Topic 6 National income.pdf

Topic 6: National Income Learning Outcomes: After reading this topic, the student should be able to:  Identify the concepts in national income  Differentiate the three approaches of measuring national income  Discuss the usage of national income...

Topic 6: National Income Learning Outcomes: After reading this topic, the student should be able to:  Identify the concepts in national income  Differentiate the three approaches of measuring national income  Discuss the usage of national income 1 In this chapter, we will look at how a nation’s income is calculated. There are many concepts on the calculation of national income. This topic is one of the most important topics in macroeconomics. Definition of National Income  National income can be interpreted in many ways. National income is also known as the flow of goods and services in a nation over a certain period of time, usually for a year.  Some of the other definitions of national income are as follows:  National income is the total money value of all goods and services produced by a nation during one year after deducting the depreciation value of the machines used in production.  National income is the total payments received by the factors of production through the production of goods and services in a country in a year.  National income as a total net output of the nation.  National income of a country is its annual consumption and not its annual production. Concepts of National Income  Gross Domestic Product (GDP)  Gross Domestic Product (GDP) is the total market value of all final goods and services produced within a country in a given time period.  GDP can be measured at current prices or constant prices. If the domestic output is calculated on the basis of prevailing prices it is referred to as GDP at current prices.  GDP at constant prices refers to fixed prices prevailing in a base year.  In 2011, for example, the Malaysia GDP at current prices was RM 852,734 million, whereas the GDP at constant price (base year 2000 = 100) was RM540, 927 million.  GDP include goods and services produced by foreign worker in Malaysia such as by Indonesians or Nepalese. This will be included in Malaysia’s GDP. The net income from abroad will make the difference between gross domestic product and gross national product. 2  Gross National Product (GNP)  Gross National Product (GNP) is defined as the total market value of all final goods and services produced by the residents of a country during a given period of time.  GNP is the total amount of income earned by nationals of the country, regardless of where there are.  For example, income earned by Malaysians working abroad in countries like Singapore, Japan, United States etc. will be included in the GNP. However, the income earned by foreign workers working in Malaysia will not be included in the GNP.  While calculating the GNP, only final goods and services that satisfy consumption needs will be included and the value of intermediate goods and inputs will be excluded to avoid double accounting.  GNP also can be defined as the sum of the gross domestic product (GDP) and the net factor income from abroad.  Net factor income from abroad is the difference between the income received from abroad and the income paid abroad.  In order to calculate the GNP, we must add net factor income abroad to the GDP.  Market Price and Factor Cost  GDP can be measured at market price and also at factor cost.  Market price refer to the current price in the market through the forces of demand and supply.  Market price are the actual prices paid by consumers.  Market price does not reflect the real price. Therefore, the factor cost is the real price that is earned by producers or sellers.  The different between gross domestic product at the market price and the factor cost are due to indirect taxes and subsidies.  Indirect taxes are levied on goods such as excise duty, import duty and sales tax. 3   Subsidy is an incentive from the government to encourage producers to produce more.  Indirect taxes are also known as taxes on expenditure, sales tax or consumption tax.  In order to obtain the GDP at the market price, we have to include indirect taxes and exclude the subsidies given by the government.  However, to obtain the GDP at factor cost, we have to subtract indirect taxes and add subsidies to GDP at market price.  The same calculation can also be applied to find the GNP at factor cost.  Net National Product (NNP)  Net national product (NNP) is defined as the market value of the net output of final goods and services produced by a nation during a year.  In other words, Net National Product (NNP) is GNP minus the value of capital consumption or depreciation during the year.  NNP is also referred to as the national income at market prices.  In the production process, some part of capital equipment will be obsolete.  In order to replace this obsolete capital equipment, a certain part of the GNP will be kept aside.  This portion of the GNP cannot be used for consumption or investment purposes.  The portion that we deduct from the GNP is called the replacement value or depreciation value.  Depreciation is also known as capital consumption allowances.  To calculate the NNP, depreciation value should be subtracted from the GNP. 4  National Income (NI)  National income at factor cost (NI) is defined as the total of all income payments made to factors of production (land, labour, capital and entrepreneurship).  National income can be derived from the net national product (NNP) at market price by including subsidies and subtracting indirect taxes.  The difference between net national product (NNP) and national income is the market price and factor cost.  GNP market price minus depreciation, gives the NNP.  GNP factor cost minus depreciation, equals national income. Some of the calculations used to obtain national income are:  Personal Income (PI)  Personal income (PI) is the income that is actually received by individuals and households in an economy in a year.  PI can be spent, used to pay taxes or be saved. The deductions made from national income are as follows: a) Corporate income taxes – a certain portion of corporate profits that are paid out as corporate income tax before being distributed among shareholders. b) Retained earnings – which part of corporate profits retained by corporations and distributed among shareholders. c) Social security contributions – contributions of a certain percentage of the worker’s income to provident funds or pension funds. This deduction will reduce the amount of income available to the worker. In Malaysia, employees’ incomes are deducted for the Employees Provident Fund (EPF) and for the Social Security Contribution (SOCSO). SOCSO is deducted for workers who earn less than RM1,500 per month. d) Insurance premium – a certain percentage of income that is used to pay for insurance. 5   The government, on the other hand, gives social security benefits such as unemployment allowances, old age pensions and other benefits to the public.  These benefits are not from any productive work and are known as transfer payments.  PI can be derived from national income by deducting the amounts that are not available for distribution among the factors of production and adding transfer payments made by the government.  The concept of personal income is a useful concept because it will assist us in estimating the potential purchasing power of households.  Disposable Personal Income (DPI)  The personal income as defined above is not the income of any one individual or household that is wholly used for consumption.  Individuals and households will use a certain portion of their personal income to make payments to the government in terms of direct taxes.  That part of personal income that is left remaining after the payment of personal direct taxes is referred to as disposable personal income.  Thus, the disposable personal income can be obtained by deducting personal income tax from personal income. 6 Methods of Measuring National Income  There are three methods of measuring national income because national income is capable of being viewed from three dimensions – total output, total income or total expenditure, National income can be defined from any of these three dimensions.  From the circular flow, it can derive the following dimensions, assuming there are no leakages: a) All household income must be equal to household expenditure on goods and services. b) Value of output must be equal to total expenditure on goods and services c) Household income must be equal to value of output. Therefore, Income = Product = Expenditure  This fundamental identity of “Income = Product = Expenditure” gives the same results when we measure national income. The three methods measure the same flow.  National income can be calculated using three approaches: (i) Expenditure approach (ii) Income approach (iii) Product approach 7 Uses of National Income  All countries need to maintain the accounts of their income and expenditure annually. This referred to as national income accounting.  National income accounting is very important both to individual and to the government. It helps to identify sources of income and heads of expenditure.  The study of national income accounting has become very important in recent years for the following reasons: 1. Standard of Living Comparison National income data helps us compare the standard of living of people in different countries to the people living in the same country at different times. Countries with a higher national income such as the USA, the UK, Canada and Japan will have a higher standard of living. On the other hand, countries that have a low national income will have a lower standard of living (Myanmar, Vietnam and Cambodia). 2. Economic Performance Over Time National income estimates are given to measure the performance of an economy over time by comparing the national income of one time period to that of another. The national income tells us whether the economic performances of a nation is growing, stagnant or declining. In Malaysia, the national income has been steadily improving over time. 3. National Planning National income statistics are very important tool for the government to formulate its short-term and long-term economic planning. The government cannot formulate any economic planning without knowledge of the trends in national income. Furthermore, the government can also use national income statistics to forecast future developments based on current economic performance. The Malaysian government also uses national income statistics to draft the country’s ‘Malaysian Plan’ for a five-year period. 8 4. Sectoral Contribution There are three sectors in the Malaysian economy. The primary sector consist of agriculture, fishing and mining. Based on 2024, the primary sector has seen a relative decline in its contribution to Malaysia's GDP compared to previous decades. However, agriculture remains significant, with palm oil and rubber continuing to be important, though less dominant. Mining, particularly of petroleum and natural gas, remains crucial for export revenues but has seen a relatively diminished share in the overall GDP. The secondary sector consists of manufacturing and construction. The secondary sector has experienced substantial growth and transformation over recent decades. Manufacturing, especially in electronics, automotive, and machinery, remains a major contributor to Malaysia’s GDP. The construction sector has also grown, driven by infrastructure development and urbanization projects. As of 2024, the secondary sector remains pivotal in Malaysia’s economic structure, although it’s relative share has stabilized. Finally the tertiary sector comprises services like government services, electricity, gas and water; transport, storage and communication; and finance, insurance, real estate and business services. The tertiary sector is the largest contributor to Malaysia's GDP, reflecting its increasing importance in the economy. Key areas within the tertiary sector, such as financial services, real estate, and business services, have expanded significantly. The service sector’s growth is driven by increased consumer spending, the expansion of digital services, and Malaysia’s role as a regional financial hub. National income statistics enable us to identify the important sector that contribute towards economic growth. Pre-1980s: Historically, the primary sector, with contributions from rubber, palm oil, and tin, was dominant in Malaysia's economy. The sector played a crucial role in economic growth during this period. 1980s Onwards: The focus shifted towards the secondary sector, particularly manufacturing, which became increasingly important due to industrialization and export-oriented growth strategies. In Malaysia, the major contributor to the gross domestic product (GDP) is the services sector as of 2024. As of 2023, the tertiary sector, which includes services such as finance, insurance, real estate, and business services, contributed approximately 59.4% to Malaysia's Gross Domestic Product (GDP). This reflects the sector's dominant role in the 9  country's economy, driven by growth in financial services, tourism, and various service-oriented industries. As of 2024, Malaysia’s economy is characterized by a strong tertiary sector, reflecting its development into a more service-oriented and diversified economy. While the primary and secondary sectors remain important, their relative contributions to GDP have decreased, with the services sector leading in terms of overall economic contribution and growth. 5. Economic Policy National income statistics are an important tool in macroeconomic policy and analysis. National income estimates are the most comprehensive measures of aggregate economic activity in an economy. With national income estimates, future economic policies for development of a nation can be formulated. 6. Inflationary and Deflationary Gaps National income data helps us to know the purchasing power of money and helps the government implement anti-inflationary or anti-deflationary measures to stabilize the value of money. 7. National Expenditure National income estimates show us how national expenditure is divided between consumption expenditure and investment expenditure. National income provides information for reasonable depreciation to maintain capital stock. 8. Public Sector National income contains the figures of consumption, savings, investment, imports and exports. These figures enable us to know the relative performance of both the public and private sectors in the economy. 10  This pattern of expenditure can tell us the type of economic system the country is practicing. If most of the activities are performed by the state, we can conclude that the public sector is playing a dominant role in a centrally planned economy. 9. Distribution of Income National income estimates show the distribution of income among different sectors and among different factors of production in the form of rent, wages, interest and profits. 11