National Income Accounting

A variety of measures of national income and output are used in economics to estimate
total economic activity in a country or region, including gross domestic product (GDP),
gross national product (GNP), and net national income (NNI). All are concerned with
counting the total amount of goods and services produced within some "boundary". The
boundary may be defined geographically, or by citizenship; and limits on the type of
activity also form part of the conceptual boundary; for instance, these measures are for
the most part limited to counting goods and services that are exchanged for money:
production not for sale but for barter, for one's own personal use, or for one's family, is
largely left out of these measures, although some attempts are made to include some of
those kinds of production by imputing monetary values to them.

As can be imagined, arriving at a figure for the total production of goods and services in a
large region like a country entails an enormous amount of data-collection and calculation.
Although some attempts were made to estimate national incomes as long ago as the 17th
century, the systemmatic keeping of national accounts, of which these figures are a part,
only began in the 1930s, in the United States and some European countries. The impetus
for that major statistical effort was the Great Depression and the rise of Keynsian
economics, which prescribed a greater role for the government in managing an economy,
and made it necessary for governments to obtain accurate information so that their
interventions into the economy could proceed as much as possible from a basis of fact.

In order to count a good or service it is necessary to assign some value to it. The value
that all of the measures discussed here assign to a good or service is its market value – the
price it fetches when bought or sold. No attempt is made to estimate the actual usefulness
of a product – its use-value – assuming that to be any different from its market value.

Three strategies have been used to obtain the market values of all the goods and services
produced: the product (or output) method, the expenditure method, and the income
method. The product method looks at the economy on an industry-by-industry basis. The
total output of the economy is the sum of the outputs of every industry. However, since
an output of one industry may be used by another industry and become part of the output
of that second industry, to avoid counting the item twice we use, not the value output by
each industry, but the value-added; that is, the difference between the value of what it
puts out and what it takes in. The total value produced by the economy is the sum of the
values-added by every industry.

The expenditure method is based on the idea that all products are bought by somebody or
some organisation. Therefore we sum up the total amount of money people and
organisations spend in buying things. This amount must equal the value of everything
produced. Usually expenditures by private individuals, expenditures by businesses, and
expenditures by government are calculated separately and then summed to give the total
expenditure. Also, a correction term must be introduced to account for imports and
exports outside the boundary.

The income method works by summing the incomes of all producers within the
boundary. Since what they are paid is just the market value of their product, their total
income must be the total value of the product. Wages, proprieter's incomes, and corporate
profits are the major subdivisions of income.

The names of all of the measures discussed here consist of one of the words "Gross" or
"Net", followed by one of the words "National" or "Domestic", followed by one of the
words "Product", "Income", or "Expenditure". All of these terms can be explained
separately.

"Gross" means total product, regardless of the use to which it is subsequently put.
"Net" means "Gross" minus the amont that must be used to offset depreciation –
ie., wear-and-tear or obsolescence of the nation's fixed capital assets. "Net" gives
an indication of how much product is actually available for consumption or new
investment.
"Domestic" means the boundary is geographical: we are counting all goods and
services produced within the country's borders, regardless of by whom.
 "National" means the boundary is defined by citizenship (nationality). We count
all goods and services produced by the nationals of the country (or businsses
owned by them) regardless of where that production physically takes place.
The output of a French-owned cotton factory in Senegal counts as part of the
Domestic figures for Senegal, but the National figures of France.
"Product", "Income", and "Expenditure" refer to the three counting methodologies
explained earlier: the product, income, and expenditure approaches. However the
terms are used loosely.
"Product" is the general term, often used when any of the three appraoches was
actually used. Sometimes the word "Product" is used and then some additional
symbol or phrase to indicate the methodology; so, for instance, we get "Gross
Domestic Product by income", "GDP (income)", "GDP(I)", and similar
constructions.
"Income" specifically means that the income approach was used.
"Expenditure" specifically means that the expenditure approach was used.

Note that all three counting methods should in theory give the same final figure.
However, in practice minor differences are obtained from the three methods for several
reasons, including changes in inventory levels and errors in the statistics. One problem
for instance is that goods in inventory have been produced (therefore included in
Product), but not yet sold (therefore not yet included in Expenditure). Similar timing
issues can also cause a slight discrepancy between the value of goods produced (Product)
and the payments to the factors that produced the goods (Income), particularly if inputs
are purchased on credit, and also because wages are collected often after a period of
production.

National income and welfare

GDP per capita (per person) is often used as a measure of a person's welfare. Countries
with higher GDP may be more likely to also score highly on other measures of welfare,
such as life expectancy. However, there are serious limitations to the usefulness of GDP
as a measure of welfare:
 • Measures of GDP typically exclude unpaid economic activity, most importantly
domestic work such as childcare. This leads to distortions; for example, a paid
nanny's income contributes to GDP, but an unpaid parent's time spent caring for
children will not, even though they are both carrying out the same economic
activity.
• GDP takes no account of the inputs used to produce the output. For example, if
everyone worked for twice the number of hours, then GDP might roughly double,
but this does not necessarily mean that workers are better off as they would have
less leisure time. Similarly, the impact of economic activity on the environment is
not measured in calculating GDP.
• Comparison of GDP from one country to another may be distorted by movements
in exchange rates. Measuring national income at purchasing power parity may
overcome this problem at the risk of overvaluing basic goods and services, for
example subsistence farming.
• GDP does not measure factors that affect quality of life, such as the quality of the
environment (as distinct from the input value) and security from crime. This leads
to distortions - for example, spending on cleaning up an oil spill is included in
GDP, but the negative impact of the spill on well-being (e.g. loss of clean
beaches) is not measured.
• GDP is the mean (average) wealth rather than median (middle-point) wealth.
Countries with a skewed income distribution may have a relatively high per-
capita GDP while the majority of its citizens have a relatively low level of
income, due to concentration of wealth in the hands of a small fraction of the
population.

Because of this, other measures of welfare such as the Human Development Index (HDI),
Index of Sustainable Economic Welfare (ISEW), Genuine Progress Indicator (GPI), gross
national happiness (GNH), and sustainable national income (SNI) are used.
Gross Domestic Product

Gross domestic product (GDP) is defined as the "value of all final goods and services
produced in a country in 1 year".Gross National Product (GNP) is defined as the market
value of all goods and services produced in one year by labour and property supplied by
the residents of a country.

As an example, the table below shows some GDP and GNP, and NNI data for the United
States:

The output approach

The output approach focuses on finding the total output of a nation by directly finding the
total value of all goods and services a nation produces.

Because of the complication of the multiple stages in the production of a good or service,
only the final value of a good or service is included in total output. This avoids an issue
often called 'double counting', wherein the total value of a good is included several times
in national output, by counting it repeatedly in several stages of production. In the
example of meat production, the value of the good from the farm may be $10, then $30
from the butchers, and then $60 from the supermarket. The value that should be included
in final national output should be $60, not the sum of all those numbers, $100. The values
added at each stage of production over the previous stage are respectively $10, $20, and
$30. Their sum gives an alternative way of calculating the value of final output.

Formulae:

GDP(gross domestic product) at market price = value of output in an economy in a

particular year - intermediate consumption

NNP at factor cost = GDP at market price - depreciation + NFIA (net factor income from
abroad) - net indirect taxes
The income approach

The income approach focuses on finding the total output of a nation by finding the total
income received by the factors of production.

The main types of income that are included in this approach are rent (the money paid to
owners of land), salaries and wages (the money paid to workers who are involved in the
production process, and those who provide the natural resources), interest (the money
paid for the use of man-made resources, such as machines used in production), and profit
(the money gained by the entrepreneur - the businessman who combines these resources
to produce a good or service).

Formulae:NDP at factor cost = compensation of employee + operating surplus + mixed

income of self employee

National income = NDP at factor cost + NFIA (net factor income from abroad)

The expenditure approach

The expenditure approach is basically a socialist output accounting method. It focuses on

finding the total output of a nation by finding the total amount of money spent. This is
acceptable, because like income, the total value of all goods is equal to the total amount
of money spent on goods. The basic formula for domestic output combines all the
different areas in which money is spent within the region, and then combining them to
find the total output.

GDP = C + I + G + (X - M)

Where:
C = household consumption expenditures / personal consumption expenditures
I = gross private domestic investment
G = government consumption and gross investment expenditures
X = gross exports of goods and services
M = gross imports of goods and services

Note: (X - M) is often written as XN, which stands for "net exports"

Business Cycles

Fluctuations in economic activity are a feature of every economy and pose a persistent
problem, especially in the short run. These short run fluctuations in economic activity,
which are reflected in output and employment levels, are called business cycles. Business
cycles typically go through a phase of low levels of economic activity called recession
which, if not remedied, will deteriorate into depression. After this phase, the economy
begins to look up with the economic activity gradually peaking. This phase is called
boom. This is followed by a down turn in economic activity, spurred by some panic
factor. Recession then sets in and the cycle continues. While these upturns and downturns
exist in every business cycle, what cannot be predicted at all is the period for which each
phase would last. Recessions could las for a few weeks or a few years. The onset of a
business cycle and the phase that it is in at a point in time is charted by looking at the
movements in the real GDP growth rates.

Policy makers intervene with a set of policies called stablization polices to reduce the
severity of the short run fluctuations in output and employement. These stablisations
polices are largely demand management policies in the short run, because supply
management policies take a longer time to work and in the short run, the economy is
looking for quicker results.
Inflation

In economics, inflation is a rise in the general level of prices of goods and services in an
economy over a period of time. When the price level rises, each unit of currency buys
fewer goods and services; consequently, inflation is also an erosion in the purchasing
power of money – a loss of real value in the internal medium of exchange and unit of
account in the economy. A chief measure of price inflation is the inflation rate, the
annualized percentage change in a general price index (normally the Consumer Price
Index) over time.

Inflation can have positive and negative effects on an economy. Negative effects of
inflation include loss in stability in the real value of money and other monetary items
over time; uncertainty about future inflation may discourage investment and saving, and
high inflation may lead to shortages of goods if consumers begin hoarding out of concern
that prices will increase in the future. Positive effects include a mitigation of economic
recessions, and debt relief by reducing the real level of debt.

Economists generally agree that high rates of inflation and hyperinflation are caused by
an excessive growth of the money supply. Views on which factors determine low to
moderate rates of inflation are more varied. Low or moderate inflation may be attributed
to fluctuations in real demand for goods and services, or changes in available supplies
such as during scarcities, as well as to growth in the money supply. However, the
consensus view is that a long sustained period of inflation is caused by money supply
growing faster than the rate of economic growth.

Today, most mainstream economists favor a low steady rate of inflation. Low (as
opposed to zero or negative) inflation may reduce the severity of economic recessions by
enabling the labor market to adjust more quickly in a downturn, and reduce the risk that a
liquidity trap prevents monetary policy from stabilizing the economy. The task of
keeping the rate of inflation low and stable is usually given to monetary authorities.
Generally, these monetary authorities are the central banks that control the size of the
money supply through the setting of interest rates, through open market operations, and
through the setting of banking reserve requirements.
Consumer Price Index

A consumer price index (CPI) is a measure estimating the average price of consumer
goods and services purchased by households. A consumer price index measures a price
change for a constant market basket of goods and services from one period to the next
within the same area (city, region, or nation). It is a price index determined by measuring
the price of a standard group of goods meant to represent the typical market basket of a
typical urban consumer. Related, but different, terms are the United Kingdom's CPI, RPI,
and RPIX. It is one of several price indices calculated by most national statistical
agencies. The percent change in the CPI is a measure estimating inflation. The CPI can
be used to index (i.e., adjust for the effect of inflation on the real value of money: the
medium of exchange) wages, salaries, pensions, and regulated or contracted prices. The
CPI is, along with the population census and the National Income and Product Accounts,
one of the most closely watched national economic statistics.

Two basic types of data are needed to construct the CPI: price data and weighting data.
The price data are collected for a sample of goods and services from a sample of sales
outlets in a sample of locations for a sample of times. The weighting data are estimates of
the shares of the different types of expenditure as fractions of the total expenditure
covered by the index. These weights are usually based upon expenditure data obtained for
sampled decades from a sample of households. Although some of the sampling is done
using a sampling frame and probabilistic sampling methods, much is done in a
commonsense way (purposive sampling) that does not permit estimation of confidence
intervals. Therefore, the sampling variance is normally ignored, since a single estimate is
required in most of the purposes for which the index is used. Stocks greatly affect this
cause.

The index is usually computed yearly, or quarterly in some countries, as a weighted

average of sub-indices for different components of consumer expenditure, such as food,
housing, clothing, each of which is in turn a weighted average of sub-sub-indices.
Wholesale Price Index (WPI)

Wholesale Price Index (WPI) is the price of a representative basket of wholesale goods.
Some countries (like India and The Philippines) use WPI changes as a central measure of
inflation. However, India and the United States now report a producer price index
instead.

The Wholesale Price Index or WPI is the price of a representative basket of wholesale
goods. Some countries use the changes in this index to measure inflation in their
economies, in particular India – The Indian WPI figure is released weekly on every
thursday and influences stock and fixed price markets. The Wholesale Price Index
focuses on the price of goods traded between corporations, rather than goods bought by
consumers, which is measured by the Consumer Price Index. The purpose of the WPI is
to monitor price movements that reflect supply and demand in industry, manufacturing
and construction. This helps in analyzing both macroeconomic and microeconomic
conditions.

Calculation of Wholesale Price Index

The wholesale price index consists of over 2,400 commodities. The indicator tracks the
price movement of each commodity individually. Based on this individual movement, the
WPI is determined through the averaging principle. The following methods are used to
compute the WPI:

Laspeyres Formula (relative method):It is the weighted arithmetic mean based on the
fixed value-based weights for the base period.

Ten-Day Price Index: Under this method, “sample prices” with high intra-month
fluctuations are selected and surveyed every ten days through phone. Utilizing the data
retrieved by this procedure and with the assumption that other non-surveyed "sample
prices" remain unchanged, a "ten-day price index" is compiled and released.

Calculation Method: Monthly price indexes are compiled by calculating the simple
arithmetic mean of three ten-day “sample prices” in the month.
Fiscal Policy

In economics, fiscal policy is the use of government spending and revenue collection to
influence the economy. Fiscal policy can be contrasted with the other main type of
economic policy, monetary policy, which attempts to stabilize the economy by
controlling interest rates and the supply of money. The two main instruments of fiscal
policy are government spending and taxation. Changes in the level and composition of
taxation and government spending can impact on the following variables in the economy:

• Aggregate demand and the level of economic activity;

• The pattern of resource allocation;
• The distribution of income.

Fiscal policy refers to the overall effect of the budget outcome on economic activity. The
three possible stances of fiscal policy are neutral, expansionary, and contractionary:

• A neutral stance of fiscal policy implies a balanced budget where G = T

(Government spending = Tax revenue). Government spending is fully funded by
tax revenue and overall the budget outcome has a neutral effect on the level of
economic activity.
• An expansionary stance of fiscal policy involves a net increase in government
spending (G > T) through rises in government spending, a fall in taxation revenue,
or a combination of the two. This will lead to a larger budget deficit or a smaller
budget surplus than the government previously had, or a deficit if the government
previously had a balanced budget. Expansionary fiscal policy is usually associated
with a budget deficit.
• A contractionary fiscal policy (G < T) occurs when net government spending is
reduced either through higher taxation revenue, reduced government spending, or
a combination of the two. This would lead to a lower budget deficit or a larger
surplus than the government previously had, or a surplus if the government
previously had a balanced budget. Contractionary fiscal policy is usually
associated with a surplus.
Methods of funding

Governments spend money on a wide variety of things, from the military and police to
services like education and healthcare, as well as transfer payments such as welfare
benefits.

This expenditure can be funded in a number of different ways:

• Taxation
• Seignorage, the benefit from printing money
• Borrowing money from the population, resulting in a fiscal deficit
• Consumption of fiscal reserves.
• Sale of assets (e.g., land).

Funding the deficit - A fiscal deficit is often funded by issuing bonds, like treasury bills
or consols. These pay interest, either for a fixed period or indefinitely. If the
interest and capital repayments are too large, a nation may default on its debts,
usually to foreign creditors.

Consuming the surplus -A fiscal surplus is often saved for future use, and may be
invested in local (same currency) financial instruments, until needed. When income from
taxation or other sources falls, as during an economic slump, reserves allow spending to
continue at the same rate, without incurring additional debt.

Economic effects of fiscal policy

Governments use fiscal policy to influence the level of aggregate demand in the
economy, in an effort to achieve economic objectives of price stability, full employment,
and economic growth. Keynesian economics suggests that adjusting government
spending and tax rates are the best ways to stimulate aggregate demand. This can be used
in times of recession or low economic activity as an essential tool for building the
framework for strong economic growth and working toward full employment. The
government can implement these deficit-spending policies to stimulate trade due to its
size and prestige. In theory, these deficits would be paid for by an expanded economy
during the boom that would follow; this was the reasoning behind the New Deal.
Governments can use budget surplus to do two things: to slow the pace of strong
economic growth, and to stabilize prices when inflation is too high. Keynesian theory
posits that removing funds from the economy will reduce levels of aggregate demand and
contract the economy, thus stabilizing prices.

Some classical and neoclassical economists argue that fiscal policy can have no stimulus
effect; this is known as the Treasury View[citation needed], which Keynesian economics rejects.
The Treasury View refers to the theoretical positions of classical economists in the
British Treasury, who opposed Keynes' call in the 1930s for fiscal stimulus. The same
general argument has been repeated by neoclassical economists up to the present. From
their point of view, when government runs a budget deficit, funds will need to come from
public borrowing (the issue of government bonds), overseas borrowing, or the printing of
new money. When governments fund a deficit with the release of government bonds,
interest rates can increase across the market. This is because government borrowing
creates higher demand for credit in the financial markets, causing a lower aggregate
demand (AD), contrary to the objective of a budget deficit. This concept is called
crowding out; it is a "sister" of monetary policy.

Other possible problems with fiscal stimulus include the time lag between the
implementation of the policy and detectable effects in the economy, and inflationary
effects driven by increased demand. In theory, fiscal stimulus does not cause inflation
when it uses resources that would have otherwise been idle. For instance, if a fiscal
stimulus employs a worker who otherwise would have been unemployed, there is no
inflationary effect; however, if the stimulus employs a worker who otherwise would have
had a job, the stimulus is increasing demand while labor supply remains fixed, leading to
inflation.

Monetary Policy

Monetary policy is the process by which the government, central bank, or monetary
authority of a country controls (i) the supply of money, (ii) availability of money, and
(iii) cost of money or rate of interest, in order to attain a set of objectives oriented
towards the growth and stability of the economy. Monetary theory provides insight into
how to craft optimal monetary policy.Monetary policy is referred to as either being an
expansionary policy, or a contractionary policy, where an expansionary policy increases
the total supply of money in the economy, and a contractionary policy decreases the total
money supply. Expansionary policy is traditionally used to combat unemployment in a
recession by lowering interest rates, while contractionary policy involves raising interest
rates in order to combat inflation. Monetary policy is contrasted with fiscal policy, which
refers to government borrowing, spending and taxation.

Monetary policy is the process by which the government, central bank, or monetary
authority of a country controls (i) the supply of money, (ii) availability of money, and
(iii) cost of money or rate of interest, in order to attain a set of objectives oriented
towards the growth and stability of the economy. Monetary theory provides insight into
how to craft optimal monetary policy.

Monetary policy rests on the relationship between the rates of interest in an economy,
that is the price at which money can be borrowed, and the total supply of money.
Monetary policy uses a variety of tools to control one or both of these, to influence
outcomes like economic growth, inflation, exchange rates with other currencies and
unemployment. Where currency is under a monopoly of issuance, or where there is a
regulated system of issuing currency through banks which are tied to a central bank, the
monetary authority has the ability to alter the money supply and thus influence the
interest rate (in order to achieve policy goals). The beginning of monetary policy as such
comes from the late 19th century, where it was used to maintain the gold standard. A
policy is referred to as contractionary if it reduces the size of the money supply or raises
the interest rate. An expansionary policy increases the size of the money supply, or
decreases the interest rate. Furthermore, monetary policies are described as follows:
accommodative, if the interest rate set by the central monetary authority is intended to
create economic growth; neutral, if it is intended neither to create growth nor combat
inflation; or tight if intended to reduce inflation.