Three methods exist for measuring national income – the output, income, and expenditure approaches. The output approach measures the value added or intermediate output at the industry level in a year (Yin). Nations estimate the gross output in various sectors, the intermediate output, and the decrease in the value of assets from depreciation. The GDP then results from either adding up all the different components of intermediate output or subtracting the value of depreciation from the gross output or the intermediate output. For instance, if the cost of pig iron, rubber, steel, and other components used in making a car are $400, $750, $600, and $58,250 respectively; GDP = 400 + 750 + 600 + 58,250 = 60, 000.
The income approach sums all the income that accrues to the factors of production in the form of rent, interest, wages or salaries, and profit (Yin). Thus;
National Income = Compensation to workers (Wages) + Rents + Interest + Proprietor’s Income + Corporate Profits
= 4,700 + 1750 + 450 + 574 + 620 = 8,094
The expenditure method measures the total final product spent by economic agents – business, household, government, and foreign sectors. Thus, the income-expenditure model has four components – consumption (C), investment (I), government (G), and net exports (X-M), where X represents exports and M represents imports i.e. GDP = C + I + G + (X-M). For example, if personal consumption 7,620, domestic investment 834, government expenditure 3,210, and exports 533;
Y = C + I + G + NX
Y = 7620 + 834 + 3210 + (533 – 659) = 11,538
The general prices in the economy can be determined by calculating the Consumer Price Index (CPI) – the prices of goods and services that households buy for consumption (Boundless). It determines the changes in prices of a given market basket of commodities. Calculating the percentage change in the index gives the level of inflation in an economy. For multiple items,
CPI = Cost of market basket at current period prices x 100
Cost of market basket at base period prices
For example, if the price of bread and a gallon of milk is $12 and $20 respectively in the base period and $25 and $15 respectively in the second, the CPI for two loaves of bread and three milk gallons is;
CPI = 2 (25) + 3(15) X 100 = 113.1
2 (12) + 3(20)
Nations implement macroeconomic policies based on the expenditure approach. During recessions, an expansionary fiscal policy through injection of government funds into the economy creates employment. Individuals receive income and raise their consumption thus stimulating aggregate demand. Firms increase production to meet this demand further increasing employment, output, and income. An expansionary monetary policy affects interest rates. During recessions, the central bank lowers the reserve requirement ratios for banks, enabling them to lower lending rates. Firms borrow funds to finance investment, thereby increasing output and income. The opposite mechanisms occur with the implementation of contractionary fiscal and monetary policies during periods of inflation.
Works Cited
Boundless. "Defining and Calculating CPI." Boundless. N.p., n.d. Web. 19 Apr. 2016. <https://www.boundless.com/economics/textbooks/boundless-economics-textbook/measuring-output-and-income-19/cost-of-living-95/defining-and-calculating-cpi-360-12457/>.
Yin, Sam C. "National Income: Theory and Measurements." Future Website of Choonyin. N.p., 2003. Web. 19 Apr. 2016. <http://choonyin.tripod.com/nationalincome/>.
