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Calculating National Income
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SSC351 Study Guide

 

  1. In an economy, firms use factors of production to produce goods and services. The total value of final goods and services produced by all firms in an economy is called National Output. The use of production factors will create factor income. The total income received from factors of production is called National Income. The national income received by households will be used to buy the national output. The total amount spent on national output is called National Expenditure. It can be concluded that National Output = National Income = National Expenditure.
  2. In national income accounting, three approaches may be used. These are the (a) output approach, (b) income approach, and (c) the expenditure approach. Since National Output = National Income = National Expenditure, all three approaches will yield the same answer.
  3. Output Approach: When using the output approach to calculate national output/income, we must differentiate between final goods and intermediate goods as well as the value of imported goods. Final goods are goods that are used by consumers without the need of further processing, like shirts. Intermediate goods are goods that need to be processed further, like cloth when making shirts. Imported goods are goods bought from an alien country, for example, cotton bought from the United States. In the output approach, we add the value added to each intermediate goods as it goes through the production process. We only add the value added to each intermediate good to avoid the problem of double counting. If the production input involves imported goods, the value of these goods is deducted because the output approach takes into account the value of domestic output only. Study the following table and the explanation that follows to understand the concept better.

Output Type

Output

Output Value (RM)

Value Added (RM)

Intermediate Good

Cotton

100

100 - 0 = 100

Intermediate Good

Cloth

200

200 - 100 = 100

Final Good

Shirts

300

300 - 200 = 100

Total (RM)

 

600

300

    1. Cotton and cloth are intermediate goods, while shirt is the final good.
    2. In the output approach, we add values to cotton, then to cloth, to become shirts with the final value of RM300.
    3. The output value of cotton of RM100 and the value of flour at RM200 are not added because both are intermediate goods in the production of shirts.
    4. If you take the output value total of RM600 (column 3), there is double counting. In the output value of RM600, you have double counted cotton, cloth, and shirt. Why? Because in the final value of RM600, included is the output value of cotton RM100, Cloth RM200, and Shirts RM400. Double counting makes the calculation inaccurate.
    5. The final output should be RM300 (column 4).

Remember that if the production input involves imported goods, the value of these goods is deducted because the output approach takes into account the value of domestic output only. For example, if in our example above cotton is an imported good, then it is deducted from the final good value. RM300 - RM100 = RM200

Income Approach(factor cost) 

1.    National income is calculated by totaling all income received by the private and public sector of a particular country in a year.

2.    Income refers to factor income paid for the various factors of production like labour, capital, land, and entrepreneur to produce national product.

3.    Factor incomes consist of rent, profits, interest, wages, salaries, and the like.

4.    National Income (Net National Income fc) = wages and salaries + interest +profits + rent.

         Salaries and wages are income from labour.

         Rent is income received from fixed asset like buildings and land.

         Interest is income from capital.  Only net interest is included in national income.  Net interest is interest that exclude interest on national debt (loan) and interest on personal debt (loan)

         Profits are income received by entrepreneurs.

5.    Transfer payments are not treated as national income because these are payments that do not involve factors of production.  Examples of transfer payments are:

         Interest on government loans.

         Financial aids received by students.

         Welfare payments.

         Housewives’ allowances.

         Interest on consumers’ loans.

         Pension payments.

         Aids for the poor and needy 

6.    NNPfc = GNPmp + subsidies – indirect taxes – depreciation

7.    GNPmp = GNPfc + indirect taxes – subsidies + depreciation

 

Item

$ (million)

Salary and wages

8000

Rent

1000

Net Interest

1000

Corporate Profits

2500

Profits/Income of sole proprietorships

1500

NATIONAL INCOME

14000

Transfer payments

2000

Less  :  Socso Payments

2500

Less  :  Undistributed Corporate Profits

1500

Less  :  Taxes on corporate profits

500

PERSONAL INCOME

12500

Less  :  Personal Income taxes

2000

DISPOSABLE INCOME

10500



Transfer payments is part of personal income but not national income.  Why? Payments do not involve factors of production. 

Expenditure Approach. (Notes available later)