WHAT IS NATIONAL INCOME ACCOUNTING?
National Income Accounting refers to the measurement of aggregate
economic activities, particularly national income and its components.
GDP is often considered the best measure of how well the economy is
performing. The goal of GDP is to summarize in a single number the
monetary value of economic activity in a given period of time. The value
of final output produced in a given period, measured in the current
prices is referred to as Nominal GDP.GDP per capita relates the total
value of annual output to the number of people who share that output; it
therefore refers to the average GDP per person. It is commonly used as a
measure of a country‘s standard of living. However GDP does not; tell us
what portion of output every citizen is getting. There are two ways to
view this statistic:
One way to view GDP is the total income of everyone in the economy.
Another way to view GDP is as the total expenditures in the economy
.Consider the following two sector economy.
Imagine an economy that produces single good, bread, from a single input
labour. The above figure illustrates all the economic transactions that
occur between households and firms in this economy. The inner loop
represents the flow of bread and labour (expenditures). The households
sell their labour to the firms and the firms use the labour to produce
goods and services, which in turn they sell to the households
The outer loop represents the corresponding
flow of shillings (incomes). The households buy bread from the firms.
The firms use some of the revenue generated from the sale of bread to
pay workers and the remainder is the profit which belongs to the owners
of the firms. The two loops combined in the above figure gives us what
is referred to the Circular flow of income.
2.2 The components of Gross Domestic Product:
The National income accounts divide GDP into four broad categories of
spending.
Consumption: Consists of the goods services bought by households. It
is divided into three subcategories: non-durable goods, durable goods
and services.
Investment: Consists of goods bought for future use.
Government Purchases: are the goods and services bought by the state,
and local governments. This includes such items as military equipment,
highways, and the service that government workers provide.
Net exports: Takes into account trade with other countries. Net
exports are the value of goods and services exported to other countries
minus the value of goods and services that foreigners provide us. Net
exports represent the net expenditure from aboard on our goods and
services, which provide income for domestic producers. In other words it
is exports (X) minus imports (M).
A closed economy has three uses of goods and services it produces. These
three components are expressed in an equation as follows.
Y = C+ I+ G
This equation is an identity. It must hold because of the way the
variables are defined. It is called a national income accounts identity.
Real GDP vs. Nominal GDP
Measuring the standard of living
A shilling today does not buy as much as it did 20 years ago. The cost
of everything has gone up. The increase in overall prices called
inflation and is one of the primary concerns of economists and policy
makers. The most commonly used measure of the level of prices is the
CPI. This is the price of a given basket of goods and services relative
to the price the same basket in some base year
2.3 CPI vs GDP Deflator
There are key differences between the two measures
1) GDP deflator measure the prices of all goods and services produced,
where the CPI measures the prices of only the goods and services bought
by consumers. Thus an increase in the price of goods bought by firms on
the government will show up in the
GDP deflator but not in the CPI
2) GDP deflator includes only those goods produced domestically
.imported goods are not part of GDP and do not show up in the GDP
deflator. Hence an increase in the price of a Toyota made in Japan and
sold in this country affects the CPI, because the Toyota is
bought by consumers, but it dies not affect the GDP deflator
3) The CPI assigns fixed weights to the prices of different goods,
whereas the GDP deflator assigns changing weights .In other words, the
CPI is computed using a fixed basket of goods whereas the GDP deflator
allows the basket the basket of goods to change over time
