The Concepts and Measurements of National Income

Yujiro Hayami

Preface
This paper aims to provide an elementary guide on the concepts and measurements of
national income for non-technical economists and economic policy practitioners. It is
prepared as one of teaching materials for the course, Strategies and Conditions for
Development in the graduate program on international development, which was
jointly organized by the Foundation for Advanced Studies on International
Development (FASID) and the National Graduate Institute of Policy Studies (GRIPS).
The author wishes to thank for useful comments from Yoshimasa Kurabayashi,
Professor Emeritus of Hitotsubashi University, Masaaki Maruyama and Hiromitsu
Shimada of Japan Economic Planning Agency, and Tae Jong Kim of GRIPS. English
editing by Paul Kandasamy and technical assistance from Yue Yaguchi are also
gratefully acknowledged.

Contents

Preface
1 Introduction
2. Circular Economic Flows
3. Private and Social Income/Product
4. Alternative Definitions of National Income and Product
5. Gross Domestic Product and Gross Domestic Expenditure in Japan
6. The System of National Accounts
7. Comparisons over Time and across Countries
Exercise: Construction of Private and Social Accounts in a Hypothetical Village
References

1. Introduction

Various measures of national income, such as GNP (gross national product) and GDP
(gross domestic product), are commonly used for assessing the economic growth of a
nation over time, as well as for comparing its economic position with those of other
nations. Despite their very frequent use, the precise definitions of those measurements
as well as underlying concepts on what they are supposed to represent are often not
clearly understood by students and practitioners of development policies and projects.
This misunderstanding is a significant source of incorrect interpretation of data and
inappropriate designs of policies. This paper aims to advance an elementary guide on
the concepts and measurements of national income for non-technical readers.

In this endeavor, the generation and disposition of national income are conceptualized
in terms of circular flows of goods and services across current economic activities; i.e.,
from production to consumption, to saving, to investment, and back to production.
National accounts represent the convention to quantitatively describe these circular
economic activities in a consistent manner by means of double-entry bookkeeping.

This paper tries to follow the framework of standard national accounts set forth by
SNA (System of National Accounts). The newest version of SNA was prepared in1993
under the auspices of the Inter-Secretariat Working Group on National Accounts,
which consisted of five international organizations -- UN, IMF, World Bank, OECD
and Commission of European Communities. Yet, the majority of literature on
macroeconomics and development economics still uses data compiled according to the
old version, which was prepared by the Statistical Office of the United Nations in 1968.
Therefore, explanations in this paper follow the framework of the 1968 SNA, while the
direction of change in the 1993 SNA shall be indicated where necessary. For a guide
on SNA, see Kendrick (1992) and Kenessey (1994).

Although explanations in this paper are based on the framework of SNA, some

modifications in terminology are adopted. These modifications aim to make the

concepts of national accounting more easily grasped by those who are accustomed with
the terms conventionally used in the standard textbooks of macroeconomics (e.g.,
Blanchard 2000; Mankiw 2000; Sachs and Larrain 1993).

The rest of this paper is structured as follows. Section 2 advances the conceptual
framework of national accounting in terms of circular economic flows between the
firm and the household via production, income distribution, consumption, saving and
investment activities with respect to a simplified economy in which government and
overseas transactions as well as capital depreciation are abstracted away. Section 3
distinguishes between private and social incomes/products. Section 4 specifies
alternative definitions of national income and product corresponding to considerations
on capital depreciation, cross-border movements of factor incomes and government
levy/grant of indirect tax and subsidy. Section 5 illustrates those different definitions
based on the integrated production account in Japan. Section 6 develops the systems of
accounts that can quantitatively describe circular economic flows in an economy in a
consistent manner by means of double-entry bookkeeping. Section 7 discusses
problems to be encountered when using the estimates of national income and product
in the analysis of economic growth in a nation and the comparison of its economic
position with others.

2. Circular Economic Flows

National income and national product have been used interchangeably as the concepts
to represent the magnitude of economic activities in a nation. In fact, they measure the
same magnitude from different sides national product measuring from the side of
production of economic values by firms and national income measuring from the side
of distribution of the produced values to households. The relationship between the two
concepts can be understood in terms of the economic flows between firms and
households in Figure 1. In the beginning it must be understood clearly that the flows of

economic activities drawn in this figure are defined for a certain period of time. If a
calendar year is chosen as the period for measurement, production for example, covers
the activities of producing goods and services from January 1 to December 31 of this
year.

In this respect a clear distinction must be established between flow and stock variables.
National income is a typical flow variable, which aggregates various incomes earned
on different days over the year. On the other hand, the stock of capital measured as the
aggregate of goods usable for production existing at a certain time point (for example,
January 1) is a stock variable. However, capital can also be measured in flow terms,
such as the number of hours in which the services of capital goods (such as machines)
are applied to production. Capital measured in this flow term is called capital input
as distinct from the term capital stock.1 Likewise, labor force as measured by the
number of workers is a stock variable, whereas labor input as measured by their
working hours is a flow variable.

Circular economic flows illustrated in Figure 1 are based on the following simplifying
assumptions: (a) the economy under consideration is in autarky, involving no
transaction with the outside, (b) the economy consists of private firms and households
involving no government activities, (c) all the production/investment activities are
carried out by firms and all the consumption/saving activities are borne by households,
(d) these two types of activities are linked via market transactions of inputs and outputs,
(e) the firm is the organization for production, which is ultimately claimed by someone
in the household, who has contributed capital to the firms production activities, (f)
depreciation of capital arising from its use in production is not considered.

Thus, the

same individual can engage in both production activities at the firm and consumption
activities at the household at the same time. In other words, production by a person is
1

SNA does not use the term capital as an aggregate measure. The concept, which corresponds to the
conventional definition of capital stock, is produced assets consisted of both fixed assets and
inventories. The 1993 SNA dictates that not only tangible assets but also intangible assets such as
intellectual property rights should also be included in fixed assets.

Figure 1. Circular Economic Flows Between Firms and Households

Firm
F (L , K) = Y = C + I
W

C($) S($)

W + R= Y= C +S
=
G (Y)
Household

Y = national product (C + I) = national income (W + R)

L = labor
W = wage: compensation to labor
K = capital
R = profit = Y - W : compensation to capital
C = consumption : goods and services bought for current consumption
I = investment : goods bought for future production (addition to capital stock)
C + I = aggregate of final products (excluding intermediate products)
S = savings = Y C

considered the firms activity, while consumption by the same person is considered the
households activity. In this world, if a person engages in production within his own
house, such as cottage manufacturing, this activity is considered being carried out by
the hypothetical firm that he sets up in the same place as for his consumption activities.
Thus, the firm and the household are divided in terms of different functions but not in
terms of different persons involved.

Assuming the clear-cut functional division between the firm and the household,
economic flows across production, consumption, saving and investment activities can
be illustrated as shown in Figure 1. Production activities of the firm can be
conceptualized as the process of combining two factors, labor and capital, to produce
goods and services (represented by the production function denoted by F). The firm
raises revenue from the sale of those products. A part of the revenue is paid for the
service of labor applied to production and the remainder is the profit to the firm, which
is considered the economic return to the service of capital (including human capital
such as the managerial skill and entrepreneurial ability of the operator).2

Labor is supplied to the firm from the household, for which wages are paid to the
household from the firm. Profits are paid to the household for its contributions of
capital in such forms as interests and dividends. Even if a part of the profits may be
retained by the firm for the use in future production (so-called retained earnings or
undistributed profits), it is regarded as accruing to the household, since all the assets
of the firm is ultimately claimed by the household, Thus considered, all the profits are

Under the simplifying assumption that all the production activities are carried out by firms based on
labor and capital supplied from households, wages and profits represent total returns to the services of
labor and capital, respectively. In the real world, however, some workers are self-employed without
explicitly receiving wages. On the other hand, the surplus of a firm after deducting from its revenue all
the paid-out costs including wages or compensations to employees should accrue to its operator. This
surplus, which is called operating surplus, includes both returns to capital and returns to the operators
and his family members unpaid labor. Because of difficulty in separating returns to capital from returns
to capital in the operating surplus, SNA measures compensations to employees and operating surplus
separately, and adds them up to total factor income earned by labor and capital in society, which is the
same as the sum of wages and profits in our definition ( see also Section 5).

paid for the service of capital rendered for the firms production activities. As such, the
economic value produced from the firms production activities is fully paid out to the
household as either wages or profits. The sum of these wages and profits received by
all the individual households is the total income of this nation under the assumption
that not only labor but also capital are owned by households. This sum represents one
side of national income in our definition.

Wages and profits are the payments of the firm for the purchase of labor and capital
services. In order to make these payments to the household, the firm must raise
revenue by selling its products. Goods and services sold for the purpose of current use
by the household are aggregated by market prices to constitute consumption.

The

part of income, which is left unconsumed, is saving. Saving becomes the source of
finance for the household to increase the possession of capital, which may be used by
the firm with the payment of profits to the household.
.

In this simplified world consisted only by the firm and the household, saving is
channeled directly from the household to the firm for financing the purchase of goods
for the sake of increasing production in the future, though in the real world it is often
channeled through financial intermediaries, such as banks and stockbrokers. Resulting
increases in the stock of goods for future production is called capital formation in
SNA, which is equivalent to investment used in the textbooks of macroeconomics.
Hereafter, we will dare to use in this paper the definitions commonly used in the
writings of economics that capital is the stock of goods usable for production, and
investment is a new addition to this stock, instead of using the SNA terms produced
assets and capital formation (see footnote 1).
Typically, goods for consumption purposes, such as rice and shirts, are purchased by
the household, whereas goods for investment purposes, such as machines and
implements, are purchased by the firm. Therefore, it is appropriate to categorize

investment as the activity of the firm, and consumption (and saving) as the activity of
the household. Yet, since the purchase of machines and implements is ultimately
financed from the households saving, those newly purchased goods are considered the
addition to capital owned by the household.

It should be noted that not only goods bought by the firm for future production, such
as machines, but also such goods as rice and shirts, which are usually used for current
consumption, may be counted in the category of investment if they are not sold to the
household for current use but are kept in the hands of the firm for future sale. This
increase in the stock of such unsold products, either intentionally or unintentionally, is
called inventory change, whereas the purchase of productive equipment and facilities
is called fixed capital formation. Of course, these two sub-categories of investment
add up to total investment, which equals total product (the value of goods and services
produced) minus consumption (the value of goods and services currently consumed).

Circular flows of a national economy under the highly simplified assumptions, as

illustrated with Figure 1, may be restated as follows: the value of goods and services
produced by the firm in a certain period (year) is paid to the household as
compensations (wages and profits) for the services of labor and capital applied to
production; the sum of these compensations is the total income of this economy; a part
of this income is spent to buy some goods and services for current consumption and
the rest is saved; saving by the household is channeled to the firm for buying goods for
future production, including those for adjusting inventories; the sum of these
expenditures for investment and consumption is equal to the total product of this
economy, defined as the value of all goods and services produced in this year. The total
income of the economy, defined as the sum of wages and profits received by the
household, is commonly called national income, whereas total product, defined as
the sum of goods and services sold by the firm for both consumption and investment
purposes, is commonly called national product. Both measure the same thing from
different sidesthe former measuring the side of distributing incomes to labor and

capital, and the latter measuring the side of producing goods and services usable for
consumption and investment purposes.

3. Private and Social Income/Product

Explanations on the previous section might have given the impression that the incomes
of individual households in a nation add up to national income, and that the goods and
services produced by individual firms add up to national product. This impression is
not correct, however. It is important to recognize that the aggregate of private
households incomes is not the total income of society. Likewise, goods and services
produced by private firms do not add up to the total product of society. This applies to
the case of using nation as the unit of society as well as any other units such as
province, town and village. In the following explanations, the words society and
nation are used interchangeably.

Factor income and transfer income

Recall that national income is defined as the sum of compensations to the household
for its contribution of labor and capital services to production. These compensations in
the form of wages and profits are commonly called factor incomes as they accrue to
the two production factors. National income is the sum of factor incomes earned by the
household, representing the economic value produced by labor and capital to society.
However, the income of an individual household consists of not only wages and profits
but also transfers from other households, such as gifts and interests to consumption
loans. If an individual household receives such transfers from other households, they
form a part of the income to that household. However, these transfers add no economic
value to society, as they cancel out each other. For example, if household A receives a
gift from household B, it is an addition to As household income but it is a reduction
from Bs income, thereby adding none to the aggregate of incomes across households
in society. The same applies to the case that A receives interests from B for the
consumption loan that A advanced to B. Therefore, national income includes only

10

factor incomes received by individual households for their contributions of labor and
capital to production, excluding the transfers that are made across households either
directly or via intermediaries such as bank, church and government.

Final and intermediate products

Similarly, goods and services produced by individual firms in a nation do not add up to
national product. Here it is important to understand the difference between final and
intermediate products. Final products consist of goods and services either currently
consumed or set aside for future production, the sum of which is national product in
our definition. On the other hand, intermediate products are goods and services used as
inputs to the production of final products. They disappear as the production is
completed, but their economic value is incorporated into the value of final products
produced. As such, intermediate products themselves do not constitute a part of
economic value produced from current production in society, even though they are the
source of income for the individual firms that produced those intermediate products.
For example, firm A spins cotton for yarn and firm B manufactures shirts using the
yarn purchased from A. The yarn is the product for A for market sale. As such, it is the
private product of A.

However, yarn is not a part of the social product, since the yarn

itself does not add to the utility of people in society. Yarns contribution to social
product through its contribution to the production of shirts is fully incorporated in the
market value of shirts. Therefore, if only two firms, A and B, operate in a nation, only
the value of shirts should be counted in the national product.

4. Alternative Definitions of National Income and Product

Foregoing explanations pertain to a simplified world where government, international

trade and capital depreciation are abstracted away. What complications may have to be
introduced to the definitions of national income and product in the real world where
such simplifications do not apply?

11

Figure 2 illustrates how the identity between national income and product holds under
more realistic assumptions. The illustration pertains to an economy consisting of three
firmsa wheat farmer representing the agriculture sector, a flour miller representing
the industrial sector and a grocery store representing the service sector. They are firms
to the extent that they engage in production activities but, at the same time, they are
households to the extent that their operators and families engage in consumption and
saving activities. First, the farmer produces wheat with labor and capital under his
command and sells it to the miller at the price represented by the box extending from
the right edge. A part of this proceed (labeled as W) is paid as wages to laborers who
worked on the farm, and the rest becomes profits accruing to capital (R). Second, the
miller grinds the purchased wheat to make flour, which is sold to the grocery store at
the price represented by the box extending from the millers position. In this case
wheat is the intermediate product to the production of flour and the value added by the
milling activity is the sale value of flour minus the purchase value of wheat, which is
divided between wages and profits in the milling industry. Third, the grocery store
retails milled flour to consumers at the value measured by the box extended from the
grocerys position. The revenue from the retail sales, after subtracting the payment for
the purchase of flour as an intermediate product in the retailing activity, is divided
between wages and profits.

In the economy as illustrated in Figure 2, national product is the value of flour retailed
from the grocery shop to housewives (plus an increase or decrease in the shops
inventory), assuming that neither farmer nor miller engaged in retailing. It should be
obvious that this final product value of flour is the same as the summation of wages
and profits over the farmer, the miller and the grocery.

Capital depreciation
Explanations developed so far on the identity between national income and product by
means of Figure 2 is no more than the restatement of the previous section. A slight
complication arises when the depreciation of capital is taken into account. The shaded

12

Figure 2. Identity between total income (value added) and total

product (expenditure)

Production

Wheat farm
(Agriculture)

Flour mill
(Industry)

Grocery store
(Service)

Expenditure

at factor cost
R

X-M

GDP (at market price)

NFIFA

GNP (at market price)

13

T-S

area in the profit box in Figure 2 represents the value of capital depreciated in the
process of production. The remaining non-shaded area measures net profit or net return
to capital. In contrast, residual profit including depreciation is commonly called gross
profit. Correspondingly, gross national income is defined as the sum of wages and
gross profits including depreciation, whereas net national income is gross income
minus depreciation. The same distinction between net and gross concepts applies to
product, saving and investment.

Government activities
Much greater complications arise with the introduction of government activities and
transactions with overseas. First, the government purchases goods and services for
administrative purposes. This expenditure is commonly called government
consumption (G), which is added to private consumption (C) by the household in
constituting total consumption in society. This terminology assumes that the
government in lieu of the household pays for the cost of the governments
administrative services, which is ultimately incurred by citizens. For example, the cost
of maintaining the public police is counted in government consumption, although the
services of the public police are consumed by citizens, rendering the same nature of
services as the private security guard with respect to the safety of citizens lives and
properties. Second, the government finances its expenditure by levying tax. Direct
taxes such as income tax are a transfer from the household to the government. It is an
income to the government but it is a payment from the household. Since it adds no
economic value to society similar to inter-household transfers, direct tax is not counted
in national income.

On the other hand, indirect taxes such as sales tax affect the accounting of national
income. Suppose a sales tax (T) is levied proportional to the volume of retail sale at the
grocery store. The market value of flour that housewives have to pay should increase
proportionally. Since the sales tax levied goes to the coffer of the government but not
to people who contribute labor and capital to production, final product valued at the

14

market becomes larger than the sum of wages and profits. A similar divergence occurs
if the government gives a subsidy (S) on consumers purchase of flour. In this case the
market price of flour becomes smaller than the sum of compensations to labor and
capital applied to various stages for its production. As shown in Figure 2, national
product measured at market prices becomes larger (or smaller) than that measured at
factor costs by (T- S) if the government levies a larger (or smaller) amount of indirect
tax than its grant of subsidy.

Transactions with abroad

Somewhat similar complications arise with the introduction of transactions with abroad.
First, assuming an open economy, goods and services produced in a nation are not only
sold to the household and the government for current consumption and future
production within this nation but also are exported to other nations. On the other hand,
domestic consumption and investment activities are not only based on domestically
produced goods and services but also use those imported from abroad. Thus, the
balance of trade defined as export (X) minus import (M) constitutes a component of
national product, together with domestic private consumption (C), government
consumption (G), investment (I), as shown in Figure 2.

Second, in the open economy, not only are products traded among countries but also
labor and capital move across borders. Correspondingly, earnings of these production
factors tend to move in directions opposite to the factor movements. For example,
Hondas automobile factories in the United States employ capital and the labor owned
by firms and households located in Japan. If a part of the profits is remitted to Hondas
headquarter and a part of the wages is remitted to the employees families in Japan,
they may appropriately be considered a part of factor income of households in Japan,
under the assumption that any income to the firm ultimately accrue to the household.
The inflow of profits and wages earned abroad, such as the remittances from Honda
America to Japan, is called factor income from abroad (FIFA). Similarly, the outflow
of earnings of foreign capital and labor, such as the remittance from IBM Japan to the

15

United States, is called factor income to abroad(FITA) in the accounting of national

income for Japan. The balance between the inflow and the outflow (FIFA - FITA) is
called net factor income from abroad (NFIFA).

The sum of wages and profits earned within the geographical boundary of the nation is
called domestic income or domestic product. Domestic product added with NFIFA is
the definition of national income or national product in the open economy. Namely,
domestic product is a measure of economic value produced by labor and capital as they
are applied to production within the nations geographic boundary, whereas national
income is considered to measure the sum of factor incomes, which ultimately accrue to
households located within the nation (either directly or via firms), irrespective of
whether the incomes are earned inside or outside the territorial boundary.3

Similarly, national product at market prices can be redefined for the open economy by
adding NFIFA to domestic product, the latter being defined as the market value of final
product produced inside the nations territorial boundary, as illustrated in the lower
section of Figure 2.

Combinations of different concepts

To recapitulate, national income (and product) can be measured in two different ways
each (1) corresponding to either inclusion or exclusion of capital depreciation, (2)
corresponding to valuation either at factor costs or at market prices, and (3)
corresponding to the coverage of incomes either being limited to those produced from
economic activities within the nations territory or including those remitted from
abroad. Differences between the two different measurements by concept are as
summarized in Figure 3.

Theoretically, eight different definitions of national product are possible for the
3

SNA limits the scope of national income aggregation to households and firms having the status of
residency in the nation.

16

Figure 3. Different definitions of national product/income

Gross

National

Net

Capital depreciation

Domestic

Net factor income from abroad (NIFA)

Market price Factor cost = Indirect tax subsidy

GDP:

Gross, Domestic, Market price

GNP:

Gross, National, Market price

NDP:

Net, Domestic, Factor cost

NNP:

Net, National, Factor cost

(National income)

17

combinations of the two measurements by the three concepts. However, commonly

used are the four measures corresponding to the following four combinations: First,
the most commonly used is gross national product (GNP), which is the measure of
product gross of capital depreciation, valued at market prices and national in scope.
Second, almost equally common is gross domestic product (GDP), which is gross
of depreciation, valued at market prices and domestic in scope. Third, net national
product(NNP) is net of depreciation, valued at factor costs and national in scope.
NNP is commonly called national income among practitioners of national accounts
and macroeconomic analysts, because it is the sum of incomes distributed to
households in the nation, which can be disposed for either consumption or savings.
Fourth, net domestic product (NDP) is net of depreciation, valued at factor costs
and domestic in scope. Note, however, that the 1993 SNA recommends to replace
GNP by the term gross national income (GNI) and, also, to terminate the use of
NNP, while the terms GDP and NDP should be maintained.4 Correspondingly, the
use of GDP has become increasingly more common relative to the use of GNP in
macroeconimic analyses.
In theory, GNP and GDP can be valued at factor costs also, but in practice it has been
customary to value them at market prices, whereas it has been customary to value
NNP and NDP at factor costs. This is because gross product involving total
investment in the current period has been used in macroeconomic analysis as a
convenient measure of effective demand to determine market fluctuations, for which
market-price valuation is more appropriate. On the other hand, net product excluding
depreciation has been considered a better measure of economic welfare, as it is equal
to the income that is spendable for consumption to derive utility.

SNA has long recommended that the term product should be limited to values in the domestic concept and that the
term income should apply only to those of the national concept. The number of countries and organizations adopting
this recommendation has recently been increasing.

18

5. Gross Domestic Product and Gross Domestic Expenditure in Japan

Relationships among these different measures of national income and product can best
be understood with reference to a concrete example of the account expressing the
identity between total expenditure and total income in a national economy. The case of
Japan, as shown in Table 1, is used as such an example.
The account in Table 1 represents a balance between the earnings and the expenses of a
hypothetical firm (Japan Inc.), which is a conglomerate combining all the production
activities in Japan under its management. This Japan Inc. is supposed to cover not only
the production activities of private firms but also to cover the activities of the
government to the extent that it produces public goods and services useful to citizens.
As with any business account, the right-hand column of Table 1 records earnings and
the left-hand column records expenses of this conglomerate. As a convention of
national accounting this account is structured in gross and domestic terms. This means
that Japan Inc. is supposed to operate all the production activities inside Japans
territorial borders but not those operating outside. In this definition, our Japan Inc.
includes the activities of IBM Japan but not Honda America.
Earnings of Japan Inc. should come from the sales of its products for consumption to
households(private consumption: C) and to the government (government consumption:
G), for investments in both fixed capital (If) and inventory (Ii) and for export to abroad
(X). However, the total sales of goods and services for these purposes recorded as C, G,
I (= If +Ii), and X may include not only those produced by Japan Inc. but also goods
imported from abroad (M). Therefore, the total revenue of Japan Inc., which is earned
from the sales of goods and services produced in Japan, should amount to (C + G + I
+X M).
Out of this revenue Japan Inc. pay expenses as entered in the left-hand column of
Table 1. First, it must pay wages to employees (compensation of employees: We). Note

19

Table 1. Gross Domestic Product and Gross Domestic Expenditure, Japan 1998
Fiscal Year (April-March)
Trillion Yen
Compensation of employees (We)

282

Trillion Yen

57 Private consumption (C)

Operating surplus (Re)

90

18 Government consumption (G)

Depreciation (D)

83

17 Fixed capital formation (If)

Indirect tax (IT)

44

9 Inventory change (Ii)

Subsidy (-S)

-3

-1 Export (X)

Statistical discrepancy (E)

1
(0.6)
497

GDP (Gross domestic product)

FIFA
- FITA
NFIFA (A)

0 Import (-M)
(0.2)
100 GDE (Gross domestic expenditure)

28
-21
7

=
GNP = GDP + A

305

61

51

10

132

27

-1
(-0.5)

0
(0.1)

54

11

-44

-9

497

100

National income
(Net national product at factor cost: NNP)

504

We + Re
372

+A
+ 7 = 379

Net domestic product at factor cost:: NDP

Source: Japan Economic Planning Agency, Annual Report on National Accounts 2000, Tokyo, 2000.

20

that We is a part of total value produced by labor, because it includes wages explicitly
paid to the labor of employees alone, not including compensation to self-employed
labor. Second, the allowance for the replacement of capital depreciated (D) must be
reserved. Third, indirect tax (T) must be submitted to the government. Because a part
of this taxation may be recovered by subsidy (S), net payment from Japan Inc. to the
government is (T- S). Finally, any surplus of the revenue after paying all those
expenses should accrue to the operators of Japan Inc. for their contributions of capital
and managerial/entrepreneurial work. Re is supposed to consist of compensations to
both capital and unpaid labor of operators and their family members. Therefore, the
sum of this operating surplus (Re) and employee compensation (We) equals to the sum
of wages (W) and profits (R).

If Re is calculated as the residual of Japan Inc. in the account shown in Table 1, (We +
Re + D + T S) should be equal to the total of the right-hand column. However,
because data recorded in the left-hand column and those in the right-hand column are
estimated independently, statistical errors involved in estimation processes may result
in the gap between the total of expenses explicitly measured in the left-hand column
and the total of earnings in the right-hand column. This gap, which is called statistical
discrepancy(E), should enter in the left-hand column in order to establish the
accounting identity. E serves as a yardstick to evaluate over-all accuracy of data
assembled in this accounting, though it does not tell which items suffer greater errors
than others and how large the individual errors are.

In the account shown in Table 1, the total of the right-hand side is labeled as gross
domestic expenditure. The word expenditure is conventionally used as it represents
expenditure for the purchase of goods and services produced by Japan Inc. However,
since this account expresses the identity between earnings and expenses from the
viewpoint of Japan Inc., it is more appropriate to call the right-hand total as revenue
or product than expenditure. Likewise, from the viewpoint of Japan Inc. the
left-hand total may better be called expenditure. Though it is perfectly legitimate to

21

call the total of left-hand side gross domestic product as is conventionally labeled,
there is nothing wrong theoretically to call it gross domestic income.

As recorded in Table 1, GDP measured as (C + G + I + X M) was 497 trillion yen

(t-yen) in Japan in 1998. Net domestic product (NDP), which is defined as (We + Re =
W + R), was 372 t-yen. In the same year, FIFA was 28 t-yen and FITA was 21 t-yen,
the balance of which (NFIFA) was 7 t-yen. Adding NFIFA to GDP and NDP produces,
respectively, GNP of 504 t-yen and national income or net national product (NNP) of
379 t-yen.

6. The System of National Accounts

We now move to see how the production account examined in the previous section
stands out in the system of national accounts representing circular economic flows
explained in Section 2.

The simple system under autarky

For understanding the nature of the national accounting system, it should be
convenient to begin with the most simplified system consistent with the flow chart in
Figure 1. In this simplified model, government activities, transactions with abroad and
capital depreciation are abstracted away. Therefore, there is only one measure of
national income, involving no such dichotomies as gross versus net, national versus
domestic, and market-price versus factor-cost valuation.

Circular flows of this

economy are expressed by three accounts in Table 2.

The production account shown on the top of Table 2 represents the balance between
the earnings and expenses of the aggregate firm (e.g., Japan Inc.). It is a simplified
version of Table 1, excluding variables related with government (G, T, and S), those
related with abroad (X, M, FIFA and FITA) and capital depreciation (D). For the sake
of simplicity fixed capital formation (If) and inventory change (Ii) are aggregated into

22

Table 2. The simple system of national accounts under autarky

(1) Production A/C

Y (= We + Re)

C
I (= If + Ii)

(2) Income Appropriation A/C

C
Y
S

(3) Capital Finance A/C

I

23

total investment (I), and compensation of employees (We) and operating surplus (Re) are
aggregated into total factor income (Y). Further, it is assumed that all the data are measured
without statistical error. With those simplifications, goods and services produced by the firm
were sold for either consumption(C) or investment (I), as entered in the right-hand column.
Out of this revenue earned from the sales of products, the firm pays compensation to labor
and capital used for domestic production with their sum (Y) entered in the left column.

A/C (2) in the middle of Table 2 is the account of the household. It expresses how the
household spends the incomes that it earned. Y is recorded in the left column of A/C (1) as
the payment to the household from the firm, while it is also entered in the right column of
A/C (2) as the income received by the household. A part of this income is spent for
consumption (C), and the rest is saved (S), as entered in the left column.

How this saving is used for financing investment is expressed by A/C (3). For the sake of
expository convenience this account may be conceptualized as the account of a hypothetical
bank (representing financial intermediaries), which channels all the savings from the
household to the firm without costs. Namely, the household is supposed to deposit savings in
the bank, from which the bank advances loan to the firm for the purchase of capital goods.
The deposit of savings is entered in the right side, because it represents a receipt by the bank,
while the loan from the bank for financing investment by the firm is counted as a
disbursement by the bank, which should be entered in the left column.5

Thus, the system of three simple accounts in Table 2 represents a consistent description of

In this explanation the bank is considered serving as a mere pipeline of fund flows from the household to the
bank without involving resource-using activities to produce economic values. In the real world, banks and other
financial intermediaries add values to society by improving allocation of funds through such activities as
analysis of markets, monitoring and enforcement of credit contracts. The economic values that are thus produced
by labor and capital applied to financial intermediation are supposed to be included in Y, together with the values
added by the activities of non-financial firms.

24

circular economic flows involving activities of production by the firm, consumption and
saving by the household, and investment finance through the bank. Consistency here means
that the total of the revenue side (right) equals that of the expenditure side (left) in each of the
accounts, and that the grand total of all the revenues for three agents (firm, household and
bank) is matched by the total of all the expenditures. This consistency can be checked if all
the variables that are once entered in the right-hand sides appear again somewhere in the
left-hand sides. If this consistency is confirmed, the system is called fully articulated. The
system in Table 2 is indeed consistent and fully articulated, because C that appears in the right
of A/C (1) appears again in the left of (2).

Y in the left of (1) appears in the right of (2), I in

the right of (1) appears in the left of (3), and S in the left of (2) appears in the right of (3).

It should be noted that the three accounts in Table 2 represent the following identities:
(1)

Y=C+I

(2)

Y=C+S

(3)

I=S

which are well known in the textbooks of macroeconomics. It is useful for the students of
macroeconomics to conceptualize the meanings of these equations in terms of the circular
economic flows described in Figure 1 and Table 2.

The system of four integrated accounts

How should the system be modified in order to come closer to the real world by incorporating
government activities and transactions with abroad? The system of four basic accounts, which
is commonly used as the core of national accounting, is presented in Table 3.

Compared with the format specified in SNA, the system presented in Table 3 is simplified in
the following respects: First, similar to the case of Table 2, it is assumed that data are not
subject to statistical error, that compensation of employees and

25

Table 3. The system of four integrated accounts

(1) Production A/C

C

Y = We + Re = W + R : Net domestic
income (NDP)
D : Capital depreciation
T : Indirect tax subsidy

X
C : Private consumption

-M

G : Government consumption
I = If + Ii : Gross domestic investment
X : Export
(2) Income Appropriation A/C
C
Y
G

M : Import
A = NFIFA : Net factor income from
abroad = Factor income from abroad
Factor income to abroad

B : Net current transfer from abroad =

Transfer from abroad Transfer to
abroad
F : Net investment to abroad =
Investment to abroad Investment
from abroad

(3) Capital Finance A/C

I

Y + D + T : GDP
Y + D + T + A : GNP
Y + A : National income (NNP)
Y + A + B + T : National disposable
income

(4) External Transaction A/C

X

X M + A + B : current balance of
payment

-M
A
B

26

operating surplus are added up to net domestic income (Y) and that fixed capital
formation and inventory change are added up to gross domestic investment (I). Second,
indirect tax net of subsidy (T) is entered, instead of entering the two components
separately. Third, non-trade transactions are entered in net terms; i.e., net factor income
from abroad (labeled here as A instead of NFIEA) and net current transfer from abroad
(B) are entered instead of separating between factor incomes from abroad and to abroad,
and between transfers from abroad and to abroad.

When these simplifications are adopted, it would need no explanation that A/C (1) in
Table 3 is essentially the same as the account in Table 1, which establishes the identity
between gross domestic product and gross domestic expenditure in Japan. In A/C (2),
not only Y but also net factor income from abroad (A) and net transfer from abroad (B)
are entered in the right-hand column. B is the balance between gift and grant received
by this country from foreign countries and those given by this county to abroad
(through such channels as ODA). The sum of A and B represents the net receipt from
abroad, which augments disposable income by the citizens of this nation beyond the
income produced within the geographical boundary of the nation. Further, net indirect
tax levied by the government (T) enters in the right column as it adds to the disposable
income in the nation.6 For this reason, the sum of the right column (Y + A + B + T) is
called national disposable income. A part of it is spent for consumption by
households as well as by government and the rest is saved, as shown in the left column.

This saving (S) together with the allowance set aside for the replacement of
depreciated capital (D) constitutes the total fund of this nation for financing
investment. The fund may be used either for investment within this nation (domestic
investment: I) or net investment to abroad (F). Viewed from Japan, for example, F
may include construction of a new factory by Honda America based of the finance of
6

Direct taxes, such as income tax, are supposed to be levied from factor income (Y) and transferred for spending by the
government. Indirect taxes are also transfers from the household to the government, either directly or via the firm, but they are
levied from the source other than Y and , therefore, must be counted in national disposable income in addition to Y.

27

its parent company in Japan, its purchase of GMs shares and the increase of its
deposit in Citibank at New York, from which similar investments by IBM Japan
should be subtracted.

A/C (4) establishes the balance in transactions between this nation (Japan) and foreign
countries grouped together (the rest of the world). This is the account of overseas. As
such, the right column records receipts of foreign exchange by the rest of the world
from Japan and the left records payments from overseas to Japan. Export of Japan (X)
belongs to the latter category and, hence, enters in the left column. Import (M) belongs
to the latter, thereby entering in the left in its negative value, though it is not wrong
theoretically to enter the positive value of M in the right column instead. The balance
of trade measured by (X - M) represents the net payment from the rest of the world to
Japan concerning trades of goods and services. Both net factor income from abroad (A)
and net transfer abroad (B) are the same as the balance of trade at the point that they
represent net payments to Japan from abroad. The sum of these net payments (X - M +
A + B) is commonly called the current balance of payments. If this balance is positive,
it may be spent for buying fixed assets overseas (such as the new factory of Honda
Japan) or increasing financial claims to abroad including foreign currencies. Since F is
the sum of increases in both fixed and financial assets held by Japan in the rest of the
world, the identity between net investment to abroad (F) and the current balance of
payments is established, as shown in A/C (4), under the simplifying assumption that
capital transfers are absent.7

It should be easy to see that GDP in this model is given by (Y+D+T), GNP is given by
(Y+ D +T+ A), and national income or NNP is given by (Y + A).
7

If capital transfers, such as ODA grants for fixed capital formation in recipient countries, are to be considered, the current
balance of payments (X-M +A+B) plus net capital transfer from abroad (which is minus in aid-giving countries like Japan)
is the net increase in assets held by the nation in the rest of the world (after deducting the increase in assets held by the rest of
the world in this nation). In other words, the current account surplus of a nation can be used to finance either for increasing its
assets held abroad by this nation or for granting capital assets to other nations. In SNA the net increase in assets held abroad is
called net lending instead of net investment to the rest of the world. However, assets held abroad include not only credits
but also equities accumulated through foreign direct investment.

28

Checking if all the variables that once enter in the right-hand columns of the four
accounts appear again in the left-hand columns confirms that this system is fully
articulated. Thereby it is guaranteed that the four accounts represent a system by which
current flows of economy across production, consumption and saving, investment
finance and transactions with the rest of the world are consistently documented in
quantitative terms.

As explained before, A/C (1) put together all the production activities by both private
firms and the government. Similar integration of households and the government in
consumption and saving apply to Account (2). In A/C (3) and A/C (4), activities by
households, firms and government are integrated. For this reason these four accounts
are called integrated accounts. Any more complicated system can be contemplated,
which adds to the integrated accounts those covering activities of various economic
players, such as firms, households and governments (central and local), separately in
any degree of aggregation.

7. Comparisons over Time and across Countries

Measures of national income and product as defined in national accounts are the
aggregate outcomes of various economic activities. GDP, for example, is the aggregate
of goods (and services) produced within a nations territory, which are either consumed,
or invested or exported. These goods are aggregated using current market prices as
weights. However, market prices change over time and across space, which make it
difficult to analyze inter-temporal changes and international differences in GDP in real
terms.

29

Comparison over time

First, the difficulty involved in over-time comparison shall be discussed. Usually, a
change in GDP from one year to another reflect not only increases (or decreases) of the
quantities of goods produced but also changes in prices. If all the prices double while
quantities produced remaining constant, GDP doubles but it can hardly be appropriate
to consider economic growth occurred between the two year. Therefore, in order to use
GDP for the analysis of economic growth, influences of changes in the price level must
be removed from changes in nominal GDP measured at current prices for estimating
real GDP valued at constant prices.

The direct way to estimate real GDP is to aggregate goods using the same set of prices
as weights for different years under comparison. Another way is to deflate nominal
GDP by the index that is designed to measure changes in the price level. The price
index can be constructed by aggregating prices using the same set of product quantities
as weights for different years. The question is which years prices or quantities should
be used as weights for index construction. The outcomes are usually different for
different sets of weight. This is the so-called index number problem, which is explained
in any textbook of economic and business statistics (e.g., Wannacott and Wannacott
1990), so we shall not deliberate on it. It is sufficient to recall that the index using the
initial years prices or quantities is called the Laspeyres index (L-index) and the index
using the end years is called the Paache index (P-index), and that the deflation of total
product measured in current prices by the L-price index produces the P-quantity index
and the deflation by the P-price index produces the L-quantity index.

The problem is that, if applied to the analysis of economic growth over a long span of
time, the L-quantity index tends to overestimate the rate of growth and the P-quantity
index to underestimate. Economic development is usually characterized by a relative
expansion in the output of new goods characterized by rapid technical progress to result
in declines in their costs and prices, relative to old products characterized by slow

30

technical progress. Such an economy is illustrated in Table 4. This hypothetical

economy is supposed to produce shirts representing the old product and calculators
representing the new product. The output of shirt did not increase while their prices
rose. In contrast, a large increase in the output of calculator was associated with a sharp
decline in their prices. Nominal product, which is obtained from aggregation of the two
commodities by current prices, increased from $1000 in the initial year to $2600 in the
end year with an increase by 160 percent. On the other hand, real product based on the
initial year prices was as large as $ 4800 in the end year, with an increase by 380
percent, while that based on the end year prices recorded an increase by less than 60
percent. Incidentally, it can easily be confirmed in Table 4 that the deflation of nominal
product by the L-price index produces the P-quantity index and the deflation by the
L-price index produces the P-quantity index

It is difficult to say which estimate of real product is a more appropriate measure of

economic growth in the economy of producing these two commodities. However, it is
likely to produce serious bias if one single set of prices at one time point is used
aggregation of products over a long period involving dynamic changes in technology.
To some extent this hazard may be reduced by changing price weights for several
sub-periods and splicing them together into a single series. Any such procedure,
however, is not free from arbitrariness. Therefore, analysts dealing with long-term
economic development must be careful in making inferences with sound judgment on
the index number problem that their data series are likely to be suffering from.

In actual practice, real GDP is calculated by summing up real products of various

commodity groups, such as food and clothing, which are obtained by deflating
current-price aggregates of commodities in the groups by their price indexes. This
procedure is used because only current value series by the group but not individual
commodity quantities are available in most cases, especially for services. Division of
nominal GDP by the sum of real products by group produces a kind of price index for
GDP, which is commonly called the implicit deflator.

31

Table 4. Alternative calculations of real product

Initial year

End year

(1)

(2)

Index
(2)/(1)X100

Shirt : Quantity (piece)

Price ($)

80
10

80
20

100
200

Calculator : Quantity (piece)

Price ($)

10
20

200
5

2,000
25

1,000

2,600

260

1,000
1,650

4,800
2,600

480
157.6

100
100

165
54.2

Total product ($)

Nominal
Real : aggregated by
Initial prices (Laspeyres)
End prices (Paache)
Deflator (index) : weighted by
Initial quantities (Laspeyres)
End quantities (Paache)

32

Comparison across countries

Essentially the same difficulty as for over-time comparison besets comparison across countries. The
major problem in comparing GNP or GDP across countries is how to convert them from local
currencies into comparable units having the same purchasing power. The commonly used
procedureconversion by exchange rates into US dollarsis known to underestimate the level of
production in developing economies relative to that of developed economies. The reason is that market
exchange rates are supposed to reflect the purchasing power of currencies relative to that of the base
currency (US$) with respect to tradable goods alone. Because the prices of non-tradables, such as real
properties and services, relative to those of tradables are usually lower in developing economies than in
developed economies, market exchange rates tend to underestimate the purchasing power of local
currencies in developing economies for the whole range of goods and services, including both tradables
and non-tradables. In order to correct this bias, efforts have been led by the International Comparison
Programme of the United Nations to estimate the purchasing power parities (PPP) of local currencies
relative to US dollar. The PPP of a country is a kind of price index with US $ set equal to 1, which is
obtained by aggregating the price ratios of tradables and non-tradables between this country and the
USA, using their quantities as weights. In practice, a rather sophisticated formula is used for this index,
which is beyond the scope of the present discussion. Interested readers may consult with Kravis, Heston
and Summers (1978; 1982), Kurabayashi and Sakura (1990), and United Nations Statistical Division
(1992)

Table 5 compares GNPs per capita in selected countries between the series converted by exchange rates
and those by purchasing power PPP. For example, per-capita GNP in Ethiopia in exchange rate
conversion was 100 US dollars, which was much less than one-two hundredth of the USA. In PPP
conversion, however, Ethiopias GNP per capita is valued as much as 450 dollars or about one-sixtieth
of the USA. The relationship of these two series is more clearly visible in Figure 4, which plots

33

Table 5. International comparison between GNPs in current US dollars converted by

exchange rates and purchasing power parities, 1995
(1)

Ethiopia
Bangladesh
Nigeria
Kenya
India
Pakistan
China
Indonesia
Peru
Thailand
Brazil
Argentina
Korea, Rep.
UK
France
USA
Japan

(2)

(3)

Converted by current
exchange rate
US$
Rank
100
17
240
16
260
15
280
14
340
13
460
12
620
11
980
10
2,310
9
2,740
8
3,640
7
8,030
6
9,700
5
18,700
4
24,990
3
26,980
2
39,640
1

(4)

Converted by purchasing
power parity
US$
Rank
450
17
1,380
14
1,220
16
1,380
14
1,400
13
2,230
12
2,920
11
3,800
9
3,770
10
7,540
7
5,400
8
8,310
6
11,450
5
19,260
4
21,030
3
26,980
1
22,110
2

Sources: World Bank, World Development Indicators, 1997;

World Bank, World Development Indicators CD-ROM, 1998.

34

(YP)
lnYP = 3.7+0.61 lnY, r = 0.98
(t=20.7)

GNP converted by purchasing power parity ($)

US
Ja

UK
Fr
Ko
T

10,000

Ar
Br
Is
Pe

Ch
Pa
Ke
In

Ba
Ni

1,000

Et

100
45
(Y)
1,000

100

10,000

GNP converted by current exchange rate $)

Figure 4. International comparison between GNPs in current US dollars

converted by exchange rates and purchasing power parities, 1995 (Log scale)
Legend: Ar Argentina
Ba Bangladesh
Fr France
In India
Ko Korea, Rep.
Ni Nigeria
US United States

Br Brazil
Is Indonesia
Pa Pakistan

Ch China
Ja Japan
Pe Peru

Sources: Table 5. (col.1 and 3).

35

Et Ethiopia
Ke Kenya
UK United Kingdom

countries with the horizontal axis measuring GNP per capita converted by exchange rate (Y) and the
vertical axis measuring that converted by PPP (YP). It can be observed that low-income economies
diverge farther above the 45-degree line relative to high-income ones, reflecting the tendency that the
poorer the economies, the more seriously underestimated their national incomes are.8

However, the correlation coefficient is as high as 0.98 and Spearmans rank correlation coefficient is
even higher than 0.99, implying that changes in the order of countries according to the magnitude of
GNP per capita seldom occur except within a group of countries with relatively homogenous income
levels. Thus, the choice of the one series over the other seriously affects conclusion on the absolute
income levels of developing relative to developed economies, but their ranks remain largely unaffected.

Errors in measurement
It should now be clear that the index number problem inherent in the comparison of aggregated statistics
such as GDP and GNP seriously constrains their usefulness in the analysis of economic development.
However, even more serious are errors involved in data collected for the estimation of GDP. For
example, consumption (C) and investment (I) are estimated mainly from the production statistics of
goods and services. The data of individual product outputs cannot be free from both sampling and
observation errors, which are bound to occur in the process of statistical survey. Even less reliable is the
information on the allocation of goods produced among the uses of intermediate product, consumption

The coefficient of YP being 0.6 in the regression of ln YP on ln Y shown in Figure 4 (where ln stands for natural logarithmic
transformation) implies the relationship that YP increases only by 60 percent corresponding to the 100-percent increase in Y.
Take a developed country, say USA, as the base of comparison. If a developing country has Y lower than that of USA by k
percent, the index number of this countrys Y with USA set equal to 100 is (100 k), while the comparable index number of YP
is (100 0.6 k). Therefore, this countrys income position relative to USA as measured by Y is 0.4 k-percent lower than that
measured by YP. Needless to say, this percentage difference increases as k increases, implying that the poorer the country is
relative to USA, the larger the difference from USA is when its GNP per capita is converted by exchange rate than when
converted by PPP.

36

and investment. These statistical problems beset not only consumption and investment but also the other
components of GDP as well.

One of the most serious limitations of national account statistics, such as GDP, is that they mainly cover
goods and services traded through markets, while excluding many items not traded through markets.
The typical example is housekeeping work by wives in their own households. Because they are not
employed and, hence, do not receive wages, their services are not counted in national income, whereas
the same services are counted if provided by maids employed on wages. The following famous joke
holds: If you want to increase the national income of your country, divorce your wife and employ her
as a maid.

While the services of housewives to family members are excluded, the goods that they produced for
home consumption are supposed to be imputed by market prices for inclusion in national accounts. In
fact, the imputed values of a few major items, such as agricultural products consumed in farmers
households and residential houses being used by their owners, are counted in national income. Yet, most
commodities produced at the home base, such as yarn spun and clothes woven by a housewife are
usually not included, when consumed at home. Even when they are sold outside her home, these
household products often fail to be captured by the statistical agencies of the government. Similarly, the
use of family labor by small peasants to plant trees and improve pasture are the activities that are
theoretically considered investment, but are difficult to measure for inclusion in national account
statistics. Therefore, the more subsistence-oriented economies are, the stronger the tendency is for their
national incomes and investments to be underestimated relative to market-oriented economies. This
problem must always be kept in mind when using national income measures such as GDP and GNP for
the analysis of economic development from low-income to high-income stages.

37

Exercise: Construction of Private and Social Accounts in a Hypothetical Village

In order to improve the understanding of the nature of social accounts, an exercise is designed to
construct the system of social accounts for a hypothetical economy.

The economy for this exercise is an isolated village consisting of only two personsa farmer and a
blacksmith. Their economic positions and interactions are as shown in Figure 5. The farmer grows rice
with the labor of 3 family members (husband, wife and son) using his own farm implements on 2
hectares of paddy field. The blacksmith crafts farm implements with two family members (husband and
wife only) working with his own equipment, while his son is still too young to work. Both the farm and
the blacksmith are the units of production as well as the units of consumption and saving.

In a certain year the farmer produced 100 bags of rice and the blacksmith manufactured two ploughs.
Because his family labor was not sufficient in busy seasons, the farmer hired the blacksmith for 100 days
by paying 20 bags as wages. The farmer added the two ploughs to his stock of farm implements by
paying the price of 10 bags of rice per plough to the blacksmith. Meanwhile, the blacksmith borrowed
from the farmer 15 bags of rice to supplement his family consumption, for which he paid the interest of
5 bags but was unable to pay back the principal within the year. In effect, one half of the rice produced
by the farmer was consumed in the blacksmith household and the rest consumed in the farmer
household.

The private accounts of the farmer and the blacksmith as well as the social accounts of this two-person
village are constructed in Table 6, using one bag of rice as the unit of measurement. In this accounting
rice consumed within the farmer household is counted in social product, following the convention of
national accounting.
38

Figure 5. Economic positions of a farmer and a blacksmith in the two-person village

Transactions

BLACKSMITH

Terms of trade

FARMER
Labor : 2 workers
Factor
Endowment

Labor : 3 workers
Land : 2 hectares
Capital : Farm implements

s
ay
d
k
)
or
0 w work
0
1 ed
r
(hi
gs
ba
0
2 ge)
a
(w

Land :

5 workdays
1 bag

Capital : Blacksmith equipment

2 ploughs
Production

Income

100 bags of rice

20 bags

5 bags
(interest)
85 bags

2 ploughs

35 bags

15 bags
(loan)
Consumption

50 bags

50 bags

39

10 bags
1 plough

Table 6. The Private accounts of a farmer and a blacksmith, and the social account of
the two person village
Private A/C
Farmer

Blacksmith

(1) Production

(1) Production

Wb

20

Cb

50

Rf

80

Cf

50

100

Rb

100

50

Rf

80

Cb

85

85

20

Il

15

Sf

35

50
5

55

20

100

100

20

120

50

Wb

20

Rb

20

35

-Il

-15

S
40

-15

Sb

-15

35

100

Wb

20

100

-15

(4) External transaction

20

Wb

20

Cb

If

20

If

20

Il

15

Il

15
55

120

120

20

20

20

20

(4) External transaction

50
5

55

40

20

(3) Capital finance

-15

Wb

55

120

(2) Income appropriation

(3) Capital finance

(4) External transaction

Cb

Wb

20

40

(3) Capital finance

If

20

Sb

35

(1) Production

(2) Income appropriation

i
Sf

If

20

(2) Income appropriation

Cf

20

Social A/C
Village

Symbols used in Table 6

Farmer
Hired labor wage (Compensation of employee)

Social

Blacksmith

Wb (payment)

Wb (receipt)

Rf

Rb

R = Rf + Rb

Cf (imputed)

Cb

C = Cf + Cb

Domestic investment

If

I = If

External investment (loan)

Il

-Il

Savings

Sf

Sb

S = Sf + Sb

Interest on consumption loan

-i

Operator surplus
Consumption

41

Wb

Readers are advised to

Try to understand how the accounts in Table 6 are constructed by referring to explanations advanced in
Sections 3 and 6.

Try to reconstruct these accounts on the blank form of the Table 7, based on the information in Figure
5, without referring to Table 6.

42

Table 7. The Private accounts of a farmer and a blacksmith, and the social account of
the two person village
Private A/C

Social A/C
Village

Farmer

Blacksmith

(1) Production

(1) Production

(1) Production

(2) Income appropriation

(2) Income appropriation

(2) Income appropriation

(3) Capital finance

(3) Capital finance

(3) Capital finance

(4) External transaction

(4) External transaction

(4) External transaction

43

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44