Chapter 2

• Contents

1. The national income and product account

2. Problems associated with counting GDP
3. Methods of Measuring GDP
4. Difference Between Inflation and CPI
5. Nominal and Real GDP
6. Other Social Accounts
7. National product and the Underground Economy (The
Informal Sector)
8. National income And Economic Welfare
The national income and
product account
• To study the economy as whole requires measures of the level
of economic activity
• National income account (NIA):
• It is the money value of all goods and services produced in an
economy.
• It is an accounting record of the level of economic activities of an
economy.
• It is a measure of aggregate output, income, and expenditure in the
economy.
• There are two most important and widely used measures of national
income
• Gross domestic product(GDP)
• Gross national product(GNP)
NIA
• Money value+ Current+ final goods &services=GDP/GNP
NIA are important for the following
reasons
• Enables a country to measure the level of total output
in the economy in a given period of time. It is used to
explain the causes for such level of performance in the
country.
• Enables to observe the long run tend of the economy
by including growth and decline. In macroeconomics
the government is always concerned about the long
run performance of the economy.
• It provides information to formulate policies
• Fiscal policies
• Monetary policies
• Income policies
• Trade policies
GDP
• It is the total value of currently produced final goods
and services that are produced in a countries border
during a given period of time, usually one year.
• It is products produced by the country with its own
recourses.
• It measures current production only
• We talk only newly produced final goods and services
• Any output produced last year will not be counted
• We talk end products of the production process.
• We don’t talk about “intermediate goods” in GDP
Calculation.
GDP
• In GDP we take the market value of Goods and services:
• We use money as common unit of measurement.
• We take the market value of final produced goods and
services
GNP
• It is the total value of goods and services
currently produced by “domestically owned”
factors of production in a given period of time,
usually a year.
• Products are produced by resources owned by
the citizens of the country.
• It measures the total output or income
generated by Domestic resident’s factors of
production irrespective of where these
resources are used.
GNP
Example 1: Ethiopian labor lived in Saudi Arabia produced
output in Saudi Arabia counted as part of Ethiopian GNP
Example 2: The value of roads built by a Chinese company in
Ethiopia Counted as Chinese GNP and Ethiopian GDP
GNP
• Therefore GNP= GDP+NFI (Net factor Income)
• NFI = Y1-Y0 Where
• yI= income inflow (received from abroad)
• Y0 =Income outflow (received by foreigners)
Continued. . .
• If YI>Y0 then income from abroad is positive hence GNP>GDP
• If YI<Y0 then income from abroad is negative hence GNP<GDP
• If YI=Y0 NFI=0 hence GNP=GDP. This kind of Economy known
as Closed Economy.
GNP
• Similarity between GDP &GNP is that they are concerned with
currently produced goods and services. Their difference is that
a matter of ownership of this goods and services.
Problems associated with counting GDP
1) Double counting
2) Do not include non-productive transactions
Example: transfer payments
3) It is very difficult to measure non-marketed outputs: these are
those goods that are produced and consumed in the house
without payment.

• Example: Government produced public goods like roads and

public services (health and Education) Households’ outputs
like mothers baking Injera, bearing children and washing
Clothes, Leisure Activities
Problems associated with
counting GDP
4) It is difficult to measure outputs produced in the informal
sectors
5) Distribution of income across the households
6) Cost of environmental damage is not included: like
environmental degradation, air pollution, and weather
pollution.etc.
Methods of Measuring GDP

• We have 3 methods:
1. Product(output)value added approach
2 . Expenditure approach
3. Income approach
Methods of Measuring GDP

• Output approach
 it is the direct way of measuring GDP
GDP calculatd by adding the market value of all goods and
services produced by each sectors of the economy. Sectors of
the economy are agricultural, industrial and service sectors.
Methods of Measuring GDP

Stages of Value of Cost of Value

production output intermediat Added
e inputs

farmer 5000 0 5000

factory 15000 5000 10000
retailer 18000 15000 3000
total - - 18000
Methods of Measuring GDP
Income Approach
• It measures GDP interims income earned.
• It is not necessary to include all personal incomes.
• All transfer payments are excluded
• Transfer payments
Methods of Measuring GDP
• Here GDP measured by adding all incomes of factors of
production of;
• Domestic labor( wage)
• Land( rent)
• Capital ( interest)
• Entrepreneur ability ( profit)
Methods of Measuring GDP
• Major components in income approach includes the
following: -
a) Compensation of employers( wages and salaries of workers)
b) Rental income ( reward for land)
c) Interest income( reward for private capital)
d) Properties income ( profits or reward for Entrepreneur)
e) Indirect Business tax( sales and exercise tax)
f) Depreciation
Methods of Measuring GDP
Expenditure approach

• It measures GDP from expenditure angle.

• GDP is measured by Adding spending or
expenditures on final goods and services
produced in the country
• Expenditure may be for purchase of various: -
Raw materials
Intermediate goods
Service of factors
Goods and services of finished goods
Methods of Measuring GDP
• Thus from view point of the expenditure GDP can be
measured by using the following formulae: -
• In closed economy:- an economy which has no economic
transaction with the rest of the world
GNP=GDP=C+I+G
• In an open economy :-an economy which has economic
relations with the rest of the world
GDP=C+I+G+-NX
GNP=GDP+NFI
Methods of Measuring GDP
• Where
• C-- Consumption expenditure
• I--Gross domestic private investment expenditure
• G—government expenditure
• NX-net export (export-import) +ve if Export>import
-ve if export<import
Methods of Measuring GDP
• Consumption expenditure
• It refers to society’s total expenditure on consumption goods
and services in accounting period. They are classified as:-
1. Durable consumer goods: - consumed for long period of
time like radio, car, etc.
2. Non durable consumer goods: -consumed in short period of
time like food, fuel, etc.
3. Services like education, health, haircut, etc.
Methods of Measuring GDP
• Gross Domestic private investment
• They are expenditures by the private sector for investment
purpose. They are three types:
I. Business fixed investment
II. Construction expenditures
III. Increase in inventories( change in stocks)
Methods of Measuring GDP
• They are government expenditures (federal or local
government) on currently produced goods and services
except:
• Public transfer payments( But they are government
expenditures)
• Interest payments or the countries debt. This two are not in
calculating GDP.
 Difference Between Inflation and CPI
• Inflation is an increase of the price of goods and services in
general terms.

• The Consumer Price Index is a measure of the inflation as

experienced by people in their day-to-day life.

• Inflation is measured in many ways and Consumer Price Index

is the most common method used.

• When the inflation is high, people have to spend more money

for the same services and goods that they were previously
able to get at a low price.

• Inflation always has a wider reach whereas CPI is based on the

consumer product indices.
How the Consumer Price Index Is
Calculated
4. Choose a base year and compute the index.
• Designate one year as the base year, making it the benchmark
against which other years are compared.
• Compute the index by dividing the price of the basket in one year
by the price in the base year and multiplying by 100.
Price of basket of goods and services
Consumer price index  100
Price of basket in base year
How the Consumer Price Index
Is Calculated
• The inflation rate is calculated as follows:

CPI in Year 2  CPI in Year 1

Inflation Rate in Year 2= 100
CPI in Year 1
Table 1 Calculating the Consumer
Price Index and the Inflation Rate:
An Example
Table 1 Calculating the Consumer Price Index
and the Inflation Rate: An Example
Nominal and Real GDP
Nominal GDP
• It is the monetary value of goods and services measured at
current market price.
• It is a current birr GDP
• It is not useful to compare a country’s economic performance
over time
 Nominal and Real GDP
• Real GDP
 nominal GDP Difficulties arises when we want to compare
GDP of one year with that of another because the prices of
Goods and services are not all constant in all years.
Since the unit of measurement is not constant, the GDP
measurement for different years cannot be compared.
Nominal and Real GDP
• It is the remain after price adjustment
• It is the measure of real production measured by removing
the effects of price changes on GDP measurement.
• It measures the value of the economy output interims of the
prices of the base years.
• It is found by Deflating the Nominal GDP. By deflating we
mean that the process of avoiding the effects of changes in
the general price level from the GDP.
Nominal and Real GDP
Nominal and Real GDP
Nominal and Real GDP
Nominal and Real GDP
Nominal and Real GDP
Nominal and Real GDP
Nominal and Real GDP
Nominal and Real GDP
Nominal and Real GDP
Nominal and Real GDP
Nominal and Real GDP
Other Social Accounts
1. NET DOMESTIC PRODUCT(NDP):
it is a measure of the total value of Goods and services
consumed by the society
NDP= GDP-Depreciation
The word Gross in the GDP indicates that depreciation has
not been deducted from the total output. The word Net in
NDP indicates that depreciation has already been deducted.
Other Social Accounts
2. NET INCOME(NI): total income earned by our factors of
production
NI= NDP-Indirect business tax+ Net Factor Income
3. PERSONAL INCOME(PI): an income earned by an individual
• PI= [NI-social security contribution - corporate income tax -
rental income tax] + [public transfer payments + interest on
government dept]
Other Social Accounts
4) PERSONAL DISPOSABLE INCOME(PDI OR DI)
It also known as Disposable income
It is an income earned and utilized totally by an individual.
It is a net income of an individual
DI= PI-personal income tax
DI= C+S
Where C---consumption
• S---savings
•
National product and the
Underground Economy (The
Informal Sector)

• Underground economies are certain economic activities go

unrecorded (not reported to the government) or their value
deliberately under recorded (not fully reported).
National product and the
Underground Economy (The
Informal Sector)

• They are two kinds (the Legal and The illegal once).
1. Activities that are legal but under recorded for tax purposes
• Example; for many consumer services like Decorating and
Plumbing payments’
2. Activities that are illegal( Drug trade and Smuggling)
National product and the
Underground Economy (The
Informal Sector)

• The underground economies are bad not good by social

consensus for the following reasons:
 GDP will obviously understate the economic performance
 the official unemployment rate is overstated.
 National income And
Economic Welfare
• Can we conclude that if national income raises from one year
to another the standard of living? The answer is “NO” we
cannot make statements about standard of living unless we
first convert the nominal national income.
• National income includes some items that ought to be
excluded from the standard of living measure. National
income also excludes some items that ought to be included in
the standard of living measure
 National income And
Economic Welfare
PLUS
• The value of non-marketed Goods(self-provided Goods)
• The value of leisure
Minus
• Cost of Environmental Damage: