Lectures in Economics 10

Lectures following Rüdiger Dornbusch’ works (10)

National accounting
(shortened version)

Gross national product (GNP) is the total value of the economy’s output or production in a given period, such as a year. GNP is widely used as the basic measure of the performance of the economy in producing goods and services.
The circular flow diagram (Figure 4-1) showed that the economy’s output of goods and services generates the incomes received by owners of factors of production, because payments for purchases of goods and services eventually end up as wages and profits for the people who produce the goods . National income is the total income received by the economy’s factors of production. We study national income accounting in part because it provides us with definitions and measures of GNP and national income. But we also study it because it is necessary for our analysis of the determination of the levels of output, income, and employmentin later chapters. The tasks of this chapter is to show how national income is related to GNP.

This chapter starts by carefully deflning GNP and describing how it is measured. Then we focus on two important sets of relationships. First, there are the links between GNP, or output, and the incomes earned in the economy. Second, there are the links between expenditures on goods and services and the value of output produced. These relationships, too, are shown in Figure 4-1. The accounting relationships between output and income and between expenditures and output are the foundation for our first model of income and output determination, which will be set out in Chapter 6.

The measurement of GNP and the links among GNP, income, and spending take up most of this chapter. We also want to know how accurate our measurements are and for what purposes they are used. The chapter ends with a discussion ofthe uses made of GNP data, emphasizing the distinction between nominal and real (inflation-corrected) GNP and mentioning some shortcomings of GNP as a measure of the economy’s total output.


Gross national product is the market value of the goods and services produced within a given period by domestically owned factors of production.

We avoid double counting by focusing  on each firm’s value added. Value added is the increase in the value to be counted in GNP. But some of goods resulting from production output is not sold. Value added is calculated by deducting  from the value of the firm’s production the cost of the bought produced goods or raw materials and other inputs.

Table 5-1 illustrates this for the case of an automobile producer. Total sales by that producer were, say, $10 billion.  (Tire producer in parentheses)
$4 billion represents the value of the steel, tires, plastics, electricity, and other produced goods that were bought by the carmaker for use in automobile production; these are also called intermediate owners’ services goods. Deducting the cost of the intermediate goods, we see that the automobile producer’s value added was $6 billion.

AUTOMOBILE PRODUCER                                        (  TIRE PRODUCER
Value of goods produced $10 billion                     Value of production $350 million
Less: Cost of purchased                                                Less: Cost of purchased produced inputs
produced inputs
(steel, tires, (rubber, cord
electricity, etc.) 4 billion                                              150 million
Equals: Value added $ 6 billion                                  Equals: Value added $200 million)



Volunteer services, the value of housework, and do-it-yourself activities are not included because it is difficult to estimate the value of production located in the domestic economy, whoever owns them. Also excluded from GNP is the
value of illegal activities, such as illegal  gambling, and production that is concealed to avoid taxes. For instance, when a handyman asks to be paid in cash, it is quite likely  that the value of the service he performed will never be counted in GNP because he  will not report the payment as income. Such activities are part of what is called the underground economy, or the part of the economy that escapes the official statistics. Some  economists have estimated that the output of the underground economy is as much as  one-quarter of official GNP, but most estimates are closer to 3 to 5 percent of GNP.

Another point to note is that it is the value of goods currently produced that is part of GNP. Transactions in existing assets, for instance, houses, are not included. The value of an old house when it is sold is not a current productive activity of the economy, and so the value of the house is not included  in GNP. We would, though, include the
value of any brokerage services associated with the purchase and sale of the house, since the broker adds to the current output  of the economy by bringing buyer and seller  together. By comparison, when a new house is built, the value of the house is counted in GNP.

Finally, GNP measures the value of output produced by domestically owned factors of production. Part of the GNP is produced abroad. For instance, the income earned by an American working in Paris is part of U.S. GNP. Similarly, when an American company owns a factory in Germany and receives profits from its operation, those profits count as part of U.S. GNP. By the same argument, the income earned in the United States by factors of production owned abroad is not part of U.S. GNP.


(Thousands of 1979 Dollars)


GNP statistical estimates are made in two ways.One is obtained from the produce value,the other is obtained from the incomes earned by people.We recall from Figure 4-I that production and the value are closely related.

Bangladesh 90
China 260
EI Salvador 670
Syria 1,030
Argentina 2,230
Hungary 3,850
Italy 5,250
United States 10,630
Switzerland 13,920
Kuwait 17,100

Source: World Bank, World Development Report, 1981,
pp. 134-135.

Some of the numbers are hard to believe. Whereas per capita income in the United States was above $10,600 in 1979
in Bangladesh it was only $90. Americans could not live on so low an income. Probably the value of output produced in Bangladesh is above $90, because some output is produced by farmers who consume their own crops. But the GNP is so
low that people starve, and ill health leads to early  death. At the other end of the scale is Kuwait, whose oil production leads to per capita GNP being 60 percent higher than that in the United States.

l Macroeconomics is the study of the operation of the whole. The major macroeconomic issues are inflation, unemployment and growth and whether there is anything the government can do about them.
2 Macroeconomics is distinguished from microeconomics by taking into account the interactions between the decisions made by firms and households as summarized in Figure 4-1. Households supply the factors of production to firms, which use them to produce goods and services. In return for the services of the factors of production firms pay incomes to households, which are used by the households to buy the goods and services produced by the firms.
3 A reduction in purchases of goods by households can reduce employment of labor, reducing households’ incomes
thereby reducing spending on goods and services.  a most  important question to be studied is what mechanisms exist to prevent these from developing into major problems.
4 Growth is an increase in the production of goods and services. Growth may occur either when unemployed resources are put to work so that the economy moves from inside the PPF to tl when the PPF itself shifts out. The PPF may shift either when there are more factors of production or because existing factors come more productive.
5 The inflation rate is the rate at which prices of goods are rising. In the United States in the last 20 years prices have arisen. The inflation rate started out around 1 percent and has been above 13 percent since then. By international standards inflation has been low. Prices may also fall sometimes, in this case there is deflation.
6 A country that has faster growth than another will eventually have a larger real GNP, however far behind it started.
7 Unemployment in the U.S. economy has risen on from the seventies. In 1982 it stood at the highest level in the post
II WW period. Unemployment rates differ sharply among different countries. Youths and blacks have particularly high unemployment rates.