CHAPTER TWO

National Income Accounting

2.1 The concepts of GDP and GNP
Gross Domestic Product (GDP) is the market monetary value of all final goods and services
produced in one year within the boundary of a given country, whether by citizens or foreigners.

Gross National Product (GNP) is the market monetary value of all final goods and services
produce by resources owned and supplied by country citizens irrespective of where the resources
are produced and located (in or out of the country).

2.2 Approaches of measuring national income (GDP/GNP)

Gross National Products (GNP): The total market value of all final goods and services produced
in a given time period. Each good and services produced and brought to market has a price.
That price serves as a measure of value for calculating the total output. Once we know the price
of each final good and service, we can readily calculate the value of output produced in a given
time period. The total money value of final out put produced each year is what we refer to as our
Gross-National Product (GNP). The use of prices to value market output allows us to summarize
our out put activity and to compare the output of one period with that of another. GNP
accounting can also provide a basis for compassing one country economic performance with
another’s.
Two of the most important measure of the overall economy’s performance are GDP and GNP.
1. Gross Domestic Product (GDP) is the market monetary value of all final goods and
services produced in one year within the boundary of a given country, whether by
citizens or foreigners.
2. Gross National Product (GNP) is the market monetary value of all final goods and
services produce by resources owned and supplied by country citizens irrespective of
where the resources are produced and located (in or out of the country). In other words,
GNP=GDP+NFI (Net factor income)
NFI=(Factor Income received from Abroad)-(factor income paid abroad).
GNP may be greater, equal, or less than GDP.
1. If NFI>0, then GNP>GDP
It means that the income earned by a domestic company in any overseas country is more
than the income earned by a foreign firm within the country.
2. If NFI=0, then GNP=GDP
It means that the income earned by a domestic company in any overseas country is equal
to the income earned by a foreign firm within the country.
3. If NFI<0, then GNP<GDP
It means that the income earned by a domestic company in any overseas country is
exceeds the income earned by a foreign firm within the country

2.3 Other social Accounts(GNP,NNP,NI,PI and DI)

The subject matter of this unit is national income accounting. This type of accounting measures
or estimates the size of
 Gross National Product(GNP)
 Net National Product(NNP)
 National Income(NI)
 Personal Income(PI) and
 Disposable Income (DI)

This is national income accounting because it involves estimating output or income for the nation
society as a whole, rather than for an individual business firm or family.
The value of a nation’s output equals the total expenditure for this output, and those expenditure
become the income of those in the nation who have produced this output.

There are two equally acceptable methods, for obtaining each of the five income output measures
listed above. These two methods are the expenditures method and the income method. In
addition the unit discusses the purpose of social accounting and the short coming in using these
income – output measures.
National Income accounting: - is the measurement of aggregate economic activity, particularly
national income and its components.
Gross National Product (GNP) is the market monetary value of all final goods and services
produce by resources owned and supplied by country citizens (Ethiopians) irrespective of where
the resources are produced and located (in or out of the country). In other words,
GNP=GDP+NFI (Net factor income)
Net National Product(NNP): is the total value of goods produced and services provided in a
country during one year, after depreciation of capital goods has been allowed for.
NNP= GNP- Depreciation

National Income: is a measure of the money value of all final goods and services that are
produced in a country in one year.
National Income (NI): is the total income earned by current factors of production.
NI=NNP-Indirect Business Taxes
Personal Income (PI): income received by households before payment of personal taxes. That
means National Income minus corporate taxes, minus retained earnings, minus social security
insurance plus transfer payments, plus net interest, equals personal income.
Disposal Personal Income (DI): Disposal income is the difference between personal income
and personal taxes i.e. DI= PI-PT

2.4 Nominal versus Real GDP

Nominal GDP is the gross domestic product of a country of a given year, estimated on the basis
of the price of the goods and services of the same year. The formula for determining the nominal
GDP of a country is
Nominal GDP= Real GDP x Price Index
100
Real GDP is the gross domestic product of a country of a given year, estimated on the basis of
the price of the goods and services of the base year. The formula for determining the Real GDP
of a country is
Real GDP= Nominal GDP X 100
Price Index

The real GDP of a country can be more, equal, and less than its Nominal GDP.
Real GDP=Nominal GDP: when the price level of goods and services in the base year is the
same as the price level of goods and services in the current year.
 Real GDP<Nominal GDP: when the price level of goods and services in the base year is less
than the price level of goods and services in the current year.
Real GDP>Nominal GDP when the price level of goods and services in the base year is more
than the price level of goods and services in the current year.
2.5 The GDP Deflator and the consumer Price Index
The Real GDP of an economy is affected by any change in its physical output only. However,
the Nominal GDP of an economy is affected by any change in its price and physical output both.
For eliminating this effect of price change for the determination of the real change in the physical
output of an economy, GDP Deflator is used. Hence, GDP Deflator measures the average price
level of the goods and services of an economy that make up GDP.
The formula for calculating GDP Deflator is as follows:
GDP Deflator (price index) = Nominal GDP X 100
Real GDP

2.6 GDP and Welfare

GDP is the total value of all the final goods and services produced within the domestic
boundaries of a country during a year. It can be calculated at Market Price or Factor Cost.

Gross in Gross Domestic product means that the total value of final goods and services include
depreciation, i.e, no provision has been made for it.

Domestic in Gross Domestic product means that the final goods and services produced are
located within the domestic boundaries of the country.

Product in Gross Domestic product indicates that only final goods and services are included.

Market price in GDP at MP means that the amount of indirect taxes paid is included GDP;
however, the subsidies are excluded from it. However, factor cost in GDP at FC means that the
gross total value of all the final goods and services is included.

GDP is often used as an index to measure the welfare of people. Welfare here refers to the
sense of material well-being amongst people. The welfare of people depends upon the per
head availability of goods and services. It means that higher GDP is good for a country, as it
indicates greater welfare for the people.
However, higher GDP does not always mean greater welfare for people.

2.7 The Business Cycle

Business cycle refers to their current up and downs in the level of economic activity that extends over a
period of several years. The economy cycles continuously between growth and contraction . Some
periods of growth are greater than others , and some periods of contraction are deeper than the others are
Peaks, troughs and periods of contraction or expansion characterize the business cycle
 Peak- the economy is at full employment and the national out put is also at ,or very close,
capacity. There is shortage of labor, parts and materials. National income and national product
correspond to a very high degree of utilization of labor, factories and offices. Inflation is usually
present in the peak of economic cycle.

Recession or contraction- is a period of at least six months after the peak and before the trough
during which, the economy declines as measured by GDP. During recession Output, trade,
income and employment both decline. Price also decline as unemployment starts to increase.

Trough-is where output and employment ‘bottom out’ at their lowest level. During this time,
there is an excess amount of unemployment and idle productive capacity. Businesses are more
likely to fail because if low demand for their product. At the trough, unemployment is high and
output is low.

Expansion (recovery): the economy’s level of output and employment expand towards full
employment.

2.7 Unemployment and Inflation

Unemployment

Unemployment rate is the percentage of total labor force that is currently unemployed (total
unemployment divided by total employment force times 100). Let L be note the labor force, E the
number of employed workers, and U the number of unemployed workers. Because every worker is
either employed or unemployed, the labor force is the sum of the employed and the unemployed:

L=E+U

In this notation, the rate of unemployment is U/L.

There are different types of unemployment:

Frictional unemployment: At any point of time, some workers will be ‘between jobs’. That is some
workers will be in the process of voluntary switching jobs. Others will have job connections but will be
temporarily laid off because of seasonality or model change occurs.

Example: college graduates

Structural unemployment; is unemployment resulting from permanent shifts in the pattern demand for
goods and services or from changes in technology. Structurally unemployed workers have skills that are
not in demand by employers because of permanent changes in the economy.

Cyclical unemployment: is the amount of unemployment resulting from declines in real GDP during
periods of recession or in any period when the economy fails to operate at its potential.

Inflation

Inflation Is a rising general level of prices. There are different types of inflation;

Demand-pull inflation: changes in the price level have been attributed to an excess of total demand.
The business sector cannot respond to this excess demand by expanding real output for the obvious
reason that all available resources are already fully employed. Therefore, this excess demand will bid up
the price of the fixed real output, causing demand pull inflation.

Cost push inflation–inflation may arise on the supply or cost side of the market. Unions have
considerable control over wage rates. They obtain a wage increase. Large corporate employers faced
now with increased costs but also in the possession of considerable market power, push their increased
wage cost onto consumers by raising the prices of their production.

Structural inflation-is due to the change in the structure of total demand. This is due to the market
power of big business and unions. Prices and wages tend to be flexible up ward but inflexible downward.