Empowering Economic Minds
National Income Accounting
National Income Accounting
What is National Income Accounting?
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When we say National Income Accounting, this refers to the process of evaluating the economic well-being of a country by measuring its economic activity such as the economy’s production, expenditures and income, and records the annual flow of goods and services over a specific period of time. It tracks the annual flow of goods and services over a specific period and provides insights into the economy's performance through key macroeconomic indicators such as Gross Domestic Product (GDP), Gross National Product (GNP), Gross National Income (GNI), Personal Income (PI), and Personal Disposable Income (PDI). These indicators collectively describe the overall state of the economy.
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Some Important National Income Account Identities
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As mentioned, GDP represents the total market value of all final goods and services produced within a country during a specific period. For example, if clothes are manufactured in the Philippines within a given year, their value contributes to the Philippine GDP for that year.
On the other hand, Gross National Product (GNP) measures the total market value of all final goods and services produced by a country's citizens within a specific period, regardless of where the production occurs. For example, if a Filipino-owned company operates a factory in Japan and produces goods there, the value of those goods would be included in the Philippines' GNP, not Japan's. Additionally, when you compute the GNP, it is expressed as:
GNP = GDP + Net Factor Payments from Abroad
Where, the Net Factor Income (Payments from) Abroad measures the difference between what a country's residents earn abroad and what foreigners earn in that country.
Example of Computing GNP:
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Assume that the GDP of the Philippines is PHP 10 trillion, while the Income earned by Filipinos abroad is PHP 500 billion, and the income earned by foreigners within the Philippines is PHP 300 billion.
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Using the formula, we have:
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GNP = PHP 10 trillion + (PHP 500 billion – PHP 300 billion)
GNP = PHP 10 trillion + PHP 200 billion
GNP = PHP 10.2 trillion
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This amount reflects the total value of all final goods and services produced by the country's citizens, both within the Philippines and abroad, for that specific period.
Therefore, the main difference between GDP and GNP lies in the location of production. GDP measures the value of goods and services produced within a country's borders, while GNP accounts for the value of goods and services produced by a country's citizens, regardless of where the production occurs.
Another important national income account is the Gross National Income (GNI), which represents the total amount of money earned by a nation's residents and businesses. Like Gross National Product (GNP), GNI includes income from both domestic and international sources, but it also accounts for indirect business taxes—taxes imposed on businesses, such as license fees, sales taxes, and customs duties. These taxes are not part of the income earned by individuals or businesses, so they are subtracted when calculating GNI to get a more accurate measure of the income that actually flows to the nation's residents.
Example of Computing GNI:
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Suppose that the GNP of the Philippines is PHP 10.2 trillion and the indirect business taxes is PHP 100 billion.
Using the formula, we have:
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GNI = GNP – Indirect Business Taxes
GNI = PHP 10.2 trillion – PHP 100 billion
GNI = PHP 10.1 trillion
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This represents the total income earned by the nation’s people and businesses, after accounting for indirect business taxes.
In addition to other national income accounts, we have the Net National Product (NNP), Personal Income (PI), and Personal Disposable Income (PDI).
First, the Net Domestic Product (NDP) represents the market value of newly produced goods within a given period, after subtracting the value of capital goods that have been consumed or worn out (depreciation or capital consumption allowance). It is calculated using the formula:
NDP = GDP – Depreciation
Meanwhile, Personal Income (PI) is the total gross income received by households from various sources, including factor payments such as salaries, interest, rent, proprietor’s income, dividends, and transfer payments. It can be calculated using the following formulas:
PI = Salaries + Interest + Rent + Proprietor’s Income + Dividends + Transfer Payments
This formula calculates Personal Income by summing up the various sources of income that directly accrue to households.
Alternative formula:
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PI = GNP – Depreciation – Indirect Business Taxes – Corporate Income Tax – Social Insurance Contributions – Undistributed Corporate Profits + Transfer Payments
The alternative formula derives Personal Income by starting with Gross National Product (GNP) and making a series of deductions and additions in terms of the depreciation, indirect business taxes, corporate income tax, social insurance contributions, undistributed corporate profits, and transfer payments.
Moreover, the Personal Disposable Income (PDI) refers to the income remaining with households after deducting personal taxes and other charges, and adding transfer payments. It represents the income available for households to spend or save, also known as after-tax income. It is calculated using the following formulas.
First formula, considering personal income and taxes:
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PDI = Personal Income – Personal Taxes
Alternative formula considering the consumption and savings:
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PDI = Consumption + Savings
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Example of computing NDP, PI, and PDI:
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Suppose the economy has the following macroeconomic data as measured in US$.
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GDP (Gross Domestic Product): $2 trillion Depreciation: $300 billion
Salaries: $1 trillion Interest: $100 billion
Rent: $50 billion Proprietor’s Income: $200 billion
Dividends: $150 billion Transfer Payments: $100 billion
Corporate Income Tax: $200 billion Indirect Business Taxes: $50 billion
Social Insurance Contributions: $100 billion Personal Taxes: $400 billion
Undistributed Corporate Profits: $100 billion
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Computing Net Domestic Product (NDP):
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Using the formula, we have:
NDP = $2 trillion – $300 billion
NDP = $1.7 trillion
Computing Personal Income (PI):
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Using the first formula of PI, we have:
PI = Salaries + Interest + Rent + Proprietor’s Income + Dividends + Transfer Payments
PI = $1 trillion + $100 billion + $50 billion + $200 billion + $150 billion + $100 billion
PI = $1.6 trillion
Computing Personal Disposable Income (PDI):
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Using the first formula of PDI, we have:
PDI = Personal Income – Personal Taxes
PDI = $1.6 trillion – $400 billion
PDI = $1.2 trillion
These calculations give an overview of how these national income accounts can be computed using given economic data.
National Income Account Identity of a Simple Economy
Let's proceed to the National Income Account identity, typically expressed as Y = C + I + G + NX. But this time, we will focus our on a simplified economy with no government intervention and no foreign trade. In this scenario, there are only two components of GDP: Consumption (C), which represents the spending by households on goods and services, and Investment (I), which reflects the spending by firms on business activities and the production of additional goods and services.
To understand the relationship between various components of a simple economy, we can break down the National Income Accounting process into a few key steps. These steps will help us establish the connection between GDP, consumption, investment, and saving.
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In a simple economy, where there are no government interventions or foreign trade, Gross Domestic Product (GDP) is represented by the total income (Y). This income is generated from two primary sources: consumption (C) and investment (I).​​​
In establishing the relationship among Saving (S), Consumption (C), and GDP (Y), the following equation 2 shows that all income (Y) in the economy is either spent on consumption or saved.
We will now then equate equations (1) and (2):
Here, the left-hand side of the equation represents the demand side (consumption and investment), while the right-hand side reflects the allocation of income (consumption and saving).
By rearranging Equation 3, we isolate (I) and demonstrate that it is equal to (S).
This final equation highlights that, in a simple economy, the amount invested by firms is equal to the amount saved by households. This equality is fundamental to understanding the flow of funds in an economy.
Incorporating Government and Foreign Trade Sectors to The National Income Identity
We will now add the government and foreign trade sectors to the national income account identity as indicated in equation (5).
Now, let’s understand the relationship between output (Y) and disposable income (Yd). Disposable income (Yd) is derived from the total output (Y) by adjusting for taxes (TA) and transfer payments (TR). This is what households have left after taxes have been deducted and any government transfer payments have been added. The equation is expressed as:
Disposable income (Yd) is then used for either consumption (C) or saving (S) as expressed as:
By rearranging Equation 6 and substituting it into Equation 5, we get the equation (8) as expressed by:
Further, by substituting Equation 7 into Equation 8, we derive:
With some rearrangement, this can be simplified to:
The equation (10) tells us that the excess of savings over investment in the private sector equals the sum of the government budget deficit and the trade surplus (positive NX).
Based on the national income account identities that we presented, we derived the following formula for national Savings (S) and Investment (I).
These formulas illustrate how savings, investment, government budget positions, and trade balances are interconnected in the economy.
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You can watch the video here for the national income identity derivation and example here.
Further Learnings
References
Dornbusch, R., Fischer, S., & Startz, R. (2011). Macroeconomics (11th ed.). McGraw-Hill.
Mankiw, N.G. (2018). Principles of Macroeconomics (Eight Edition). Cengage Learning: Boston, United States of America.
Orejana, A.J., & Teves, M.R.Y. (2014). Introduction to Economics, Land Reform, Taxation and Cooperatives: Text and Workbook. MSU-IIT: Iligan City, Philippines.