Measures of national income and output

Measures of national income and output are used in economics to estimate the welfare of an economy to estimate the value of goods and services produced in an economy. National economies have been using systems of national accounting first developed by Kuznets within 1940s and 1960s ( Kuznets 1948a, 1956, 1966, 1971). Some of the more common measures are Gross National Product (GNP), Gross Domestic Product (GDP), Net National Product (NNP), and Net National Income (NNI).

Overview

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

Thus,GNP=GNI=GNE by definition. However, in practice minor differences are obtained from the various methods due to changes in inventory levels. This is because goods in inventory have been produced (therefore included in GNP), but not yet sold (therefore not yet included in GNE). Similar timing issues can also cause a slight discrepancy between the value of goods produced (GNP) and the payments to the factors that produced the goods, particularly if inputs are purchased on credit, and also because wages are collected often after a period of production.

Definitions

Gross

"Gross" means depreciation of capital stock is not subtracted. If net investment (which is gross investment minus depreciation) is substituted for gross investment in the any below equations, then the formula for net domestic product is obtained. Consumption and investment in this equation are expenditure on final goods and services. The exports-minus-imports part of the equation (often called net exports) adjusts this by subtracting the part of this expenditure not produced domestically (the imports), and adding back in domestic area (the exports).

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.

EXAMPLE: A car sold to a consumer is a final good; the components such as tires sold to the car manufacturer are not; they are intermediate goods used to make the final good. The same tires, if sold to a consumer, would be a final good. Only final goods are included when measuring national income. If intermediate goods were included too, this would lead 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.

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

Income is counted as part of GNP according to who owns the factors of production rather than where the production takes place.

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 GNP because the capital used in production (the factory, machinery, etc.) is German owned. The wages of the American workers would be part of US GNP, while wages of any German workers on the site would be part of German 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 is unchanged.

Real GNP measures the value of output in two or more different years by valuing the goods and services produced at the same prices. For example, GNP might be calculated for 2000, 2001 and 2002 using the prices prevailing in 2002 for all of the calculations. This gives a measure of national income which is not distorted by inflation.

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 measures of welfare, such as life expectancy. However, there are serious limitations 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 lead to distortions; for example, a paid childminder's income will contribute to GNP, whereas an unpaid mother's time spent caring for her 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 leisure time. 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 this problem.

Depreciation and Net National Product

Not all of GNP data show the production of final goods and services - part of it represents output that is set aside to maintain the nation's productive capacity. Capital goods, such as buildings and machinery, lose value over time due to wear and tear and obsolescence.

NOTE: Depreciation measures the amount of GNP that must be spent on new capital goods to offset this effect.

Hence, through the “Income Approach”, we define:

• 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.

Then, in summary, we have:

• Personal savings (S) plus personal consumption (C) = personal disposable income (PDI).

• PDI plus personal taxes paid minus transfer payments received = personal income (PI).

• PI plus retained earnings plus corporate taxes plus transfer payments plus interest on the public debt = net national income (NNI).

• NNI plus indirect taxes = net national product (NNP).

• NNP plus depreciation = gross national product (GNP).

Gross Domestic Product

Gross Domestic Product (GDP) is the total value of final goods and services produced within a country's borders in a year. GDP counts income according to where it is earned rather than who owns the factors of production.

EXAMPLE: In the above case of a German-owned car factory operating in the US, all of the income from the car factory would be counted as US GDP rather than German GDP.

Map of countries by 2007 GDP (nominal) per capita (IMF, April 2008).

CIA World Factbook 2007 figures of total nominal GDP (top) compared to PPP-adjusted GDP (bottom).

File:GDP PPP Per Capita Worldmap 2008 CIA Factbook.svg

World map showing GDP (PPP) per capita.

The gross domestic product (GDP) or gross domestic income (GDI) is one of the measures of national income and output for a given country's economy. GDP is defined as the total market value of all final goods and services produced within the country in a given period of time (usually a calendar year). It is also considered the sum of a value added at every stage of production (the intermediate stages) of all final goods and services produced within a country in a given period of time, and it is given a money value.

A common equation for GDP is:

GDP = consumption + investment + government expenditures + exports - imports.

Another way of measuring GDP is to measure the total income payable in the GDP income accounts. In this situation, Gross Domestic Income (GDI) is sometimes used rather than Gross Domestic Product. This should provide the same figure as the expenditure method described above.Although, again, by definition, GDI=GDP, in practice, however, measurement errors will make the two figures slightly off when reported by national statistical agencies.)

Examples of GDP component variables

There are 4 variables in the above GDP equation: C, I, G, and NX ( exports-imports).

EXAMPLE 1: If you spend money to renovate your hotel so that occupancy rates increase, that is private investment, but if you buy shares in a consortium to do the same thing it is saving. The former is included when measuring GDP (in I), the latter is not. However, when the consortium conducted its own expenditure on renovation, that expenditure would be included in GDP.

EXAMPLE 2: If a hotel is a private home then renovation spending would be measured as Consumption, but if a government agency is converting the hotel into an office for civil servants the renovation spending would be measured as part of public sector spending (G).

EXAMPLE 3: If the renovation involves the purchase of a chandelier from abroad, that spending would also be counted as an increase in imports, so that NX would fall and the total GDP is affected by the purchase. (This highlights the fact that GDP is intended to measure domestic production rather than total consumption or spending. Spending is really a convenient means of estimating production.)

EXAMPLE 4: If a domestic producer is paid to make the chandelier for a foreign hotel, the situation would be reversed, and the payment would be counted in NX (positively, as an export). Again, GDP is attempting to measure production through the means of expenditure; if the chandelier produced had been bought domestically it would have been included in the GDP figures (in C or I) when purchased by a consumer or a business, but because it was exported it is necessary to 'correct' the amount consumed domestically to give the amount produced domestically. (As in Gross Domestic Product.)

Doublecounting in GDP

EXAMPLE: The intermediate goods selling prices for a book ( sold in a bookstore ) are as follows: A tree company sells to a paper mill wood for $1; the paper mill sells paper to a textbook publisher for $3; the publisher sells the textbook to a bookstore for $7 and the bookstore sells the textbook for $75. Although the sum of all intermediate prices plus the selling price of the book comes to $86, we add to GDP only the final selling price $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."

GDP vs. GNP

To convert from GDP to GNP you must add factor input payments to foreigners that correspond to goods and services produced in the domestic country using the factor inputs supplied by foreigners. To convert from GNP to GDP you must subtract factor income receipts from foreigners that correspond to goods and services produced abroad using factor inputs supplied by domestic sources. NOTE: GDP is a better measure of the state of production in the short term. GNP is a better when analysing sources and uses of income on a longer term basis.

GDP and Standard of living

World GDP per capita (in 1990 Geary-Khamis dollars) changed very little for most of human history before the industrial revolution. (Note the empty areas mean no data, not very low levels. There are data for the years 1, 1000, 1500, 1600, 1700, 1820, 1900, and 2003.)

GDP per capita is often used as an indicator of standard of living in an economy, the rationale being that all citizens would benefit from their country's increased economic production.

Simon Kuznets, the inventor of the GDP, had this to say in his very first report to the US Congress in 1934 said:

...the welfare of a nation [can] scarcely be inferred from a measure of national income...

In 1962, Kuznets stated:

Distinctions must be kept in mind between quantity and quality of growth, between costs and returns, and between the short and long run. Goals for more growth should specify more growth of what and for what.

The major advantages to using GDP per capita as an indicator of standard of living are that it is measured frequently, widely and consistently; frequently in that most countries provide information on GDP on a quarterly basis (which allows a user to spot trends more quickly), widely in that some measure of GDP is available for practically every country in the world (allowing crude comparisons between the standard of living in different countries), and consistently in that the technical definitions used within GDP are relatively consistent between countries, and so there can be confidence that the same thing is being measured in each country.

The major disadvantage of using GDP as an indicator of standard of living is that it is not, strictly speaking, a measure of standard of living.

Austrian economist critique - Criticisms of GDP figures were expressed by Austrian economist Frank Shostak. Among other criticisms, he stated the following:

The GDP framework cannot tell us whether final goods and services that were produced during a particular period of time are a reflection of real wealth expansion, or a reflection of capital consumption.

He goes on:

For instance, if a government embarks on the building of a pyramid, which adds absolutely nothing to the well-being of individuals, the GDP framework will regard this as economic growth. In reality, however, the building of the pyramid will divert real funding from wealth-generating activities, thereby stifling the production of wealth.

Austrian economists are critical of the basic idea of attempting to quantify national output. Shostak quotes Austrian economist Ludwig von Mises:

The attempt to determine in money the wealth of a nation or the whole mankind are as childish as the mystic efforts to solve the riddles of the universe by worrying about the dimension of the pyramid of Cheops.

Gross National Income

Gross national income (GNI) is GDP less net taxes on production and imports, less compensation of employees and property income payable to the rest of the world plus the corresponding items receivable from the rest of the world.

In other words, Gross national income ( GNI ) is GDP less primary incomes payable to non-resident units plus primary incomes receivable from non-resident units. From this point of view, GNP is the better indicator of the country’s economic trend.

However, calculating the real GDP growth allows economists to determine if production increased or decreased, regardless of changes in the purchasing power of the currency.

An alternative approach to measuring GNI at market prices is as the aggregate value of the balances of gross primary incomes for all sectors.

NOTE: GNI is identical to gross national product (GNP) as, generally, used previously in national accounts and we may formulate basic principle of fundamental national accounting:

The value of total output equals the value of total income which makes another very important point:

“....Real income cannot be increased without producing more, redistributing income does nothing to increase the amount of wealth available at any point in time....”(Mings 2000)

Net National Income

Net National Income (NNI) is an economics term used in National income accounting. It can be defined as the Net National Product (NNP) minus indirect taxes. Net National Income encompasses the income of households, businesses, and the government. It can be expressed as:

NNI = C + I + G + (NX) + net foreign factor income - indirect taxes - depreciation,

where:

• C = Consumption
• I = Investments
• G = Government spending
• NX = net exports (exports minus imports)

Conclusion

Various national accounting formulas for GDP, GNP and NI = National Income ( that includes wages, rents, interest and profits, not only in the form of cash payments, but as income from contributions made by employers to pension funds, income of the self-employed, and undistributed business profits ) --- using specific economic terms, such as :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 --- are summarized here:

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

However, as soon as these strictly economic statistics ( e. g. GNP, GDP ) start aspiring to capture the well-being or standard of living trends and their mapping in any particular country, those claims will be absolutely false.

There are two reasons, why these economic statistics cannot tell anything at all about the well-being of the society even if taken onto per capita basis. True, we can infer that if GDP ( or GNP ) per capita series in constant dollars grows within the short period of years, the living standard may increase as well; but that is all we can say. As the Austrian economist Frank Shostak ( Shostak 2001 ) claims above, if any government starts building pyramids, GDP will be growing, yet – as the pyramids have no use for anybody – the standard of living will not.

The other reason is that we cannot compare with or statistically infer anything from the two or more environments that are absolutely independent on each other. One is economy and the other is sociology.

EXAMPLE 1: Imagine the oil-rich developing country where all the monetary growth ( mapped by GDP, GNP per capita, etc. ) goes to a ruling clique and virtually nothing to the rest of the society. There, unless the income distribution ( from the oil ) is just, most of the society’s expectations, dreams of a better life are shattered and the coefficient of “well-being” ( which is based on “feeling good” ) will actually be decreasing.

EXAMPLE 2: This from Eastern Europe. When, under Communist regime, everybody with exception of a chosen few was equally poor ( no matter what job anybody was doing ) the “mood” and to large extent even the “content with the situation” and “moral”( though not necessarily “ethics”) was quite high. Once the “democratic” turnaround, propelled by the old Communist constitution, gave rise to the new class of nouveau riche ( i. e. old Communist apparatchiks who simply stolen the state property, because there was nothing in the constitution that they legally couldn’t ) the still poor rest-of- society’s “mood” and, thus, its “well-being” went down drastically even though the GDP et al kept rising. Explanation: income distribution ( mapped by the Ginni Index) showed incredibly high social stratification which, in Europe, historically leads to societies’ doldrums ( Karasek 2005).

But, even in the strictly economic sphere, these measures of national income and output can serve their purpose ( i.e. comparing economic trends within its own country’s history, or with other countries’ trends; provide short-term forecasting, etc. ) only under a specific conditions. These conditions are:

• Keep the definition of each of the statistical characteristic ( measure ) constant over long period of time ( ideal would be not to change it at all throughout the society’s history.) In so far the comparison with other countries, the problem of considerably different basic definitions, due to political or other “societal” considerations, should be looked for. Hence, we read:

“…using Marxist principles, those countries sometime exclude from aggregate output the value of wide ranges of services, such as government administration and transportation. Attention is instead concentrated on output of goods. The exclusion understate GNP and influence planning, which tend to neglect transport, distribution and services. Aggregate growth rates are overstated since productivity increases more rapidly in the ( counter) goods-producing sectors than in ( neglected service sectors…”( Herick-Kindleberger 1983).

• In analysis of historical trends, comparisons with other country’s trends and, above all, modelling and forecasts, work only with constant data series. That means to leave inflation or deflation out of all the data-series ( Karasek 1988: 36, 73-74, 82 ).

• And then, still a big problem remains as the question of comparison of the living standards among several countries comes up. Even though we have the above defined characteristics, such as “Personal Disposable Income ( PDI )” computed for individual country’s currency, the current official exchange rates are not a good “equalizer.” We have to go through the “typical consumers’ baskets” of an individual ( or a household ) needs that have to be bought in a certain period ( week, month etc. ). These “baskets” represent the cost of living and have to be compared with personal ( or a household) income for the same period. Then and only then we can have a bit more precise international comparison of living standards for the given countries.

• When using various quantitative data-series ( monetary, physical, etc.) for statistical “massaging” and modelling, the “technique of transformation of absolute values into growth rates” proved to yield the best and most statistically credible result ( Karasek 1988: 33, 73-75 ).

To conclude the almost impossible task of international comparisons of income and output statistics, we should heed the advice of Oscar Morgenstern who says that:

”…... 10% to 30% error can be expected in any real numerical ( economic ) datum......…” ( Morgenstern 1963: Ch. 6, fn. 14 ).

References

ISBN links support NWE through referral fees

• Herick, B., C.P. Kindleberger ( 1983), Economic Development, McGraw-Hill Book Co.
• Karasek, Mirek & W. Alem ( 1988 ) , Socio - Economic Modelling & Forecasting in Lesser Developed Countries , The Book Guild Ltd., Lewes, London ( U.K.), 160 pp.
• Karasek, Mirek ( 2005 ) “Institutional and Political Challenges and Opportunities for Integration in Central Asia” , CAG Portal Forum 2005 , http://www.cagateway.org/downloads/Karasek. pdf.
• Kuznets, S. (1948a), Discussion of the new Department of Commerce Income Series; National Income: a New Version. The Review of Economics and Statistics, Vol. XXX, Number 3, 151-179.
• Kuznets, Simon (1956), ‘Quantitative Aspects of the Economic Growth of Nations. I.

Levels and Variability of Rates of Growth’, Economic Development and Cultural Change, 5, 1-94.

• Kuznets, Simon (1966), Modern Economic Growth, New Haven, CT: Yale University

Press.

• Kuznets, Simon (1971), Economic Growth of Nations: Total Output and Production

Structure, Cambridge, Mass.: Harvard University Press.

• Mings, Turley, and Marlin, Matthew. (2000). The Study of Economics: Principles, Concepts, and Applications, 6th ed. Dushkin/McGraw-Hill.
• Morgenstern, O. ( 1963), On the Accuracy of Economic Observations, Princeton: Princeton U. Press
• Shostak, Frank ( 2001), “What is up with the GDP?” von Mises Institute, 23/8/2001

External links

• Historicalstatistics.org: Links to historical national accounts and statistics for different countries and regions
• World Bank's Development and Education Program Website

Global

• Australian Bureau of Statistics Manual on GDP measurement
• GDP-indexed bonds
• GDP scaled maps
• Euro area GDP growth rate (since 1996) as compared to the Bank Rate (since 2000)
• World Development Indicators (WDI)
• Economist Country Briefings
• UN Statistical Databases
• GDP Animated Cartogram.

Data

• Bureau of Economic Analysis: Official United States GDP data
• Historicalstatistics.org: Links to historical statistics on GDP for different countries and regions
• Complete listing of countries by GDP: Current Exchange Rate Method Purchasing Power Parity Method
• Historical US GDP (1790 to 2005)

Articles and books

• What's wrong with the GDP?
• Limitations of GDP Statistics by Schenk, Robert.
• whether output and CPI inflation are mismeasured, by Nouriel Roubini and David Backus, in Lectures in Macroeconomics
• "Measurement of the Aggregate Economy", chapter 22 of Dr. Roger A. McCain's Essential Principles of Economics: A Hypermedia Text
• Growth, Accumulation, Crisis: With New Macroeconomic Data for Sweden 1800-2000 by Rodney Edvinsson
• Clifford Cobb, Ted Halstead and Jonathan Rowe. "If the GDP is up, why is America down?" The Atlantic Monthly, vol. 276, no. 4, October 1995, pages 59-78.

Credits

New World Encyclopedia writers and editors rewrote and completed the Wikipedia article in accordance with New World Encyclopedia standards. This article abides by terms of the Creative Commons CC-by-sa 3.0 License (CC-by-sa), which may be used and disseminated with proper attribution. Credit is due under the terms of this license that can reference both the New World Encyclopedia contributors and the selfless volunteer contributors of the Wikimedia Foundation. To cite this article click here for a list of acceptable citing formats.The history of earlier contributions by wikipedians is accessible to researchers here:

• Measures_of_national_income_and_output  ^history
• Gross_domestic_product  ^history
• Gross_National_Income  ^history
• Net_National_Product  ^history
• Net_National_Income  ^history

The history of this article since it was imported to New World Encyclopedia:

• History of "Measures of national income and output"

Note: Some restrictions may apply to use of individual images which are separately licensed.