Study notes

Measuring National Income

  • Levels: AS, A Level
  • Exam boards: AQA, Edexcel, OCR, IB, Other, Pre-U

What is meant by national income?

National income measures the monetary value of the flow of output of goods and services produced in an economy over a period of time.

Measuring the level and rate of growth of national income (Y) is important for seeing:

  • The rate of economic growth
  • Changes to average living standards
  • Changes to the distribution of income

Gross Domestic Product

Gross domestic product (GDP) is the total value of output in an economy and is used to measure change in economic activity. GDP includes the output of foreign owned businesses that are located in a country following foreign direct investment. For example, the output produced at the Nissan car plant on Tyne and Wear and by foreign owned restaurants and banks all contribute to the UK’s GDP.

There are 3 ways of calculating GDP all of which should sum to the same amount:

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

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: adding factor incomes

Here GDP is the sum of the incomes earned through the production of goods and services. This is:

  • Income from people in jobs and in self-employment +
  • Profits of private sector businesses +
  • Rent income from the ownership of land =
  • Gross Domestic product (by factor incomes)

Only those incomes that come from the production of goods and services are included in the calculation of GDP by the income approach. We exclude:

  • Transfer payments e.g. the state pension; income support for families on low incomes; the Jobseekers’ Allowance for the unemployed and welfare assistance, such housing benefit.
  • Private transfers of money from one individual to another.
  • Income not registered with the Inland Revenue or Customs and Excise. Every year, billions of pounds worth of activity is not declared to the tax authorities.

This is known as the shadow economy or black economy.

According to a World Bank report published in 2010, the average size of the shadow economy (as a percentage of official gross domestic product) in Sub-Saharan Africa was 38%; in Europe and Central Asia (mostly transition countries), it was 36%, and in high-income OECD countries it was13%

Published figures for GDP by factor incomes will be inaccurate because much activity is not officially recorded, including subsistence farming, barter transactions and the shadow economy.

Many African countries in particular have trouble measuring the size of their relatively large subsistence economies and unrecorded economic activity.

In 2013 the United States made changes to the way that the value of their GDP is calculated. They now include the amount spent on intellectual property outlays such as pop song production and drug patents for the first time.

Share of GDP by Sector for Selected Nations (2014)

The Value Added and Contributions to a Nation’s GDP method

  • There are four main wealth-generating sectors of the economy: manufacturing, oil and gas, farming, forestry and fishing and a wide range of service-sector industries.
  • 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 goods or services as a result of the production process

Value added = value of production - value of intermediate goods

Let us say that you buy a ham and mushroom pizza from Dominos at a price of £14.99 - this is the final retail price and will count as consumption.

The pizza has many ingredients at different stages of the supply chain, for example tomato growers, dough, mushroom farmers plus the value created by Dominos themselves as they put the pizza together and get it to the consumer.

Some products have a low value-added, for example those really cheap tee-shirts that you might find in a supermarket for little more than £5. These are low cost, high volume, low priced products.

Other goods and services are such that lots of value can be added as we move from sourcing the raw

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Examiner - GCE A Level - Economics

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