B4:PUBLIC FINANCE DCRC

NATIONAL INCOME ACCOUNTING

1. Meaning Of National Income And National Income Accounting.
National income is the total value of all goods and services produced in the country in a given time
period.
National income accounting is a set of methods and principles used for measuring an economy’s
overall performance, focusing especially on the overall level of production of goods and services. National
income accounting provides the necessary information which is used to assess the health of an economy
and to forecast future growth and development of a country.
2. The Concepts Of National Income
There are different concepts of National Income, namely; GNP, GDP, NNP, Personal Income and
Disposable Income etc.
(i) Gross Domestic Product (GDP)
Gross Domestic Product is the market value of the final goods and services produced within the domestic
territory of a country during one year inclusive of depreciation.
(ii) Net Domestic Product at Market Price
Net Domestic Product is the market value of final goods and services produced by all the producers in
the domestic territory of a country during an accounting year exclusive of consumption of fixed capital. It
is equal to the net value added.
(iii) Gross National Product (GNP)
GNP at market price is sum total of all the goods and services produced in a country during a year and
net income from abroad. GNP is the sum of Gross Domestic Product and Net Factor Income from abroad.
(iv) Net factor income from abroad
Difference between the factor incomes earned by our residents from abroad and factor income earned
by non-residents within our country.
(v) Net National Product (NNP)
In the process of production of goods and services, there will be some depreciation of fixed capital also
called as consumption of fixed capital, if the value of depreciation is deducted from the value of gross
national product in a year, we obtain the value of net national product.
(vi) GNP/GDP at Market Price and at Factor Cost
GNP/GDP can either be measured at market price or at factor cost, when it is measured at market price
it includes indirect taxes imposed by the government but excludes subsidies provided by the government
to producers and consumers, when it is measured at factor cost it includes only factor costs i.e. factor
incomes this means that in order to get GNP/GDP at factor cost, we must deduct indirect tax and add
subsidies.
GNP at market price = GNP at factor cost + indirect tax – subsidies
GNP at factor cost = GNP at market price – indirect tax + subsidies

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GDP at market price = GDP at factor cost + indirect tax – subsidies

GDP at factor cost = GDP at market price – indirect tax + subsidies
(vii) National income
Net National Product at factor cost is also called as national income.
(viii) Private Income
Private Income is defined as “the total of factor income from all sources and current transfers from the
government and rest of the world accruing to private sector” or in other words the private income refers
to the income from socially accepted source including retained income of corporation
(ix) Personal Income
Prof. Peterson defines Personal Income as “the income actually received by persons from all sources in
the form of current transfer payments and factor income.”
(x) Disposable Income
Prof. Peterson defined Disposable Income as “the income remaining with individuals after deduction of
all taxes levied against their income and their property by the government.” Disposable Income refers to
the income actually received by the households from all sources. The individual can dispose this income
according to his wish, as it is derived after deducting direct taxes.
(xi) Personal savings
It is disposable income left after paying Personal consumption expenditure
(xii) Per capita Income
Per capita Income is derived from dividing national income from the total population of the country.
(xiii) Nominal GDP and Real GDP
Nominal GDP is the market value of all final goods and services produced in a geographical region usually
a country, on the other hand, Real GDP is a macroeconomic measure of the value of the output
economically adjusted for price changes. Values for real GDP are adjusted for difference in price levels
while figures for Nominal GDP are not adjusted. Nominal values of GDP from different time periods can
differ due to change in quantities of goods and services and/or changes in general price levels while for
Real GDP the difference depict solely the changes in quantities produced. Generally, Real GDP is a
better index of welfare of the people, when Real GDP rises, flows of goods and services tends to rise,
other things remaining constant. This means great availability of goods per person, implying higher level
of welfare
Determinants Of The Size Of National Income
The size of nation income will depends on the following factors
(i) The Available Stock of Natural Resource
Availability of large stock of natural resources such as minerals, water sources, soils, weather condition
precipitates the growth of national income where low stock of natural resources leads to low production
consequently to low national income.

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(ii) Stock of Capital Goods

The size of the national income depends on the size of the capital goods available in a country; if the
size of capital goods such as factories, machines, infrastructures and raw materials is large a country
would experience faster growth of the national income unlike when a nation is facing a shortage of capital
goods.
(iii) Level of Technology
The size of national income depends on the level of technology a country has achieved, if in a country
production is done by using advanced technology output will be large as well as the national income.
(iv) Human Resources Available
National income depends on the available labour, both skilled and unskilled labour, managerial capacity,
efficiency and the number of entrepreneurs.
(v) Political Situation
When there is political stability in a country investors become confident to invest their capital therefore
resulting in the increase in the national income
Measurement Methods Of National Income
There are three approaches for measuring GDP; the income approach, Value added approach and the
expenditure approach.
(i) Expenditure Approach
According to the expenditure approach, the GDP is the total amount spent on goods and services by the
household sector, business sector, government sector and international sector. Spending by the
household sector is consumption (C),spending by the business sector is investment in capital goods (I),
Government spending is (G) and exports is (X)
Thus, Total expenditure of a nation = C + I + G + (X – M)
(ii) Income Approach
According to the income approach, the GDP is the total income earned by the household sector in a year,
the income of the household sector is the interest received in exchange for capital, profit received in
exchange for enterprise, rent received in exchange for land and wages received in exchange for labour.
Thus, Total income of a nation = interest + profit + rent + wages
(iii) Value-added Approach
The method measures GDP as the sum of value added at each stage of production (from initial to final
stage).The main sectors whose production value is added up are: (i) agriculture (ii) manufacturing (iii)
construction (iv) transport and communication (v) banking (vi) administration and defence and (vii)
distribution of income.
Example 1
The 2018 National Income accounts for a Country Zinduna include the following:-

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Wages and Salaries 430,000

Imports of Goods and Services 220,000
Rent 50,000
Value Added in Agriculture 100,000
Govt. Current Expenditure on goods and services 130,000
Capital consumption 70,000
Value added in Construction 50,000
Consumers’ Expenditure 450,000
Dividends 500,000
Income from self-employment* 60,000
Exports of goods and services 650,000
Undistributed Profit* 110,000
Gross Domestic Fixed Investment 150,000
Value added in Distributive Trades 150,000
Value added in Manufacturing 600,000
Value of Physical increase in stocks 10,000
Trading surplus of public corporations* 20,000
Value added in other sectors 270,000
*Gross of Depreciation
required
(i) Classify these items into separate accounts of GNP, GNI, and GNE.
(ii) Calculate Net National Product, Net National Expenditure and Net National Income

Uses of National income Accounting/Statistics

• Distribution of income among various factors of the production and sectors in the economy i.e.
households, business/firm and government sectors
• Used to show the growth rate of the national economy by comparing GNP
• Provide informations on international transactions and hence helps in measurement of balance
of payments issues
• Comparison of standards of living by using Per Capita income

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• They measure the size of various economic sectors i.e. agriculture, industry and infrastructure
etc.
• They shows the pattern of expenditure (public and private), which is important in making national
budget.
• They show the rate of resource utilization as an increase in national income may be attributable
to increased utilization of national resources and vice versa
• They provide saving information which is important for investments projection
• They provide information on economic problems i.e. inflation, fall in income, unemployment etc.

Problems Of Computing/Compiling National Income

There are many difficulties in measuring national income of a country accurately. The difficulties involved
in national income accounting are both conceptual and statically in nature. Some of these difficulties
involved in the measurement of national income are discussed below:
(i) Non Monetary Transactions
The first problem in National Income accounting relates to the treatment of non-monetary transactions
such as the services of housewives to the members of the families. For example, if a man employees a
maid servant for household work, payment to her will appear as a positive item in the national income.
But, if the man were to marry to the maid servant, she would performing the same job as before but
without any extra payments. In this case, the national income will decrease as her services performed
remains the same as before.
(ii) Problem of Double Counting
Only final goods and services should be included in the national income accounting. But, it is very difficult
to distinguish between final goods and intermediate goods and services. An intermediate goods and
service used for final consumption. The difference between final goods and services and intermediate
goods and services depends on the use of those goods and services so there are possibilities of double
counting.
(iii) The Underground Economy
The underground economy consists of illegal and uncleared transactions where the goods and services
are themselves illegal such as drugs, gambling, smuggling, and prostitution. Since, these incomes are
not included in the national income, the national income seems to be less than the actual amount as they
are not included in the accounting.
(iv) Petty Production
There are large numbers of petty producers and it is difficult to include their production in national income
because they do not maintain any account.
(v) Public Services
Another problem is whether the public services like general administration, police, army services, should
be included in national income or not. It is very difficult to evaluate such services.
(vi) Transfer Payments

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Individual get pension, unemployment allowance and interest on public loans, but these payments
creates difficulty in the measurement of national income. These earnings are a part of individual income
and they are also a part of government expenditures.
(vii) Capital Gains or Loss
When the market prices of capital assets change the owners make capital gains or loss such gains or
losses are not included in national income.
(viii) Price Changes
National income is the money value of goods and services. Money value depends on market price, which
often changes. The problem of changing prices is one of the major problems of national income
accounting. Due to price rises the value of national income for particular year appends to increase even
when the production is decreasing.
(ix) Wages and Salaries paid in Kind
Additional payments made in kind may not be included in national income. But, the facilities given in kind
are calculated as the supplements of wages and salaries on the income side
(x) Illiteracy and Ignorance
The main problem is whether to include the income generated within the country or even generated
abroad in national income and which method should be used in the measurement of national income.
Besides these, the following points are also represents the difficulties in national income accounting:
• Second hand transactions;
• Environment damages;
• Calculation of depreciation;
• Inadequate and unreliable statistics; etc

Roles Of The Government In National Income

The government policies influence the national Income of a country in many ways. Some of these are
explained below.
(i) Education and health care policies: increased investment in this sector contributes in improving the
quality of human capital of a country which results in increased production. When
production increases, the national income also increases and therefore GNP increases. It is important
that a government aims to increase the quality of its workforce by increasing educational and professional
training opportunities.
(ii) Institutional infrastructure: improvements in the institutional infrastructure of the country in areas
such as law and order, judiciary system, banking and insurance sector and stable and efficient
government organisations are important to GNP growth.
(iii) Infrastructure policies: improvement in the physical infrastructure of the country is fundamental to
supporting economic activity and encouraging GNP growth. It includes development of roads, railway
lines, airlines, bridges, dams, power generation plants etc.

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(iv) Social policies: strong policies to reduce unemployment, to control population, to improve social
security, to make better education available, to formulate good environmental policies etc. play a vital
role in the development of a country’s economy and therefore have a significant impact on GNP.
However, there is also a different view that needs to be understood. Although GDP and GNP reflect the
overall health of the economy, an increased GDP does not always mean development. Economic wealth
does not always mean good quality of life. More money within a country does not always mean better
quality of life for everybody.
Weaknesses Of Using Per Capital Income (PCI) Statistics To Compare Standard Of Living Among
Countries
Per capita income =National Income/Total Population
Per capita income is also referred to as income per head. This is calculated as shown above by taking
total income divided by total population. It’s the average income. It gives the amount of output per person
in a given economy at a particular time. It indicates the amount of goods and services that are available
for each individual in an economy. It also indicates the standards of living of people i.e. their material
well being
PCI Shortcomings:
• It doesn’t take into consideration income distribution i.e. it may be high but less % of the
population has money
• per capita does not represent the real living standards;- It doesn’t consider cost of living i.e. per
capita income may be high but a country have inflation
• Doesn’t take into consideration working hours and leisure time;- high per capita income may be
as a result of high workload and high stress
• Per capita income do not consider quality of goods consumed in different countries.ie high GDP
can be as a result of many goods produced with low quality
• GDP doesn’t take into consideration of negative externalities which contribute highly to the
standard of living of people e.g. pollution, congestion

Role Of The Public Sector In The Circular Flow Of Income And Expenditure
A study of the economy reveals that money flows in a circular fashion in the economy; from individuals
to businesses and back to individuals. The expenditure of individuals becomes the income for the
businesses and the expenditure of the businesses becomes the income of the individuals.
An individual spends his income (salary, rent, dividends) for buying consumable goods and services from
the businesses, for paying taxes to the government and for savings in the form of investments. The
businesses use the money (spent by individuals while buying the goods and services and while making
investments) to set up their business, to buy material to manufacture goods and to pay their employees.
Thus, the economy of any country can be divided into five sectors:
• Household sector: this includes all individuals and families
• Business sector: this includes the firms and organisations
• Financial sector: this includes banks and financial institutions
• Government sector: this includes the ruling bodies of the state and the central government

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• International sector: this includes the import and export

Based on the above classification, various models are framed to understand the circular flow process.
The following diagram explains the five sector circular flow model

Diagram 1: Five sector circular flow model

We will use the above diagrammatical representation to understand how money flows through the
economy through various sectors
Two sector model
The two important sectors that exist in any economy are the household sector and the business sector.
The four flows shown in the diagram are explained as follows:
1. Output (O): the most obvious flow is the provision of goods and services by the business sector to
the household sector.
2. Expenditure (E): the household sector needs to pay for the goods and services supplied by the
business sector.
3. Resources (R): the household sector provides the resources i.e. the factors of production to the
business sector. The factors of production are capital, enterprise, land and labour (CELL).
4. Income (Y): the returns for factors of production are interest or dividend (for capital), profit (for
enterprise), rent (for land) and wages (for labour)
In the two sector model, as the cash keeps flowing in the economy, the state of equilibrium is defined as
a situation in which there no scope for the variations in levels of income (Y), expenditure (E) and output
(O) to change i.e. Y = E = O

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Three sector model

The three sector model expands the simple two sector economy by introducing one more sector – the
financial sector. With the introduction of one new sector, two new flows arise in the economy (see diagram
1):
5. Savings (S): savings flow from households to the banks.
6. Investments (I): money goes back from banks to the business sector in the form of investments. Thus,
money for investments in the business sector is procured from savings that the household sector puts in
the banks.
Four sector model
Now, let’s go one step further and introduce the fourth sector – the government sector. As one new sector
is introduced, two new flows arise in the economy (see diagram):
7. Taxes (T): taxes are a flow from the household sector to the government.
8. Government spending (G): government then puts the money (collected in the form of taxes) back in
the flow system by way of government spending.
Five sector model
We are living in a very globalised world and we deal more and more with the international sector.
Therefore, the most realistic representation of the flow system is to include the international sector. The
two new sectors that arise in the economy on inclusion of the international sector are:
9. Import (M): the household sector buys goods and services from overseas
10. Export (X): the businesses sell goods and services to overseas customers
Thus, to summarise: There are five sectors in an economy (household, business, financial, government,
international).
There are four types of flows between the household sector and the business sector (output,
expenditure, resources, and income).
There are three flows going out from the household sector (savings, taxes and imports). Collectively,
these are called ‘leakages’.
There are three flows going into the business sector (investments, government spending and exports).
Collectively these are called ‘injections’.
In a five-sector model, the state of equilibrium occurs when the total leakages are equal to the total
injections that occur in the economy.
This can be shown in equation form as:
Savings + taxes + imports = Investments + government spending + exports
S+T+M = I+G+X
In other words,
If injection > leakages; this means the economy is growing

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If injection < leakages; this means the economy is diminishing

If injection = leakages; this means the economy is stable

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