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National Income Accounting PDF
National Income Accounting PDF
Discipline Courses-I
Semester-I
Paper I: Principales of Economics(POE)
Unit-III
Lesson: National Income Accounting
Lesson Developer: Rakhi Arora and Vaishali Kapoor
College/Department: Rajdhani College, University of Delhi
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National Income Accounting
Table of Contents:
1. Learning outcomes
2. Introduction
3. What is macroeconomics?
4. Measurement of GDP
6. Price Indexes
7. Summary
8. Exercises
9. Glossary
10. References
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National Income Accounting
Learning outcomes:
After you have read this chapter, you should be able to:-
INTRODUCTION
Newspapers, these days, are full of headlines symptomatic of the worsened conditions of
the global economy; which suggest that policy makers and economists have been worried
about what form the ongoing global financial crisis will take, how all economies would be
affected and whether all economies would emerge as gainers and take the lead? One needs
to know, how economists predict these crises & their repercussions;how economists study
the symptoms of any disturbance in the economy and provide the cure.
Economists & researchers keep studying every economy with the help of various economic
variables & economic tools at hand & economic data that is widely released in various
newspapers journals & articles –mostly produced by government. These data /statistics are
used to study the economy & policy makers use them to monitor the ongoing development
processes in the economy &to formulate policies.
This chapter broadly covers the macroeconomic issues and the macroeconomic
variablesin Section one. It discusses in Section two the Gross Domestic Product, GDP, –
an indicator of the health of an economy and in Section three, it explains the meaning of
Consumer Price Index,CPI, which represents the overall prices. This chapter largely
focuses on the accounting of National Income.
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National Income Accounting
WHAT IS MACROCONOMICS?
Macro Economics is the study of the structure and performance of national economies and
of the policies that government‟s use to try to affect economic performance.
8000000
7000000
6000000
5000000
4000000
3000000 National income of
2000000 India Rs. Cr
1000000
0
1950-51
2011-12
1960-61
1970-71
1980-81
1990-91
2000-01
2000-02
2005-06
2006-07
2007-08
2008-09
2009-10
2010-11
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National Income Accounting
(iii) Inflation
Many efforts have been devoted by the economists to identify the costs &
consequences of even the moderate inflation. The key questions that need to be
addressed are: who are Gainers & losers from inflation? What costs does inflation
impose on society and their severity? What are the causes of inflation? What are the
best ways to curb it? Figure 2 shows the behavior of consumer goods prices over
time in India. They have been rising since 1950 and have doubled in the last decade
owing to droughts, US crisis and recession.
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National Income Accounting
200
150
0
1970-71
2011-12
1950-51
1960-61
1980-81
1990-91
2000-01
2000-02
2005-06
2006-07
2007-08
2008-09
2009-10
2010-11
This issue focuses on the economic links among nations – international trade &
borrowings etc. that affect the performance of individual economies & world
economy as a whole. The recent crisis affected the entire globe even when it
originated in US as Sub Prime crisis. This shows that countries are linked by
international trade and more so by financial flows.
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National Income Accounting
MEASUREMENT OF GDP
The national income accounts are an accounting framework used in measuring current
economic activity. National Income Accounts are set up in a way that mirrors the structure
of the economy. Working through these accounts is a first important step towards
understanding how the macro economy works.
The economic activity that occurs during a period of time can be measured in the following
3 ways:
All three approaches portray the identical picture of the economy. The money value
computed from either of the above ways is technically known as National income of the
economy.
VARIANTS OF GDP
GDP is the market value of all final goods and services produced by normal residents
as well as non-residents in the domestic territory of a country in a year. It includes
the market value of only final goods and ignores intermediate goods to avoid the
problem of double counting (i.e.) to count all goods and services produced in any
given year only once.
GDP= C+I+G+NX
Where,
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National Income Accounting
C= Value of final consumer goods and services produced in a year and consumed by
households.
NX=Exports-Imports
It is defined as the total market value of all final goods and services produced in a
year by normal residents of a country. These residents may be national or non-
national companies having their set up plants in India.
GNP=GDP+NFIA
Where,
NFIA is the difference between factor income received from abroad by normal
residents of India for rendering factor services in other countries and the factor
incomes paid to the foreign residents for factor services rendered by them in the
domestic territory of India.
The capital goods wear out or fall in value as a result of its consumption or use in
the production process. This consumption of fixed capital or fall in the value of fixed
capital due to wear and tear is called depreciation. So this depreciation is to be
deducted from GDP to get NDP. Therefore,NDP is the net market value i.e. after
providing for depreciation, all final goods and services produced by normal residents
as well as non-residents in the domestic territory of a country in a year. Therefore,
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National Income Accounting
NDP= GDP-Depreciation
It refers to the market value of goods and services produced by normal residents of
a country in a year after providing for depreciation.
It is also known as National income at market price.
NNP= GNP-Depreciation
Or
NNP= GDP-Depreciation+ NFIA
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National Income Accounting
A useful way to study the economic interactions among the four sectors in the economy is
through a circular flow diagram, which shows the income received and payments made by
each sector. The phenomenon of three methods of measurement of national income giving
identical results can be shown diagrammatically through the circular flow of money in the
economy.
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National Income Accounting
Let‟s analyze the circular flow step by step. Households provide their services to the firms
and government and in return they get wages. The circular flow diagram above shows the
flow of wages in the household sector as a compensation for their services. Interest on
corporate and government bonds and dividends from firms is another receipt of the
households. Social security benefits, veterans‟ benefits, and welfare payments are also
received by some of the households from the government. These kinds of payments from
the government for which the recipient does not supply any good/service/labor are called as
Transfer Payments. All these receipts constitute the total income received by the
households.
Households pay out by purchasing goods/services from the firms and by giving taxes to the
government. These components constitute the total payments by the households. The
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National Income Accounting
gap between the total receipts and total payments of the households is whatthey save/dis-
save. Savings are categorized as a „leakage‟ from the circular flow as they withdraw the
current income/purchasing power from the system.
Goods/services are sold to the households and the government by the firms. Revenues are
generated by these sales which are shown as a flow into the firm sector in the diagram
above. Wages, interest and dividends are paid by the firms to the households and taxes are
paid by the firms to the government. These expenses are shown as flows out of the firm
sector.
Taxes are collected by the government from the households and the firms. Government
makes payments also by purchasing goods /services from the firms, paying wages and
interest to the households, and by making transfer payments to the households. Households
expend part of their income on imports and rest on domestically produced goods/services.
GDP can be obtained by adding up the four major categories of expenditures of national
income accounts- Consumption, Investment, Government purchases of goods/services, net
exports of goods/services. According to the expenditure approach, GDP is measured as the
total spending on the final goods/services produced in the nation during a specified period
of time of the national income.
Symbolically,
= total income
=total expenditure;
C= consumption;
I= investment;
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National Income Accounting
Y=C+1+G+NX.
1. Consumption.
2. Investment
Investment includes both spending for new capital goods, called fixed investment,
and increases in firms, inventory holding, called inventory investment. Investment,
in India, accounted for 37% of GDP in 2010. Fixed investment in turn has two major
components.
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National Income Accounting
Much like the distinction between private-sector consumption and investment some
part of government purchases accounts for current needs (such as employee
salaries) as some is devoted to acquiring capital goods (such as office buildings).
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National Income Accounting
4. Net Exports
Net exports are exports minus imports. Exports are the goods and services produced
within a country that are purchased by foreigners. . It is about 22% of GDP in 2010
in India.
Imports are the goods and service produced abroad that are purchased by a
country‟s residents, which was about 26% of GDP in 2010 in India. Net exports are
positive if exports are greater than imports and negative if imports exceed exports.
Exports are added to total spending because they represent spending (by foreigners)
on final goods and services produced in a country. Imports are subtracted from total
spending because consumption, investment, and government purchases are defined
to include imported goods and service. Subtracting imports ensures that total
spending C+I+G+NX, reflects spending only on output produced in the country.
According to the Income Approach, National Income is the summation of eight types of
income. It totals the income received by the producers inclusive of the profits and the taxes
payment to the government. The eight components are as follows:
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National Income Accounting
6. Taxes on production and imports-It includes indirect business taxes such as sales
tax and excise taxes that are paid by businesses central to state, and local
governments, as well as customs duties and taxes on residential real estate and
motor vehicle licenses paid by households. These taxes have averaged about 7% of
GDP for the past 25 years.
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National Income Accounting
In addition to the eight components of national income just described, three other items
need to be accounted for to obtain GDP:
Statistical discrepancy;
Depreciation; and
Net factor payments.
GDP, measured in rupee terms, is sum of value of the output produced in the economy, i.e.
sum of product of prices of different commodities produced and their respective quantities.
Nominal GDP = ∑piqi
Where,
pi= price of the ithcommodity
qi= quantity of the ithcommodity
The value of goods/services measured at current prices is usually called as nominal GDP by
the economists. Nominal GDP is not capable of reflecting accurately as to how well an
economy is able to satisfy the demands of households, firms and the government. If only all
the prices double and the quantities remain unchanged, then accordingly GDP would double.
But it would be misleading to state that the ability of the economy to satisfy the demands
has doubled as the quantities of every good-produced remains unchanged.
A better and more reliable measure to monitor the economy‟s well-being would be one that
would not be influenced by the changes in prices. Henceforth, real GDP is used by the
economists. Real GDP is the measurement of the value of goods/services using a constant
set of prices, i.e., it would tell us the affect on expenditure on output when only quantities
change and prices don‟t.
A real variable is an economic variable that is measured by the base year prices. The
physical quantity of the economic activity is measured by the real economic variables. Real
GDP measures the physical volume of an economy‟s final production, using the base year
prices. Nominal GDP measures the value of an economy‟s final output, using the current
market prices.
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National Income Accounting
PRICE INDEXES
A measure of the average level of prices for some specified set of goods/services relative to
the prices in a specified base year is called as the Price Index. For instance, a GDP deflator
is a price index, which measures the overall level of goods/services included in GDP. It is
defined as follows:
The GDP deflator (divided by 100) is the amount by which nominal GDP must be divided,
or” deflated” to obtain real GDP. In our example, we have already computed nominal GDP
and real GDP, so we can now calculate the GDP deflator by rewriting the preceding formula
as:
GDP deflator deals with the average level of prices of goods/services that are included in
GDP. The CPI, Consumer Price Index, is available monthly. The Bureau of labor Statistics
constructs the CPI by sending people out each month to find the current prices of a fixed
list, or “basket” of consumer goods and services, including many specific items of food,
clothing, housing, and fuel. The CPI for the month is then computed as:
100*(Current cost of a basket of consumer items)/ (cost of the same basket of items in
reference base period).
SUMMARY
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National Income Accounting
National income of the economy can be computed by either adding the expenditure
incurred by the residents in a year or by adding everybody‟s income. Either of the
two sums will yield same result as income of one person is expenditure of the other
and vice a versa.
Computations could be made easy by remembering following equations:
1. Net + CFC = Gross
2. EC+ NIT = MKT Price
3. Domestic + NFIA = National
In expenditure method, national income is computed by adding consumption (C),
government expenditure (G), investment (I) and net exports (NX) in a given
accounting year.
While calculating national income by income method, following components are
added:Compensation of employees, Proprietors‟ income, Rental income of persons,
corporate profits, Net interest, Taxes on production and imports, Current surplus of
government enterprises, and Business current transfer payments (net).
Real economic variables deal with the physical quantity of the economic activity
using base year prices. For example, real GDP is at constant prices i.e. it measures
physical production of this year at base year prices. In contrast, nominal GDP is
current rupee- GDP i.e. rupee value of an economy‟s final output, measured at
current market prices.
A price indexmeasures theaverage level of prices of a basket of goods/services
relative to the prices of the same basket in a specified base year.
EXERCISES
Q1. Which of the following items will be included while calculating GDP of India? Why and
why not?
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National Income Accounting
Q1. What are major macroeconomic issues that each economy has to deal with? Explain it
with reference to Indian scenario.
Q2. What are the approaches to measuring economic activity? Why do they give same
answer?
Q3. List all the components of total spending. Why imports are subtracted when GDP is
computed in the expenditure method?
Q4. “For assessing growth performance of an economy real GDP is a better measure”.
Comment.
NUMERICALS
Q1. Calculate national income from expenditure method and gross domestic product at
factor cost by income method:
d. Change in stock 50
e. Exports 40
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National Income Accounting
g. Subsidies 20
i. Imports 50
Q2. Calculate Gross National Product at market prices from the following data?
e. Net exports 10
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National Income Accounting
f. Interest 4,000
g. Rent 4,176
i. Subsidies 1,348
Q4. From the following data, calculate national income and gross domestic product:
d. Profit 100
e. Interest 80
f. Rent 40
g. Royalty 20
Q5. Consider a three good economy and for this economy then, calculate nominal GDP for
year 1 and year 2 and real GDP for year 2 from the following given information:
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National Income Accounting
GLOSSARY
Refernces
3. http://data.worldbank.org/indicator/NE.CON.PETC.ZS
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National Income Accounting
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