National Income Accounting


national income accounting -- the study of the methods of measuring the aggregate output and aggregate income of an economy

taking the nation's economic pulse -- helps define the relationship between an economy's total output and total income

we did not take comprehensive statistics until 1930s (Simon Kuznets - 1971 Nobel prize)

basic principle (fundamental national accounting identity) -- the value of total output equals the value of total income

this principle implies --the only way to increase real income is to increase real output

This point is very important! -- real income cannot be increased without producing more, redistributing income does nothing to increase the amount of wealth available at any point in time

fundamental national accounting identity indicates two methods for calculating GDP

  1. expenditure approach
  2. income approach
circular flow diagram

The diagram represents money flows, not tangible goods and services which could be visualized as flowing in the opposite direction from the arrows depicted below.

The "reddish" looking arrows illustrate the basic circular flow of money from households to firms.  These flows are the basis for much of our national income accounting.

The "bluish" arrows depict:

leakages -- income that is not spent on domestically produced goods and services (savings - S, taxes - T, imports - M)

The "greenish" arrows depict:

injections -- expenditures that add to the circular flow of expenditure (investment -- I, government expenditure - G, exports - X)

The injections inject spending into the economy that is lost with the leakages.

Study Question:
Explain the role of leakages and injections in the circular flow of expenditure and income model.  Use the circular flow diagram as a basis for your explanation.

double counting

final goods (purchased by their ultimate users) -- goods that are not used up in the production of other goods in the current period -- these count toward the calculation of GDP

intermediate goods (purchased for resale or use in producing another good) -- goods that are completely used up in the production of another good

intermediate goods do not enter the circular flow -- remain in the business sector, hence intermediate goods are not part of total output

example of double counting:

The data in the table below represent the selling price of the intermediate good.  After converting the tree to paper the paper manufacturer sells the paper to the textbook publisher for $3.

textbook production:

tree. . . . . . . . . . . . . . . . $1
paper . . . . . . . . . . . . . .   3
book  . . . . . . . . . . . . . .   7
bookstore . . . . . . . . . . . 75
sum of factor payments  $86

How much is added to GDP? $86, $75?

The correct answer is "$75".  The price of the "tree", "paper", and book is included in the final selling price of the book by the bookstore.  To include these amounts in GDP calculation would be to "double count."

value added -- amount of "value" that is "added" at each stage of production, the value of  firm's product minus the value of the resources it purchases from other firms

methods for calculating GDP

  1. expenditure approach -- sum the monetary value of all final goods and services
  2. income approach -- sum all factor incomes
two sides of the same coin

expenditure approach

expenditure approach -- sum the monetary value of all final goods and services


C = personal consumption expenditures -- final goods and services, non durable and durable goods.


I = gross private domestic investment  -- expenditures that add to (or replace) the economy's capital stock (plants, equipment, structures, and inventories).

investment is not an intermediate good because it is not completely used up

two main categories of investment

  1. inventory investment - increase or decrease (disinvestment) in the value of the stocks of inventories that businesses have on hand.
  2. fixed investment -- addition of new plants, equipment, commercial buildings, and residential structures

G = local, state, federal purchases of final goods and services.

net exports

exports minus imports

X = exports (produced domestically but sold to foreigners) -- dollars in, goods out

M = imports (produced by foreigners but purchased by domestic consumers) -- dollars out, goods in
Study Question:
Outline the expenditure approach for calculating output (gross domestic product -- GDP).  Define the major variables.

income approach

income approach -- sum all factor incomes

national income -- sum of all payments made to resource owners

  1. compensation of employees ~ 71% of national income
  2. rental income, rent -- payment for the use of property, e.g. land, housing, office space
  3. corporate profit -- return to owners of incorporated firms
    1. dividends
    2. retained earnings
    3. corporate taxes
  4. proprietor's income -- own own business
  5. net interest, how capital enters the process
Study Question:
Outline the income approach for calculating output (national income).  Give definitions when appropriate.

reconciling GDP with national income

measures of GDP are not identical with measures of national income

personal consumption expenditure depends on disposable personal income and GDP is a much wider measure than personal disposable income -- in order understand Keynesian economics we must know how disposable personal income relates to GDP

information relating to the reconciliation of GDP to disposable personal income:

GDP and GNP (gross national product) are distinguished by where the output is produced and who owns the resources producing the output.  GDP is computed on a geographic basis, not national citizenship.  If something is produced within the geographic boundaries of a nation in counts toward GDP.  A Japanese citizen living and working in the US contributes to the US's GDP.  If one were computing GNP, the Japanese person in the US would add to Japan's GNP, not the United State's
definitions relating to the reconciliation of GDP to disposable personal income:
depreciation -- value of existing capital stock used up

indirect business taxes -- not levied on the firm directly, rather on a good or service (sales taxes, excise taxes, customs duties, property taxes, fees)

the following equation indicates how to reconcile GDP to disposable personal income

Study Question:
Show how the discrepancy between output calculated by the expenditure approach (GDP) and output calculated by the income approach (national income) is reconciled.