 400 + 4000 + 1600 + 200 = 17770 billion birr
2. GNP = GDP + Net income from a broad
GNP = 17770 + 800 – 500 = 18070 billion birr

2.3: Other Social Accounts

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In the previous section, we have discussed GNP as measure of the economy’s annual output.
However, there are also other social accounts, which can be derived from GNP and has equal
importance such as:
 Net national Product (NNP)
 National Income (NI)
 Personal income (PI)
 Personal disposable income (PDI)
Net National product (NNP): GNP as a measure of the economy’s annual output may have
defect because it fails to take into account capital consumption allowance, which is necessary to
replace the capital goods used up in that year’s production. Hence, net national product is a more
accurate measure of economy’s annual output than gross national product and it is given as:
Net National Product = Gross National Product – Capital Consumption Allowance
…………………………………………………….. 2.10

National income (NI): National income is the income earned by economic resource (input)
suppliers for their contributions of land, labor, capital and entrepreneurial ability, which involved
in the given year’s production activity. It measures the income received by resource supplier for
their contributions to current production. However, from the components of NNP, indirect
business tax, which is collected by the government, does not reflect the productive contributions
of economic resources because government contributes nothing directly to the production in
return to the indirect business tax. Hence, to get the national income, we must subtract indirect
business tax from net national product.

National income = Net National Product – Indirect Business Tax + Subsidies

………………………………… 2.11

Personal income (PI): Part of national income like social security contribution (payroll taxes),
and corporate income taxes are not actually received by individuals. Therefore, they should be
subtracted from the national income. On the other hand, transfer payment, which includes
welfare payments, veterans’ payments, and unemployment compensation, are not currently
earned. Therefore, in order to get personal income (PI) which is a measure of income received by

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individuals, we must subtract from national income those types of income which are earned but
not received and add those types of income which are received and but not currently earned.

Personal income (PI) =National income (NI) - social security contribution (SSC) -corporate
profits -Net interest + transfer payment + Dividend + personal interest
income

………………………………………………… 2.12

Personal Disposable Income (PDI): Personal disposal income is the difference between
personal income and personal income taxes. It is the amount of income which households
divided it as saving and consumption. Personal taxes include personal income taxes, personal
property taxes and inheritance taxes.

Personal Disposable Income = Personal Income – Personal Income Taxes

…………………………………………………………. 2.13

2.4. Measuring Cost of Living

2.4.1. Nominal versus Real Gross Domestic Product

Nominal GDP (NGDP) measures the money value of all finished goods and services according
to price during the year in which the goods and service are produced. That means it measures the
value of current production in terms of current prices. This type of measurement can be
influenced by both changes in the price and production (output).

Real GDP (RGDP) measures the money value of all finished goods and services using a certain
base year price. Real GDP is nominal GDP adjusted to eliminate inflation.

Real GDP = Nominal GDP for the given year X 100

GDP deflator for that year

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…………………………………………………… 2.14

2.4.2. GDP Deflator and Consumer Price Index

The GDP deflator, also called the implicit price deflator for GDP, is defined as the ratio of
nominal GDP to real GDP.
GDP deflator = Nominal GDP X 100%
Real GDP

…………………………………………………… 2.15

The GDP Deflator reflects what’s happening to the overall level of prices in the economy. To
better understand this, consider again an economy with only one good, then nominal GDP is the
total number of dollars spent on bread in that year, PXQ. Real GDP is the number of loaves of
bread produced in that year times the price of bread in some base year, p base x Q. The GDP
deflator is the price of bread in that year relative to the price bread in the base year, P.P base.

The definition of the GDP deflator allows us to separate nominal GDP in to two parts, one part
measures quantities (real GDP) and the other measures of prices (the GDP deflator) that are:

Nominal GDP = Real GDP X GDP deflator

……………………………………………….. 2.16

Nominal GDP measures the current dollar value of the output of the economy. Real GDP
measures output valued at constant price and the GDP deflator measures the price of output
relative to its price in the base year.

Consumer’s price index (CPI): Inflation or deflation is derived from a price index; a price
index is a number that shows how the average level of prices has changed over time. To create a
price index assign one year as the base year. We determine all changes in prices from that base
year then weight the change in price for each good by the year as assigned a value of 100. The
price index for years other the base year indicates the change in the average level of prices
between any year and the base year, which can be expressed as percentage changes.
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CPI = Current prices x fixed market basked quantity
Base year prices x fixed market basket quantity
Inflation rate = CPI of current yr- CPI of base yr x 100%
CPI base year

…………………………………………………… 2.16

2.5. Importance of National Income Statistics

National income statistics are of great importance, with their help, one can know the actual state
of the economy’s performance. These statistics are also very useful for providing direction to the
future policy formulation. The importance of national income statistics has grown over the years
and now in almost every country they are providing very handy to the policy makers. The
reasons for the growing importance of national income statistics are:

1. Indices of economic warfare: National income statistics are useful indices of the
economic welfare of the people. With their help one can very easily draw a comparison
between the economic conditions of the people living in different countries and of those
living within the country at different periods of time these statistics are very useful for
knowing the changes in the standard of living of the people all over the world.

2. Aid to economic policy and planning: National income statistics are a pointer to the
changes in the economic activity taking place in the economy under the impact of various
policies of the government. Whether a particular policy has yielded the desired results or not
can be known by the national income statistics. And on the basis of the studies and researches
conducted with the help of these statistics, the policy makers can bring about suitable
changes in their policies, they also provide important tools for economic planning.

3. Index of economic structure: National income statistics are a very useful index of the
economic structure of a country. They provide useful knowledge about the performance of
various sectors of the economy. Thus, one can have a clear idea of the sectors which are
lagging behind in economic development and the sectors which hare advancing in economic
growth.
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4. Useful pace for the formulation of budgetary policies: National income statistics
provides a very useful and important base for the formulation of government budgets it is on
the basis of these figures that the finance minister is able to have a comparative idea of the
importance of different taxation measures, public borrowing or deficit financing and other
fiscal measures. They also help the finance minister in preparing the budget, particularly in
formulating proposals for a federal government they are a useful guide for determining the
amount of granting aid and subsidies to be provided to the various units.

5. Significance for defense and development: National income statistics enables the
government to make proper allocation of the national product between defense and
development programs of the economy.

6. Significance for deciding the role of public sector: With the help of national income
statistics the government can very well find out the relative significance of public and private
sectors in the economy. The government can also formulate policies for regulating the role of
both the sectors for future growth of the economy.

7. Importance in developing countries national income statistics are of special importance to

the developing countries like ours. We can know the relative usefulness of various sectors of
the economy and formulate policies accordingly.

2.7. Difficulties of Measuring National Income

The calculation of national income is not an easy task. The difficulties faced are:

a. Definition of Nation

While calculating national income nation does not mean only the political or geographical
boundaries of a country for calculating the value of final goods and services produced in the
country. We also include the income earned by the national abroad.

b. Stage of Economic Activity

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It is also difficult to determine the stage of economic activity at which the national income is to
be calculated. It has been agreed that the stage of economic activity may be decided by the
objective for which the national income is being calculated whether the income should be
calculated at the stage of production or distribution or consumption. The consumption stage
should be taken in to consideration if the objective is to measure the economic progress. Hence,
the production stage can be used to measure the welfare of the people.

c. Transfer Payments

Transfer payments also pose a great difficulty in measuring national income. It has generally
been agreed that the best way is to consider only the disposable income of the individuals or
groups.

d. Illegal Income

The exclusion of illegal income certainly reduces the size of the national income. But this is a
practical difficulty and is not solved to date.

e. Inadequate Data

In almost all the countries, difficulty has been faced in the calculation of national income
because of the non availability of adequate data. Sometimes the data is also not reliable. This is a
general difficulty and cannot be solved.

f. Non Monetized Sector

The difficulty is special to the developing countries where a substantial portion of the total
produce is not bought to the market for sale. It is either retained for self – consumption or
exchanged for other goods and services. This is also a general difficulty foe the estimation of NI.

g. Depreciation Valuation

The value of depreciation is to be deducted from the GNP to get the NNP. But the valuation of
such depreciation is full of difficulties. For example, the change in the price of capital goods

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from year to year, the change in the price of capital goods from year to year, the age composition
of the capital stock, and depreciation in cost due to non use of the capital stock etc.

h. Price Level Changes

Since the national income is measure interims of money whose value itself keeps on changing, it
is difficult to make a stable calculation of national income. Which is assessed interims of prices
of the base year. But then, the problems of constructing price index numbers will arise.

2. 7. GDP and Welfare

GDP, as we have seen, measures both the economy’s total income and the economy’s total
expenditure on goods and services. Thus, GDP per person tells us the income and expenditure of
the average person in the economy. Because most people would prefer to receive higher income
and enjoy higher expenditure, GDP per person seems a natural measure of the economic well-
being of the average individual.

Some people, yet, dispute the validity of GDP as a measure of well-being. A large GDP does
in fact help us to lead a good life. GDP does not measure the health of our children, but
nations with larger GDP can afford better healthcare for their children. GDP does not
measure the quality of their education, but nations with larger GDP can afford better
educational systems.

GDP does not measure the beauty of our poetry, but nations with larger GDP can afford to
teach more of their citizens to read and enjoy poetry. GDP does not take account of our
intelligence, integrity, courage, wisdom, or devotion to country, but all of these laudable
attributes are easier to foster when people are less concerned about being able to afford the
material necessities of life.

Hence, GDP does not directly measure those things that make life worthwhile, but it does
measure our ability to obtain many of the inputs into a worthwhile life. GDP is not, however,
a perfect measure of well-being.

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Some things that contribute to a good life are left out of GDP. One is leisure. Suppose, for
instance, that everyone in the economy suddenly started working every day of the week, rather
than enjoying leisure on weekends. More goods and services would be produced, and GDP
would rise. Yet despite the increase in GDP, we should not conclude low GDP per person, fewer
school-age children are actually in school, and those who are in school must learn with fewer
teachers per student. These countries also tend to have fewer televisions, fewer telephones, fewer
paved roads, and fewer households with electricity. International data leave no doubt that a
nation’s GDP per person is closely associated with its citizens’ standard of living.

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