THE USE OF MACROECONOMIC DATA, AND THE DEFINITION AND ACCOUNTING OF NATIONAL INCOME (CONTINUEDâ€¦â€¦â€¦â€¦â€¦..)

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MACROECONOMIC EQUILIBRIUM & VARIABLES; THE DETERMINATION OF EQUILIBRIUM INCOME >>

Introduction to Economics ECO401

Lesson 9.2

THE USE OF MACROECONOMIC DATA, AND THE DEFINITION AND ACCOUNTING OF

NATIONAL INCOME (CONTINUED.................)

Gross National Product (GNP):

Gross national product (GNP) is the value, at current market prices, of all final goods and

services produced during a year by the factors owned by the citizens of a country. Thus the

income earned by Pakistani citizens working in the US would be included in Pakistan's GNP

but excluded from Pakistan's GDP. Conversely, the income earned by a US citizen (individual

or corporate) in Pakistan would be included in Pakistan's GDP but excluded from Pakistan's

GNP. Generally, GNP = GDP + net factor income from abroad.

Net National Product (NNP):

Mathematically, national income is net national product (NNP). It is GNP adjusted for

depreciation. In words, it is the net output of commodities and services flowing during the year

from the country's production system in the hands of ultimate consumers.

Per Capita Income, Personal Income and Disposable Income:

Per capita income is obtained by dividing the national income by the total number of

population. It is the average annual income per head for all the inhabitants of the country; it is

used to represent the standard of living of the people.

The personal income of an individual is the total amount of income s/he receives form

deploying all the different factors of production s/he owns. Aggregate personal income is just

the above definition aggregated for the whole of the economy.

Disposable income is obtained by subtracting the amount of direct taxes from the personal

income of the person. Aggregate holds as above as well.

Real GDP, Nominal GDP and Price Deflator:

Real flow includes services of land labor and capital going from households to firms, and

products of firms as physical goods of services flowing to households. Real GDP therefore

excludes the effect of prices and focuses entirely on the volume (or quantity) of goods and

services produced.

Money (or nominal) flow includes the payments firms make to households for factor services

and also it includes the household spending money to buy goods from firms. Nominal GDP

would therefore include the effect of changes in the price level, as it is a measure of the money

value of goods and services produced.

It is the price deflator (see price\ratio expression in brackets below) which enables us to move

from nominal to real GDP. It provides a measure of the change in prices from the base (or

benchmark) year to year `a', given values for some aggregate price index for the two years:

Real GDP year a = Nominal GDP year a X (Price Index base year / Price Index year a)

Using a similar formula and the same base year, Real GDP year b can be calculated and then

be compared with Real GDP year a to get an idea of real GDP growth over the `a' to `b'

period.

Per Capita GDP:

Per capita GDP is simply the total GDP of the economy divided by the no. of people in the

economy. The GDP of China might be bigger than the GDP of Switzerland but in average per

capita terms, Switzerland's income might be several times that of China's; the figure given in

the lectures was 160.

The Purchasing Parity (PPP): The purchasing power parity (PPP) measure of GDP

recognizes the fact that a given amount of income in one country might not be able to

Introduction to Economics ECO401

purchase the same quantity of goods and services in another country. So, for e.g., if China'

per capita income is 1/160th of Switzerland's per capital income, it might be that goods and

services in China are much cheaper and therefore China's per capita income does not need to

grow 160 times in order to deliver the same standard of living as in Switzerland. The PPP GDP

per capita is therefore a more sensible measure to use for comparison across countries at

different levels of development. This is indeed the reason why many international development

organizations prefer this over simple GDP per capital.

Drawback of GDP Based Measures:

There are many caveats with a GDP based measure of national income.

i. GDP by definition excludes productive activities in the informal economy. Thus,

activities such as a person painting a wall in his own house, or a woman cooking

food in her house, would be excluded by a GDP-based measure. In countries

where a large part of economic activity goes unreported and undocumented (like

in lower income countries), the GDP might seriously understate the level of

national income and production.

ii. GDP cannot include the black or illegal economy. So, for example, if a banned

good is produced illegally and exported outside the country, and foreign money is

received in exchange for it, then that "export revenue" will not be included as part

of the GDP. Lower income countries often confront a large black economy which

cannot be documented. Living standards in such countries are therefore often

higher than what a per capital income measure based on GDP would suggest.

iii. A GDP-based measure of welfare or living standards also needs to be corrected

for externalities. For e.g., if a country's GDP is growing at a very fast rate but this

is at the cost of rising environmental pollution (which might cause serious future

health hazards) or non-renewable natural resource depletion, then a simple GDP

measure of income will overstate the performance of the economy and ignore the

serious long-term risks it faces.

Introduction to Economics ECO401

END OF UNIT 9 - EXERCISES

If we were trying to get a `true' measure of national production, which of the following

activities would you include: (a) washing-up; (b) planting flowers in the garden; (c)

playing an educational game with children in the family; (d) playing any game with

children in the family; (e) cooking your own supper; (f) cooking the supper for the

whole family; (g) reading a novel for pleasure; (h) reading a textbook as part of

studying? Is there a measurement problem if you get pleasure from the do-it-yourself

activity itself as well as from its outcome?

The difficulty stems from separating production from consumption. In the paid-employment

sector of the economy, the distinction is clear. With production, money flows from firms to

households (as wages, etc.), and with consumption, money flows from households to firms.

Many activities in the home, however, have both a production and consumption element.

Although they all lead to a benefit when complete (e.g. washing-up leads to clean dishes),

several, if not all, could give pleasure while they are actually being performed. If so, should

two lots of benefits be recorded (or even three)? Playing an educational game with children

can give pleasure to the children, future benefits to the children from the educational element,

and pleasure to the parents. Then there is the cost element. Should this be deducted? It is

not deducted for marketed output. In other words, the final value of goods and services sold is

what is included, not the value minus the cost of producing them: costs such as the disutility

(effort, boredom, etc.) experienced by workers.

Ideally, a true measure of national welfare, as opposed to national production, should be only

a net measure (i.e. benefits from consumption, minus costs of production). If this principle was

used to measure welfare in the household, then all pleasurable activities should be included

with a positive sign (including things such as reading a novel for pleasure) and anything

causing displeasure should be recorded with a negative sign. Most of the above activities

would have elements of both benefits and costs. However, when marketed national

production is recorded, costs are ignored, and so for comparative purposes, household

production should be recorded on the same basis, and only the benefits recorded.

All the above items bring pleasure, either directly (such as reading a novel) or indirectly (such

as doing the washing-up), and in this sense they should all be included, but whether activities

that give direct pleasure should count as production or merely as consumption, is a question of

definition.

Review this question after the balance of payments lectures. If the Malaysian ringgit is

undervalued by 47 per cent in PPP terms against the US dollar, and the Swiss franc

overvalued by 53 per cent, what implications does this have for the interpretation of

Malaysian, Swiss and US GDP statistics?

The GDP figures understate the purchasing value of Malaysian national income by 47 per cent

relative to US national income, and overstate the purchasing value of Swiss national income

by 53 per cent relative to US national income. In other words, at the exchange rates in

question, Malaysian national income seems 47 per cent lower relative US national income

than it really is in purchasing terms, and Swiss national income seems 53 per cent higher

relative to US national income than it really is in purchasing terms.

If there are no sales taxes, no net factor income from abroad and no depreciation, will

the GDP at market prices and national income measures collapse to the same thing?

Yes.

i. National income is NNP at factor cost = GNP at factor cost - depreciation. Since

depreciation = 0, NNP at factor cost = GNP at factor cost.

ii. GNP at factor cost = GDP at factor cost + net factor income from abroad. Since

net factor income from abroad = 0, GNP at factor cost = GDP at factor cost

iii. GDP at factor cost = GDP at market price sales taxes. Since sales taxes = 0,

GDP at factor cost = GDP at market price

Introduction to Economics ECO401

iv. Therefore NNP at factor cost = GDP at market price.

If nominal GDP has increased by 10% over last year but real GDP has fallen by 2%, by

what percentage must have prices risen?

12%. Real GDP growth rate = GDP growth rate the rate of inflation. -2% = 10% +?;? = -

12%.

Is population growth good or bad for a country's economic welfare?

It depends. If the energies of the growing population (and labour force) can be usefully and

efficiently employed towards productive activity, then the growth impact of the larger

population may dominate the negative impact of the large denominator in the per capital

income formula. However, if more and more people produce less and less (law of diminishing

returns) and the quality of human capital created is generally poor, then it might well be that a

large population leads to a decline in per capita income and hence average living standards.

It also depends on the starting level of the population. In many African countries, centuries of

slavery and migration to other countries, and decades of disease and wars, have led to the

working populations in these countries to fall below the minimum threshold required for them

to "take off" in an economic sense. By contrast, many South Asian and East Asian countries

are quite heavily populated and could use a little cooling down of population growth rates.

How should one treat macroeconomic statistics?

With extreme caution, as such data is likely to be used and abused by different interest groups

to support their respective stories. It is usually not the data which is misleading or not

consistent with the truth but the manner in which it is presented which makes a certain

interpretation of that data more likely. Objective analysis of data consists in stripping it off its

particular dressings and looking at all the possible stories it can tell.

By what would we need to divide GDP in order to get a measure of labour productivity

per hour?

The total number of hours worked in the year throughout the country.

Is the size of the underground or black economy likely to increase or decrease as the

level of unemployment rises?

It could rise or fall depending on which of two effects is the larger. On the one hand, if a

certain proportion of unemployed people claim unemployment benefit and work in the

underground economy, then, with a higher official level of unemployed, the size of the

underground economy is likely to be bigger. On the other hand, if the economy is in

recession, it is likely that the size of the underground economy will shrink along with the rest of

the economy.

Name some external benefits that are not included in GDP statistics?

Three examples are: the pleasure people get from seeing other people's attractive houses and

gardens, aesthetically pleasing architecture, improved health from a better diet.

Are worries about the consequences of economic growth a `luxury' that only rich

countries can afford?

This is a very cynical way of looking at the issue. The point is that the marginal benefit of

increased output in a poor country is likely to be much higher than in a rich country (given the

diminishing marginal utility of income). Thus if a costbenefit study were done of specific

growth policies, the benefits would probably enter with a higher value per unit in a poor country

than in a rich country. This does not mean that the cost should be ignored. It is just that

people may be prepared to make bigger sacrifices for increased output in poor countries than

in rich countries.

Introduction to Economics ECO401

We must be careful with these arguments, however. They could be used to `justify' policies

that are highly damaging to the environment by governments which have little long-term

interest in the welfare of the people, or by firms which are unconcerned about the

environmental consequences of their activities. The point is that costs should still be taken

into account: it is just that the benefits should possibly be given a higher weighting.

If a retailer buys a product from a wholesaler for £80 and sells it to a consumer for £100,

then the £20 of value that has been added will go partly in wages, partly in rent and

partly in profits. Thus £20 of income has been generated at the retail stage. But the

good actually contributes a total of £100 to GDP. Where then is the remaining £80

worth of income recorded?

At the wholesale stage and earlier. Each stage adds value value that is partly in wages,

partly in rent, etc. When the values added at all the stages are summed, this gives the final

value of the good.

An index called the index of sustainable economic welfare (ISEW) has been developed

by certain economists to measure sustainable development in different countries. The

index takes account of factors like depletion of natural resources which reduces the

likelihood of growth being sustained. Make out a case against using ISEW. How would

an advocate of the use of ISEW reply to your points?

There are three major criticisms of ISEW. The first concerns its use as a substitute for GDP.

GDP is not meant to be a true measure of living standards, both now and sustainable into the

future. Instead it is primarily a measure of output that involves exchange, an important

measure when attempting to understand the relationship between aggregate demand (as

expressed through exchange relationships) and aggregate supply. The second criticism

concerns the selection of items that should be included. Any list could be criticized for

including too many or too few items. For example, it could be argued that various forms of

public expenditure should be included (other than on health and education, which are already

included). On the other hand, various forms of `services of household labour' are not clearly

production. They could be seen as a form of consumption. For example, does time spent

gardening constitutes work or pleasure? We would not include watching television or sitting

relaxing as production, so should be include gardening or any other hobbies as production

which generates pleasure when consumed or merely as pure consumption? Similarly, do

relationships between people constitute the `provision of services' or is it rather mere joint

consumption? The third and perhaps the most serious criticism concerns measurement.

How, for example, should the depletion of non-renewable resources or long-term

environmental damage be measured? Such measurement entails various value judgments

about the relationship between present and future costs. In fact, the value placed on all non-

marketed items is likely to be highly controversial (more so than marketed items, where

corrections for market distortions could relatively easily be made).

An advocate of ISEW would reply that ISEW, as its name says, is meant to be a measure of

sustainable economic welfare, and not a measure of marketed output and is thus doing

something different from the conventional use of GDP. If GDP is used, not for its original

purpose, but as a measure of welfare, then ISEW is superior. As far as the selection of items

and their measurement is concerned, there will be inevitably be disagreement, because

people have different values. But here the advocate of ISEW would reply with the last two

sentences of the box.

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