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THE USE OF MACROECONOMIC DATA, AND THE DEFINITION AND ACCOUNTING OF NATIONAL INCOME (CONTINUED……………..)

<< THE USE OF MACROECONOMIC DATA, AND THE DEFINITION AND ACCOUNTING OF NATIONAL INCOME
MACROECONOMIC EQUILIBRIUM & VARIABLES; THE DETERMINATION OF EQUILIBRIUM INCOME >>
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Introduction to Economics ­ECO401
VU
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
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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.
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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
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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.
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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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Table of Contents:
  1. INTRODUCTION TO ECONOMICS:Economic Systems
  2. INTRODUCTION TO ECONOMICS (CONTINUED………):Opportunity Cost
  3. DEMAND, SUPPLY AND EQUILIBRIUM:Goods Market and Factors Market
  4. DEMAND, SUPPLY AND EQUILIBRIUM (CONTINUED……..)
  5. DEMAND, SUPPLY AND EQUILIBRIUM (CONTINUED……..):Equilibrium
  6. ELASTICITIES:Price Elasticity of Demand, Point Elasticity, Arc Elasticity
  7. ELASTICITIES (CONTINUED………….):Total revenue and Elasticity
  8. ELASTICITIES (CONTINUED………….):Short Run and Long Run, Incidence of Taxation
  9. BACKGROUND TO DEMAND/CONSUMPTION:CONSUMER BEHAVIOR
  10. BACKGROUND TO DEMAND/CONSUMPTION (CONTINUED…………….)
  11. BACKGROUND TO DEMAND/CONSUMPTION (CONTINUED…………….)The Indifference Curve Approach
  12. BACKGROUND TO DEMAND/CONSUMPTION (CONTINUED…………….):Normal Goods and Giffen Good
  13. BACKGROUND TO SUPPLY/COSTS:PRODUCTIVE THEORY
  14. BACKGROUND TO SUPPLY/COSTS (CONTINUED…………..):The Scale of Production
  15. BACKGROUND TO SUPPLY/COSTS (CONTINUED…………..):Isoquant
  16. BACKGROUND TO SUPPLY/COSTS (CONTINUED…………..):COSTS
  17. BACKGROUND TO SUPPLY/COSTS (CONTINUED…………..):REVENUES
  18. BACKGROUND TO SUPPLY/COSTS (CONTINUED…………..):PROFIT MAXIMISATION
  19. MARKET STRUCTURES:PERFECT COMPETITION, Allocative efficiency
  20. MARKET STRUCTURES (CONTINUED………..):MONOPOLY
  21. MARKET STRUCTURES (CONTINUED………..):PRICE DISCRIMINATION
  22. MARKET STRUCTURES (CONTINUED………..):OLIGOPOLY
  23. SELECTED ISSUES IN MICROECONOMICS:WELFARE ECONOMICS
  24. SELECTED ISSUES IN MICROECONOMICS (CONTINUED……………)
  25. INTRODUCTION TO MACROECONOMICS:Price Level and its Effects:
  26. INTRODUCTION TO MACROECONOMICS (CONTINUED………..)
  27. INTRODUCTION TO MACROECONOMICS (CONTINUED………..):The Monetarist School
  28. THE USE OF MACROECONOMIC DATA, AND THE DEFINITION AND ACCOUNTING OF NATIONAL INCOME
  29. THE USE OF MACROECONOMIC DATA, AND THE DEFINITION AND ACCOUNTING OF NATIONAL INCOME (CONTINUED……………..)
  30. MACROECONOMIC EQUILIBRIUM & VARIABLES; THE DETERMINATION OF EQUILIBRIUM INCOME
  31. MACROECONOMIC EQUILIBRIUM & VARIABLES; THE DETERMINATION OF EQUILIBRIUM INCOME (CONTINUED………..)
  32. MACROECONOMIC EQUILIBRIUM & VARIABLES; THE DETERMINATION OF EQUILIBRIUM INCOME (CONTINUED………..):The Accelerator
  33. THE FOUR BIG MACROECONOMIC ISSUES AND THEIR INTER-RELATIONSHIPS
  34. THE FOUR BIG MACROECONOMIC ISSUES AND THEIR INTER-RELATIONSHIPS (CONTINUED…….)
  35. THE FOUR BIG MACROECONOMIC ISSUES AND THEIR INTER-RELATIONSHIPS (CONTINUED…….):Causes of Inflation
  36. THE FOUR BIG MACROECONOMIC ISSUES AND THEIR INTER-RELATIONSHIPS (CONTINUED…….):BALANCE OF PAYMENTS
  37. THE FOUR BIG MACROECONOMIC ISSUES AND THEIR INTER-RELATIONSHIPS (CONTINUED…….):GROWTH
  38. THE FOUR BIG MACROECONOMIC ISSUES AND THEIR INTER-RELATIONSHIPS (CONTINUED…….):Land
  39. THE FOUR BIG MACROECONOMIC ISSUES AND THEIR INTER-RELATIONSHIPS (CONTINUED…….):Growth-inflation
  40. FISCAL POLICY AND TAXATION:Budget Deficit, Budget Surplus and Balanced Budget
  41. MONEY, CENTRAL BANKING AND MONETARY POLICY
  42. MONEY, CENTRAL BANKING AND MONETARY POLICY (CONTINUED…….)
  43. JOINT EQUILIBRIUM IN THE MONEY AND GOODS MARKETS: THE IS-LM FRAMEWORK
  44. AN INTRODUCTION TO INTERNATIONAL TRADE AND FINANCE
  45. PROBLEMS OF LOWER INCOME COUNTRIES:Poverty trap theories: