Lecture 4

National Income Accounting -contd

EEP-I
 National
Nationalincome
incomeaccounts
accounts

The
The 33 -- methods
methods of
of
national
national income
income accounting
accounting
 The circular flow of National income

(2) Production or
(1) Incomes value added

(3) Expenditure
 Three Methods of Computing An
Economy’s Income

1. Resource Cost or Income Approach:

Sum the total wages , rents, interest and profit paid by firms for
resources

2. Value Added or Production Method

Sum the value added at each stage of production process

3. Expenditure Approach:
Sum the total expenditures by households (from the top portion of
the circular flow).
Relationship between Expenditure, Output and Income methods of measuring GDP of a country
Stage of Sales Cost of intermediate Value added Factor Incomes
production receipts products
Wheat 20 0 20 r+w+i+p=20
Flour 35 20 15 r+w+i+p=15
Dough 65 35 30 r+w+i+p=30
Bread 100 65 35 r+w+i+p=35
Total 220 120 100 r+w+i+p(=100-indirect
tax+ subsides)

1. Total sales receipt- Cost of intermediate product= Final Expenditure or Final Good
2. Total sales receipt/Total Revenue- Cost of intermediate product= Value added
3. Final Expenditure=Value Added= r+w+i+p
4. Expenditure method= Value Added Method= Income method
Measure GDP
5. Expenditure method(GDPMP)= Value Added Method(GDPMP) = Income
method(GDPFC)

So, conceptually may be all method are equal but in reality all are not equal.
1. Income method
 Income method
a) Identify the productive enterprises and classify them into various sectors such as
agriculture, fishing, forestry, manufacturing, transport, trade and commerce, banking
etc.
b) Classify the factor payment. Like
i) Compensation of employees- wages and salaries, employers’ contribution social security
schemes.
ii) Rent and also royalty, if any
iii) Interest
iv) Profits: Dividends, Undistributed profits and corporate income tax
v) Mixed income of the self employed (in case of India)
c) Measure factor payments of each enterprise.
d) Factor payments of an industry or sector
e) Aggregate of all factor payment of an industry or sector= Net Domestic Product (NDPFC)
f) Finally, NDPFC + net factor income earned from abroad to domestic factor income = NNPFC =NI
 Income method contd…

Note:
1) Transfer payment are not included
2) Imputed rent of self occupied houses are included
3) Illegal money are not included
4) Windfall gains like prize won or lotteries are not
included
5) Corporate profit tax included in the profit part
6) Death duties, gift tax, wealth tax, tax on lotteries is
not included
receipts from sale of goods is not included
7) Income equal to the value of production used for self
consumption is included
 Diagram of income approach to NI

Net Indirect Taxes

Net Factor Income Consumption of Consumption of
from Abroad Fixed Capital Fixed Capital

Dividends Dividends
Undistributed Profit Undistributed Profit
Profit Profit
Corporate Income Corporate Income
Tax Tax

Interest Interest Interest Interest

Rent Rent Rent Rent
Mixed income of Mixed income of Mixed income of Mixed income of
self-employed self-employed self-employed self-employed

Compensation of Compensation of Compensation of Compensation of

Employees Employees Employees Employees

NDPFC NNPFC GDPFC GDPMP

 2. Value Added Method

• This method is called output method or production method also.

• Under this the economy is divided into different industrial sectors such
as agriculture, fishing, mining etc. net value added at factor cost (NVAFC)
by each productive enterprise as well as by each industry. So first to get
(NVAFC) they have to find out the value of the output.
Calculate: Value of the output= the quantity of goods and services
produced by a particular enterprise multiplied by their market price.
…..(1)

• Value of the output= Sales + Change in Stocks

Calculate: GVAMP = Value of the output - intermediate consumption

…..(2)
GVAMP disposes in three item
1) Making depreciation provision for consumption of
fixed capital during the year
2) Making payments of indirect taxes such as excise
duties, sales tax, import duty to the government
3) Making factor payment like wages + interest + profit
to the factors of production whose services have
been used for the production of a good.
NVAMP = GVAMP – depreciation …..(3)
NVAFC = NVAMP –(Net Indirect tax) …..............(4)
= wage+ rent +interest +profit …..(5)
 NVAFC to National Income

= NVAFC of an industry or sector (n= number of productive

enterprise in an industry) …..(6)

= NDPFC (j= number of industry or sector) …..(7)

Now, NDPFC + net factor income from abroad = NNPFC =NI …..(8)
Note:
a) Imputed rent values of self houses is included in value of output
b) Sale and purchase of second hand goods is not included
c) Value of production of self consumption is counted
d) Value of services of housewives are not included
e) Value of intermediate goods must not counted
 3. Expenditure method

Less Depreciation Net Factor Income

Abroad
Gross Domestic
Capital Formation (I)
Net Domestic Net Domestic
Capital Formation Capital Formation

Govt. Final Govt. Final

Govt. Final
Consumption Consumption
Consumption
Expenditure (G) Expenditure (G) Expenditure (G)
NDPMP - Less Net
Private Final Indirect Tax
Private Final Consumption Private Final
Consumption Consumption
Expenditure (C)
Expenditure (C) Expenditure (C)

Net Export(X-M) Net Export(X-M) Net Export(X-M)

GDPMP NDPMP NDPFC NNPFC

 Which method is more appropriate as
a measure of GDP?
Methods Application

OUTPUT METHOD Sectoral growth rate calculation

( Agriculture, manufacturing, service etc.)

EXPENDITURE Estimation of Aggregate Demand of Nation

METHOD (Cause and fluctuation of C,I,G,NX)

INCOME METHOD Distrbuted to each factor of production

(% if NI for Wages, rent, interest and Profits)
 What is Not Counted in GDP?
1. Activities which are 2. All non-market 3. Component which
not part of GDP transactions are for welfare of the
Activities which does society
not follow the four Can be included but due to
major points: market measurement problems they
value, finished good, are omitted. GDP does not account
Like: for inefficiency.
produced, time should
be omitted.
Like:
GDP will look only at the
i) Transfer payments i) Mother’s services at home market value of final
and other social ii)Un-organised sector goods and services
securities produced and will pay
ii) Selling of iii) Certain types of investment no held to the adverse
Secondhand goods that contribute to growth but lifestyles, which result
iii) Increase in price of not included in GDP like from the increased
investment in R&D, economic activities.
a companies share
Investment in human capital

iv) Economic transaction takes

place illegally( black money)
 National Income & Related Aggregates
4 - Important distinctions
 Between a Gross Concept and a Net Concept – Depreciation
 Between At Factor Costs Concept and a At Market Prices Concept –
Net Indirect Taxes
 Between a At domestic Concept and a National Prices Concept -
NFIAbroad
 Real and Nominal concept – Price level
 India, GDP Statistics:
Source: Reserve Bank of India, Publication, Annual, Handbook of statistics on Indian Economy.
https://www.rbi.org.in/ Amount in Crores
Year GDPMP GDPMP GNPMP Net tax GNPFC Gross Net Total NNPFC Popula
(Curren (Base (Base on (Base capital capital Depr (Base tion in
t Prices) Prices Prices products Prices forma formati etiati Prices Lakhs
2011- 2011- 2011- tion on on 2011-
12) 12) 12) 12)
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11)

2012-13 9944013 9213017 9104662 666741 3639296 2628635 8094001 12350

2013-14 11233522 9801370 9679027 737721 3448236 2347626 8578417 12510
2014-15 12467959 10527674 10402987 815541 3659763 2481119 9224343 12670
2015-16 13771874 11369493 11234571 877623 3917358 2646468 9963681 12830
2016-17 15362386 12298327 12153754 979355 4146020 2765066 10772800 12990
2017-18 17095005 13179857 13034121 1075693 4679689 3176728 11531159 13160
2018-19 19010164 14077586 13932287 1170650 - - 12329646 13320

1. Calculate Deflator year wise and then see the annual rate of inflation.
2. Find out the annual increase of Real GDP, which reflects the annual increase in demand
of goods and services.
3. Can one estimate the trend in National Income?
4. Calculate Per capita income year wise? What is the trend?
 International Comparison of GDP: Development Indicators
Source: Column 2-5 world bank, 6 UNDP

Country Nominal GDP GDP PPP (US Per capita Per capita HDI rank
(US trillion$) trillion$) in Nominal GDP GDP PPP In 2017
in 2019 2019 (US $) in 2018 (US
trillion$)in
2018

USA 21.34 21.41 62606 62606 13

(1) (2) (8) (10) (High HDI)
China 14.22 27.44 9608 18110 86
(2) (1) (67) (73) (Medium HDI)
India 2.97 11.44 2063 7874 130
(5) (3) (142) (119) (Low HDI)

Russia 1.61 4.32 11327 29123 49

(12) (6) (60) (49) (High HDI)
Brazil 1.96 3.55 8968 16154 79
(9) (8) (73) (80) (Medium HDI)

1-60: High HDI

61-112: Medium HDI
112-151: Low HDI
International comparison of GDP- how standard of living of the people varies across the countries
One method:
Step1:To take the average of
per capita of GDP(or GNP) in
each country in nominal terms
Step 2: Convert that into a
common currency, normally
US Dollar
Step 3: At going exchange rate
see the relative position
Atlas method - a World Bank method
A country's GNI in local currency is converted into
U.S. dollars using the Atlas conversion factor,
which uses a three-year average of exchange
rate, adjusted for the difference between the
rate of inflation in the country (using the
country's GDP deflator), and that in a number
of developed countries(using a weighted
average of the countries' GDP deflators in
SDR terms).
The resulting GNI in U.S. dollars is divided by the
country's midyear population to obtain the GNI
per capita.
• https://datahelpdesk.worldbank.org/knowled
gebase/articles/378832-the-world-bank-atlas
-method-detailed-methodology
 2nd problem: with the earlier methodology it fails to capture the
differences in prices for the same goods and services across countries.

PPP method adjust the different relative prices among

the countries before making comparison in a common
currency.
 Purchasing Power Parity PPP
Let, market exchange rate between Dollar and Rupee is 60. One Dollar in the US will buy one
liter of milk there. Corresponding money in terms of Rupee i.e., Rs 60 can buy three liters of milk
in India.
Suppose that India’s GDP is Rs 600. This will become $10 in market exchange rate terms. If milk
is the only commodity produced in the world (you imagine it for simplicity sake), one will think
that India is producing 10 liters of milk, if we use the market exchange rate. Actually, India
produces 30 liters of milk. This higher volume of production in India is not expressed if we use
the market exchange rate to measure GDP. To overcome this defect and to accurately measure
the GDP, we can use the Purchasing Power Parity exchange rate.
Under PPP, we measure the GDP of India by measuring how much milk that Rupees 60 can
purchase in India and One Dollar can purchase in the US.
Here, one dollar in the US can purchase one liter of milk whereas Rs 20 can purchase one liter of
milk in India. $ 1 = Rs 20 This is the purchasing power parity exchange rate we obtained. Using
this exchange rate we can calculate that India’s GDP of Rs 600 will become $30.  
Thus, in terms of PPP, India’s GDP is $30 in contrast to the $10 we estimated by using market
exchange rate. The PPP exchange rates help to minimize misleading international comparisons
that can arise with the use of market exchange rates.
If you ask how much units of Indian currency is equivalent to one US Dollar in terms of PPP, the
World Bank has estimated it scientifically.
The World Bank is using purchasing power parity conversion factor to correctly represent the
PPP exchange rate. As per the WB estimate, 17.12 Indian Rupee is equal to one US Dollar in
terms of purchasing power in 2014 (Source: http://data.worldbank.org/indicator/PA.NUS.PPP).
Human Development Index
(HDI)= f(Life expectancy at birth, Expected years of schooling, Mean years of
schooling
 Home Assignment:
1) Why Indian life spans continue to be shorter than those of other developing and developed nations

2) Is Indian economy should move from consumption economy to investment economy? Pros and cons.
 Difficulties of measuring income in developing
countries

• In India still huge output does not come to the market at all. Mainly
in agricultural product major output consumed at farm level itself.
• Because of illiteracy producers have no idea on quantity and value
of their output and do not have practice to keep regular accounts.
• Due to disguised unemployment individual may receive income
partly from farm ownership partly from manual work in industry,
this become difficult to calculate NI.
• Unorganised and scattered sector effect to calculate NI
• Lack of adequate statistical data.