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National Income Accounting

Methods of measurement of National Income (or GDP):

1. Production or value-added approach

2. Income approach
3. Expenditure approach
4. An alternative mixed approach

Triple identity:
Net national product/sum of distributive share or factor payments/Net
national expenditure

GDP is the market value of all final goods and services produced within a country
in a given period of time.

National Income/GDP Accounting (what is and not included):

➢ Only final goods and services (not intermediate goods and services) included
➢ Only economic activities (supported by a payment) are included
Transfer payments (old-age pensions, unemployment allowances, maternity benefits,
free scholarships, etc.) are not included. Because they render no economic activity.
➢ Only factor payments of an asset built not its capital gains.
➢ Only new goods not resale of goods are included.
➢ Only legal not illegal income earned is included.
➢ Factor prices and not market prices are included – adjust for taxes and subsidies
➢ Govt earned profits but not spent (went to the exchequer) are not included.

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Key concepts in National Income Accounting

GDP at market price and NDP at Market price
NDP at market price = GDP at market price – Depreciation.

Depreciation means the loss of value suffered by nation’s stock of assets or fixed capital
through wear and tear.

GNP at market price and NNP at market price

GNP at Market price = GDP at market price + Net Income from Abroad

NNP at Market price = GNP at market price – Depreciation

NNP at Factor Cost and National Income

NNP at factor cost is the sum of the distributive share of all factors of production i.e. rent for
land, wage for labour, interest for capital, and profit for entrepreneurs.

NNP at factor cost (or net national income) can be arrived from the GNP at market price as
below:

NNP at factor cost = GNP at market price – depreciation – taxes + subsidies.

Personal Income and Disposable Personal Income

Personal Income = Net National Income – Undistributed corporate profits –

Social Insurance + dividends + govt’s transfer payments + personal net-interest
income

Disposable Personal Income (DPI)

Disposable income is the amount of money households have for spending and
saving after income-tax has been accounted for.

DPI = Personal Income – Personal income taxes

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Components of GNP:

Y = C + I + G + NX

Nominal GDP and Real GDP:

GDP is computed by the current prices, and it gives a misleading picture if GDP of
current year compared with GDP of another year in the past without adjusting to their
prices in two different periods.
To jettison this problem, economists use real GDP, which is the value of goods and
services measured using a constant set of prices. For this purpose, economists chose a
base year prices to compare the outputs of two different periods.

Example: taking 2011 as a base year

The real GDP in 2021 would be equal to the value of GDP produced in 2021 at the
base year (i.e 2011) prices.

Real GDP 2021 = Quantity of output produced in 2021 x 2011 price level

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The GDP Deflator & Inflation Rate

The GDP deflator is the ratio of nominal GDP to real GDP.

It reflects what’s happening to the overall price level in the economy.
It measures the current level of prices relative to the level of prices in the base
year.
That is, GDP deflator = (Nominal GDP / Real GDP) x 100

In other words Real GDP = nominal GDP / GDP deflator.

Using the GDP deflator, the changes in prices (inflation rate) between two
consecutive years is computed as follows:

Inflation rate in year 2 = [(GDP deflator in year 2 – GDP deflator in year

1)/GDP deflator in year 1] x 100.

Hypothetical example of calculating GDP Deflator

Year Price Quantity Price of Quantity GDP at GDP at GDP Inflation

of an of Apples an of current base Deflato rate
Apple Produced Orange Oranges prices year r (from
produced [nomina (2011) the
l GDP] prices previou
[Real s year)
GDP]
2011 3 10 2 15 60 60 100 -
2020 5 10 3 15 95 60 158 58 %
2021 8 12 5 20 196 76 257 63 %

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The Consumer Price Index (CPI) and Inflation

The consumer price index is the measure of overall cost of the basket of
goods and services bought by a typical consumer.
Steps
Fix the basket of goods and service and attach weight to each good
according to their importance in the consumption basket.
Find prices of these basket of goods at each point in time.
Compute the basket’s cost in each year at their respective prices.
Chose a base year

Compute the Consumer Price index as follows:

Consumer price index = (Price of the basket of goods in the current
year/price of the basket of goods in the base year) x 100

Components of India’s CPI

The CPI is calculated for rural areas, and urban areas, and then a combined weight is used
to determine the national average. Here are the constituents of CPI.
Sub group/group Rural Urban Combined

Cereals and products 19.08 8.73 14.59

Pulses and products 3.25 1.87 2.65

Milk and milk products 8.59 6.61 7.73

Oils and fats 4.67 2.89 3.9

Egg, fish and meat 3.38 2.26 2.89

Vegetables 6.57 3.96 5.44

Fruits 1.9 1.88 1.89

Sugar etc 2.41 1.26 1.91

Condiments and spices 2.13 1.16 1.71

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Non- alcoholic beverages 2.04 2.02 2.03

Prepared meals etc 2.57 3.17 2.83

Pan, tobacco and Intoxicants 2.73 1.35 2.13

Food, beverages and tobacco Total 59.31 37.15 49.71

Fuel and light 10.42 8.4 9.49

Clothing and bedding 4.6 3.34 4.05
Footwear 0.77 0.57 0.68
Clothing, bedding and footwear 5.36 3.91 4.73

Housing  22.53 9.77

Education 2.71 4.18 3.35
Medical care 6.72 4.34 5.69

Recreation and amusement 1 1.99 1.43

Transport and communication 5.83 9.84 7.57

Personal care 3.05 2.74 2.92

Household requisites 4.48 3.92 4.3

Others 1.12 0.99 1.06

Miscellaneous 24.91 28 26.31

Total 100 100 100.00

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How is CPI data collected?

Surveys are conducted to collect price data in urban and local areas.

In the urban areas, 310 towns have been identified where the data is
collected, and similarly there are 1,182 villages from where data is
collected for rural areas.
The post office workers are used to collect data in rural areas while
employees of NSSO collect data in urban areas.
The survey is being done every month that helps establish the index
values.
To see exactly how these statistics are constructed, let’s consider a
simple economy where only two goods are consumed.

Consumer Price Index and Inflation

Year Price Quantity Price Quantity Cost of Cost of Consume Inflation

of an of of an of the the basket r Price rate
(Base year
Apple Apples in Orange Oranges basket Index
prices_In
the in the (Curren Rs.)
basket basket t
prices_I
n Rs.)
2011 3 10 2 15 60 60 100 Base
year
2020 5 10 3 15 95 60 158 58 %
2021 8 10 5 15 155 60 258 63 %

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Year 2 cost of the basket (10 apples & 15 oranges) = 95, year 1 cost = 60

Consumer price index in year 2 = 95/60 x 100 = 158

CPI in year 1 = 100

CPI in year 3 = 155/60 x 100 = 258

Inflation rate is calculated as follows:

E.g. inflation rate for year 2 (2020)= [(CPI in year 2 – CPI in year 1)/CPI in year 1] x 100

i.e., [(158 – 100)/100] x 100 = 58 percent

For Inflation rate in year 3 (2021) = [(CPI in year 3 – CPI in year 2)/CPI in year 2] x 100

= [(258 – 158) /158] x 100

= 63.29

CPI for year 3 =

So, inflation rate in year 3 = (258 – 158)/158] x 100 = 63.29 %

Difference between GDP deflator and CPI

Usually, both statistics tell the same story. Yet the two important differences
can cause them to diverge:

1. GDP deflator reflects the price of all goods and services produced domestically, whereas
the consumer price index reflects the prices of all goods and services bought by consumers
(as in the basket).

For example, suppose that the price of an airplane rises, inflation is reflected in GDP deflator but
not in CPI inflation because it is not a part of the basket of goods and services bought by a
typical consumer. Reverse is the case for increase in import of petrol price.

2. How various prices are weighed to yield a single number for the overall level of prices.
The CPI compares the price of a fixed basket of goods to the price of the same basket in the
base year. Only occasionally the base year (or the basket of goods) is changed. By contrast, the
GDP deflator compares the price of currently produced goods and services to the price of the
same goods and services in the base year. Thus, the group of goods and services used to
compute the GDP deflator changes automatically over time.

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Computation of Wholesale Price Index

Here are the components of the WPI index.
Primary Articles Percent Manufactured Products Percent
Food Articles 15.4025 Food Products 11.5378
Beverages, Tobacco and Tobacco Products1.3391
Non Food Articles 6.1381 Textiles 9.7999
Minerals 0.4847 Wood and Wood Products 0.1731
Paper and Paper Products 2.0440
Sub Total 22.0253
Leather and Leather Products 1.0193
Rubber and Plastic Products 2.3882
Fuel, Power, Light & Lubricants Chemicals and Chemical Products 11.9312
Non-Metallic Mineral Products 2.5159
Coal Mining 1.7529
Machinery and Machine Tools 8.3633
Mineral Oils 6.9896 Transport Equipment and Parts 4.2948
Electricity 5.4837 Basic Metals and Alloys 8.3419
Sub Total 63.7485
Sub Total 14.2262
Grand Total 100.00

Rapid Fire Questions

1. What is Triple identity?
2. Name the three big concepts of Macroeconomics?
3. What is the distinction between:
a. GNP and NNP
b. GNP and GDP
c. GDP and NDP
d. NNP at mp and NNP at fc
e. PI and DI
4. What is GDP deflator?
5. What is CPI?
6. What is difference between GDP deflator and CIP index.

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Readings for the next class

1. Economic inefficiencies cause collapse of communist
regimes_Salvatore_micro_Example 1-2, p-10.
2. Comparing the standard of living of various countries_
Salvatore_micro_Example 4-5, p-111.

Thank You!

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