Method for National income Measurement

AS Macroeconomics / International Economy

Measuring National Income

 

We need information on how much spending, income and output is being created in an economy over a period of time. National income data gives us this information as we see in this chapter.

Measuring national income

To measure how much output, spending and income has been generated in a given time period we use national income accounts. These accounts measure three things:

1. Output: i.e. the total value of the output of goods and services produced in the UK.

2. Spending: i.e. the total amount of expenditure taking place in the economy.

3. Incomes: i.e. the total income generated through production of goods and services.

What is National Income?

National income measures the money value of the flow of output of goods and services produced within an economy over a period of time. Measuring the level and rate of growth of national income (Y) is important to economists when they are considering:
The rate of economic growth
Changes over time to the average living standards of the population
Changes over time to the distribution of income between different groups within the population  (i.e. measuring the scale of income and wealth inequalities within society)

Consumer spending accounts for over two thirds of total spending. Consumer spending has been strong in recent years, a reflection of rising living standards and low unemployment, but this may now be coming to an end because of the mountain of household debt

Gross Domestic Product

Gross Domestic Product (GDP) measures the value of output produced within the domestic boundaries of the UK over a given time period. An important point is that our GDP includes the output of foreign owned businesses that are located in the UK following foreign direct investment in the UK economy. The output of motor vehicles produced at the giant Nissan car plant on Tyne and Wear and by the many foreign owned restaurants and banks all contribute to the UK’s GDP.

There are three ways of calculating GDP - all of which should sum to the same amount since the following identity must hold true:

National Output = National Expenditure (Aggregate Demand) = National Income

Firstly we consider total spending on goods and services produced within the economy:

Nissan at Sunderland – Celebrating 20 years of production

The Nissan plant at Washington, Tyne and Wear is celebrating its 20th anniversary in July 2006, the first car having rolled off the line on July 8th, 1986. In that first year of production 470 staff had a production target of 24,000 Bluebirds. Twenty years on, more than 4,200 employees produce around 310,000 Micras, C+Cs, NOTEs, Almeras and Primeras each year. That car has been followed by 4.3 million others thanks to a total investment of £2.3 billion. Production is set to rise from 310,000 per year last year to 400,000 in 2007 with the introduction of a new small 4x4, and Sunderland has been rated as Europe's most productive car factory for the last eight years.
Sources: Reuters News, Sunderland Echo, July 2006

(i) The Expenditure Method of calculating GDP (aggregate demand)

This is the sum of spending on UK produced goods and services measured at current market prices. The full equation for GDP using this approach is GDP = C + I + G + (X-M) where

C: Household spending
I: Capital Investment spending
G: Government spending
X: Exports of Goods and Services
M: Imports of Goods and Services

The Income Method of calculating GDP (the Sum of Factor Incomes)

Here GDP is the sum of the incomes earned through the production of goods and services. The main factor incomes are as follows:

Income from people employment and in self-employment
+
Profits of private sector companies
+
Rent income from land
=
Gross Domestic product (by factor income)

It is important to recognise that only those incomes that are actually generated through the production of output of goods and services are included in the calculation of GDP by the income approach.

We exclude from the accounts the following items:

• Transfer payments e.g. the state pension paid to retired people; income support paid to families on low incomes; the Jobseekers’ Allowance given to the unemployed and other forms of welfare assistance including child benefit and housing benefit.
• Private transfers of money from one individual to another.
• Income that is not registered with the Inland Revenue or Customs and Excise. Every year, billions of pounds worth of economic activity is not declared to the tax authorities. This is known as the shadow economy where goods and services are exchanged but the value of these transactions is hidden from the authorities and therefore does not show up in the official statistics!). It is impossible to be precise about the size of the shadow economy but some economists believe that between 8 – 15 per cent of national output and spending goes unrecorded by the official figures.

Output Method of calculating GDP – using the concept of value added

This measure of GDP adds together the value of output produced by each of the productive sectors in the economy using the concept of value added. 

Value added is the increase in the value of a product at each successive stage of the production process. We use this approach to avoid the problems of double-counting the value of intermediate inputs.

The table below shows indices of value added from various sectors of the economy in recent years. We can see from the data that manufacturing industry has seen barely any growth at all over the period from 2001-2004 whereas distribution, hotels and catering together with business services and finance have been sectors enjoying strong increases in the volume of output. These figures illustrate a process of structural change, with a continued decline in manufacturing output and jobs relative to the rest of the economy. By far the largest share of total national output (GDP) comes from our service industries.

Index of Gross Value Added by selected industry for the UK
	Mining and quarrying, inc oil & gas extraction	Manufacturing	Construction	Distribution, hotels, and catering; repairs	Business services and finance
2001 weights in total GDP (out of 1000)	28	172	57	159	249
2001	100	100	100	100	100
2002	100	97	104	105	102
2003	94	97	109	108	106
2004	87	98	113	113	111

We can see from the following chart how there have been divergences in the growth achieved by the manufacturing and the service sectors of the British economy. Indeed by the middle of 2006, the index of manufacturing output was below the level achieved at the start of 2000.

In contrast the service industries have enjoyed strong growth, leading to a continued process of structural change in the economy – away from traditional heavy industries towards service businesses.