David K.H. Begg, Gianluigi Vernasca-Economics-McGraw Hill Higher Education (2011)

15.4 National income accounting
physical goods and services. It includes the wages of civil servants and soldiers, the purchase of computers,
tanks and military aircraft, and investment in roads and hospitals.
Governments also spend money on transfer payments or benefits, B. These include
pensions, unemployment benefit and subsidies to firms.
Transfer payments do not affect national income or national output. They are not
included in GDP. There is no corresponding net physical output. Taxes and transfer
payments merely redistribute existing income and spending power away from
Transfer payments are
monetary payments that
require no goods or services
in return.
people being taxed and towards people being subsidized. In contrast, spending G on goods and services
produces net output, and gives rise to factor earnings in the firms supplying this output and also to
additional spending power of the households receiving this income. Hence government spending G on
goods and services is part of GDP. It is final expenditure since government is now an additional end user
of the output.
National income accounts aim to provide a logically coherent set of definitions
and measures of national output. However, taxes drive a wedge between the price
the purchaser pays and the price the seller receives. We can choose to value national
output either at market prices inclusive of indirect taxes on goods and services, or
at the prices received by producers after indirect taxes have been paid.
GDP at market prices
measures domestic output
inclusive of indirect taxes on
goods and services.
So far we have studied a closed economy not transacting with the rest of the world. We now examine an
open economy that deals with other countries.
Households, firms and the government may buy imports Z that are not part of domestic output and do not
give rise to domestic factor incomes. These goods are not in the output measure of GDP, the value added
by domestic producers. However, imports show up in final expenditure. There are
two solutions to this problem. We could subtract the import component separately
from C, I, G and X and measure only final expenditure on the domestically made
bit of consumption, investment, government spending and exports. But it is easier
to continue to measure total final expenditure on C, I, G and exports X and then
to subtract from this total expenditure on imports Z. It comes to exactly the same
thing.
Exports {X) are domestically
produced but sold abroad.
Imports {Z) are produced
abroad but purchased for use
in the domestic economy.
In the previous section, we saw that our definitions should imply that total income, expenditure and
output measures of total activity should coincide. We now explain how this works once we introduce
the government and foreign sectors as well. The complete system of national accounts is summarized in
Figure 15.6.
We begin on the left with gross national product (or gross national income - same thing) at market prices.
The second column is the expenditure measure of GNP, which comprises spending by households on
consumption, spending by firms on investment, spending by government goods and services (which we
could think of as government contributions to consumption and investment), net exports (the excess of
exports over imports) and, finally, net international transfers from abroad.
This last item is sometimes called net international property income, since most transfers arise from the
return on assets held abroad (minus the return paid by us to foreigners holding assets in our country).
International transfer payments also include aid by the UK when an earthquake hits Haiti, or remittances
of cash to their families by foreign workers temporarily resident in the UK.
The third column takes us from GNP to GDP. The latter measures gross output during the period. Whereas
net international transfer payments add to our income, they do not add to our physical output of goods
and services. Hence, Figure 15.6 deducts these from GNP to get to GDP.
The fourth column shows the difference between gross and net output. Net means deducting depreciation
of physical capital as buildings and machinery wear out or become obsolete. Statisticians have to make
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