Measuring national income and its impact on standard of living

National income is a very basic concept in macroeconomics about which we should how much output our economy is producing over a given period of time. National income statistics give us much information about how a nation’s economic growth and related objectives such as: quality of life, standard of living of one country compared to another. In this essay, I have a closer look in measuring national income and its significance on a nation’s well-being.

National income, as known as Gross Domestic Product (GDP), is the money value of total goods and services produced within a country over a twelve-month period. This annual figure is very helpful to the economists to track the economic growth’s rate, average living standard in one country as well as the distribution of income between different groups of population (i.e. inequality gap). Three major components of national income accounts are: output, spending expenditure and income; which respectively represent three methods of measuring GDP. We will study these three methods in turn and consider which factors should be taken into account to achieve accurate figures.

Firstly, GDP value can be measured by adding up the total final value of goods and services that are manufactured within an economy, industry by industry using the concept is value added. Value added is defined as the increase in the value of a product at each consecutive stage of the production process. The reason for this approach is to avoid the problems of double-counting the value of intermediate inputs. To the best of my knowledge, there are three productive sectors in an economy: primary (agriculture goods), secondary (manufactured goods) and tertiary (services), quaternary (research and development). There has been a strong increase in volume of output in the tertiary sector. The table below illustrates how the recent data has contributed to a structural change in the economy.

As we can see from the table, the gross value added figure of mining and quarrying and manufacturing has observed a continued decline in output from the period of five years (2001-2004) whereas distribution, hotels, catering together with business services were enjoying a strong growth in total production. So far, the largest share of total national output (GDP) comes from our service industries. Noticeably, there have been divergences created between secondary and tertiary sectors of the British economy. In fact, the service area has made a speedy jump over the past decade compared to manufacturing trend line which is quite gradually fluctuate until 2006, shown in the chart below:

Second, we can also generate national income level by adding up total incomes of each individual household from production in form of wages, salaries, profits, rents and interest. It is important to take notice that only those incomes that are actually generated from production activities count for the GDP calculation. By that we have to exclude: Income that is not registered with the Inland Revenue or Customs and Excise (underground economy earned income), transfer payment from Government (income support, unemployed benefit, state pension…) This is known as Factor income earned from firms method.

Following simple circular flow of income and expenditure between households and firms, the third method focus on all domestic expenditures and spending are made throughout the year to consume the nation’s production, also called aggregate demand. Assuming there is no injections and withdrawals interference, the value of all products sold must therefore be the value of what are produced. We use this expenditure method to calculate this sales value. The full equation for GDP using this approach is: GDP = C + I + G+ (X – M) where C is total consumption, I is Investment, G is Government spending, X and M imply Exports and Imports of both goods and services in international trade sector.

Moreover, either calculated by any method above, the figures outcome should generate the same amount as the following relation holds true: National product is equal to National Expenditure (Aggregate Demand) and equals to National Income.

General speaking, GDP can be regarded as an indicator to measure the size of its economy. When reading national income statistics or making sensible comparison of one year’s to another, we should take into account some factors that might influence the its accuracy. We have to adjust for inflation. For instance, if this year national income has gone 10 per cent higher than last year figure but meanwhile price level has also risen by 10 per cent, then the average person will be no better off at all. Real national income (income after inflation) should increase by a faster rate than that of inflation, hence intriguing a positive economic growth. What about population? GDP per-capita is a basic way of measuring average living standard for the citizens.

UK is a high-income country by international standards, however, its GDP per capita still not at the very and behind some countries like USA which is apparently a strong economy. We have known China – the third largest economy in the world and its currency have been said to likely overtake US dollars. However, in fact GDP per capita (GDP per head) of China is only 11 per cent than that of USA. We seem to be more interested in the output or income per head rather than the total GDP output figures. Besides, we face a big problem when comparing GDP figures of different countries due to exchange rates. But exchange rate might be a poor indicator of purchasing power of the currency over other countries. Let’s say £1 in UK may exchange for 30,000VND (Viet Nam currency) but no one can guarantee that £1 can buy the same amount of goods as 30,000 in Viet Nam, more or less. Luxembourg obviously has lower level of national income than UK but in the chart, its GDP per capita leads the other countries. Thus, the European Commission publishes the purchasing-power parity rate as a common currency to convert GDP.

Source: OCED.com

To some extent, after taking inflation, exchange rates and the size of population, GDP is quite useful in measuring level of income within one nation, provided that we are clear about distinctions of different measures. However, when it comes to living standard or welfare of the inhabitants, it is not necessarily true that we take GDP figure as a perfect key indicator and rely exclusive on it to measure one country’s well-being as it involves many other problems. To understand the relationship between national income and living standards, we define living standards as material welfare of the inhabitant in an economy. The basic measure of the standard of living refers to per capita real GDP. It is found by dividing real GDP by the size of the population (Geoff Riley, Eton College, September 2006)

The underground economy is a big pain that economists might experience when trying to find the precise rate of growth of national income/output. They might either underestimate or overestimate the level of all economic activities taking place every day. The underground economy comprises of illegal and unclaimed transactions. These transactions could be illegal productions/ consumption of illegal goods such as drugs, weapons, prostitution, or sometimes people hide money earned transactions from authorities for high tax purposes and avoid losing benefits. A shop would be more pleased to receive cash from customers in order to avoid VAT. A person does extra evening job but does not declare his income, known as “moonlighting” In this case, the loss of national income from production of output becomes out of control. In addition, using production of output may be a poor indicator to determine nation’s well-being for some reasons. Firstly, because production involves externalities and social costs such as: pollution, problem of global warming, human costs. GDP ignores these external costs and only record the rapid growth in the national statistics. Some production of bad causes also lead to an increase in total expenditure hence raising GDP. More serious crime commitment in the society result in more expenditure on security enforcement, rise in illness will lead to an increase in health care service, so on and so forth. These undesirable effect may literally pull up the GDP. On the other hand, the distribution of disposable income is not considered in GDP when inequality gap problem might arise. GDP per capita of some classes of society probably rise but making others worse-off. By this we mean GDP information is not adequate and reliable enough to determine one nation’s welfare.

On the other hands, there are various aspects of life we should put high priority if we desire to gain high living standard and happiness of citizens. By providing more access to clean water and sanitation services, internet supply, and subsidising education support for poor children, less environmental issues, reducing inequality gap between the rich and the poor, improvement on working hours and conditions of labour, we aim at greater self-sufficiency economy and balance between both materialistic and spiritual life for residents. According to UN water expert Brian Appleton:”The equivalent of 12 jumbo jets of children die every day from sanitation-related diseases”. The commission says that everyone could have clean drinking water and improved sanitation facilities within 25 years if governments made water provision a priority.”, as from BBC news (2000).

To conclude, it does not mean we can reject or rely completely on the GDP figures as a means of judging economic performance. Although GDP statistics cannot express to be a good tool of measuring economic health, they are still effective measurement of output and income.

Biography:

John Sloman & Alison Wride, “Economics”, seventh edition, (2009), Pearson education.

Geoff Riley, Eton College, September 2006, revision note from tutor2u.com

Available at:

http://tutor2u.net/economics/revision-notes/as-macro-national-income.html

and

http://tutor2u.net/economics/revision-notes/a2-macro-national-income-living-standards.html

Wikipedia: available at:

http://en.wikipedia.org/wiki/Economy

‘Billions without clean water’ (March 2000) Available at: http://news.bbc.co.uk/1/hi/676064.stm