How are national income, expenditure and product measured?

1428 words (6 pages) essay in Economics

5/12/16 Economics Reference this

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In the realm of macroeconomics, national “income”, “expenditure” and “product (output)” are key terms when analysing and understanding a nation’s economic activity. National Income accounts are used to measure how much income, expenditure and output is being induced as a result of a country’s economic activity. In essence, national income is the estimated monetary value of the flow of goods and services over a period of time [1] . Essential to this operation is the Gross Domestic Product. By using the “income method” the “expenditure method” or the “output” method, the Gross Domestic Product (GDP) can be obtained [2] . GDP refers to the value of all final goods [3] produced in an economy and measuring it aids governments keep track of the nation’s economic status [4] . Despite its practicality there are limitations to these methods’ accuracy in terms of indicating the standard of living.

As previously stated, GDP can be determined by the three methods mentioned above, which in theory should all give the same result [5] . The most clear-cut of which being the product method [6] which basically determines total output by summing up all existing production within a countries borders. [7] 

The logic behind the expenditure method is that total product must be consumed [8] , therefore households’ total expenditure should equal the value of the total product. As far as economies are concerned, the motivation behind producing a good or service is to have it sold [9] . Assuming that all produced goods are sold, one could measure GDP by measuring the total amount of money used by households to consume these goods [10] . GDP components are useful when measuring in terms of expenditure [11] . The equation for measuring GDP or in this case Y is as follows:

Y = C + I + G + (X – M)

GDP is the sum of consumption, investment, government spending and exports subtracted by the value of imports. [12] 

Whereas the income method follows that GDP can be determined by summing up all producers’ incomes, stating that they should equal the value of their product [13] . By summing the total value of incomes firms pay for households’ factors of production. This is to say that a firm uses household labour in exchange for wages, interest for capital, rent for land and profits are granted as a result of entrepreneurship [14] . Similarly, GDP can also be obtained by measuring total income. In theory, the values obtained by both manifestations of the income method should be identical, however in practice errors in measurement will conclude with these values being slightly off. [15] 

One of the fundamental issues that is presented when preparing national economic accounts is what limits to set for the production boundary [16] . In other words, which selection of human activities is to be included or neglected from the measure of production in an economy [17] . One would think that all market-intended output would be included in the boundary. The term “market output” refers to anything which is produced for purchase, at an “economically significant” price. The “significance” in the price lies in its ability to influence producers on how much they are willing to sell and how much consumers are willing to buy. An exception being illegal goods and services which even if are sold at economically significant prices are nevertheless excluded [18] . Similarly, natural production processes that have not undergone tampering by external forces are also excluded [19] . Furthermore, services provided from one party to another free of charge (like favours or friendly gestures) such as meal provision and preparation, cleaning, emotional support as well as care of sick or elderly is also not included [20] . Similarly, transfer payments are excluded as well. Pensions paid to retirees, low income families receiving financial support as well as the unemployed, and other versions of welfare assistance like child support or housing support are also excluded [21] .

Although these exceptions were presented as an issue in truth they are an inefficiency. In the process of procuring a value for GDP by using the methods stated, certain factors, economic interactions and activities are neglected from the record. Such examples include, as previously mentioned, the “underground economy” or the “black market” in which economic behaviour generating production (illegal trade, tax-avoidance) is unreported resulting in an underestimated GDP.

The inability to adjust to a quality improvement and new goods leads to GDP understating true economic growth. Today’s computers for example are cheaper and have increased performance than computers produced in the past. By only accounting for their monetary value, GDP treats them as the same product. In general the introduction of new goods and services can not be measured accurately seeing that these types of occurances are not reflected in GDP neglecting the fact these improvements may increase the standard of living.

In conclusion, measuring how much income, expenditure and product has been brought about over a certain period of time requires the use of national income accounts. National income accounts measure three quantities. The total value of produced goods and services within the border of a country, the total value of expenditure undergone in an economy and the total amount of income generated as a result of producing these goods and services. As previously mentioned, national income measures the monetary value of the circulation of goods produced in a country within a certain period of time. The level and rate of growth of national income is an essential value for economists, owners of businesses, and especially heads of state when considering the rate of change of economic growth [22] , change as a result of time in terms of average living standards of a society, as well as changes in terms of income distribution among different groups of the population [23] , in other words it measures the magnitude of income and wealth inequalities in a society. Moreover, these measurements indicate what point in the business cycle the economy finds itself in. This indication can prove itself to be particularly useful to leaders in the business world and the government (indicating whether the economy is experiencing a recession or inflation etc.). At the center of these measurements lies the Gross Domestic Product, and the three methods of calculating it are the income method, the expenditure method and output method. Although GDP measures the total output produced in an economy over a given period of time, it fails to consider certain transactions. Despite its use to organisational entities, as explained previously there are vast limitations to these measurements that conclude with undervalued/underestimated GDP figures.

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