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Measuring the Economy I:

National Income

Chapter 02

Macroeconomic Analysis I

BOOKS

Abel, A. B, Bernanke, B. s. and Croushore, D. (2011), Macroeconomics, 7th Edition, Pearson.

Ünsal, E. (2017), Makro İktisat, 11. Baskı, Murat Yayınları, Ankara.
Dornbusch, R., Fischer, S., Startz, R. (2018), Macroeconomics, 13th Edition, McGraw-Hill.
Mankiw, N. G. (2010), Macroeconomics, 7th Edition, Worth Publishers.
Gordon, R. J. (2012), Macroeconomics, 12th Edition, Pearson.

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The Books used in this chapter

This section includes Chapter 2 (Abel et al., 2011) and Chapter 2 (Ünsal, 2017)

Macroeconomic Analysis I

Chapter Outline
• National Income Accounting: The Measurement of
Production, Income, and Expenditure

• Gross Domestic Product

• Saving and Wealth

• Real GDP

Macroeconomic Analysis I

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National Income Accounting

Income (Y= $1,000,000)

Labor

Households Firms

Goods

Expenditure ($1,000,000)

Macroeconomic Analysis I

National Income Accounting

National income accounts: An accounting framework used in measuring current economic activity
Three alternative approaches give the same measurements of the amount of current
economic activity:

– Production approach: the amount of output produced

• The product approach measures economic activity by adding the market values of goods and services
produced, excluding any goods and services used up in intermediate stages of production. The value
added of any producer is the value of its output minus the value of the inputs it purchases from other
producers. The production approach computes economic activity by summing the value added by all
producers.

= =∑

– Income approach: the incomes generated by production

• The income approach measures economic activity by adding all income received by producers of
output, including wages received by workers and profits received by owners of firms.

GDP = Y = Labor Income + Capital Income + Net Indirect Taxes + Depreciation

– Expenditure approach: the amount of spending by purchasers
• the expenditure approach measures activity by adding the amount spent by all final users of output.
GDP = Y = C + I + G + EX - IM

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National Income Accounting

Why are the three approaches equivalent?

– They must be, by definition

– Any output produced (production approach) is purchased by

someone (expenditure approach) and results in income to
someone (income approach)

– The fundamental identity of national income accounting:

total production = total income = total expenditure

Macroeconomic Analysis I

National Income Accounting

We can illustrate why these three approaches are equivalent by an example. Imagine an
economy with only two businesses, called Company A and Company B.
Company A pays $15,000 per year in wages to
workers to pick oranges, and it sells these
Company A
oranges for $35,000 ($10,000 worth of oranges
Company A’s employees to households and $25,000 worth of oranges
to Company B). Thus Company A’s profit
before taxes is $35,000 - $15,000 = $20,000.
Because Company A pays taxes of $5000, its
Company B after-tax profit is $15,000.

Company AB Company B buys $25,000 of oranges from

Company B’s employees Company A and pays wages of $10,000 to
workers to process the oranges into orange
juice. It sells the orange juice for $40,000, so
Company A
its profit before taxes is $5000 ($40,000 -
$25,000 - $10,000). After paying taxes of
$2000, its after-tax profit is $3000.
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National Income Accounting

Company AA
Company The production approach:
Company A’s employees
$ 35,000
+ $ 40,000 ("double count" the $25,000 of oranges)
$ 75,000 (Double counting mistake)

To avoid "double counting", we sum value

Company B
added rather than output:
Company
CompanyBAB Company A’s value added = $35,000
Company B’s employees
Company B's value added = ($40,000 - $25,000) =
$15,000

Company A $ 35,000
+ $ 15,000
$ 50,000 (GDP = Total value added in the Economy)

Macroeconomic Analysis I

National Income Accounting

The income approach:
Company A The (before-tax) profits of Company A = 20,000
Company A’s employees The (before-tax) profits of Company B = 5,000
Total (before-tax) profit (Capital Income) = 25,000

Wage Income received from Company A = $ 15,000

Wage Income received from Company B = $ 10,000
Total Wage (Labor Income) = $ 25,000
Company B
Capital Income (before tax) + Labor Income = GDP
25,000 + 25,000 = 50,000
Company AB
Company B’s employees
The (after-tax) profits of Company A = 15,000
The (after-tax) profits of Company B = 3,000
Total (after-tax) profit (Capital Income) = 18,000
Company A
Capital Income (after tax) + Labor Income + Taxes = GDP
18,000 + 25,000 + 7,000 = 50,000

Note: Depreciation is omitted.

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National Income Accounting

The expenditure approach:
Company A
Company A’s employees In this example, households are final users of
oranges. Company B is not an final user of
oranges because it sells the oranges (in
processed, liquid form) to households.

Thus final users purchase $10,000 of oranges

Company B from Company A and $40,000 of orange juice
from Company B for a total of $50,000, the
Company AB same amount computed in both the product
and the expenditure approaches
Company B’s employees

The sum of all expenditures = $ 50,000 = GDP

Company A

Macroeconomic Analysis I

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GDP: The production approach to measuring GDP

• The production approach to measuring GDP

– GDP (gross domestic product) is the market value of final

goods and services newly (currently) produced by residents
of a country within the territorial boundary of the country
during a particular time period.

– The GDP of a country is often referred to as the country’s

output and/or income

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GDP: The production approach to measuring GDP

Market value: Goods and services are counted in GDP at their market values
that is, at the prices at which they are sold. The advantage of using market values is that
it allows adding the production of different goods and services. A problem with using
market values to measure GDP is that some useful goods and services are not sold in
formal markets
– Problem: misses nonmarket items such as homemaking,
child-rearing services, the value of environmental quality,
and natural resource depletion

– Exception: Non-market production: There is some

adjustment to reflect the underground economy

– Exception: Government services (that aren’t sold in markets)

are valued at their cost of production

Macroeconomic Analysis I

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GDP: The production approach to measuring GDP

Newly (currently) produced: GDP counts only things

produced in the given period; excludes things produced
earlier (goods resold)

• GDP also excludes any transaction (transfer payments) in which

money is transferred without any accompanying goods and
services in return.
• Transfer payments (Social security, madicare and unemployment benefits)

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GDP: The production approach to measuring GDP

Final goods and services
– Don’t count intermediate goods and services (those used up in the
production of other goods and services in the same period that they
themselves were produced)
– Final goods & services are those that are not intermediate
– Capital goods (goods used to produce other goods) are final goods since
they aren’t used up in the same period that they are produced

– Inventory investment (the amount that inventories of unsold finished

goods, goods in process, and raw materials have changed during the
period) is also treated as a final good

– Adding up value added works well, since it automatically excludes

intermediate goods

Macroeconomic Analysis I

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GDP: The production approach to measuring GDP

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GDP: The production approach to measuring GDP

Table: Production approach to Measuring GDP at current prices in Turkey, 2016
Sector Millions of TL % of GDP
Agriculture 161,305 6
Industry 511,806 20
Mining and Quarrying 21,369 1
Manufacturing 432,980 17
Electricity, gas, steam and air conditioning supply 33,936 1
Water supply, sewerage, waste management and remediation activities 23,521 1
Services 1,402,423 54
Wholesale and Retail Trade 296,142 11
Transport, storage 197,259 8
Accomodation and Food Service Activities 67,498 3
Information and Communication 63,445 2
Financial and Insurance Activities 87,063 3
Real Estate Activities 201,561 8
Professional, Scientific and Technical Activities 59,863 2
Administrative and Support Service Activities 77,432 3
Public Administration and Defence; Compulsory Social Cecurity 119,176 5
Education 114,175 4
Human Health and Social Work Activities 68,274 3
Arts, Entertaintment and Recreation 24,106 1
Other Service Activities 25,186 1
Activities of Household as Employers 1,243 0
Construction 223,363 10
Taxes-Subsidies (Net Taxes) 309,629 12
Totals (equals GDP) Y 2,608,526 100
Macroeconomic Analysis I

Source: TURKSTAT

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GDP: The production approach to measuring GDP

GNP vs. GDP

• Gross Domestic Product (GDP): • Gross National Product (GNP):
is the market value of final goods and services is the market value of final goods and
newly (currently) produced by residents of a services newly (currently) produced by all
country within the territorial boundary of the citizens of a country (whether within or
country during a particular time period. outside the country) during a particular
time period.

GNP = GDP + (factor payments from abroad – factor payments to abroad)

Net Factor Payments (NFP)

Examples of factor payments: wages, profits, rent, interest & dividends on assets

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GDP: The production approach to measuring GDP

• GNP vs. GDP

– Example: Engineering revenues for a road built by a U.S. company in
Saudi Arabia is part of U.S. GNP (built by a U.S. factor of production), not
U.S. GDP, and is part of Saudi GDP (built in Saudi Arabia), not Saudi GNP

– Difference between GNP and GDP is small for the United States, about
0.2%, but higher for countries that have many citizens working abroad

– The distinction between GNP and GDP is more important for countries
such as Egypt and Turkey that have many citizens working abroad. The
reason is that income earned by workers abroad is part of a country's
GNP but not its GDP.

Macroeconomic Analysis I

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GNP vs. GDP in select countries, 2009

GNP – GDP (% of
Country GNP GDP
GDP)

Bangladesh $99,391 $89,378 11.2

Japan $5,198,865 $5,067,526 2.6

United States $14,345,303 $14,256,300 0.6

China $4,937,980 $4,984,731 –0.9

Canada $1,323,476 $1,336,067 –0.9

Mexico $860,849 $874,902 –1.6

Greece $316,267 $329,924 –4.1

Nigeria $155,303 $168,994 –8.1

Ireland $183,174 $227,193 –19.4

GNP and GDP in millions of current U.S. dollars

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GDP: The expenditure approach to measuring GDP

• The expenditure approach to measuring GDP

– The expenditure approach measures total spending on final goods and
services produced within a nation during a specified period of time

Y=GDP = total production (output)

= total income
= total expenditure

Four main categories of spending:

– consumption (C),
– investment (I),
– government purchases of goods and services (G), and
– net exports (NX)

Y = C + I + G + NX the income-expenditure identity

Macroeconomic Analysis I

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GDP: The expenditure approach to measuring GDP

– Consumption (C): spending by domestic households on final

goods and services (including those produced abroad)

• About 60 % of Turkish GDP in 2016

• Three categories
– Consumer durables (examples: cars, TV sets, furniture, major
appliances)

– Nondurable goods (examples: food, clothing, fuel)

– Services (examples: education, health care, financial services,

transportation)

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GDP: The expenditure approach to measuring GDP

– Investment (I): spending for new capital goods (fixed

investment) plus inventory investment

• About 30 % of Turkish GDP in 2016

• Business (or nonresidential) fixed investment: spending by

businesses on structures and equipment and software

• Residential fixed investment: spending on the construction of

houses and apartment buildings

• Inventory investment: the increase in firms’ inventories of goods

– Any goods that are unsold automatically are counted as part of
unplanned inventory investment

Macroeconomic Analysis I

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GDP: The expenditure approach to measuring GDP

– Government purchases of goods and services (G) spending by the
government on goods or services

• About 15 % of Turkish GDP in 2016.

• Not all government expenditures are NOT included in GDP

– Some are payments that are not made in exchange for current goods and services
– One type is transfers, including Social Security payments, and unemployment
benefits
– Another type is interest payments on the government debt

• Some government spending is for capital goods that add to the nation’s capital
stock, such as highways, airports, bridges, and water and sewer systems

Government expenditure = Government purchases or spending (G) + Transfer payments (TR) +

+ interest payments on government debt (INT)

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GDP: The expenditure approach to measuring GDP

– Net exports (NX): exports minus imports

• Exports (EX): goods produced in the country that are purchased by

foreigners

• Imports (IM): goods produced abroad that are purchased by

residents in the country

– Imports are subtracted from GDP, as they represent goods

produced abroad, and were included in consumption,
investment, and government purchases

NX = EX - IM
Macroeconomic Analysis I

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GDP: The expenditure approach to measuring GDP

NX can be >, <, or = 0

U.S. NX has been negative since the 1980’s → trade
deficit

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GDP: The expenditure approach to measuring GDP

Table: Expenditure approach to Measuring GDP at current prices in Turkey, 2016

Millions of TL % of GDP
Consumption (C) 1,560,518 60

Government Spending (G) 14

386,977
Inevestment (I) 29
764,662
Fixed Investment 793,024

Change in Stocks - 28,363 1

2,683,794
Domestic Expenditure (C+I+G) 103

Net Exports (NX) -75,269 -3

Exports of Goods and Services (EX) 572,965 22

Imports of Goods and Services (IM) 648,233 25

Source: TURKSTAT
Totals (equals GDP) Y 2,608,526 100

Macroeconomic Analysis I

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GDP: The income approach to measuring GDP

National income =
Labor
+ compensation of employees (wages, salaries, benefits etc.)
Income
+ proprietors’ income
+ rental income
+ corporate profits Capital
+ net interest Income
+ current surplus of government enterprises
+ taxes on production and imports (indirect taxes)
+ business current transfer payments (subsidies)

Net Indirect Taxes = Indirect taxes – subsidies

Net National Product (NNP) = National Income - Net Indirect Taxes

GNP = Net national product + depreciation

GDP = GNP - Net Factor Payment (NFP)

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GDP: The income approach to measuring GDP

+ compensation of employees (wages, salaries, benefits etc.)
+ proprietors’ income
+ rental income
+ corporate profits
+ net interest
+ current surplus of government enterprises
+ taxes on production and imports (indirect taxes)
+ business current transfer payments (subsidies)
= National Income (NI)
- Net Indirect Taxes (Indirect taxes – subsidies)
= Net National Product (NNP)
+ Depreciation
= GNP
- Net Factor Payments
= GDP

Macroeconomic Analysis I

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GDP: The income approach to measuring GDP

– Private sector income
Private disposable income (PDI) = Y + NFP + TR + INT – T
Y = gross domestic product (GDP);
NFP = net factor payments from abroad;
TR = transfers received from the government;
INT = interest payments on the government's debt;
T = taxes.

– Government sector income

Net Government income = taxes – transfers – interest payments
= T – TR – INT
Private disposable income + government’s net income = Y + NFP + TR + INT – T + T – TR – INT
= Y + NFP = GDP + NFP
GNP = GDP + NFP
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GDP: The income approach to measuring GDP

GDP
+ Net factor Payment
= GNP
- Depreciation
= Net National Product (NNP)
+ Net Indirect Taxes (Indirect taxes – subsidies)
= National Income (NI) National Income (NI) =
+ compensation of employees (wages, salaries, benefits etc.)
- undistributed corporate profit + proprietors’ income
- Corporate Tax + rental income
+ corporate profits
- Social Insurance Contributions + net interest
+ Dividends + current surplus of government enterprises
+ taxes on production and imports (indirect taxes)
+ Transfer payment to Individuals + business current transfer payments (subsidies)
+ Personal Interest Income
= Personal Income (PI)
- Personal Tax and NonTax Payments (e.g parking ticket)
= Disposable Personal Income (DPI)

Macroeconomic Analysis I

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GDP: The income approach to measuring GDP

• Summary

+ Labor Income (Salary, Wage etc.)

+ Capital Income (Rent, Interest, Net Profit etc.)
+ Net Indirect Taxes
+ Depreciation
= GDP

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GDP: The income approach to measuring GDP

Table: Income Approach to Measuring GDP at current price in Turkey, 2016

Thousand TL Share (%)

Labour Income 840 205 090 32.1
Capital Income 1 065 893 639 40.9
Net Taxes 309 629 285 11.9
Depreciation 392 797 734 15.1
Total (equals GDP) (Y) 2 608 525 749 100
Source: TURKSTAT, [Link]

Macroeconomic Analysis I

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Saving and Wealth

• Wealth
If you wanted to assess the economic situation of a household, the current income of the
household would be an important piece of information. As for a household, the economic well-
being of a country depends not only on its income but also on its wealth. The wealth of an
entire nation is called national wealth.

– Household wealth = a household’s assets minus its liabilities

– National wealth = sum of all households’, firms’, and

governments’ wealth within the nation

– Saving by individuals, businesses, and government

determine wealth

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Saving and Wealth

• Measures of aggregate saving

– Saving = current income – current spending

– Saving rate = saving/current income

– Private saving = private disposable income – Consumption

Spvt = (Y + NFP – T + TR + INT ) – C

Macroeconomic Analysis I

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Saving and Wealth

• Measures of aggregate saving
– Government saving = net government income – government purchases
of goods and services

Sgovt = T – (TR – INT – G)

• Government saving (government budget surplus) = government receipts –

government outlays
– Government receipts = tax revenue (T)
– Government outlays = government purchases of goods and services (G)
+ transfers (TR) + interest payments on government debt (INT)
• Government budget deficit = – Sgovt
• Simplification: count government investment as government purchases, not
investment

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Saving and Wealth

• Measures of aggregate saving
– National saving
National saving = private saving + government saving
S = Spvt + Sgovt

S = [Y + NFP – T + TR + INT – C] + [T – TR – INT – G]

S = Y + NFP – C – G

S = GNP – C – G
Macroeconomic Analysis I

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Saving and Wealth

S = GNP – C – G

S = C + I + G + EX –IM +NFP – C -G
• The uses of private saving
S = I + (NX + NFP)
S = I + CA CA= Current Accuont deficit/surplus

Derived from S = Y + NFP – C – G and Y = C + I + G + NX

CA = NX + NFP = current account balance

The difference between national saving and

S - I = CA investment is equal to the current account
deficit / surplus

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Saving and Wealth

• The uses of private saving

Spvt = I + (–Sgovt) + CA (using S = Spvt + Sgovt)

Saving is used in three ways:

• investment (I)
• government budget deficit (–Sgovt)
• current account balance (CA)

Macroeconomic Analysis I

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Saving and Wealth

Summary: Measures of the Aggregate Savings

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Saving and Wealth

• Relating saving and wealth
– Stocks and flows
• Flow variables: measured per unit of time (GDP, income, saving,
investment)

• Stock variables: measured at a point in time (quantity of money,

value of houses, capital stock)

• Flow variables often equal rates of change of stock variables

– Wealth and saving as stock and flow (wealth is a stock, saving

is a flow)

Macroeconomic Analysis I

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Saving and Wealth

• Relating saving and wealth
National wealth: domestic physical assets + net foreign assets + human capital
• Country’s domestic physical assets = capital goods and land
• Country’s net foreign assets =
+ foreign assets (foreign stocks, bonds, and capital goods owned by domestic residents)
- foreign liabilities (domestic stocks, bonds, and capital goods owned by foreigners)

• Wealth matters because the economic well-being of a country

depends on it

S = I + CA
• This equation shows that national saving has two uses: (1) to increase the
stock of domestic physical capital through investment, I, and (2) to increase
the nation's stock of net foreign assets by lending to foreigners or acquiring
foreign assets in an amount equal to the current account balance, CA.
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Real GDP
• Real GDP
– Nominal variables are those in TL terms

– Problem: Do changes in nominal values reflect changes in

prices or quantities?

– Real variables: adjust for price changes; reflect only quantity

changes

Macroeconomic Analysis I

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Real GDP
• Nominal GDP vs. Real GDP
– Nominal GDP is the dollar (or TL) value of an economy’s final
output measured at current market prices
• Nominal GDP, also called current-dollar (or TL) GDP, is the dollar
value (or TL) of an economy's final output measured at current
market prices.

– Real GDP is an estimate of the value of an economy’s final

output, adjusting for changes in the overall price level
• Real GDP, also called constant-dollar (or TL) GDP, measures the
physical volume of an economy's final production using the prices of
a base year.

– Example of computers and bicycles

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Real GDP

Table: Production and Price Data

Source: Abel (2011)

Macroeconomic Analysis I

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Real GDP
Table Calculation of Real Output with Alternative Base Years

Source: Abel (2011)

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Real GDP
• Economic Growth
– The increase in the amount of goods and services produced in a country over a
given time period is called economic growth.

– Economic growth means that the real RGDP increases continuously over time.

− 1
ℎ = 100

&'() *+, ( -' .'/01101/ 23 -' 4'5026 1

!" # $ %$ ℎ = -1
*+,&'() *+, ( -' '16 23 -' 4'5026

n = number of years

Macroeconomic Analysis I

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