National Income

National income accounting

 This measures the economy’s overall performance. The
accounting helps economists and policy makers to:
 Assess the health of the economy by comparing levels of production at
regular intervals
THE ECONOMY’S INCOME AND
EXPENDITURE
 When judging whether the economy is doing well or poorly, it is natural to
look at the total income that everyone in the economy is earning.
 For an economy as a whole, income must equal expenditure because:
 Every transaction has a buyer and a seller.
 Every dollar of spending by some buyer is a dollar of income for some seller.
 GROSS DOMESTIC PRODUCT
Gross domestic product (GDP) is a measure of the
income and expenditures of an economy.
It is the total market value of all final goods and services
produced within a country in a given period of time.
It doesn’t include what the citizens earn from other
countries (property income from abroad, shares in
foreign companies and interest from loans advanced
to foreigners
 The definition of GDP has four important pieces
5

 Market Value: measured in Kwacha (or other currency)

– the individual outputs (such as peanut butter,
oranges, etc produced by a country ) have to be
summed up using a common unit which is the market
value
 Final goods and services (not intermediate goods) – we
focus on the final selling price of the commodity. This
helps to avoid double counting . For example, burger
king buys beef for K20, and sells a burger at K50, we
ignore the price of intermediate input –beef and go for
the price of the burger which is K50. this avoids double
counting
 Produced within a country Geographical concept
(expatriates are not included) when looking at GDP
 Summary: THE MEASUREMENT OF
GROSS DOMESTIC PRODUCT
Intermediate goods are
partly finished goods that
“GDP is the Market Value . . .” form inputs to a subsequent
Output is valued at market prices. production process that
then uses them up.
“. . . Of All Final . . .”
It records only the value of final goods, not intermediate
goods (the value is counted only once).
“. . . Goods and Services . . . “
It includes both tangible goods (food, clothing, cars) and
intangible services (haircuts, housecleaning).
THE MEASUREMENT OF GROSS DOMESTIC PRODUCT

“. . . Produced . . .”
It includes goods and services currently produced, not
transactions involving goods produced in the past.
“ . . . Within a Country . . .”
It measures the value of production within the geographic
confines of a country.
“. . . In a Given Period of Time.”
It measures the value of production that takes place within a
specific interval of time, usually a year or a quarter (three
months).
National Income Measurement and
Determination

Gross National Income (GNI), is the total income

of a country.
Gross domestic product (GDP) measures the
value of output produced in a country, no
matter whose citizens contribute to this
production.
Gross National Income, measures the value of
the income that its citizens earn, from whatever
countries this income is derived.
Gross national Income (GNI) -
is the total domestic and foreign output claimed by
residents of a country, consisting of:
gross domestic product (GDP), plus factor incomes
earned by foreign residents, minus income earned in
the domestic economy by nonresidents
It includes income earned by resident from abroad.
 Residents of a given country can earn income from abroad in three main ways:
a. Can own property abroad
b. Own shares in foreign companies
c. Can earn interest from loans advanced to foreigners
THE CIRCULAR FLOW OF
INCOME
Circular flow of income

In principle, the decisions of the many

households, firms and government
departments determine the economy’s total
spending, income and output

The transactions mainly between households

and firms can be used to model how output is
determined in an economy.

We can use the circular flow of income to

show the three ways in which income can be
measured:
A. the value of all goods and services produced
B. the total value of earnings arising from the factor
services supplied
C. the total value of spending on goods and
services.
❖the value of production
❖the level of factor incomes or
❖total expenditure on goods and
services.
The circular flow of income diagram is an
example of a model.
We all know that the economy consists of millions
of people engaged in many activities—buying,
selling, working, hiring, manufacturing, and so on.
To understand how the economy works, we
simplify our thinking about all these activities using
a model of how the economy is organized and
how participants in the economy interact with
one another.
 What happens in the circular flow?

 Individuals/Households- Firms - buy productive

provide a service, labor to resources from factor markets
the factor market in
exchange for wages. HH to create a product that they
also purchase goods and sell to the Product Market
services from the product
market using your income
Product Market- receives
products from businesses and
 Factor Market- This is where provides goods and services
factors of production are
bought and sold. The Factor directly to the individual
Market gives productive consumer in exchange for
resources to Businesses in payment.
exchange for payment.
Summary: Circular Flow (simple model)

Household income = household spending (all

income)
The value of output = total spending on goods
and services (all goods sold)
The equality of income and
expenditure can be illustrated
with the circular-flow diagram.
the level of economic activity can be
measured by valuing total spending, total
output or total earnings.
Figure 1 The Circular-Flow Diagram

MARKETS
Revenue FOR Spending
GOODS AND SERVICES Two economic
•Firms sell
Goods
•Households buy
Goods and actors:
and services services
sold bought Households and
Firms

FIRMS HOUSEHOLDS
•Produce and sell •Buy and consume
goods and services goods and services
•Hire and use factors •Own and sell factors
of production of production

Factors of MARKETS Labor, land,

production FOR and capital
FACTORS OF PRODUCTION
Wages, rent, •Households sell Income
and profit •Firms buy
= Flow of inputs
and outputs
= Flow of dollars

Copyright © 2004 South-Western

THE CIRCULAR-FLOW DIAGRAM
Assumptions of the model

1.The economy has

two decision makers
which are households
and firms
2.Firms produce goods
and services using inputs
or Factors of production
(L, K, H) which are owned
Or money by households
 THE CIRCULAR-FLOW DIAGRAM
Assumptions of the model
3. Households and firms interact
in two types of markets.

a) In the markets for goods and

services, households are buyers
and firms are sellers of goods and
services

b. Factor markets -households are

sellers and firms are buyers.
In this market, HH provide firms the
Consumption can be regarded as total inputs e.g labor, land and capital
expenditure by HH on commodities which that the firms use to produce
yield utility in the current period
commodities
 THE CIRCULAR-FLOW DIAGRAM
Assumptions of the model
The inner loop represents the
flows of commodities between
households and firms.
o HH own the factors of
production. They sell their L Land
and K to the firms in the markets
for the factors of production. In
return they get wages, rent,
salaries and profits

o The firms then use these factors

to produce goods and services,
which in turn are sold to
Consumption can be regarded as total
expenditure by HH on commodities which
households in the commodities
yield utility in the current period markets.
o The HH spending on goods and
services is called consumption
 WHAT OF THE OUTER LOOP?
What does it represent?
The outer loop shows payment flows.

Dr. Mudenda
 LET US EXPAND OUR MODEL!

What happens if firms do not sell all

their output?
What happens if firms sell output not to
households but to other firms?
What happens if households do not
spend all their incomes?
 Exports
Factor
Market
GDP=

Part of the HH income that is nor spent on

consumption is either:
 saved, spent on imports or transferred to
Government government as taxes
o Saving- is the part of income not spent
buying goods and services or paid as

Government
borrowing
taxes to government which is not spent in
the current period
o HH may put their savings in the banks or
Financial
GDP= Income
financial institutions.
Institutions
o The firms tend to borrow the savings from
the financial markets and use it as
investment for the production
o Investment – is the production or
expenditure by firms on goods and
services which are not for current
consumption or the purchase of need
capital goods like factories & machines
by the firms
  Saving and investment are always equal, in the absence of government
and foreign sectors (closed economy).
 Investment spending by firms is matched by an income flow to
households in excess of their consumer spending.
Inventories or stocks are goods
currently held by a firm for
future production or sale. Saving is defined as
 the excess of income
over consumption

In a market economy, financial institutions and financial markets

channel household saving to the firms that wish to borrow to
invest in new capital goods.
Government and foreign sector
Exports Factor
Market

GDP=

Some of the goods that are

Government
not bought by local people
can be sold to other countries.

Government
borrowing
These are called EXPORTS (X)
Also, local people, firms &
Financial
Institutions
GDP=
Income government can buy goods
from abroad. These are called
IMPORTS (M)
The difference between
exports and imports is called
the net export NX= X-M
 Government and foreign sector
Exports Factor
Market

GDP=
When HH save, the money
move out of the circular flow
Government
of income. This is called a
LEAKAGE
Leakage from the circular flow

Government
borrowing
is the money not recycled
from HH to firms
GDP=
Financial
However, when firms invest,
Income
Institutions

we have an INJECTION into

the circular flow.
Injection is the money that
o Taxes, savings and imports are called leakages
flows to firms without being
to circular flow of income recycled through the
o Government spending, exports and investment ARE
injections in the circular flow households.
 Market Prices vs Basic Prices
Taxes drive a wedge between the price the purchaser pays and the
price the seller receives.
We can choose to value national output either at market prices
inclusive of indirect taxes on goods and services (the price consumers
pay), or at the prices received by producers after indirect taxes have
been paid.
GDP at market prices measures domestic output inclusive of
indirect taxes on goods and services.
GDP at basic prices measures domestic output exclusive of indirect
taxes on goods and services.
THE COMPONENTS OF GDP

GDP includes all items

produced in the economy
and sold legally in markets.
THE COMPONENTS OF GDP

What Is Not Counted in GDP?

GDP excludes most items that are
produced and consumed at home and
that never enter the marketplace.
It excludes items produced and sold
illicitly, such as illegal drugs.
 THE COMPONENTS OF GDP
 Let Y denote total output in the  Consumption (C):
economy or GDP,
 The spending by
 C denote household spending , S households on goods
denotes savings. By definition, and services, with the
exception of purchases
savings is unspent income: of new housing.
 Y ≈ C+S ; Since savings are equal to  Investment (I):
investment we can also say  The spending on capital
equipment, inventories,
Y ≈ C +I ; and structures, including
new housing.
o Government raises revenue through direct taxes on (wages,
profits etc.) and through indirect taxes (VAT, excise duty etc.)
o Taxes finance two kinds of expenditure.
o First government spending on goods (physical goods) and
services (wages etc) G
o Government also spends money on transfer payments or
benefits (B) such as social cash transfers, pensions etc.
o A transfer payment by government is one for which no
corresponding service is provided by the recipient (These
don’t affect GDP)
 THE COMPONENTS OF GDP

Government Purchases (G):

The spending on goods and services by
governments.
Does not include transfer payments because
they are not made in exchange for currently
produced goods or services.
Net Exports (NX): Transfer payments are monetary
payments that require no goods or
Exports minus Imports. services in return.
 THEREFORE THE COMPONENTS OF GDP
GDP (Y) is the sum of the following:
Consumption (C)
 Investment (I)
 Government Purchases (G)
 Net Exports (NX)

Y = C + I + G + NX
APPROACHES TO THE
CIRCULAR FLOW
  The circular flow of income shows as three approached to
measuring income (GDP) in a closed economy
 Expenditure approach – this highlights the importance of
consumer spending versus government spending
 measures the total amount spent by purchasers of output
on all final goods and services during a given period
 Income approach – Computes the total amount of earned
by all factors of production in form of wages, rent, profit, and
interest in producing final goods and services
 Emphasizes importance of factors of production
Product or Value added Approach
Emphasizes the usefulness of tracking how goods are
sold and resold
Measures economic activity by adding the
market value of goods and services produced. It
makes use of the value-added concept

All three methods should give us the same amount

EXAMPLE
Assume the country is made up of 2 companies: trade
Mwisho (produces oranges and TJ investments (makes
juice using oranges)
Trade Mwisho
Wages to employees K15, 000
Taxes paid to government 5,000
Revenue from sale of oranges 35,000
o Oranges sold to the public 10, 000
o Oranges sold to TJ investment 25, 000

T. J Investments
Wages paid to employees K 10, 000
Taxes to government 2,000
Oranges purchased from Mwisho 25, 000

Revenue from sales of Juice 40, 000

 Trade Mwisho :
 Pays wages 15, 000 Example: computing output
Trade Mwisho
 Sells oranges at 35, 000
Wages to employees (picking K15, 000
 Before tax Profit is: 35000-15000 oranges)
 =K20, 000 Taxes paid to government 5,000
Revenue from sale of oranges 35,000
 K5000 paid as taxes hence
subtract from 20, 000 gives o Oranges sold to the public 10, 000
K15000 after tax income
o Oranges sold to TJ 25, 000
 T J Investments: investment
 Pays wages 10, 000 T. J Investments
Wages paid to employees K 10, 000
 Buys oranges 25, 000 processing oranges
 Sells orange juice 40, 000 Taxes to government 2,000

 Tax to government 2000 Oranges purchased from 25, 000

Mwisho
 Profit before tax is 5000
Revenue from sales of Juice 40, 000
 Profit after tax is 3000
 Value added is gross
output minus the
value of input goods
used up in making
 Question: what is the total value of Example: computing output that output.
the economic activity in this
country? Trade Mwisho
Wages to employees K15, 000
 The three methods: product ,
Taxes paid to government 5,000
income and expenditure approach
Revenue from sale of oranges 35,000
give us the same results:
o Oranges sold to the public 10, 000
1. Product Value added Approach:
o Oranges sold to TJ investment 25, 000
o Value added of any producer is the value of
the inputs it purchases from other producers T. J Investments
o The approach sums up all the value added Wages paid to employees K 10, 000
by all producers
Taxes to government 2,000
Oranges purchased from 25, 000
Mwisho
Revenue from sales of Juice 40, 000
1. Product Value added Approach: Example: computing output
Trade Mwisho
o Mwisho produces output of 35, 000
Wages to employees K15, 000
o T J investment produces output of K40, 000
Taxes paid to government 5,000
o If we measure economic activity by Revenue from sale of oranges 35,000
adding 35000 and 25, 000 , we would
double count the K25, 000 TJ spent on o Oranges sold to the public 10, 000
oranges
o Oranges sold to TJ investment 25, 000
o Hence – we subtract this from the final sale
40, 000 – 25, 000 = 15000
T. J Investments
o Mwisho doesn’t use any input bought Wages paid to employees K 10, 000
elsewhere:
Taxes to government 2,000
o Hence its value added equal its revenue of Oranges purchased from Mwisho 25, 000
K35,000
o Total Economic activity is: Revenue from sales of Juice 40, 000

o K35,000 + k15,000 = K50, 000

2. Income Approach:
o Measures economic activity by Example: computing output
adding all income received by Trade Mwisho
producers of output , including wages Wages to employees K15, 000
received by workers and profits by
Taxes paid to government 5,000
owners of firms:
Revenue from sale of oranges 35,000
o Mwisho before tax profit is K20, 000
(35000-15000) o Oranges sold to the public 10, 000
o T. J investments profit is revenue
K40,000 minus 25000 used to buy o Oranges sold to TJ investment 25, 000
oranges and K10, 000 paid as wages
to its employes gives us K5000 T. J Investments
Wages paid to employees K 10, 000
o Economic activity is:
Taxes to government 2,000
o Profit for Mwisho is 20, 000
Oranges purchased from Mwisho 25, 000
o Profit for TJ investments is K5000
Revenue from sales of Juice 40, 000
o Wages in the two companies K25,000
o Total economic activity K50, 000
2. Expenditure Approach
Example: computing output
o Measures economic activity by
adding the amount spent by all Trade Mwisho
ultimate users of output Wages to employees K15, 000
o In this example, HHs are ultimate users: Taxes paid to government 5,000
o Mwisho sells oranges worth K10, 000 to Revenue from sale of oranges 35,000
ultimate users
o Oranges sold to the public 10, 000
o T.J. Investment sells Juice worth K40,000
to ultimate users o Oranges sold to TJ 25, 000
investment
o Total expenditure is: 50,000 T. J Investments
o The three methods give us the same output Wages paid to employees K 10, 000
level;
Taxes to government 2,000
o Reason: the value of goods and services Oranges purchased from 25, 000
produced in a period is by definition equal to Mwisho
the amount that buyers must spend to
purchase them. This means the product and Revenue from sales of Juice 40, 000
expenditure approach are equal
 GDP: Production and Income(1)
44  What is the GDP in this simple two firm economy?

STEEL COMPANY (FIRM 1) CAR COMPANY (FIRM 2)

REVENUES REVENUES FROM

100 200
FROM SALES SALES

EXPENSES 80 EXPENSES 170

WAGES 80 WAGES 70

STEEL
100
PURCHASES

PROFIT 20 PROFIT 30
 GDP: Production and Income(2)
 Method 1: GDP is the value of the final goods and services
45 produced in the economy during a given period
 Count only the value of final goods(not intermediate goods)

STEEL COMPANY (FIRM 1) CAR COMPANY (FIRM 2)

REVENUES REVENUES FROM

100 200
FROM SALES SALES

EXPENSES 80 EXPENSES 170

WAGES 80 WAGES 70

STEEL
100
PURCHASES

PROFIT 20 PROFIT 30

STEEL AND CAR COMPANY

REVENUES FROM SALES 200

EXPENSES (WAGES) 80 + 70 = 150

PROFIT 20 + 30 = 50
 GDP: Production and Income(3)
46  Method 2: GDP is the sum of value added in the
economy during a given period
 Value added = value of production minus value of intermediate goods
used in production

STEEL COMPANY (FIRM 1) CAR COMPANY (FIRM 2)

REVENUES REVENUES FROM Value added = Value of

100 200
FROM SALES SALES
production (200) – value
EXPENSES 80 EXPENSES 170
of intermediate goods
WAGES 80 WAGES 70 (100)
STEEL
100
PURCHASES

PROFIT 20 PROFIT 30
 GDP: Production and Income(4)

47  Method 3: GDP is the sum of income in the economy during a given

period

STEEL COMPANY (FIRM 1) CAR COMPANY (FIRM 2)

Labour Income
REVENUES REVENUES FROM
100 200
FROM SALES SALES

EXPENSES 80 EXPENSES 170

Capital Income
WAGES 80 WAGES 70

STEEL
100
PURCHASES

PROFIT 20 PROFIT 30