zNational Income Accounting - Introduction

Definition: It is the sum of incomes earned by the nation's factors of production during a given
period of time usually a year. It measures only current productive activity. For example since social
security benefits are received at retirement and not during the working life of the person, it is not
added to the estimate.h

National Income Terminologies

1. Gross domestic product (GDP) or GDP at market prices - It is the monetary value of goods and services
produced using resources of both nationals and non - nationals residing within the geographical
boundary of the country during a given period of [Link] is gross because no allowance has been made
for depreciation or capital consumption allowance. Market price means that the GDP was calculated
based on prices prevailing on the market.

2. Depreciation - It is the money put aside to take care of care of the wear and tear of a capital asset
example plant and machinery.

3. Net factor income from abroad - It is the difference between incomes of nationals abroad and
incomes of foreigners in the host county.

4. Gross National Product ( GNP ) - It is the total monetary value of goods and services produced using
resources of only nationals irrespective of whether they are within or outside the country.

GNP = GDP + Net factor income from abroad

5. Net National Product (NNP)- It is the total monetary value of goods and services produced using
resources of only nationals after allowance has been made for depreciation.

NNP = GDP + Net Factor Income - Depreciation

[Link] prices and Factor cost - This is when the GDP or national income estimates contain indirect
taxes and subsidies. When indirect taxes are imposed on goods and services, it increases the cost of
production. Subsidies reduce the cost of production.

On the contrary, factor cost measures the value of the national income at the actual cost of production.
To obtain factor cost from market prices, indirect taxes are deducted because it increases the cost of
production. Subsidies are added because it reduces the cost of production.

7. Net national product at factor cost - It is the same as the national income of the country.

NNP at factor cost = GDP + Net factor income from abroad - Depreciation + Subsidies - Indirect taxes.

Exercise 1

The data below shows the Ghanaian economy in 2021, study the information carefully and use it to
answer the questions that follow :

GDP = 19000
Depreciation = 5900

Population = 1000

Indirect taxes = 1500

Subsidies = 900

Incomes of nationals abroad = 800

Incomes of foreigners in the country= 600

1. Calculate the GNP , NNP, NDP and NNP at factor cost

2. Calculate the per Capita income of the country.

Solution to exercise 1

1. GNP= GDP + Net Factor Income from abroad

But Net factor income from abroad= Income of nationals abroad - incomes of foreigners in the country

= 800 - 600

= 200

= 19,000 + ( 200)

= 19,200

2. NNP = GNP -; Depreciation

= 19200 - 5900

= 13,300

3. NDP = 19,000 - 5900

= 13,100

4. NNP at factor cost ,= NNP - Indirect taxes + subsidies

= 13,300 - 1500 + 900

= 12,700
5. Per Capita income = NNP at factor cost or National Income ÷ Total population

= 12,700 ÷ 1000

= 12.70

Exercise 2

Assuming that in 1983 the following data was extracted from the world bank report , study the
information carefully and use it to answer the questions that follow.

Net domestic product ( NDP) = $25,000.

Depreciation or capital consumption allowance = $10,000

Population = 500

Income of nationals abroad = $ 2500

Income of foreigners in the country = $1659

Indirect taxes = $ 1200

Subsidies = $ 699

1. Obtain the GDP of the country in 1983.

2. Calculate the net factor income from abroad.

3. Obtain the GNP of the country .

4. Why is the GNP of this country greater than its GDP ?

5. Calculate the national income of the country .

6. Calculate the per Capita income of the country.

THE CIRCULAR FLOW OF INCOME

The circular flow of income is a technique used to explain why the three approaches used in measuring
national income are the same. The approaches are: income, output and expenditure approaches.

ASSUMPTIONS

The theory is built on the following assumptions:

1. There are only two sectors in the economy that is firms and the household sectors.
2. Households don’t save
 3. Households are the owners of all productive resources ie land, capital, enterprise and layout
services
4. Firms buy productive resources from households ie land, capital, entrepreneur and labour
services.
5. Firms sell all goods produced to household.
6. All goods produced are demanded by the household sector.

Explaination of the Circular flow of income

Firms buy or hire productive resources such as land, capital , labour and entrepreneurial
services from households to produce goods and services. This is called the national output or
the national income using the output approach.

When firms buy productive resources from households they make payments to the factors of
production in the form of rent to landowners, interest to capital owners, profits to
entrepreneurs and wages to labour. The sum of these rewards is called the national income
using the income approach.

When households receive the factor payments, they spend the entire incomes earned on goods
and services. This is called national expenditure or the national income using the expenditure
approach.

Reasons why the approaches are the same

1. Since households do not save , it means that the national income will be equal to the
national expenditure.

2. The value of input must be equal to the value of output.

The value of input refers to the reward received by households in the form of rent to
landowners, interest to capital owners , profits to entrepreneurs and wages to labour. The
sum of these rewards is called the national income . In effect the sum of these rewards
determines the value of the output which is called the national output. National income will
therefore be equal to the national output.

3. Finally, since all goods produced by firms are demanded, the national output will be equal
to the national income.

Importance of National Income Estimates

1. To know the importance of the various sectors of the economy,: When the product approach is
used, it provides information about the various sectors of the economy to output. In view of
this, sectors that are not doing well can be identified and the appropriate solutions found.
 2. To correct income inequality – When the income approach is used, it provides adequate picture
about the distribution of income in the country ie rent to landowners, interest to capital owners,
profits to entrepreneurs and wages to labour. Where the inequality in incomes are pervasive ,
steps such as progressive taxation may be employed to correct this phenomenon.
3. To attract foreign investment: Foreign investors rely on the per Capita income in determining
the market for their [Link] higher the per capita income , other things being equal, demand
will also increase and thus they are induced to invest in the country.
4. To compare standard of living among countries - The per Capita income can also be used to
compare standard of living among countries Since income determines the purchasing power of
consumers, it is anticipated that a higher per Capita income will reflect a higher standard of
living than a country with lower ³per capita income.
5. It can be used to determine the contribution made by a member country to an international
organization : Ghana belongs to international organizations such as UN, ECOWAS etc. The GDP
and the per Capita income are the indicatirs used to determine the contributions. Usually, the
higher the GDP or per Capita income, the higher the contribution of a country.
6. To know the balance of trade position of the country: When the expenditure approach is used ,
it provides information about the balance of trade position of the country. This will inform policy
makers to know the next line of action to take in order to control a deficit or a surplus . If the
payment for imports exceeds receipts from exports , it is a deficit on the balance of trade. To
resolve this, exports must be encouraged and imports discouraged.

Measurement of National Income

The three approaches used in measuring national income are: Expenditure, Income and the Output
Approaches.

The Expenditure Approach

The national income is measured by summing the expenses made on goods and services by the final
consumers.

In an open economy the final consumers comprise expenses made on goods and services by the
household on durable goods (refrigerator, car, television etc), non-durable goods (🍞 bread, milk etc) and
on services. It is denoted by the alphabet ( C)

The second component is the gross domestic private investment by firms denoted by the alphabet (I).
This involves the acquisition of fixed assets such as plant and machinery which enhances further
production It is therefore synonymous to the stock if capital.

When depreciation or capital consumption is deducted from the gross domestic product, it is called net
domestic private investment.

The net domestic private investment may be positive, negative or zero.

When it is positive, the economy is growing because capital formation is greater than capital
consumption. When it is negative, the economy is declining because capital consumption is greater than
capital [Link] it is zero, the economy will be stagnant because çapital formation will be equal
to capital consumption.

The third component is government expenditure on recurrent and capital expenditure denoted by G.

Finally when the economy is opened to international trade, the next component is net exports or
balance of trade which is the difference between exports and imports. It is denoted by the alphabets (X -
M ).

Obtaining the National Income using the expenditure approach

It is worthy to note that this approach involves spending on goods and services on the market and thus
it is obtained at market prices.

By definition

GDP or Gross domestic expenditure = C + I + G + ( X - M ).

The national Income which is the same as the NNP at factor cost = GDP + NFI - Depreciation + Subsidies
- Indirect taxes

Review Questions

Use the data below to answer the questions that follow:

Household consumption (C) = $6000

Gross domestic private investment (I) = $4000

Government or Public Spending = $7000

Exports = $3000

Imports = $2000
Incomes of foreigners = $600

Incomes of nationals abroad = $800

Indirect taxes = $1000

Subsidies = $ 600

Population = 300

Depreciation= $500

a) Calculate the GDP of the country.

b) Obtain the NNP of the country.

c) Comment on the values of the GDP and GNP.

d) Calculate the net domestic private investment and indicate whether the economy is growing,
stagnant or declining.

e) Calculate the national income of the country.

f) Obtain the per capita income of the country.

Problems of the expenditure approach

1. Double counting: This approach must include only final expenses by the final consumer. When an
expeñditure made is not meant for final use yet it is considered as such then an error of double counting
will be committed.

2. Smuggling - When this takes center stage in a country, it will affect the net exports component of the
national income. In effect the national income will be overstated or under stated.

3. Depreciation - When this component is not well estimated, the national income will either be
overstated or understated

The Output Approach

It is also called the product or the value added approach.

The approach involves summing up the contribution made by each sector of the economy to output
during a given period of time.

For example if a cassava farmer produces cassava worth $100 which was purchased by a gari producer
who finally processed the cassava and sold it for$290 which was finally sold by a gari seller at $ 320, the
national income will be $320 being contribution of $100 from the farmer, $190 from the gari producer
and $30 from the gari seller and not $100 plus $290 plus $320 which will be equal to $710. If the value
of the raw materials or the value of the intermediate products are not deducted, the error of double
counting will be committed.

Problems of the Product Approach

1. Double counting ,- This occurs when the value of intermediate products are not deducted. In the
process the national income will be overestimated.

2. Data collection challenges - It is difficult to gather data especially productive activities in remote areas
of the country due to inaccessible roads and poor record keeping..

3. Subsistence farming - Such productive activities are not captured on the market and thus may be
exempted from the estimates. The national income will thus be understated.

4. Depreciation - The national income may be either overstated or understated if it is not estimated
properly.

Review Questions

Use the data below to answer the questions that follow. Where calculations are involved show
workings.

Manufacturing ,- $ 2000

Construction - $3300

Retailing - $1000
Electricity supply -$550

Water supply - $600

Telecommunication - $800

Crop sector- $700

Fisheries - $905

Livestock sector- $ 450

Depreciation.- $490

Incomes of nationals abroad - $350

Incomes of foreigners - $200

a) Calculate the GDP of the country.

b. . Obtain the NDP of the country

c. Calculate the national income of the country.

d. Calculate the GNP per Capita and the per Capita income of the country. Explain why the values are
different.

INCOME APPROACH

Under this approach the national income is obtained by summing the incomes of the nation's factors of
production (rent to landowners, wages to labour, interest to capital owners and profits to
entrepreneurs as shown below.

These 5 terms are the main pieces of Gross Domestic Income (GDI) under the income approach. They
show how the money earned from producing GDP gets shared out to people who provided the factors
of production.

1. Compensation of Employees

What it is: All income earned by workers for their labour.

Includes:

- Wages and salaries before tax

- Allowances, bonuses, overtime

- Employer contributions to social security, pensions, health insurance

Example: A teacher’s GH₵3,000 monthly salary + GH₵200 SSNIT paid by the school = GH₵3,200
compensation.

In GDP: This is the return to _labour_.

*2. Proprietors’ Income*

*What it is:* Income of self-employed people and unincorporated businesses. Also called _mixed
income_ because it’s a mix of wages for the owners labour and profit from the business.

*Includes:*

- Profits of sole proprietors: tailors, farmers, trotro drivers, shop owners

- Income of partnerships that aren’t companies

*Example:* A seamstress makes GH₵2,500 profit a month. Part is pay for her sewing work, part is return
on her sewing machine.

In GDP: This is the return to labour + capital for small businesses.

*3. Rental Income*

*What it is:* Income earned by households and businesses from lending out property.

*Includes:*

- Rent for land, buildings, houses

- Royalties from patents, copyrights

Imputed rent : estimate of what homeowners would pay themselves if they rented their own house

*Excludes:* Rent paid by one firm to another firm — that’s intermediate cost.

*Example:* A landlord collects GH₵1,000 rent each month from tenants.

*In GDP:* This is the return to _land/property_.

*4. Corporate Profits*

*What it is:* Profits earned by incorporated companies before tax.

*Includes:*

- Dividends paid to shareholders

- Undistributed profits/retained earnings kept by the company

- Corporate income taxes paid to government

*Example:* MTN Ghana makes GH₵500m profit: GH₵200m paid as tax, GH₵150m paid as dividends,
GH₵150m kept for expansion. All GH₵500m counts.

*In GDP:* This is the return to _capital/entrepreneurship_ for companies.

*5. Net Interest*

*What it is:* Interest households receive from businesses and the rest of the world, minus interest they
pay.

*Includes:*

- Interest from bank deposits, bonds, loans to firms

*Excludes:*

- Interest on government debt — treated as transfer payment

- Interest on consumer loans — not from production

*Example:* You earn GH₵300 interest from your T-bills but pay GH₵50 interest on your business loan.
Net interest = GH₵250.

*In GDP:* This is the return to _capital_ lent to producers.

---

*How they fit together in GDI*

*GDI = Compensation of employees + Proprietors’ income + Rental income + Corporate profits + Net
interest + Net indirect taxes + Depreciation

NDI = GDI - Depreciation

NNI = NDI + NFIA

NNI at factor cost or national income = NNI – Indirect tax + Subsidies

PROBLEMS OF THE INCOME APPROACH

1. Double counting - When transfer payments example social security benefits received by retired
persons are added to the national income estimates, the estimates will be overstated.

2. Unpaid services - Certain unpaid services such as services of housewives and self executed jobs like a
landlord painting his own apartment may be ignored in the estimates. In the process the estimates will
be understated. However, if the same tasks are done by a security manor a painter respectively, they
are included in the estimates.
3. Scope of Accounting - Certain activities that generate income may be exempted by some countries
like Ghana. For example Incomes earned by commercial sex workers are not included. This will
understate the national income value.

4. Self employed workers - Most of these workers may under declare their Incomes. This will have the
far reaching consequence of under stating the national income.

Exercise

Use the data below to answer the questions that follow:

Capital consumption allowance =$500

Wages= $1900

Incomes of nationals abroad= $600

Incomes of foreigners in the country= $300

Interest = $700

Indirect taxes=$400

Subsidies= $500

profits = $800

rent = $800

Solution

a) Calculate the national income of the country.

b) Obtain the GNP of the country

c) Obtain the GDP of the country

d) If the population of the country is 300, calculate the per capita income of the country.

a) National Income*

$NI = Wages + Interest + Rent + Profits + Net facto income from abroad

$NI = 1,900 + 700 + 800 + 800 + 600 - 300$

$NI = 4,500$

*b) GNP*

$GNP = NI + Depreciation + (Indirect\ taxes - Subsidies)$

$= 4,500 + 500 + 400 - 500 = 5,000$

*c) GDP*

$GDP = GNP – Net factor income from abroad

$= 5,000 - 300 = 4,700$

THE PER CAPITA INCOME

It is defined as the ratio of the national income to the total population.

Per Capita income= National Income ÷ Total Population

Globally the per Capita income is used as an indication in measuring standard of living among countries.

Shortcomings of the per Capita income

1. Inflation and deflationary conditions - Inflation bloats the national income whiles deflation shrinks the
national income. When these óutcomes are not corrected using price indices, the national income and
thus by extension the per capita income will fail to be an accurate indicator for measuring standard of
living.

2. Uneven distribution of income - Per Capita income provides estimate for average Incomes. In view of
this when Incomes are not evenly or fairly distributed, inspite of a very high per Capita income,it does
not mean that everyone in the country is enjoying high living standard.

3. Composition of the national income - Living standard is indexed on the consumption of real goods
and services. Where the composition is not on real goods example expenses on amunitions , then
inspite of a very high per capita income, it does ñot mean that the standard of living is high.

4. Unpaid services - Certain unpaid services such as services of housewives and self executed jobs like a
landlord painting his own apartment may be ignored in the estimates. In the process the estimates will
be understated. However, if the same tasks were done by a security man or a painter respectively, they
are included in the estimates. Thus countries that fail to consider such services will experience lower per
capita income which will be wrongfully translated as low standard of living.

5. Unreliable data - There are also challenges in calculating the national income and population figures.
Some of the problems encountered in calculating national income are unpaid services of self executed
task , composition of national income etc whiles some of the population challenges include poor town
planning,

superstitious beliefs etc are glaring challenges.

REASONS FOR THE DIFFERENCES IN THE NATIONAL INCOME OF COUNTRIES

1. The quantity and quality of natural resources - Income generated from a natural resource is
dependent on quantity and quality. The quality determines the price and the quantity complements in
raising revenue depending on the price of the [Link] both indicators are high, more income can be
generated for development.

2. The quantity and quality of çapital

resources - Çapital is a man made good that aids to boost production and ultimately generation of
more income. This means that a country that is capable of increasing acquisition of the quality of the
çapital resources can boost production and thus national income rapidly.

3. The quantity and quality of human resources - Human resources refer to

the skills and abilities of a nation's labour [Link] stands to reason that since trained labour force
contributes more to output and income. A large stock of trained populace can lead to higher output and
income.

4. Changes in Technology - It refers to new improved ways of doing [Link] is [Link]

through research. Africa is blessed with abundant natural resources but she is poor because she lacks
the technology to exploit these resources on her [Link] she continues to be exploited
because huge profits are being exploited by these countries that provide the requisite technology.

5. Efficiency in the allocation of resources - When resources are efficiently allocated to the productive
sectors of the economy, corruption and embezzlement of funds controlled as well as proper monitoring
of the funds released to these sectors, productivity and incomes will rise. This is what we fail to properly
do in Africa hence the low national incomes recorded in Africa

6. Attitude - Attitude is everything. A positive attitude towards work raises production culminating into
rising Incomes. This can be accomplished by eliminating absenteeism, lateness, loitering, pilfering
among others
l