National Income: Circular Flow and GDP

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Questions and Answers

In a two-sector economy within the circular flow of income, what financial flow is equivalent to the flow of goods and services from firms to households?

  • Firms investing in capital goods.
  • Households paying firms for consumption. (correct)
  • Firms paying wages to the government.
  • Government providing subsidies to firms.

In a three-sector economy, how does the government primarily interact within the circular flow of income?

  • By only collecting taxes from firms.
  • By only providing goods and services to households.
  • By collecting taxes from households and firms, and making payments through goods, services, and subsidies. (correct)
  • By exclusively engaging in international trade.

How does the foreign sector impact the circular flow of income in a four-sector economy?

  • By only receiving factor payments from households.
  • By only providing labor to domestic firms.
  • By exclusively focusing on government transactions.
  • Through the exchange of imports and exports which influences payments to and from other countries. (correct)

Which of the following best differentiates Gross Domestic Product (GDP) from Gross National Product (GNP)?

<p>GDP measures the value of output within a country’s borders, while GNP measures the output of a country's residents, regardless of location. (D)</p> Signup and view all the answers

How are subsidies and indirect taxes related to the calculation of GDP at factor cost?

<p>Subsidies are added and indirect taxes are subtracted from GDP at market price. (C)</p> Signup and view all the answers

What adjustment differentiates Net National Income (NNI) from Gross National Income (GNI)?

<p>Subtraction of depreciation value. (B)</p> Signup and view all the answers

How does one derive Disposable Personal Income (DPI) from Personal Income (PI)?

<p>Subtracting personal income taxes. (B)</p> Signup and view all the answers

Which approach to measuring GDP involves summing the incomes received from the factors of production?

<p>Income approach. (C)</p> Signup and view all the answers

Which of the following components is included in the income approach to calculating national income?

<p>Compensation of employees. (C)</p> Signup and view all the answers

Using the income approach, how would you calculate the Net Domestic Product (NDP) at factor cost?

<p>Compensation of employees + Net interest + Rental income + Corporate profits + Proprietor's income (C)</p> Signup and view all the answers

Which of the following best describes the expenditure approach to measuring GDP?

<p>Adding up all spending on final goods and services. (C)</p> Signup and view all the answers

In the expenditure approach to calculating GDP, what does 'I' represent?

<p>Gross private domestic investment.. (A)</p> Signup and view all the answers

Which of the following is the formula for calculating GDP at market price using the expenditure approach?

<p>GDP = C + I + G + (X - M) (B)</p> Signup and view all the answers

What is the primary focus of the output approach in measuring national income?

<p>Adding up the net value of goods and services produced across various sectors. (A)</p> Signup and view all the answers

How do you calculate Gross National Product at factor cost (GNPfc) using the output approach?

<p>GNPfc = GDPfc + Net factor income abroad (C)</p> Signup and view all the answers

What is the main difference between nominal income and real income?

<p>Nominal income is measured at current prices, while real income is adjusted for inflation. (B)</p> Signup and view all the answers

If Nominal GDP increases but the GDP deflator also increases, what can be accurately concluded?

<p>Real GDP may have increased, decreased, or stayed the same, depending on the magnitude of changes. (B)</p> Signup and view all the answers

What does GDP per capita primarily indicate?

<p>The average income level per person, often used as an indicator of living standards. (C)</p> Signup and view all the answers

Which formula accurately calculates the growth rate of an economy?

<p>Growth Rate (%) = (Real GDP this year – Real GDP last year) / Real GDP last year × 100% (D)</p> Signup and view all the answers

How is the standard of living in a country typically assessed using national income statistics?

<p>By measuring GDP per capita. (B)</p> Signup and view all the answers

How can national income statistics assist in government planning and policymaking?

<p>By offering insights into historical trends and sectoral performance. (D)</p> Signup and view all the answers

How do national income statistics support international comparisons of economic well-being?

<p>By enabling comparisons of both the absolute economic size and the average individual's economic status. (A)</p> Signup and view all the answers

How does the presence of a large non-monetized sector primarily affect the computation of national income?

<p>It makes computation more difficult due to unrecorded economic activities. (B)</p> Signup and view all the answers

Why does the existence of an underground economy pose a challenge in accurately measuring GDP?

<p>It results in transactions being unreported, leading to underestimation of GDP. (B)</p> Signup and view all the answers

How do non-market transactions typically affect GDP calculations?

<p>They are excluded, leading to an underestimation of actual economic activity. (A)</p> Signup and view all the answers

In national income accounting, what is the primary consequence of double counting?

<p>It causes an overestimation of national income. (B)</p> Signup and view all the answers

If a country's Nominal GDP grew by 5% and its inflation rate was 2%, approximately what was the country's Real GDP growth?

<p>3% (B)</p> Signup and view all the answers

If a significant portion of a country's income is generated from illegal activities, what is the likely impact on its official GDP figures?

<p>GDP figures will be underestimated. (A)</p> Signup and view all the answers

Which situation exemplifies a non-market transaction that is typically excluded from GDP calculations?

<p>A homeowner performing their own home repairs. (C)</p> Signup and view all the answers

What measure would provide insight into the average economic well-being of individuals within a nation?

<p>GDP per capita. (B)</p> Signup and view all the answers

How does subtracting 'Capital Consumption' from 'Gross National Product at factor cost' allow for the calculations of 'National Income'?

<p>By indicating the value of used capital. (C)</p> Signup and view all the answers

When evaluating economic growth, why might policymakers prefer to examine real GDP figures over nominal GDP figures?

<p>Nominal GDP is not adjusted for price changes. (B)</p> Signup and view all the answers

If Country A has a higher GDP than Country B, but Country B has a significantly higher GDP per capita, what can be inferred?

<p>The total population of Country A is greater than that of Country B. (A)</p> Signup and view all the answers

Which would provide economists with insight into the total value of economic activity without adjusting for inflation?

<p>Nominal GDP. (D)</p> Signup and view all the answers

What effect does a large, thriving 'underground economy' have on GDP?

<p>GDP data will misrepresent total economic activity as this activity is not being measured. (B)</p> Signup and view all the answers

Flashcards

Circular flow of income

An economic model showing the flow of money through the economy.

Two-sector economy flow

Flow of factors from households to firms, matched by money flow.

Three-sector economy role

The government collects taxes, buys goods/services, and makes payments.

Four-sector economy

Includes government and foreign sector, with imports and exports.

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Gross Domestic Product (GDP)

Value of output produced by factors of production within a country.

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Gross National Product (GNP)

Total market value of final goods/services by residents of a country.

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Market Price

Current price in the market via supply and demand.

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Factor Cost

Price of output based on the cost of factors of production.

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Net National Income

Value of national income adjusted for depreciation.

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Personal Income (PI)

Real income earned by households before income taxes.

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Disposable Personal Income (DPI)

Income available for consumption/saving after taxes.

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Gross Domestic Product (GDP)

Total market value of all final goods/services produced within a country.

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Income Approach

Measures national income from sum of incomes from output production.

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National Income (NI)

National Income plus Net Factor Income Abroad.

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Components of Income Approach

Compensation of employees, proprietor's income, rental income, corporate profits and net interest

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Formula of GDP at factor cost in Income Approach

Formula: GDP at factor cost = [Compensation of Employees + Net Interest + Rental Income + Corporate Profits + Proprietor's Income] + Depreciation

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Expenditure Approach

Measures national income by total spending on goods and services.

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Components of Expenditure Approach

Components include personal consumption, gross private domestic investment, government expenditure and net export.

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Formula: Personal Income (PI)

The formula is National income + Transfer Payments – Corporate Income Taxes – Retained/Undistributed Earnings – Employee's Provident Fund (EPF) – Social Security Contributions (SOCSO) – Insurance Premium

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Output Approach

Measures national income by adding net value of goods and services by sector.

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Sectors in Output Approach

Three sectors: primary, secondary, and tertiary.

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Nominal Income

National income measured at current prices.

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Real Income

National income measured at constant prices or in a base year.

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Per Capita Income

Average income per head of population, indicator of living standards.

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Growth Rate(%)

Formula: Growth Rate(%) = (Real GNP this year – Real GNP last year)/Real GNP Last Year

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Growth Rate

Percentage change in quantity of goods/services produced from one to another.

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Standard of Living

Reflects individuals' welfare based on goods/services they can consume; measured by GDP per capita.

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Government Planning and Policies

Statistics guide policy makers for future planning; historical trends are visible.

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Sectoral Contributions

Study reports relative importance of different components of Economy.

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International Comparisons

Compares economy sizes and average individual well-being between countries.

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Problems: Non-monetized sector

Non-monetized activities make national income computation difficult.

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Problems: Underground Economy

Official GDP estimates may not account for underground economy.

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Non Market Transactions

Productive work done that is unpaid, such as food grown, clothes made, etc

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Problems: Double Counting

Double counting in national income appear when values of final or intermediate goods are included.

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Study Notes

  • Chapter 10 focuses on measuring national income and output
  • Components of macroeconomics are households, firms, government, and the rest of the world

Circular Flow of Income

  • The circular flow of income is an economic model depicting how money flows through the economy
  • It describes the movement of factors of production and factors of payment
  • Factors of production from households flow to firms, and goods and services flow from firms to households
  • These flows are matched by money flows, with firms paying income to households (Y) and households paying firms for consumption (C)
  • The government collects taxes from households and firms and makes payments, buys goods/services from firms, pays wages/interest to households, and makes transfer payments
  • A four-sector economy includes a foreign sector, accounting for exports and imports

Concepts of National Income

  • Gross Domestic Product (GDP) measures the value of output produced by factors of production within a country
  • It measures the total income earned within a country, regardless of citizenship (local and foreign residents)
  • Income earned by residents working abroad is excluded from the GDP
  • Gross National Product (GNP) measures the total market value of all final goods and services produced by a country's residents during a period of time
  • It measures the income earned by a country's residents, regardless of where they are
  • Income earned by foreigners working in the country is excluded from the GNP

Market vs Factor Cost

  • Market price is the current price determined by the forces of supply and demand
  • Factor cost is the price of output valued based on the cost of factors of production
  • It represents the actual price earned by producers or sellers
  • GDP at factor cost equals GDP at market price minus indirect taxes plus subsidies
  • GNP at factor cost equals GNP at market price minus indirect taxes plus subsidies

Gross vs Net National Income

  • Gross national income is the value of national income associated with the value of depreciation
  • Net national income adjusts the value of national income for depreciation
  • Net national income equals gross national income minus depreciation
  • NDP at market price is GDP at market price minus depreciation value
  • NNP at market price is GNP at market price minus depreciation value

Personal vs Disposable Income

  • Personal income (PI) is the real income earned by households before personal income taxes
  • PI = National income + Transfer payments – Corporate income taxes – Retained earnings – Employee's Provident Fund (EPF) – Social security contributions (SOCSO) – Insurance premium
  • Disposable personal income (DPI) is the income available for personal consumption and saving after taxes
  • DPI = Personal income – Personal income tax

Methods of Measuring Income

  • National income is commonly referred to as the Gross Domestic Product (GDP)
  • GDP is the total market value of all final goods/services produced within a time period by the factors of production located within a country
  • The GDP can be computed in three ways:
  • Income approach
  • Expenditure approach
  • Product or output approach
  • Since these three are all measuring the same thing, they must be identical
  • National Income = National Expenditure = National Product

Income Approach

  • Measures national income by looking at the GDP from the perspective of sum of incomes received from the production of the output
  • Components include:
  • Compensation of employees
  • Proprietors' income
  • Rental income
  • Corporate profits
  • Net interest
  • GDP at factor cost = [Compensation of Employees + Net Interest + Rental Income + Corporate Profits + Proprietor's Income] + Depreciation
  • NDP at factor cost = [Compensation of Employees + Net Interest + Rental Income + Corporate Profits + Proprietor's Income]
  • NI = NDPfc + Net Factor Income Abroad
  • PI = National income + Transfer Payments – Corporate Income Taxes – Retained/Undistributed Earnings – Employee's Provident Fund (EPF) – Social Security Contributions (SOCSO) – Insurance Premium
  • DPI = Personal Income – Personal Income Tax

Expenditure Approach

  • Measures national income by looking at the GDP from the perspective of total spending on the final goods and services
  • Components include:
  • Personal Consumption Expenditure (C)
  • Gross Private Domestic Investment (I)
  • Government Expenditure (G)
  • Net Export (X – M)
  • GDP at market price = C + I + G + (X – M)
  • GNPmp = GDPmp + Net Factor Income Abroad
  • GNPfc = GNPmp + Subsidies – Indirect Taxes
  • National Income (NI) = GNPfc – Depreciation
  • Personal Income (PI) = National income + Transfer Payments – Corporate Income Taxes – Retained/Undistributed Earnings – Employee's Provident Fund (EPF) – Social Security Contributions (SOCSO) – Insurance Premium
  • Disposable Personal Income (DPI) = Personal Income – Personal Income Tax

Output Approach

  • Under Output (Product or Value Added) Approach, national income is measured by adding up the net value of all the goods and services produced in the country, sector by sector during the year
  • Three sectors include:
  • Primary Sector
  • Secondary Sector
  • Tertiary Sector
  • GDP = Value of final products in the economy
  • GNPfc = GDPfc + Net Factor Income Abroad
  • National Income (NI) = GNPfc – Depreciation
  • Personal Income (PI) = National income + Transfer Payments – Corporate Income Taxes – Retained/Undistributed Earnings – Employee's Provident Fund (EPF) – Social Security Contributions (SOCSO) – Insurance Premium
  • Disposable Personal Income (DPI) = Personal Income – Personal Income Tax

Nominal vs Real Income

  • Nominal income is the national income that is measured in the current price level
  • Any change in nominal income reflects the combined effects of change in quantity and change in price level
  • Real income is the national income that is measured at a constant price (base year)
  • By comparing the value of production in the two years at the same prices, the changes in real income reflects only the changes in real output
  • Real GDP = (Nominal GDP) / (GDP deflator)
  • GDP Deflator = (Current year price index) / (Base year price index)
  • Real GDP = Nominal GDP × (Base year price index) / (Current year price index)

Per Capita Income and Growth Rate

  • GDP per capita is often used as an indicator of living standards
  • Per capita income is the average income per head of population
  • Per Capita Income = (National income) / (Total population)
  • Growth rate is the percentage change in quantity of goods and services produced from one to another
  • Growth Rate(%) = [(Real GNP this year – Real GNP last year) / (Real GNP last year)] ×100%

Uses of National Income Statistics

  • Standard of living indicators reflect the individuals' welfare
  • It shows how much goods and services can be consumed by each individual in a country, and can be measured by GDP per capita
  • Government planning and policies rely on available statistics of national income to guide policy makers in planning for the future
  • From the national income data, the government can view the historical trends and performance of economic sectors
  • Sectoral contribution analyzes the economic sectors in the economy to see the relative importance of the various parts of the economy, and whether these change with time relatively
  • International comparisons uses the national income statistics to compare the absolute size of one economy relative to another, as well as to compare how well-off the average individual is in each country

Problems of Measuring National Income

  • Problems of non-monetized sector due to the existence of a large number of non-monetized activities in some countries, especially in the agricultural sector
  • Underground economy GDP estimates may not take into account the underground economy, in which transactions contributing to production are unreported
  • Non-market transactions occurs when there are many productive works done in the economy that they are not paid; food grown in backyard plots, home repairs, do-it-yourself goods and services
  • Problems of expertise and modern machinery due to the the lack of professionals such as statisticians, researchers, programmers and analysts
  • Problems of expertise and modern machinery when both values of final goods and intermediate goods are included

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