National Income Analysis

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The Social Science Encyclopedia, Second Edition

In any economy every year there are millions of transactions which combine to give the overall level of economic activity. It is the classification, presentation and study of statistics relating to such transactions which is the concern of national income analysis. Such information is vital to policy makers in assessing what changes are needed in short-term economic policy and in assessing long-term performance of the economy, the latter being of particular interest to developing economies. International organizations may use national income as a basis for allocating aid or demanding contributions to their budget.

The first works in national income were by Sir William Petty and Gregory King in England in the seventeenth century. Modern pioneers include Kuznets in the USA and Bowley, Stamp and Clark in the UK. The development and use of Keynesian economics gave a great impetus to national income analysis during and after the Second World War with Richard Stone, Nobel Laureate 1984, as the leading figure (Stone and Stone 1965).

The central point of national income analysis is the measurement of the amount of economic activity or national product: that is, the value of all goods and services crossing the production boundary. There are three methods of arriving at this aggregate figure. First, the income method totals all incomes earned in economic activity in the form of wages, rent and profits (including undistributed amounts). Old-age pensions and similar transfer payments are excluded as not representing economic activity. Second, the expenditure method totals all items of final expenditure—private and government expenditure on current consumption and industrial and government purchases of capital equipment. Payments by one firm to another for raw materials or components or other inputs must be excluded. Such items of intermediate expenditure are used up in the production process and do not cross the production boundary. Third, the production method looks at each firm and industry and measures its value added—the value of its output less the value of intermediate purchases from other firms. This represents an individual firm’s contribution to the national product.

When due allowance is made for imports and exports, these three methods will, in principle, yield identical estimates of national income. In practice this is not always the case due to a less than perfect supply of information to government statisticians who are required often to reconcile three slightly differing estimates.

It is generally agreed that national income is a measure of economic activity. Unfortunately there is no general agreement about what constitutes economic activity, that is, where to draw the production boundary. Transfer payments and intermediate expenditures have been noted as transactions which are excluded because they do not cross the production boundary. Many countries follow the UN System of National Accounts (SNA) and include all goods and services (including the services of government employees) for which there is a payment, either in money or in kind. The principal difference occurs in the Soviet Material Product System (MPS) which emphasizes material output and excludes government services and many personal services such as entertainment and hairdressing.

Whatever definition is adopted, there are three different pairs of concepts of national income which can be used. First, a measure of gross national product makes no allowance for depreciation—wear and tear of capital equipment. Net national product subtracts an estimate of depreciation from the gross measure, and is a more accurate reflection of the achievement of the economy. Second, if expenditures are valued at the prices paid by purchasers they will include indirect taxes and will yield a measure of national income at market prices. For many purposes of comparison, both internally and externally, it is desirable to deduct indirect taxes (and add on any subsidies) and obtain a measure at factor cost, which is the essential costs of production. Such a measure is obtained automatically using the income or production methods. The third pair are measures of gross domestic product (GDP) and gross national product (GNP). The former relates to all economic activity taking place within the geographical limits of the economy. The latter measures economic activity carried out by the resources—labour and capital owned by national members of the economy. In many developing countries dependent on foreign capital, the outflow of profits means that GDP can exceed GNP by up to 20 per cent. These pairs of concepts can be combined in various ways, the most common being gross domestic product at factor cost.

The three methods of measuring national income serve as a focus for different analyses of the aggregate. The income accounts can be used to analyse the shares of wages and profits in total national income and the equality, or otherwise, of the distribution of this income to individuals. The details of the production accounts enable one to examine the relative importance of different industries (for example, manufacturing and services), of different regions in the country, or of privately and publicly owned production. On the expenditure side, much attention has focused in Western Europe on the split between private and public spending. In general, economists are interested in the division between consumption and investment (the purchase of new capital equipment). Here national income analysis is very closely related to macroeconomics and the study of what determines the size of these items and how changes in them affect the overall level of national income.

All transactions are measured in money terms and give national income in current prices, but it is necessary to allow for price changes when making comparisons between years. Values at current prices are adjusted by an appropriate index of prices in order to obtain estimates in constant prices. Any observed changes will then reflect only changes in quantity and not in price.

National income analysis originated in the measurement of production, income and expenditure aggregate flows, but gradually more and detailed transactions have been included. The analysis of transactions between firms and industries known as input-output analysis is a separate topic. Borrowing and lending, that is, transactions in financial assets, are analysed in a flow-of-funds table, and the accounting system can be extended to include stocks as well as flows. National balance sheets record the value of assets, financial and physical, held by members of the economy at the end of each accounting period. The presentation and analysis of this more complicated system of accounts is greatly facilitated by showing the data in a large square table (see Table 1) recording transactions between sectors of the economy in the columns and those in the rows. Known as a social accounting matrix, this is the most recent methodological development in this field.

A.G.Armstrong

University of Bristol

Stone, R. and Stone, G. (1965) National Income and Expenditure, 7th edn, London.

Abraham, W.I. (1969) National Income and Economic Accounting, Englewood Cliffs, NJ.

Beckerman, W. (1976) An Introduction to National Income Analysis, London.

See also: investment; national wealth.

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