CH 1 -National Income Accounting HK Certificate of

CH 1 -National Income Accounting HK Certificate of Education Examination By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 1

National Economic Objectives Attaining full employment Attaining economic growth Stabilizing the general price level By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 2

National Income Accounting By measuring national income of the economic territory of an economy, one can estimate how well his economy performs in achieving its national economic objectives. By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 3

Stock Concept A stock is any measurement at a particular point of time. Example: On 14 th August 2004, Peter’s total wealth was $200, 000. By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 4

Flow Concept A flow is any measurement that spreads over a certain period of time. Example: Peter earns $8, 000 as his monthly income. By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 5

Stock or Flow? Peter earns an interest of $10 from his $100, 000 saving in HK Bank for a month. Flow On 31 st August 2004, Welcome’s total stock Stock of goods in Long Ping Estate was $1 million. A secondary school teacher earns $16, 000 per month. Flow HK’s GDP for the year of 2003 was $20, 000 Flow billions. By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 6

Intermediate Vs. Final Goods Intermediate goods are goods and services produced for assisting further or other production. Final goods are goods for final use or consumption. A good can be an intermediate good or a final good, depending on how it is being used. By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 7

Intermediate or Final Goods? Flour bought by Golden Apple Cake shop. Intermediate Lobster cooked by mom for celebrating your pass in Econ test. Final Fish steamed by the cook of a fish stall for his workers. Final An ice-cream you bought from Mc. Donald’s. Final By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 8

Basic Circular Flow Model Factors of production Factor Income Firms Households Expenditure Goods & services Real Flow Money Flow By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 9

We consider the basic circular flow of a certain economy. Real Flow Goods & Services $20 Firms $300 $200 Total market value of all final goods = $20 + $300 + $200 = $520 Households Factors of Production By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 10

We consider the basic circular flow of a certain economy. Real Flow Goods & Services $20 Firms $300 $200 Total market value of all final goods = $20 + $300 + $200 = $520 Households National Product or National Output Factors of Production By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 11

On the other hand, we consider the households total expenditure on these goods. Real Flow Money Flow Goods & Services $20 $300 $200 $100 $100 Firms Households Factors of Production By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 12

On the other hand, we consider the households total expenditure on these goods. Real Flow Money Flow Goods & Services $20 Firms $300 $200 $100 Expenditure on Final Goods & Services Total Expenditure on these goods = $20 + $300 + $200 = $520 $100 Households Factors of Production By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 13

On the other hand, we consider the households total expenditure on these goods. Real Flow Money Flow Goods & Services $20 Firms $300 $200 $100 Expenditure on Final Goods & Services Total Expenditure on these goods = $20 + $300 + $200 = $520 $100 Households National Expenditure Factors of Production By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 14

Those households who provide factors services in the production would receive income from the firms. Money Flow Households’ total income = $200 + $50 + $120 = $520 Expenditure on Final Goods & Services Firms Households Factor Income Wages Interest Rental Income Profit $200 $50 $120 By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 15

Those households who provide factors services in the production would receive income from the firms. Money Flow Households’ total income = $200 + $50 + $120 = $520 National Income Expenditure on Final Goods & Services Firms Households Factor Income Wages Interest Rental Income Profit $200 $50 $120 By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 16

Real Flow Money Flow Goods & Services $20 $300 $200 $100 $100 Expenditure on Final Goods & Services Firms Households Factor Income Wages Interest Rental Income Profit $200 $50 $120 Factors of Production By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 17

From the above analysis, we find that: Real Flow Money Flow Goods & Services The total market values of final goods & services $300 $20 $200 $100 $100 Expenditure on Final Goods & Services The total expenditures on Households the final goods & services Firms Factor Income Wages Interest The $200 Rental Income total income $50 $150 of the households Profit $120 Factors of Production By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 18

That is: Real Flow Money Flow Goods & Services National Product $20 $300 $200 $100 National Expenditure on Final Goods & Services Firms $100 Expenditure Households Factor Income National Income Rental Wages Interest Income $200 Ex 1: TB/P. 8/MCQ 1 By Mr. LAU san-fat/ver 2004 $50 $150 Profit $120 Factors of Production CH 1 -National Income Accounting-SV 19

National Output and … National Output (NO) is the measure of total market value of all final goods & services. National Expenditure (NE) is the measure of total expenditure on final goods & services. National Income (NI) is the measure of households’ total income. NO ≡ NE ≡ NI By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 20

Gross Domestic Product (GDP) Definition: GDP is an aggregate measure of the total value of production of all resident producing units within the economic territory of an economy in a specified period, usu. a quarter or a year. By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 21

Resident Producing Unit (RPU) A resident producing unit maintains her centre of economic interests in the economic territory of an economy. A RPU therefore ordinarily operates in the economic territory. By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 22

Resident Producing Unit or Not? A factory producing toys in HK Yes! By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 23

Resident Producing Unit or Not? A fast food shop in HK Yes! By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 24

Resident Producing Unit or Not? An Citibank Corporation in HK Yes! An Citibank Corporation in USA No! By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 25

Resident Producing Unit or Not? Yes! It depends By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 26

Gross National Product (GNP) Definition: GNP is a measure of the total income earned by residents of an economy from engaging in various economic activities, irrespective of whether the economic activities are carried out within the economic territory or outside. GNP is identical to Gross national income (GNI), which is a contemporary term. By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 27

Residents of an Economy Residents maintain their center of economic interests in an economy. Resident individuals refer to those who normally stay in the economic territory of the economy for at least 12 months or longer, or intend to do so, irrespective of their nationality. Resident organizations (or RPUs) refer to those which ordinarily operate in the economic territory. By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 28

Residents or Not? A foreign domestic helper working in HK Yes A branch of a foreign bank operating in HK Yes A solicitor coming to HK to work on a short-term 3 -month contract for a local company No By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 29

GDP Versus GNP GDP Value of production GNP (Factor) income earned By resident producing unit By residents Factors are owned by residents or nonresidents Within the economic territory Factors are owned by residents only By Mr. LAU san-fat/ver 2004 Within or outside the economic territory CH 1 -National Income Accounting-SV 30

GDP Versus GNP GDP is more relevant for analysis related to production activities within the economy, e. g. employment, productivity, industrial output, investment in equipment & structure. GNP is useful for analyzing economic situations relating to income of residents, investment behavior, domestic demand & inflation. By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 31

Being Included in GDP or GNP? Mr. Chan is now living in HK. He has a toy factory here and earns $2 million this year. HK’s GDP Mr. Chan also has a garment factory in China and earns $1. 2 million this year. A Filipino maid in HK usually gets a longterm contract of two years. She earns $22, 000 this year. A retired old man who is a resident of HK and earns a rental income of $50 000 this year from his house in Australia. HK’s GNP By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV HK’s GNP 32

From GDP to GNP = GDP + (Factor income earned by residents from outside the economic territory – Factor income earned by non-residents from within the economy) = GDP + Net factor income from abroad or External Factor Income Flows By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 33

From GDP to GNP Factor Income = investment income + compensation of employees Investment income = direct investment income(e. g. dividends) + portfolio investment income(e. g. security interest) + other investment income(e. g. deposits interest) By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 34

From GNP to GDP = GNP – (Factor income earned by residents from outside the economic territory – Factor income earned by non-residents from within the economy) = GNP – Net Factor Income from Abroad or Net External Factor Income Flows Ex 2: TB/P. 26/MCQ 6 & 7 Ex 3: TB/P. 27/MCQ 8 By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 35

More About National Income Statistics GDP at factor cost = GDP at market price – indirect business taxes + subsidies By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 36

By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 37

By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 38

More About National Income Statistics GDP at factor cost = GDP at market price – indirect business taxes + subsidies GDP at market price = GDP at factor cost + indirect business taxes - subsidies GDP per capita = GDP/population size Net Domestic Product, NDP = GDP depreciation By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 39

More About National Income Statistics Net National Product, NNP = GNP depreciation National Income, NI = W + I + R + By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 40

Measuring GDP(1): The Product or Output Approach GDP is total market values of all final goods and services produced by the resident producing units of an economy within a specified period. Intermediate goods are excluded to avoid the problem of double counting. In reality, it is hard to distinguish between final and intermediate goods. – thus, value-added method is adopted By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 41

By Value Added Approach (From C. S. D. )GDP is an aggregate measure of the total value of net output of all resident producing units of a country or territory in a specified period. Net output is measured by value added Value added = value of gross output – value of intermediate consumption – Intermediate consumption is the value of goods & services used up during production. By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 42

By Value Added Approach value added = sales revenue - input cost By value added approach, – GDP = summation of value added in ALL stages of production + indirect business taxes (IBT) – subsidies (S) By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 43

Stage 1: Growing wheat Input cost (wheat seeds) = $0. 0 Sales revenue (wheat) = $2. 0 Value added = $(2. 0 - 0. 0) = $2. 0 By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 44

Stage 2: Milling wheat Input cost (wheat) = $2. 0 Sales revenue (flour) = $3. 5 Value added = $(3. 5 - 2. 0) = $1. 5 By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 45

Stage 3: Baking bread Input cost (flour) = $3. 5 Sales revenue (bread)= $6. 0 Value added = $(6. 0 - 3. 5) = $2. 5 By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 46

Measuring GDP: Given: final good: bread ($6. 0) Intermediate goods: wheat ($2. 0) flour ($3. 5) • By Output Approach, GDP = $6. 0 • By Value Added Method GDP = $[(2. 0 - 0. 0) + (3. 5 - 2. 0) + (6. 0 - 3. 5)] = $6. 0 By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 47

Items Being Excluded from GDP Items Reasons Non-marketed or selfsustained products No market value involved l. Reference: TB/P. 21/Closer Look Ex 4: TB/P. 13/Q 2. 1 Ex 5: TB/P. 18/MCQ 4 By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 48

Measuring GDP(2): The Expenditure Approach GDP = C + I + G + (X - M) while (C + I + G + X) = total final demand By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 49

Measuring GDP(2): The Expenditure Approach on ‘C’: only expenditure on consuming final products counted on ‘I’: I = gross domestic fixed capital formation + change in stocks – gross domestic fixed capital formation = expenditure on land, buildings & construction, plant, machinery, equipment & related expenses – change in stocks = unsold goods (values of raw materials & work-in-progress) By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 50

Measuring GDP(2): The Expenditure Approach net investment = gross investment – depreciation Ex 6: Why should the changes in inventories be included in GDP? • TB/P. 15/Closer Look By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 51

Measuring GDP(2): The Expenditure Approach on ‘G’: including payments to civil servants & expenditure on final products while excluding transfer payments on ‘X-M’: net exports = net exports of goods + net exports of services = [domestic exports of goods + re-exports of goods – imports of goods] + [exports of services – imports of services] By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 52

Why M is deducted from the total final demand? The value of imports has to be removed because EACH of the components of C, G, I & X has import contents (both direct and indirect import contents) but it is not possible to remove such. They are therefore removed collectively by the subtraction of M. Hence, GDP = C + G + I + X - M By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 53

Items Being Excluded from GDP Items Reasons Unreported transactions No data is available Illegal transactions No data is available Second-handed goods No current production involved By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 54

Items Being Excluded from GDP Items Reasons Expenditure on stocks, i. e. shares & bonds Expenditure on welfare payments -no production involved -a mere transfer of ownership No production involved Ex 7: TB/P. 11/MCQ 2 EX 8: TB/P. 17/Q 2. 2 By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 55

Measuring GDP(3): The Income Approach By income approach, GDP is calculated as the sum of incomes for the factors of production distributed by the resident producing units in a country or territory, as rewards to their production of goods and provision of services. In other words, GDP is the sum of factors income (arising from production) provided by the resident producing units in an economic territory in a specified period. By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 56

Measuring GDP(3): The Income Approach Factor incomes = compensation of employees (including wages, salaries & other employee benefits) + gross operating surplus of enterprises By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 57

Measuring GDP(3): The Income Approach By income approach, GDP = compensation of employees + gross operating surplus of enterprises + indirect business taxes – subsidies = W + I + R + + depreciation allowance + indirect business taxes – subsidies By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 58

Items Being Excluded from GDP Items Reasons Income from gifts, gambling & lucky draw By Mr. LAU san-fat/ver 2004 No production involved CH 1 -National Income Accounting-SV 59

Comparison of the 3 Approaches Expenditure Approach X I = Imported contents removed at the aggregate level, i. e. deducting M from (C + I + G + X) G C By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 60

Comparison of the 3 Approaches Expenditure Approach X Income Approach Product Approach gross operating surplus Value added: manufacturing sector I G C By Mr. LAU san-fat/ver 2004 Compensation of employees IBT - S Value added: services sector Value added: other sectors GDP at factor cost GDP at market price IBT - S CH 1 -National Income Accounting-SV 61

GDP at Current Market Prices GDP at current market prices/Money GDP/Nominal GDP measures the market value of final goods and services at current market prices. Nominal GDP = P x Q By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 62

GDP at Constant Market Prices GDP at constant market prices/Real GDP measures the market value of final goods and services at the prices of a particular chosen year called base year(with constant general price, i. e. P =1). Real GDP = P x Q = 1 x Q = real output (in current year) Therefore, Real GDP = Real output = Real living standard By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 63

Nominal GDP Vs. Real GDP As nominal GDP = P x Q – nominal GDP = P x Q or = Px Q Thus, nominal GDP real output Thus, nominal GDP real living standard By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 64

Find Real GDP: by Implicit GDP Deflator As (price index of the base year/price index of the current year) = (real GDP/money GDP) and price index of the base year = 100 – implicit GDP deflator = (money GDP/real GDP)x 100 – thus, implicit GDP deflator = price index of the current year – thus, real GDP = money GDP x (100/price index of the current year) By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 65

Money GDP, Prices & Real GDP If %↑money GDP > %↑P ↑real GDP If %↑money GDP < %↑P ↓real GDP If %↑money GDP = %↑P real GDP If %↑money GDP & %↓P ↑real GDP By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 66

Money GDP, Prices & Real GDP If %↓money GDP & %↑P ↓real GDP If %↓money GDP > %↓P ↓real GDP If %↓money GDP < %↓P ↑real GDP If %↓money GDP = %↓P real GDP By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 67

Money GDP, Prices & Real GDP If %↑money GDP > %↑real GDP ↑P If %↑money GDP < %↑real GDP ↓P If %↑money GDP = %↑real GDP P If %↑money GDP & %↓real GDP ↑P By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 68

Money GDP, Prices & Real GDP If %↓money GDP & %↑real GDP ↑P If %↓money GDP > %↓real GDP ↓P If %↓money GDP < %↓real GDP ↑P If %↓money GDP & =%↓real GDP P Ex 9: TB/P. 28/MCQ 9 By Mr. LAU san-fat/ver 2004 Ex 10: TB/P. 30/MCQ 10 CH 1 -National Income Accounting-SV 69

The Growth Rate of GDP growth rate = [(GDP of current period – GDP of last period)/GDP of last period] x 100% Real GDP growth rate = [(real GDP of current period – real GDP of last period)/real GDP of last period] x 100% Ex 11: TB/P. 31/MCQ 11 Ex 12: TB/P. 32/MCQ 12 By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 70

Uses of National Income Statistics as a measurement of living standard as a basis for international comparison of welfare or living standard as a basis formulating government policies as a basis formulating business decisions as an indicator of economic progress Ex 13: TB/P. 37/MCQ 13 By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 71

Limitations of National Income Statistics nominal GDP neglects the effects of price change – real GDP is preferred By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 72

Limitations of National Income Statistics real GDP neglects the effects of population size – real GDP per capita is preferred By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 73

Limitations of National Income Statistics real GDP per capita ignores the problem of income distribution – uneven distribution of income implies the problem of widening income gap By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 74

Limitations of National Income Statistics real GDP per capita ignores the effects of self-sustained products, non-marketed goods & unreported transactions – real GDP per capita underestimates the real standard of living By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 75

Limitations of National Income Statistics real GDP per capita ignores the desirable and undesirable effects of production real GDP per capita neglects the effects of composition of GDP – larger portion of consumer goods supports a higher present living standard while larger portion of capital goods implies a higher future living standard Ex 14: TB/P. 38/MCQ 14 By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 76

Factors Affecting National Income Demand-side Factors: – consumption (C) demand – investment (I) demand – government expenditure (G) demand – net exports (X-M) demand By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 77

Factors Affecting National Income Supply-side Factors: – labor productivity – amount of capital (goods) – amount of land – level of entrepreneurship – level of technology Ex 15: TB/P. 39/MCQ 15 Revision Ex: TB/P. 43 By Mr. LAU san-fat/ver 2004 CH 1 -National Income Accounting-SV 78