National Income and Balance of Payments AccountsP a g e | 1

Key Principles of National Income

1. Only output produced during a particular year is included2. Includes only official market transactions3. Transfer payments (no output generated) are not included

Gross Domestic Product (GDP)

1. Total monetary value of all final goods and services produced by residents within the geographical boundary of the country

2. Singapore measures its GDP using the (i) Product-based approach and (ii) Expenditure approach, as it better reflects Singapore’s move towards a service-based economy

GDP vs GNP

1. National – owned by the nationals of the country2. Domestic – located within the geographical boundaries of the

country3. Difference: Inclusion/exclusion of factor payments from

abroad

Nominal vs Real

1. Real GDP = NominalGDP

Price Index of the given yearX100

Per Capita

1. Real GDP per Capita = RealGDP

Total PopulationX100

2. Standard of living refers to the amount of goods and services at one’s disposal to enjoy (income earned as it represents his purchasing power)

Account Methods

1. Product approacha. Measures the value added at each stage of

productionb. Value added – increase in the value of a product at

each successive stage of the production processc. Value added = Value of output – Value of

intermediate inputs2. Income method

a. Measures the sum of the final incomes earned through the production of goods and services

3. Expenditure Methoda. Sum of the final expenditure on a country’s goods

and services produced within the countryb. GDP = C + I + G + (X-M)c. GDP derived is at market priced value, where

output value is distorted by net taxes (taxes – subsidies). Taxes are removed and subsidies are included to convert to factor cost value.

Accounting Concepts

Gross vs Net

1. Capital replacement is needed for depreciation of existing capital assets

2. Net investment = Gross investment – Depreciation

Market Prices vs Factor Costs

1. Market prices show the valuation at prices actually paid on the market

2. Factor cost shows the factor incomes generated from the production of goods and services

3. GDP at Factor Cost = GDP at Market Prices – Indirect Taxes + Subsidies

Personal Income

1. Personal Disposable Income = Personal Income – Taxes

Use of National Income

1. Standard of living measurement2. Economic growth rate measurement3. Economic sectors analysis4. Expenditure pattern analysis5. Income distribution analysis6. Business planning by firms

Statistical Basis in Comparisons using National Income

1. Time comparisona. Use real GDP per capitab. Compare between different time periods

2. Space comparisona. Use real GDP per capita in US$b. Compare between different countries

Limitations in Measuring Standard of Living

Measurement problems

1. Statistical accuracy differs between two countries2. Under-declaration and non-accountability of activities3. Poor administration and lack of communication (in developing

countries)

Interpretation problems

1. Income distribution2. Quality and type of goods and services produced3. Externalities are ignored4. Composition of output5. Leisure and human costs of production are not taken into

account

Purchasing Power Parity

1. Measures the amount of foreign currencies needed to buy the same basket of goods and services in the 2 countries

2. Eliminates differences in price levels between countries3. Preferable because it reflects the relative costs of goods and

services in various countries

Limitations

1. Quality of products not taken into account2. Difference in basket of goods consumed (different lifestyles)

Alternative Indicators of Standard of Living

1. Physical Quality of Life Index (PQLI)a. Life expectancy at age 1b. Infant mortalityc. Literacy rates

2. Measure of Economic Welfare (MEW)a. Value of leisureb. Value of non-marketed activitiesc. Discounting for externalities

3. Human Development Index (HDI)a. Life expentancyb. Literacyc. PPP-adjusted GNP per capita

Theories of Trade

Theory of Absolute Advantage

1. Countries export goods which they can produce cheaper and import goods which other countries can produce cheaper

2. Limitation: No free trade if one country can produce all the goods cheaper

Theory of Comparative Advantage

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1. Countries export goods which they have a relative cost advantage and import goods which they have a cost disadvantage

2. Relative cost = Opportunity cost3. As long as a country finds it cheaper to import a good from

another country than producing it at home, imports will continue – as long as import price < domestic opportunity cost

4. Dynamic, not static concept

Benefits of Comparative Advantage

1. Whole world enjoy greater number of goods2. Each country enjoys more of both goods (consume outside of

PPC)

Free Trade

Benefits of Free Trade

1. Consumption above PPC2. Competition will improve efficiency3. Competition will lower prices4. Economies of scale5. Larger consumer surplus6. Reduces monopoly power in country

Problems of Free Trade

1. Vulnerability to external economic conditions2. Unemployment if country has over-specialisation

a. Structural unemployment3. Unfair trade practices4. Speed up exhaustion of irreplaceable natural resources

Reasons why Real World not Fully Practising Comparative Advantage

1. Resources are not perfectly mobile2. Developing countries are gaining comparative advantage at a

rapid rate3. Value incompatibility between goods

Balance of Payments

Structure of BOP

1. Current account2. Capital account

Position of BOP

1. Surplus BOP – Net gain of foreign currencies2. Deficit BOP – Net loss of foreign currencies

Factors to Assess a Country

1. Trade balance2. Current account balance3. Capital account balance (net official reserves transactions)4. Overall BOP

Foreign Exchange

Trade-weighted Exchange Rate

1. The average exchange rate of a currency with respect to a basket of currencies express as an index

2. Weights assigned to the currencies reflect the relative importance of each country in trade

Main Exchange Rate Regimes

1. Free floating2. Fixed3. Managed float system

Free Floating

1. Appreciationa. An increase in the external value of the domestic

currency2. Depreciation

a. A decrease in the external value of the domestic currency

Fixed

1. Revaluation2. Devaluation

Factors of Demand of Currency

1. Foreign demand for country’s exports2. Foreign investments in the country3. Short term capital inflows

Factors of Supply of Currency

1. Imports2. Local firms investing overseas3. Short term capital outflows

NB. Demand of Domestic Currency Determined by

1. Factors affecting export performance2. Factors affecting inflow of foreign direct investments

Factors Affecting Exchange Rate

1. Relative rates of inflation2. Relative rates of interest3. Relative investment climate4. Structural changes in pattern of trade5. Expectations6. Country’s economic fundamentals7. Relative rates of growth

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