Investigating the three methods of calculating national income (GDP/GNP)
A government can calculate the level of economic activity by trying to measure:
- the total amount of output produced (the output method), or
- the income generated from producing it (the income method), or
- the total expenditure on purchasing it (the expenditure method).
Governments calculate how much output, income, and expenditure takes place in the economy in one year.
Syllabus says: You need to be able to Distinguish between GDP and GNP/GNI as measures of economic activity.
NB GNP and GNI are identically the same thing so the terms can be used interchangeably
So GDP definition: Gross Domestic Product is a measure of everything produced by an economy within the economy
And GNP/GNI is a measure of everything produced by an economy within the economy (GDP) PLUS everything produced by an economy outside the economy
To find national income account data relating to these three accounting methods for countries within the Organization for Economic Cooperation and Development (OECD), the StatExtracts site is particularly useful.. You can see the site in the web window below, or follow the previous link to open the site in a new web window.
Find the national accounts link by scrolling down the list on the left hand navigational bar and examine the different measures of national income.
You need to be able to:
Distinguish between the nominal value of GDP and GNP/GNI and the real value of GDP and GNP/GNI.
Remember: Nominal is to do with money flows and real is to do with physical things
You need to be able to:
Distinguish between total GDP and GNP/GNI and per capita GDP and GNP/GNI.
If country A had a total GDP of $1000 and country B had a
total GDP of $1500 can we make a valid conclusion as to which country
is doing best?
However, in practice a number of difficulties arise when trying to accurately calculate income, output and expenditure.
These difficulties include:
- The unofficial, shadow or informal economy - in which the output is not declared. This is because some producers do not want to pay tax or may be involved in illegal operations. If we look at the expenditure and income methods of measuring national income, we can get some idea of how much undeclared work might be happening. Some of us will be spending income we have not declared! Whatever the scale of this shadow economy, it means that a part of the GDP is understated. The size of the unofficial economy will vary from country to country.
- Non-marketed goods and services - some transactions do not involve money changing hands. For example, people undertaking voluntary work or helping decorate a friend's house does not appear as earned income, but it can be argued to be part of the production of the economy. Similarly, in less developed countries, much economic activity is part of the subsistence economy in which people grow/make things for themselves and the goods are not sold for money in markets. It has been argued passionately by some that women who stay at home to look after children should have this service valued and included in national income.
- Government spending - in the expenditure method of calculating national expenditure, government spending on goods and services is included. However, some government expenditure goes to producing public goods, for example defence, which are not sold. So there is a problem in ascribing an appropriate value to these goods for national income calculation.