Macro-Economics

Chapter 2
National Income Accounting
Course Contents
• Chapter 2: National Income Accounting
• Concept of National Income;
• Measurement Approaches:
• Expenditure Method,
• Income Method,
• Product Method;
• Difficulties in Measurement of National Income;
• Importance and Use of National Income
National Income Accounting
• National income Accounting is concerned with the measurement of
aggregate production and income of a country.
• It is deals with following two key issues:
• What is to be included and excluded to estimate national income?
• What method is used for estimating national income?
National Income
• Flow of goods and services in a nation over certain period of time
(generally one year).
• Since, goods and services are measured in different physical units, it is not
possible to add them together.
• Therefore, we use a common unit of measurement: Money.
• National income of a country is concerned with annual consumption and
not the units of annual production.
• Total money value of all goods and services produced by a nation during
one year after deducting the depreciation of the machine used in
production.
• The total payment received by the factors of production through the
production of goods and services in a country.
• Total net output of the nation.
Concept of National Income
• National Income is analyzed broadly with the help of two concept and
measure
• Gross Domestic Product (GDP)
• Gross National Product (GNP)

Plus

GDP GNP
Goods and Service
Goods and Service
produced within a
produced by resident
geographical
of a country
boundary of a country

Minus
Concepts of National Income
• Gross Domestic Product (GDP)
• Total money value of all the final goods and services produced within a
country in given period of time.
𝐺𝐷𝑃 = 𝑃1 𝑄1 + 𝑃2 𝑄2 + ⋯ + 𝑃𝑛 𝑄1
• Gross domestic product is the money value of all final services goods and
produced in the domestic territory of a country during an accounting year.

GDP

GDP GDP GDP GDP

At Factor Cost At Market Price Real (Constant Price) Nominal (Current Price)
Concepts of National Income
• Market Price and Factor Cost
• GDP can be measured at
• Market Price: current price in the market through the forces of demand and supply
(actual price paid by customer)
• Factor Cost: real price earned by producer or seller.
Concepts of National Income
• Gross Domestic Product (GDP)
• If the domestic product is estimated on the basis of the prevailing prices it is called
gross domestic product at current prices (Nominal GDP).
• If GDP is measured on the basis of some fixed price, that is price prevailing at a
point of time or in some base year it is known as GDP at constant price or real
gross domestic product.

𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝐺𝐷𝑃
𝐺𝐷𝑃 𝐷𝑒𝑓𝑙𝑎𝑡𝑜𝑟 =
𝑅𝑒𝑎𝑙 𝐺𝐷𝑃
% Change in GDP Deflator = Inflation
Example
Items Output Current Price Base Price
Pineapples 4240 1.3 1
Shoes 5000 10 8
Umbrellas 1060 100 100
The Nominal GDP will be the value of the current year's output using the current year's prices:
Nominal GDP in the Current Period = (4,240 X $1.30) + (5,000 X $10.00) + (1,060 X $100.00) = $161,512
The Real GDP will be the value of the current year's output using the base year's prices:
Real GDP in the Current Period = (4,240 X $1.00) + (5,000 X $8.00) + (1,060 X $100.00) = $150,240

GDP Deflator = (Nominal GDP/Real GDP) X 100

= ($156,512 / $150,240) X 100 = 104.175

There has been 4.175% inflation over the period

Change in GDP: Nominal Vs Real
• 2022
• Output: 1000
• Price = Rs 5

• Revenue = Rs 5000 • Change in Nominal:

• Gain came only from price change.
• No extra items were produced.
• 2023 • No extra jobs are created
• Output = 1000
• Price = Rs 6

• Revenue = Rs. 6000

Change in GDP: Nominal Vs Real
• 2022
• Output: 1000
• Price = Rs 5

• Revenue = Rs 5000 • Change in Real:

• Gain came from higher production.
• More items were produced.
• 2023 • More jobs are created.
• Output = 1100
• Price = Rs 5

• Revenue = Rs. 5500

Change in GDP: Nominal Vs Real
• 2022
• Output: 1000
• Price = Rs 5

• Revenue = Rs 5000 • Revenue doesn't change:

• Lower production hidden by higher price.
• Fewer items were produced.
• 2023 • Jobs may be lost (less works done).
• Output = 800
• Price = Rs 6.25

• Revenue = Rs 5000
Change in GDP: Nominal Vs Real
• 2022
• Output: 1000
• Price = Rs 5

• Revenue = Rs 5000 • Revenue gain in nominal real production

is lower:
• Extreme price increase hides lower
• 2023 production.
• Output = 800 • Fewer items were produced.
• Price = Rs 7 • Jobs may be lost (less works done).

• Revenue = Rs 5600
Concepts of National Income
• Net Domestic Product (NDP)
• While calculating GDP no provision is made for depreciation
allowance (also called capital consumption allowance). In such a
situation gross domestic product will not reveal complete flow of
goods and services through various sectors.
• A part of is therefore, set aside in the form of depreciation allowance.
When depreciation allowance is subtracted from gross domestic
product we get net domestic product.
NDP = GDP -Depreciation
Concepts of National Income
• Gross National Product (GNP)
• Total Market value of all final goods and services produced by the resident of
a country during a period of time.
• Gross national product is defined as the sum of the gross domestic product
and net factor incomes from abroad.
• Thus in order to estimate the gross national product of India we have to add
net factor income from abroad and deduct income earned by non-resident
form the gross domestic product.
GNP = GDP + NFIA
Concepts of National Income
• Gross National Product (GNP)
• Thus, GNP includes the following:
• 1. Consumer goods and services
• 2. Gross private domestic investment in capital goods
• 3. Government expenditure
• 4. Net exports (Exports-Imports)
• 5. Net factor income from abroad
Concepts of National Income
• Net National Product (NNP)
• The market value of the net output of goods and services produced by a nation in a
year.
• It can be derived by subtracting depreciation allowance from GNP. It can also be
found out by adding the net factor income from abroad to the net domestic product,
NNP = GNP – Depreciation
• If the net factor income from abroad is positive then NNP will be more than NDP, If
the net factor income from abroad is negative then NNP will be less than NDP and it
would be equal when net factor income from abroad is zero, NNP = NDP + NFIA

• Also referred as the National Income (NI) at market price

• National Income (NI) at factor cost

• The total income payments made to factors of production.
Concepts of National Income
• Personal Income (PI)
• The income that is actually received by individual and household in an
economy in a year.
• Deduction made from NI
• Corporate income tax
• Retained earnings
• Social Security contributions
• Insurance premium
Concepts of National Income
• Disposable Personal Income (DPI)
• Part of the personal income that is left after the payment of direct taxes.
• Total sum of income received by individuals and houlseholds of a country
after payment of direct personal income taxes during a year
DI = PI – Direct Taxes (Personal Taxes)
• It is available for individual and household for consumption. They divide it
into Consumption and Saving
• DI = C + S
Concepts of National Income
• Per Capita Income(PCI)
• Per Capital income is defined as the National Income of a country divided by
its population.
• Per Capital Income = NI / Total Population
Methods of Measurement (Approaches)

•Three approaches:
• Expenditure Approach
• Product Approach
• Income Approach

INCOME = PRODUCT = EXPENDITURE

Expenditure Approach
• Personal Consumption (C): Purchase of goods and services produced
by firms, individuals or households.
• Investment (I): Purchase of capital goods by firms for the use in
production and changes in the firm’s inventories.
• Government Spending (G): Expenditure incurred by federal, state and
local government for final goods and services.
• Net Export (X – M): Difference between the value of export and
imports.
Example
• Consumption Expenditure = 10.13 trillion
• Investment = 2.14 trillion
• Government Spending = 2.88 trillion
• Federal = 1.08 trillion
• State and Local = 1.80 trillion
• Net Export = -707.8 billion

• Calculate the GDP.

GDP = C + I + G + X
= 10.13 + 2.14 + 2.88 - 0.7078 = 14.44 trillion
Income Approach
• Wages and Salaries: Income received by labor from firms for the
services rendered to them.
• Net Interest: difference between total interest payment received and
total interest payment made by household.
• Rental Income: Payment for rented inputs.
• Profit: corporate profits earned by business corporation or payment
of dividend to shareholders.
Example
Items Amount Expenditure Approach
GDP = (3,657 + 741 +1,098 + (673-704) = 5,465)
Personal consumption 3657
Depreciation 400
Wage 3254 Income Approach
GDP = Wages + Rent + Interest + Profit
Indirect Business Taxes 520 GDP = (3254 + 17 +530 + (341+400+403+500) = 5,465)
Interest 530
Private Domestic Investment 741
Government Expenditure 1098 Calculate GNP
Rental Income 17
Corporate Profit 341
Export 673
Net Foreign Factor Income 20
Proprietor’s Income 403
Imports 704
Product Approach
• Measured by the net value of all final goods and services produced by
a nation during a year.
• Also referred as value added approach.
Relationship between Expenditure, Output and Income
methods of Measuring GDP

Sales Cost of Intermediate Value Factor

Stage of Production Receipt Products Added Income
1 Wheat 24 0 24 R+W+I+P
2 Flour 33 24 9 R+W+I+P
3 Dough 60 33 27 R+W+I+P
4 Bread 90 60 30 R+W+I+P
Total 207 117 90 90
Sales Receipt from final goods = 90 (Expenditure Method)
Total Sales receipt – Cost of intermediate Products = 90 (Output Method)
Total Income (R+W+I+P) = Value added = 90 (Income Method)
Expenditure Method = Output Method = Income Method
Sectors Contributing GDP
• Primary Sector: Mining, Quarrying, Agriculture, Forestry, and Fishing
• Secondary Sector: Manufacturing and Construction
• Tertiary Sector: Electricity, Gas, Water, Wholesale and Retail, Finance,
Insurance, Real Estate, Transportation, Storage, Communication etc..
Uses of National Income
• Measurement of Economic Performance
• Comparison of Standard of Living
• Economic Policy Formulation
• National Economic Planning
• Sectoral Contribution
• Inflationary and Deflationary Gaps
• National Expenditure
• Distribution of Income
Difficulties in National Income Accounting
• None-monetized Sectors:
• Problem of developing countries
• Existence of non-monetized sectors like agriculture.
• Barter exchange.
• Illiteracy
• Small producers are unable to keep accounts of their productive activities.
• Product produced for self consumption do not enter into the market
• Government do not know about such activities.
• Lack of expertise:
• Lack of expertise such as statistician, researcher, programmer, analysist etc. in
third world country.
• In such situation correct estimation can not be made.

• Lack of Sophisticated Machinery

• Lack of advanced computers or programs to process National income data.
• Traditional methods of data collection and processing.
• Double Counting:
• Usually a problem with product method.
• Possibility of inclusion of intermediate goods as final goods.
• Multi-occupation (single counting)

• False information:
• People are reluctant to disclose their income
• People generally underestimate their income.
• Probably due to expected tax obligation.
Nominal vs Real
• Real GDP is measured in in fixed price or base year price
• Nominal GDP is measured in current price
• Convert Nominal GDP in Real GDP using GDP deflator
Per Capita Income
• The average income per head of population.
• Used as a index of the standard of living of a country
Growth Rate
• The percentage change in quantity of goods and service produced in
two successive year.
Comparing Economic Performance
• When comparing economic performance using national income
statistics, be careful about:
• Price Level:
• Use Real GNP -> Eliminate effect of inflation.
• Size of Population:
• Use per capita GNP
• Income Distribution:
• More evenly distributed -> More welfare
• Composition of National Income
• More consumption expenditure, Less national defense  Higher welfare
• Exchange Rates:
• Express in same currency, exchange rate express purchasing power.
Is the GDP Good Measure of Economic Output and Welfare?

• Underground Economy: Informal economy unaccounted.

• Household Production: Goods and services produced for household
consumption.
• Quality: do not measure the change in quality of output.
• Purpose of Production: Bullet vs Wheat
• Intangibles: Leisure, happiness, optimism is not reflected.
• Distribution: Distribution of goods and service among population.
• Transfer payments: Share purchase (just transfer of ownership).