Measures of national income

Measures of national income and output are used in economics toestimate the value of goods and services produced in an economy. They use a system of national accounts ornational accounting developed by Simon Kuznets in the1960s. Some of the more common measures are Gross National Product (GNP), Gross Domestic Product (GDP), Net National Product (NNP), and Net National Income (NNI).

There are at least two or three different ways of calculating these numbers. The expenditure approachdetermines aggregate demand, or Gross National Expenditure, by summing consumption, investment, government expenditure and netexports. On the other hand, the income approach and the closely related output approach can beseen as the summation of consumption, savings and taxation. The three methods must yield the same results because the totalexpenditures on goods and services (GNE) must by definition be equal to the value of the goods and services produced (GNP) whichmust be equal to the total income paid to the factors that produced these goods and services (GNI). (GNP=GNI=GNE bydefinition)

In actual fact, there will be minor differences in the results obtained from the various methods due to changes in inventorylevels. This is because goods in inventory have been produced (and therefore included in GDP), but not yet sold (and thereforenot yet included in GNE). Similar timing issues can also cause a slight descrepency between the value of goods produced (GDP) andthe payments to the factors that produced the goods (particularly if inputs are purchased on credit).

Gross National Product

Gross National Product (GNP) is the total value of final goods and services produced in a year by domestically owned factors of production.

Final goods are goods that are ultimately consumed rather than used in the production of another good. Forexample, a car sold to a consumer is a final good; the components such as tiressold to the carmanufacturer are not; they are intermediate goods used to make the final good. The same tires, if sold to a consumer, would be afinal good. Only final goods are included when measuring national income. If intermediate goods were included too, this wouldlead to double counting; for example, the value of the tires would be counted once when they are sold to the car manufacturer,and again when the car is sold to the consumer .

Only newly produced goods are counted. Transactions in existing goods, such as second-hand cars, are not included, as these donot involve the production of new goods.

Income is counted as part of GNP according to who owns the factors of productionrather than where the production takes place. For example, in the case of a German-owned car factory operating in the US, the profits from the factory would be counted as part of German GNP rather than US GNPbecause the capital used in production (the factory, machinery, etc.) is German owned. The wages of the American workers would bepart of US GNP, while the wages of anyGerman workers on the site would be part of German GNP.

Gross Domestic Product

Gross Domestic Product (GDP) is the total value of final goods and services produced within a country's bordersin a year.

GDP counts income according to where it is earned rather than who owns the factors of production. In the above example, all ofthe income from the car factory would be counted as US GDP rather than German GDP.

To convert from GNP to GDP you must subtract factor income receipts from foreigners that correspond to goods and servicesproduced abroad using factor inputs supplied by domestic sources. To convert from GDP to GNP you must add factor input paymentsto foreigners that correspond to goods and services produced in the domestic country using the factor inputs supplied byforeigners.

GDP is a better measure of the state of production in the short term. GNP is better when analysing sources and uses ofincome.

Depreciation and Net National Product

Not all of GNP is available to produce final goods and services - part of it represents output that is set aside to maintainthe nation's productive capacity. Capital goods, such as buildings and machinery, lose value over time due to wear and tear andobsolescence. Depreciation measures the amount of GNP thatmust be spent on new capital goods to offset this effect.

In the Income Approach:

• Net National Product (NNP) is GNP minus depreciation
• Net National Income (NNI) is NNP minus indirect taxes
• Personal Income (PI) is NNI minus retained earnings, corporate taxes, transfer payments, and interest on the public debt
• Personal Disposable Income (PDI) is PI minus personal taxes, plus transfer payments.

In summary:

S = personal savings
C = personal consumption
PDI = personal disposable income
T_P = personal taxes paid
TP_P = personal transfer payments received from governments
PI = personal income
RE = retained earnings
T_C = corporate taxes
TP_C = corporate transfer payments from governments
I_G = interest on the public debt
NNI = net national income
T_IN = indirect taxes
NNP = net national product
D = depreciation
GNP = gross national product

S + C = PDI

S + C + T_P - TP_P = PI

S + C + T_P - TP_P + RE + T_C - TP_C - I_G = NNI

S + C + T_P - TP_P + RE + T_C - TP_C - I_G + T_IN = NNP

S + C + T_P - TP_P + RE + T_C - TP_C - I_G + T_IN + D = GNP

Real and nominal values

Nominal GNP measures the value of output during a given year using the prices prevailing during that year.Over time, the general level of prices rise due to inflation , leading to an increase in nominal GNP even if the volume of goods and services produced isunchanged.

Real GNP measures the value of output in two or more different years by valuing the goods and servicesadjusted for inflation. For example, if both the "nominal GNP" and price level doubled between 1995 and 2005, the "real GNP"would remain the same. For year over year GNP growh, "real GNP" is usualy used as it gives a more accurate view of theeconomy.

National income and welfare

GNP per person is often used as a measure of people's welfare. Countries with higher GNP often score highly on other measuresof welfare, such as life expectancy . However, there are seriouslimitations to the usefulness of GNP as a measure of welfare:

• Measures of GNP typically exclude unpaid economic activity, most importantly domestic work such as childcare. This can leadto distortions; for example, a paid childminder's income will contribute to GNP, whereas an unpaid mother's time spent caring forher children will not, even though they are both carrying out the same economic activity.

• GNP takes no account of the inputs used to produce the output. For example, if everyone worked for twice the number of hours,then GNP might roughly double, but this does not necessarily mean that workers are better off as they would have less leisuretime. Similarly, the impact of economic activity on the environment is not directly taken into account in calculating GNP.

• Comparison of GNP from one country to another may be distorted by movements in exchange rates. Measuring national income at purchasing power parity can help to overcome thisproblem.

Because of this, other measures of welfare such as the Index of Sustainable Economic Welfare (ISEW) and Genuine ProgressIndicator have been suggested.

National Accounting Formulas (Expenditure approach)

 C = Personal consumption expenditures I = Gross private domestic investment G = Government consumption expenditures X = Net exports of goods and services M = Net imports of goods and services NR = Net income from assets abroad CC = Consumption of fixed capital IBT = Indirect business taxes

 GDP = C + I + G + (X - M) GNP = C + I + G + (X - M) + NR NI  = C + I + G + (X - M) + NR - CC - IBT

Alternate economic measures

• Gross HappinessIndex
• GenuineProgress Index
• Human Development Index

Sources of economic data

• US Bureau of Economic Analysis

External links

• Understanding GNP and GDP (source: BBC)