National Income Accounting
These notes are designed to supplement the text for national income accounting (lectures 6
They allow you to fill in some of the gaps where the text lacks a bit of detail and we don’t
cover this level of detail in class.
The Factors of Production
From picking apples off a tree to designing and building space stations, all production
requires some effort and inputs. These inputs or ‘ingredients’ are classified according to
general groupings known as the factors of production, which are:
This category includes land, along with all natural resources like the sea,
animals, wind and other elements.
Human effort, rewarded with wages and salaries.
Goods which assist in the production of other goods and services. Examples of
capital items are tractors, factories, computers, buildings and high tech
Human nous and skill at organising and managing the other factors of
production. Output and Growth
The most widely used and conventional measure of a country’s “economic size” or national
output is Gross Domestic Product (GDP). GDP is the value of final goods and services
produced in a country over a specified period of time; usually a quarter (3 months) or a year.
Note the use of the word ‘final’ in the above definition. It would be considered double
counting if we were to include in GDP both the price of a loaf of bread and the price of its
ingredients to the baker and other producers. The market price of the loaf indicates the sum
value throughout all its stages of production; from the costs of the seed for the farmer through
to the retailer’s profit.
Gross Domestic Product can be calculated in three ways:
1. The Income Approach
Adds together all of the payments received by the factors of production which contribute to
GDP. Factors of production are items which cause production to be possible, historically
labelled as land, labour and capital. Land includes all natural resources, while capital is
equipment, machinery and tools. Note that in economics, capital is not money or equity. In
our subject, capital consists of physical goods which have been produced to assist in the
production of other goods or services. Also, it is worthwhile noting that modern economists
sometimes include a fourth factor of production, namely entrepreneurship. This is human
intelligence, vision and skill at managing and combining the other factors of production.
In addition to the returns to the factors of productions, two other items are included in the
income approach to ensure that this method actually measures the market value of current
production. Consumption of fixed capital is the technical term for depreciation. This must be
added to the sum of incomes because the “gross” in GDP indicates that depreciation has not
yet been deducted (if it has, then the resulting figure is net domestic product - NDP). Indirect
taxes are added to incomes as well because these are included in market prices, but do not
generate income for producers (but go the government instead). For the converse reason,
subsidies are subtracted.
Compensation of Employees (wages, salaries etc)
+ Operating surplus (profits)
+ Consumption of Fixed Capital (depreciation)
+ Indirect Taxes
= GDP at market prices, income approach. 2. The Production Approach
This technique aggregates together the values added at each stage of production. In New
Zealand, around 70 production sectors are subject to these calculations.
Each of these sectors makes a contribution to GDP. The sum total of these contributions gives
GDP for the economy as a whole.
By way of example, let’s return to the bread scenario alluded to earlier. The following figures
are the values of gross output (which is the product’s dollar value as it leaves the industry)
and intermediate consumption (the product’s dollar value as it enters the industry). Value
added at each stage is simply the difference between gross output and intermediate
Gross Output Intermediate Consumption Value Added
Farmer (and prior) 30c 0c 30c
Miller 70c 30c 40c
Baker $1.00 70c 30c
Retailer (GST incl.) $1.50c $1.00 50c
Value Added (total): $1.50
Note that the value added calculation equals the price of the final product (i.e. the loaf of
bread). This must be the case, and ensures consistency between the production approach and
the third method, the expenditure approach. For NZ data, see Scollay and St John, p 85.
3. The Expenditure Approach
Adding together the expenditures on New Zealand made goods and services also provides the
country’s GDP. Forms of expenditure are categorised as follows:
C Final Private Consumption Expenditure.
This is business spending on capital goods (such as buildings,
equipment and machinery).
G Government Spending on Goods and Services.
Local and central government spending on g&s, like roads, street lights
and state employees’ salaries. DOES NOT include benefits and
handouts, which economists call ‘transfer payments’. This is because
transfer payments are not actually purchasing goods or services.
X Exports of goods and services. less M Imports of goods and services.
By definition these are not produced here and so can not be considered
to form part of NZ’s domestic production.
ΔR Change in the Value of Inventories.
This records the change in value of unsold stocks, raw machinery and
work in progress (and, in NZ, the change in the value of exotic forests).
These commodities, though not sold, have still been produced and
hence should form part of GDP.
So, from the expenditure approach:
GDP = C + I + G + X - M + ΔR
This is an important macroeconomic identity! Note also that the compound term X - M is
referred to as net exports. In practice we will disregard ΔR as its value is small and can be
positive or negative.
To ponder: Economists define a state of equilibrium as a situation in which the quantity
(or value) of goods and services produced is equal to the quantity (or value) of
goods and services consumed. Therefore, macroeconomic equilibrium implies
what for the term ΔR?
New Zealand’s current level of GDP is about $140 billion, which translates to a per capita
figure of about $42500.
Related Measures of National Income
Gross National Expenditure (GNE)
Is the total of expenditure in New Zealand; so includes imports but not exports.
GNE = C + I + G
Gross National Income (GNI)
Previously known as Gross National Product, (GNP), GNI is the total value of goods and
services produced by New Zealanders, rather than in New Zealand which is what GDP
measures. So GNI adds the overseas returns of NZ factors of production but excludes the
returns earned in New Zealand of foreign factors of production.
GNI = GDP + Factor Receipts from Rest of World - Factor Payments to Rest of World
= GDP + Net Factor Receipts
Factor receipts/ payments include wages and salaries, profits, interest and share dividends. A
foreign entity, from NZ’s perspective, is defined as non New Zealand resident, be this a
person or a company. New Zealand invariably has a negative balance on its net factor receipts because more
residents of NZ send their income overseas than the reverse. Some countries, like the USA,
have a positive net factor receipt balance. This means that their GNDI is larger than their
Net Factor Receipts is also known by the term ‘net international investment income’.
Shortcomings of GDP and its Related Measures
GDP and the other measures of national income we have touched