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Topic Calculation of

2 National Income

LEARNING OUTCOMES
By the end of this topic, you should be able to:
1. Explain national income terms such as GDP, GNP and NNP;
2. Differentiate the three methods of calculating national income;
3. Assess four reasons for the significance of national income
accounting;
4. Recognise five problems regarding national income accounting;
and
5. Calculate the economic growth rate.

INTRODUCTION
This topic will start off with a discussion on economic activities as a whole,
focusing on the establishment of a total national income, and its relation to
aggregate consumption, aggregate investment and price levels. We will study the
information on our national income, which includes gross national product,
gross domestic product and other components. Such collation of information is
known as national income accounting.

2.1 CONCEPT OF NATIONAL INCOME


National income is one of the main indicators used by economists in measuring
the productivity of a country or region. It is frequently used to measure the
performance of a country.

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2.1.1 National Income


Let us now begin by discussing the concept of national income. National income
or national output refers to the value of goods and services produced by a
country over a certain period of time. The most commonly used income concepts
are GNP and GDP. Do you know what GNP and GDP are? To find out more on
GNP and GDP, let us look at the following explanation.

2.1.2 Nominal and Real National Income


You might have heard of nominal and real national income but do you know
what they really mean? To find out more, let us look at the definition in Table 2.1.

Table 2.1: Definition of Nominal National Income and Real National Income

Nominal National Income Real National Income


The total final value of goods and services The total final value of goods and services
produced by a country, which is produced by a country in a certain year,
calculated based on the years recent which is calculated based on a fixed price,
price. which is also known as market price on a
basic year. It is also known as real national
product.

2.1.3 Gross Domestic Product (GDP)


Now, let us take a look at the Gross Domestic Product (GDP) that we mentioned
earlier. GDP is the final value of goods and services produced by a certain
country within a certain period of time. This value includes goods and services
produced by the citizens and people of other nationalities living in the country.
This means that all goods and services produced by foreign workers are also
included in Malaysias GDP.

GDP can be stated as follows:

(a) Market Price (GDPmp)


Market price is the value of goods according to the price paid by the
purchaser in the market (through supply and demand).

(b) Factor Price or Factor Cost (GDPfc)


Factor cost is the value of goods based on the production factors involved
in producing them.

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There are two factors that distinguish between market price and factor cost
which are as follows:

(a) Indirect taxes: Examples include road tax, service tax, import tax and export
tax.

(b) Subsidies: Government aid in the form of money given to production


activities in an economy.

The market price of a certain item differs from its factor cost. To obtain the factor
cost from market price, we need to make the following adjustments:

Factor cost = Market price Indirect Taxes + Subsidies


Market price = Factor cost + Indirect Taxes Subsidies

Therefore, in order to obtain the GDPfc, we need to subtract indirect taxes from
GDPmp and add subsidies.

GDPfc = GDPmp Indirect Taxes + Subsidies

2.1.4 Gross National Product (GNP)


GNP is the final value of goods and services distinguished by source factors
owned by the citizens of a country, whether they operate domestically or
internationally. In other words, the GNP of a country does not take into account
the total output value produced by source factors owned by foreigners,
regardless of the fact that the factors are within the country. This means that the
income of Malaysian citizens working in Singapore is taken into consideration in
Malaysias GNP but the income of Singaporeans working in Malaysia is not.
Therefore, GNP is different from GDP because GDP takes into consideration the
value of all the goods and services produced within the country.

GDPfc = GDPmp Indirect Taxes + Subsidies

Where:

Net income of factors from abroad = Total income earned by production factors
from abroad Total income earned by production factors to abroad

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For example:

(a) Total income earned by production factors from abroad:


Income of Malaysians working in Singapore, Japan, Brunei and other
countries.

(b) Total income earned by factors of production to abroad:


Income of Indonesians, Bangladeshis, Thais and Filipinos working in
Malaysia.
GNP can also be calculated in the stated factor cost:

GNPfc = GDPmp Indirect Taxes + Subsidies + Net Factor Income from Abroad
(NFIFA)

For example, refer to Table 2.2, which shows the difference between national
GDP and GNP at market price from 1995 to 1999.

Table 2.2: Malaysias GDP and GNP at Market Price (1995 to 1999)

Year GDP (RM Million) GNP (RM Million)


1995 222,472 212,095
1996 253,735 241,931
1997 281,794 266,699
1998 284,472 269,136
1999 299,193 279,843

It can be seen that Malaysias GNP from 1995 to 1999 is less than its GDP. This
means that the total income earned by production factors to abroad was higher
than the total income earned by production factors from abroad (net factor
income payment to abroad is negative).

ACTIVITY 2.1

What do you understand by national income and GDP? Try to


explain in your own words and post it on myINSPIRE.

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2.1.5 Net National Product


In every production process, capital goods and assets such as machinery,
equipment, fittings and factories are constantly used. Through time, economic
interests from the use of these assets will deteriorate as they become less efficient
by the day. Deterioration of these assets is called depreciation. When
depreciation of the same year is subtracted from GNPmp, we will obtain the net
national product at market price (NNPmp).

NNPmp = GNPmp Depreciation


GNPmp = NNPmp + Depreciation

To obtain NNPfc, indirect taxes and depreciation have to be subtracted from


GNPmp, and subsidies must then be added to the amount as follows:

NNPfc = GNPmp Indirect taxes + Subsidy Depreciation

NNPfc is also defined as National Income.

2.1.6 Per Capita Income


Per capita income is the total income of an individual in a country. The value is
obtained by dividing national income with the total population of the country. In
other words, we can define it as income per person in a population.

SELF-CHECK 2.1

Elaborate on the two concepts of national income:


(a) Gross national product (GNP)
(b) Net national product (NNP)

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2.2 NATIONAL INCOME CALCULATION


Generally, there are three methods that you can use to calculate national income,
as shown in Figure 2.1.

Figure 2.1: Three methods of calculating national income

Let us examine these methods separately.

2.2.1 Expenditure Method


This method adds the value of government expenditures on final goods and
services purchased within a year.

The classification of expenditure is based on four components:

(a) Consumption expenditure (C);


(b) Government expenditure (G);
(c) Gross investment (I); and
(d) Net export (export import or X M = Xn).

To calculate a nations GDP at market price using the expenditure method, add
all four components of expenditure, that is:

Market price GDP = C + I + G +(X M)

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Table 2.3 shows an example of how to calculate national income using the
expenditure method.

Table 2.3: Calculation of National Income Using Expenditure Method

RM RM
Item
Million Million

1. Consumption expenditure (C) (+) 14,000


2. Government expenditure (G) (+) 8,000
3. Gross investment (public and private sectors) (I) (+) 3,500
4. Stock change (+) 100
5. Export of goods and services (X)
6. Import of goods and services (M) 7,500
Net Export (X-M) (+) 5,500 2,000
GDP at Market Price 27,600
7. Income of production factors from abroad (IFFA) 900
8. Income of production factors to abroad (IFTA) 700
Net Income of Production Factors from Abroad (IFFA IFTA) (+) 200
GNP at Market Price 27,800
9. Indirect taxes () 400
10. Subsidy (+) 280
GNP at Factor Cost 27,680
11. Depreciation () 120
NNP at Factor Cost @ National Income 27,560

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ACTIVITY 2.2
Search the Internet to find out what the following means:

(a) Household consumption expenditure;


(b) Government expenditure;
(c) Gross investment; and
(d) Net export.
Post your answers on myINSPIRE.

EXERCISE 2.1

Calculation Question

Based on the table below:

GDP at GNP at GDP at 1987 GNP at 1987 Population


Year Current Price Current Price Fixed Price Fixed Price
(RM Million) (RM Million) (RM Million) (RM Million) (Million)

1994 195,460 186,049 151,713 141,890 19.66


1995 222,472 212,095 166,625 155,204 20.11
1996 253,733 241,931 183,292 170,104 20.55
1997 281,795 266,699 196,714 182,297 21.00
1998 284,472 269,151 182,221 172,770 21.39

(a) Calculate the annual net factor payment from abroad at current
price from 1994 to1998.
(b) Explain what net factor payment from abroad means.
(c) Calculate the real GDP per capita from 1994 to 1998.
(d) Draw a graph to show the relationship between the real GDP per
capita and time.
(e) Define the direction of flow for Malaysias real GDP per capita
from 1994 to 1998 based on your answer to question (d).

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2.2.2 Production Method


The second method that we can use to calculate national income is the
production method. How do we calculate national income using this method?
You must remember that the production method is calculated by measuring the
value added for final goods and services from various production sectors within
the economy. In Malaysia, the economic sector can be divided into various
groups, as shown in Figure 2.2.

Figure 2.2: Economic sector in Malaysia

The main sector is made up of agriculture, forestry and fisheries as well as


mining. The industrial sector is made up of factory, construction, electricity,
water and gas. Transport, deposits and relations, wholesale and retail trade,
hotels and restaurants, financial, insurance, real estate and business services, civil
and defence services, as well as other types of services fall under the service
sector.

When calculating the national income using this method, we should take into
consideration only the final output value. The value of intermediate products is
not taken into consideration in the calculation of GNP. Otherwise, there will be
double counting.

For example, the process of producing shirts involves several stages. First,
cotton is used, which is then processed into thread, and from thread to cloth. It is
only from cloth that a shirt can be produced. Since cotton, thread and cloth are
intermediate products, their values need not be taken into consideration in the

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calculation of national output. Only the value of the shirt, which is the final
product, is taken into account.

ACTIVITY 2.3

What does value added mean? How and why do we need to consider
value added? Discuss these questions with your tutor and friends
during your tutorial.

2.2.3 Income Method


According to the income method, the value of national income can be obtained
by adding all the received income from production factors (labour force income,
land, capital and entrepreneurship) as shown in Table 2.4.

Table 2.4: National Income Calculation Using the Income Method

Value Value
Type of Income
(RM Million) (RM Million)

Salaries and wages (+) 15,000

Rent (+) 2,000

Gross interest less 6,000

(a) Interest on government loans (+) 1,000

(b) Interest on users loans (+) 2,000 3,000

Net interest

Profit of companies

(a) Dividend (+) 1,800


2,000
(b) Undivided profit (+) 2,000
(c) Income tax of companies (+) 5,800

Private enterprise income 1,500

Factor Cost Net National Product @ National Income 27,300

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2.3 IMPORTANCE OF MEASURING NATIONAL


INCOME
Before we go any further, let us see why so much importance is given to
measuring the national income.

(a) Measure of Economic Performance/Growth


By comparing the difference between this years national income and that
of the previous year, we can evaluate the rate of economic growth. The data
allows us to make comparisons of the nations economic performance
during a certain period of time. Also, the data can be used to compare the
countrys economic growth with that of another country.

(b) As a Sign of Success or Failure of Past Government Policies


Based on the national income account, the government can also evaluate
the effectiveness of the economic policies that have been implemented,
identify economic problems and resolve them.

(c) Measure of the Standard of Living of the Population


Generally, the national income enables us to make a comparison of the
populations standard of living. It can also be used to compare the
standard of living among different countries. National income is one of the
factors used to determine a countrys standard of living. Other factors
include illiteracy and poverty rates.

(d) Measure of the Contribution of the Economic Sector to the Country


From the national income account, we can determine the contributions of
every economic sector to the country. Based on the performance of each
economic sector, the government can assess whether its past policies were
effective. Subsequently, necessary actions can be taken to amend the
policies in the future for sectors that did not perform well.

ACTIVITY 2.4

In your opinion, which sector makes the most contribution to


Malaysias economic growth? Find the percentage of its contribution to
Malaysias GDP in the year 2000.

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2.4 PROBLEMS IN MEASURING NATIONAL


INCOME
In the process of calculating national income, various problems often arise which
include the problems discussed in the following subtopics.

2.4.1 Information Gathering


Information and data cannot be easily obtained because some parties, such as
small businessmen and farmers, do not keep records of their economic activities.
The value of their output is usually based on estimation. Sometimes errors occur
in the calculation process. Also the value of output cannot be properly calculated
due to incomplete records.

2.4.2 Economic Activities Excluded from National


Income Calculation
In the calculation of government expenditure, only the output value from productive
and marketed economic activities is taken into consideration. However, in reality,
not all economic activities are productive and marketed, such as the following:

(a) Agricultural Produce from Traditional Farmers


Self-sustaining agricultural activities are productive economic activities but
the produce is not marketed.

(b) Illegal Activities


Even though illegal activities such as drug trafficking, prostitution,
gambling and black market are productive activities, they are not included
in the national income because they are considered illegal.

(c) Domestic Activities


The domestic activities of a housewife are hard to define in monetary value
and are usually excluded from the national income.

However, in situations where a maid is hired to help out in household


chores, such activity is included in the national income calculation.

(d) Non-monetary Rewards


It is common for an employee to receive part of his salary/wages in non-
monetary form such as lodging or transport. Rewards in non-monetary
form are excluded from the calculation of national income.

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2.4.3 Double Counting Problem


In practice, it is sometimes hard to differentiate between a final product and an
intermediate product. This difficulty often results in double counting. For
example, when a housewife buys a packet of flour, it is considered a final
product. However, for a baker, it is considered an intermediate product.

2.4.4 Determining the Price of a Product


Normally, the price of goods varies from place to place. Also, the price of some
goods changes within a short period of time. For example, the price of palm oil
fluctuates daily. Thus, difficulties arise in determining the price of a product in
calculating the national income.

2.4.5 Depreciation
It is quite difficult to define the extent of depreciation because there are no
complete records regarding depreciation in various fields of economic activities.
Depreciation, from a business stand point, may be defined differently because of
the various capital goods and depreciation calculation methods used. Each
method of calculating depreciation will give a different value.

SELF-CHECK 2.2

Describe five problems in measuring income and give examples.

2.5 DETERMINING THE ECONOMIC GROWTH


RATE
From the national income data, a countrys economic growth rate can be
compared annually.

To determine a countrys economic growth rate, we have to calculate its real


income, which is the real gross domestic product (GDP) or real gross national
product (GNP) (which is based on a fixed price). The economic growth rate is the
percentage of change in the quantity of goods or services produced from year to
year.

In these calculations, the national income and its components must be stated at a
fixed price, which means that the price of a product is based on a chosen year
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and not the current price. To calculate the economic growth rate, we will use this
formula:

This year's GDPr Last year's GDPr


Economic growth rate = 100
Last year's GDPr

where GDPr is real gross domestic product.

For example, if the real GDP for year 2000 is RM14,000 million and the year
before is RM13,000 million, then the economic growth rate for 1999 is:

14, 000 13, 000


Economic growth rate = 100 = 7.69%
13, 000

ACTIVITY 2.5

1. The website, http://www.mrdowling.com/800gdp.html, shows


the GDPs of various countries in the year 2000.

Surf the website for answers to the following questions:

(a) Which country has the highest GDP value?


(b) Based on the GDP value, Malaysia is placed in the ______ th
position.
(c) Which country has the highest GDP per capita?
(d) What is the value of Malaysias GDP per capita?

2. Visit the website of the Ministry of Finance


(http://www.treasury.gov.my) to know more about the national
income rate. From this website, you can view Malaysias annual
economic growth. Click on the economic data and you will
obtain Malaysias economic growth rate.

State the economic growth rate from 1995 to 2000. The lowest
economic growth rate was in the year ________. In your opinion,
what was the cause of the low economic growth rate during that
period?

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EXERCISE 2.2

Multiple Choice Questions

1. Gross Domestic Product (GDP):

A. Is the final value of goods and services produced by a certain


country within a certain period of time.
B. Includes accumulated sales of stocks and bonds.
C. Includes sales of raw material.
D. Is the total market value of a countrys output.

2. Net national products (NNP) is equal to _____________.

A. GNP plus depreciation


B. GNP minus depreciation
C. GNP minus net investments
D. GDP minus depreciation

3. Which of the following is NOT a component of national income?

A. Consumption expenditure.
B. Government expenditure.
C. Depreciation.
D. Net exports.

4. Assume that the total market value of all final goods and services
produced in Malaysia in 1999 was RM15,000 million and the total
market value of all final goods and services sold was RM14,500
million. We can conclude that _____________.

A. GDP in 1999 was RM14, 500 million


B. NDP in 1999 was RM14, 500 million
C. NDP in 1999 was RM15,000 million
D. GDP in 1999 was RM15,000 million

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5. In calculating National Income (NI), the problem of double


counting can be avoided by _____________.

A. Including all transfers in the calculation


B. Counting both intermediate and final products
C. Only counting final goods
D. Only counting intermediate goods

National income accounting includes the calculation of gross domestic


product (GDP), gross national product (GNP) and net national product
(NNP).

The three methods used for calculating national income are expenditure,
production and income methods.

Measuring national income is important as it gives an indication of how the


economy is performing, measures the contribution of each economic sector to
the country, and reflects the standard of living of the population as well as
the effectiveness of economic policies implemented by the Government.

The problems faced in calculating national income include information


gathering, identifying economic activities excluded from national income
calculation, double counting, determining the price of products and
depreciation.

Depreciation Market price


Factor cost National output
Indirect taxes Real gross domestic product

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