AS Macroeconomics / International Economy

Measuring National Income

We need information on how much spending, income and output is being created in an economy
over a period of time. National income data gives us this information as we see in this chapter.

Measuring national income

To measure how much output, spending and income has been generated in a given time period we
use national income accounts. These accounts measure three things:

1. Output: i.e. the total value of the output of goods and services produced in the UK.

2. Spending: i.e. the total amount of expenditure taking place in the economy.

3. Incomes: i.e. the total income generated through production of goods and services.

What is National Income?

National income measures the money value of the flow of output of goods and services produced
within an economy over a period of time. Measuring the level and rate of growth of national
income (Y) is important to economists when they are considering:
The rate of economic growth
Changes over time to the average living standards of the population
Changes over time to the distribution of income between different groups within the population
(i.e. measuring the scale of income and wealth inequalities within society)

Gross Domestic Product

Gross Domestic Product (GDP) measures the value of output produced within the domestic boundaries
of the UK over a given time period. An important point is that our GDP includes the output of foreign
owned businesses that are located in the UK following foreign direct investment in the UK economy.
The output of motor vehicles produced at the giant Nissan car plant on Tyne and Wear and by the many
foreign owned restaurants and banks all contribute to the UK·s GDP.

There are three ways of calculating GDP - all of which should sum to the same amount since the
following identity must hold true:

National Output = National Expenditure (Aggregate Demand) = National Income

Firstly we consider total spending on goods and services produced within the economy:

Nissan at Sunderland ² Celebrating 20 years of production

The Nissan plant at Washington, Tyne and Wear is celebrating its 20th anniversary in July 2006, the
first car having rolled off the line on July 8th, 1986. In that first year of production 470 staff had a
production target of 24,000 Bluebirds. Twenty years on, more than 4,200 employees produce around
310,000 Micras, C+Cs, NOTEs, Almeras and Primeras each year. That car has been followed by 4.3
million others thanks to a total investment of £2.3 billion. Production is set to rise from 310,000 per
year last year to 400,000 in 2007 with the introduction of a new small 4x4, and Sunderland has been
rated as Europe's most productive car factory for the last eight years.
Êources: Reuters News, Êunderland Echo, July 2006

(i) The Expenditure Method of calculating GDP (aggregate demand)

This is the sum of spending on UK produced goods and services measured at current market prices. The
full equation for GDP using this approach is GDP = C + I + G + (X-M) where

C: Household spending
I: Capital Investment spending
G: Government spending
X: Exports of Goods and Services
M: Imports of Goods and Services

The Income Method of calculating GDP (the Sum of Factor Incomes)

Here GDP is the sum of the incomes earned through the production of goods and services. The main
factor incomes are as follows:

Income from people employment and in self-employment

+
Profits of private sector companies
+
Rent income from land
=
Gross Domestic product (by factor income)

It is important to recognise that only those incomes that are actually generated through the production
of output of goods and services are included in the calculation of GDP by the income approach.

We exclude from the accounts the following items:

uc Transfer payments e.g. the state pension paid to retired people; income support paid to
families on low incomes; the Jobseekers· Allowance given to the unemployed and other forms
of welfare assistance including child benefit and housing benefit.
uc Private transfers of money from one individual to another.
uc Income that is not registered with the Inland Revenue or Customs and Excise. Every year,
billions of pounds worth of economic activity is not declared to the tax authorities. This is
known as the shadow economy where goods and services are exchanged but the value of these
transactions is hidden from the authorities and therefore does not show up in the official
statistics!). It is impossible to be precise about the size of the shadow economy but some
economists believe that between 8 ² 15 per cent of national output and spending goes
unrecorded by the official figures.

Output Method of calculating GDP ² using the concept of value added

This measure of GDP adds together the value of output produced by each of the productive sectors in
the economy using the concept of value added.

Value added is the increase in the value of a product at each successive stage of the production
process. We use this approach to avoid the problems of double-counting the value of intermediate
inputs.
The table below shows indices of value added from various sectors of the economy in recent years. We
can see from the data that manufacturing industry has seen barely any growth at all over the period
from 2001-2004 whereas distribution, hotels and catering together with business services and finance
have been sectors enjoying strong increases in the volume of output. These figures illustrate a process
of structural change, with a continued decline in manufacturing output and jobs relative to the rest
of the economy. By far the largest share of total national output (GDP) comes from our service
industries.

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We can see from the following chart how there have been divergences in the growth achieved by the
manufacturing and the service sectors of the British economy. Indeed by the middle of 2006, the index
of manufacturing output was below the level achieved at the start of 2000.

In contrast the service industries have enjoyed strong growth, leading to a continued process of
structural change in the economy ² away from traditional heavy industries towards service businesses.
GDP and GNP (Gross National Product)

Gross National Product (GNP) measures the final value of output or expenditure by UK owned factors of
production whether they are located in the UK or overseas.

In contrast, Gross Domestic Product (GDP) is concerned only with the factor incomes generated within
the geographical boundaries of the country. So, for example, the value of the output produced by
Toyota and Deutsche Telecom in the UK counts towards our GDP but some of the profits made by
overseas companies with production plants here in the UK are sent back to their country of origin ²
adding to their GNP.

GNP = GDP + Net property income from abroad (NPIA)

NPIA is the net balance of interest, profits and dividends (IPD) coming into the UK from our assets
owned overseas matched against the flow of profits and other income from foreign owned assets
located within the UK. In recent years there has been an increasing flow of direct investment into and
out of the UK. Many foreign firms have set up production plants here whilst UK firms have expanded
their operations overseas and become multinational organisations.

The figure for net property income for the UK is strongly positive meaning that our GNP is substantially
above the figure for GDP in a normal year. For other countries who have been net recipients of
overseas investment (a good example is Ireland) their GDP is higher than their GNP.

Measuring Real National Income

When we want to measure growth in the economy we have to adjust for the effects of inflation.
Real GDP measures the volume of output produced within the economy. An increase in real output
means that AD has risen faster than the rate of inflation and therefore the economy is experiencing
positive growth.

Income per capita

Income per capita is a basic way of measuring the average standard of living for the inhabitants of a
country. The table below is taken from the latest edition of the OECD World Factbook and measures
income per head in a common currency for the year 2005, the data is adjusted for the effects of
variations in living costs between countries.

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By international standards, the UK is a high-income country although we are not in the very top of the
league tables for per capita incomes. We do have an income per head that is about ten per cent higher
than the average for the 15 established EU countries. But we are some distance behind countries such
as the United States (where productivity is much higher). And Ireland·s super-charged growth over the
last twenty years means that she has now overtaken us in terms of income-based measures of standards
of living.


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