National Income

Concepts & Measurements…

National Income Accounting

National income accounting – term used in economics to refer to the bookkeeping system that a national government uses to measure the level of the country's economic activity in a given time period. National income accounting records the level of activity in accounts such as total revenues earned by domestic corporations, wages paid to foreign and domestic workers, and the amount spent on sales and income taxes by corporations and individuals residing in the country.

National Income Accounting

National income accounting provides economists and statisticians with detailed information that can be used to track the health of an economy and to forecast future growth and development. Although national income accounting is not an exact science, it provides useful insight into how well an economy is functioning, and where monies are being generated and spent.

National Income Accounting

Some of the metrics calculated by using national income accounting include gross domestic product (GDP), gross national product (GNP) and gross national income (GNI).

National Income

According to the famous economist J.M. Keynes “ National income is the money value of all the final goods and services produced in a country during a year”

The National income of any country shows the economic position of the country.

It is the national income which helps to compare the progress of the country over a period of time.

National Income

The study of National income is important because of the following reasons:

To see the economic development of the country.

To assess the developmental objectives. To know the contribution of the various

sectors to National income.

The National Income Accounting Identity The equality of output and income is an

accounting identity in the national income accounts.

The identity can be seen in the circular flow of income in an economy: for an economy as a whole, income must equal expenditure.

Supply and demand determine the market equilibrium price and quantity that is produced and exchanged in each market.

CIRCULAR FLOW OF INCOME

■TWO SECTOR MODEL OF CIRCULAR FLOW

■THREE SECTOR MODEL OF CIRCULAR FLOW

■FOUR SECTOR MODEL OF CIRCULAR FLOW

The Circular-Flow of Income

A first, simple model that gives structure to macroeconomic interaction which shows how money flows among households and firms.

Two Sector Model

▪ There are two players Households:→Own all economic resources – land, labour, capital &

enterprise→Supply factors of production in return of rent, wages,

interest & profit→ Use this money to buy goods & services produced by

the firmsFirms:→ Hire factors of production to produce goods &

services for sale back to households

Contd:

▪ There are two types of flow between these groups

▪ A real flow. Households own factor services which they hire out to firms. Firms use these factor services to manufacture goods and services –“outer flow”

▪ A money flow. Households receive payments for their services (income) and use this money to buy the output of firms ie consumption) – “inner flow”

Two Sector Model Diagram

Two Sector Model with Savings

Assumptions:

Households are assumed to make no savings.

Firms spend all their revenue on factors of production owned by the households

Total Demand = Total Supply – Equilibrium The economy is closed ( no international

trade )

The Three Sector Model

This model includes the Government sector : Households are required to pay taxes ,either

direct (eg income tax) and indirect (eg VAT)

Government receives taxes which are used for building roads, paying government servants etc i.e Government spending denoted by G

The Four Sector Model – Open Economy With International Trade

The 4 Sector Circular Flow Model

▪ International trade (X-M) means money is spent on foreign made goods and services brought into the country ie imports (M) These withdrawals or leakages out of the circular flow of

income will be counterbalanced by flows back in. These flows are known :

Final government expenditure on goods and services eg roads and education (G)

Expenditure by overseas residents on domestically made goods and services ie export expenditure (X).

Expenditure by overseas residents on domestically made goods and services ie export expenditure (X).

National Income Accounting

What is National Income……………

Concepts of National Income…………..

Measurement of National Income………..

Difficulties in measuring National Income……..

What is National Income

Total income earned by the residents of a country in 1 year.

These accounts measure the following:

►Total value of output of goods & services produced

►Total of expenditure taking place in an economy

►Total amount of income generated through production of goods & services

National Income=National Product=National Expenditure

Concepts of National Income

►GROSS NATIONAL PRODUCT

►GROSS DOMESTIC PRODUCT

►NET NATIONAL PRODUCT OR NATIONAL INCOME AT MARKET PRICES

►NATIONAL INCOME OR NATIONAL INCOME AT FACTOR COST

►PERSONAL INCOME

►DISPOSABLE INCOME

GROSS NATIONAL PRODUCT

Total market value of all finished goods & services produced in a year by a country's residents in a year.

Calculated on annual basis GNP includes the market value only of final

goods ( Goods purchased only for final use & not for further processing or resale )

GROSS NATIONAL PRODUCTGNP Has the following components:

1. Value of final consumer goods and services produced in a year and consumed by a household denoted by (C )

2. Gross Private Investment denoted by (I )

3. Government expenditure on goods and services denoted by ( G )

4. Net Exports (X-M )

5. Net factor Income from Abroad.

GROSS NATIONAL PRODUCT

Net Factor Income from abroad is the difference between factor income received from abroad by normal residents of India for rendering factor services in other countries on the one hand and the factor incomes paid to the foreign residents for factor services rendered by them in the domestic territory of India on the other .

Nominal and Real GNP, Wholesale Price Index, Consumer Price Index, and the Deflator

GNP is estimated at both current & constant prices GNP estimated at the current prices is called Nominal GNP GNP estimated at constant prices is called Real GNP Consumer Price Index is a measure of the average change in prices

paid for a fixed market basket of consumer goods and services over a stated period of time.

Wholesale price indexes measure the changes in commodity prices at a selected stage or stages before goods reach the retail level; the prices may be those charged by manufacturers to wholesalers or by wholesalers to retailers or by some combination of these and other distributors

Deflator is a measure of the change in prices of all new, domestically produced, final goods and services in an economy.

GROSS DOMESTIC PRODUCT

Gross domestic Product is the money value of all final goods & services produced by residents & non-residents within a country’s boarders in a specified time period

It Includes: All of private & public consumption Government outlays Investment & exports less imports that occur within

an economy GDP= C+ I + G + NXWhere NX is Exports-Imports

GROSS DOMESTIC PRODUCT

The only difference between GNP and GDP is the net factor income from abroad.

GDP (MP ) = GNP (MP) – Net Factor Income from aboard.

GNP V/S GDP

GDP is calculated as the value of the total final output of all goods and services produced in a single year within a country’s boundaries. GNP is GDP plus incomes received by residents from abroad minus incomes claimed by nonresidents.

GNP V/S GDP

There are two ways of calculating GDP and GNP:

By adding together all the incomes in the economy - wages, interest, profits, and rents.

By adding together all the expenditures in the economy- consumption, investment, government purchases of goods and services, and net exports (exports minus imports).

GNP V/S GDP

In theory, the results of both calculations should be the same. Because one person’s expenditure is always another person’s income, the sum of expenditures must equal the sum of incomes.

When the calculations include expenditures made or incomes received by a country's citizens in their transactions with foreign countries, the result is GNP.

GNP V/S GDP

When the calculations are made exclusive of expenditures or incomes that originated beyond a country’s boundaries, the result is GDP.

GNP may be much less than GDP if much of the income from a country’s production flows to foreign persons or firms. For example, in 1994 Chile’s GNP was 5 percent smaller than its GDP.

GNP V/S GDP

If a country’s citizens or firms hold large amounts of the stocks and bonds of other countries’ firms or governments, and receive income from them, GNP may be greater than GDP. In Saudi Arabia, for instance, GNP exceeded GDP by 7 percent in 1994. For most countries, however, these statistical indicators differ insignificantly.

GNP V/S GDP

GDP and GNP can serve as indicators of the scale of a country's economy.

But to judge a country's level of economic development, these indicators have to be divided by the country's population. GDP per capita and GNP per capita show the approximate amount of goods and services that each person in a country would be able to buy in a year if incomes were divided equally. That is why these measures are also often called "per capita incomes."

GDP Price Index—GDP Deflator

The GDP price index, as apposed to CPI index, measures the average price level of all good and services included in the GDP estimates.  Also the base year for the GDP price index is year 2000. The closer the year in question is to the base year, the more accurate is the measure of real GDP.  That is why the GDP price index is shifted frequently and called the GDP deflator to reflect the change in price level of the goods and services produced.

GDP Price Index—GDP Deflator

The GDP price deflator has two common uses: (1) as an indicator of the price level and economic activity and (2) as a method of deflating nominal economic indicators to real terms.

GDP Price Index—GDP Deflator

Price Level Indicator: The most common use of the GDP price deflator is as an indicator of the economy's price level, and perhaps even more importantly, as a means of estimating the rate of inflation. The CPI-based inflation rate may be more widely reported by the media, but the GDP price deflator is usually the measure of choice when economists need precision in the analysis of inflation and related macroeconomic phenomena

GDP Price Index—GDP Deflator

. While the GDP price deflator is not reportedly as frequently as the CPI (quarterly versus monthly), it does provide a more comprehensive measure of the price level and thus inflation. This is why the aggregate market analysis uses the GDP price deflator to measure the price level

GDP Price Index—GDP Deflator

Deflating Nominal to Real: Economists, business leaders, and government policy makers often find it useful to convert current, or nominal economic indicators to real terms, that is to eliminate any inflationary increases of the nominal values. In fact, the "deflator" part of the GDP price deflator comes about because it is used to deflate nominal GDP to real GDP.

Deriving the Deflator

GDP price deflator = nominal GDP X 100

real GDP

For example, nominal GDP in 2002 was $10,480.8 billion and real GDP in 2002 (using 2000 prices) was $10,083.0 billion. The ratio of nominal to real (after multiplying by 100) is 103.95

GDP price deflator = $10,480.8/ $10,083.0 x 100 = 103.95

Deriving the Deflator

The interpretation of this 103.95 value for GDP price deflator in 2002 is that the average price level in the economy increased by 3.95 percent from 2000 (the base period for estimating real GDP) to 2002. Calculating the percentage change the GDP price deflator from one year to the next, then provides an excellent measure of the inflation rate. For example, the GDP price deflator is 102.38 for 2001 and 103.95 for 2002, a change of 1.54 percent.

Pros and Cons

There are three important points to note about the GDP price deflator, two pro and one con. These points are especially important when comparing the GDP price deflator to the CPI.

First, the GDP price deflator is based on ALL production in the aggregate economy. This is a definite pro. It includes not just urban consumption, as does the CPI, but also investment expenditures for capital goods, purchases by the government sector, and even exports to the foreign sector. It has it all. So for anyone truly interested in a price index for the aggregate economy, this is it.

Pros and Cons

Second, the GDP price deflator measures the prices of "current production", the prices of goods actually produced during the current year. This also a definite pro. The CPI, in contrast is based on a market basket of goods identified 5 or 10 years earlier. Again, from a macroeconomic perspective, this is a much better way to go.

ed.

Pros and Cons

Third, the GDP price deflator is reported quarterly, every three months, along with other measures in the National Income and Product Accounts. The GDP price deflator for the first three months of the year (January, February, and March) is not available until late April or May. And then, it is only a 3-month average rather than a month-by-month, blow-by-blow price index. From a timeliness perspective, the GDP price deflator comes up short on providing decision makers with the information need

Net National Product or National Income at Market Prices While calculating GNP no provision is made for

depreciation of Capital goods such as machines, equipments, tools & so on…

When depreciation allowance is subtracted from GNP, NNP is got.

Net National Product ( NNP ) is the total market value of all final goods & services after

deducting depreciation. When charges for depreciation are deducted from

GNP we get NNP NNP or National Income at MARKET Prices = GNP

- Depreciation

Net National Product or National Income at Factor Cost National income at factor cost means the

some of all domestic factor income & net factor income from aboard

NNPFC= National Income = FID ( factor income earned in domestic territory ) + NFIA (net factor income in aboard )

Indirect taxes must be subtracted & subsidies added to get NNP at market prices

NNPFC=NNPMP-Indirect taxes + subsidies

Personal Income ( PI )

Some of all income actually received by individuals during a given year

National income is the total income earned & Personal income is the total income received

Some incomes are earned such as social security contributions, corporate income-taxes and undistributed corporate profits.

Some incomes are received such as transfer payments( pensions, unemployment schemes, interest payments etc )

PI = NI - social security contributions, corporate income-taxes and undistributed corporate profits + transfer payments.

DISPOSABLE INCOME ( DI )

Not all income is available for consumption Amount left over after payment of personal direct

taxes, including income taxes, contributions to social insurance plans and other fees.

It is a measure of the funds available for personal expenditure on goods and services and personal saving for investments as well as personal transfers to other sectors of the economy.

DI = PI – Personal Taxes DI = Consumption + Savings

Measurement Of National Income

► Value Added Method

► Income Method

► Expenditure Method

Value Added Method

Also called output or Production method Measures the contribution of each producing enterprise in the

domestic territory of a country It involves the following stepsA) Identifying the producing enterprise and classifying them into

industrial sectors according to their activities; and B) Estimating the net value added by each producing enterprise

and each industrial sector and adding up the net value added by all the sectors.

To arrive at net value added at factor cost, the value of raw materials, intermediate goods & services as well as Net Indirect Taxes as well as Depreciation have to be subtracted

Value Added Income

Precautions to be taken while measuring National Income through this method

The following items need be included carefully: I) production of fixed assets by government, enterprises and

households; ii) production for self-consumption; and iii) imputed rent of owner-occupied houses. The following should not be included :i) sale of second-hand machines (Brokerage and commission

earned by the dealers of second-hand goods are a part of production and, hence, included while calculating the total value-added.)

ii) Services of housewivesiii) Value of intermediate goods

Income Approach

This method adds all the income generated by the production of final goods and services to measure the National income

Individuals earn incomes by contributing their own services & the services of their property such as land & capital to NI

NI is calculated by adding up the rent on land, wages & salaries of employees, interest on capital & profits of entrepreneurs & incomes of self-employed people.

This method has the advantage of indicating the distribution of national income among different income groups.

Income approach

Steps involved: 1. Identify the productive enterprises and classify them into various industrial sectors 2. Classify factor payments into compensation of employees, rent and royalty, interest, profits (dividends, undistributed profits and corporate income tax) Mixed income of the self-employed (household industries, family farms, unorganised enterprises) 3. Measure factor payments. Income paid out by each

enterprise can be estimated by price paid out to each factor multiplied by the number of units of each factor employed.

Income Approach

4. Add up incomes paid out by all industrial sectors

5. Sum up incomes paid out by all industrial sectors we obtain NDP fc

6. By adding net factor incomes from aboard to domestic factor incomes NDPfc we get Net National Product at factor cost

Expenditure Approach

The expenditure approach measures GDP by adding together money spent buying this year’s output: personal consumption expenditures (C), gross private domestic investment plus stock building (I), government purchases of goods and services (G), and net exports (NX).

Expenditure Method Problems

1. Intermediate goods : To avoid double counting expenditure on intermediate goods and services is ignored

2. Expenditure on second-hand goods is not part of current GDP because these goods were counted as part of GDP in the period in which they were produced and in which they were new goods

3. Selling Financial Securities: The resultant expenditure on new capital goods forms part of GDP, but the expenditure on financial securities is not.

Difficulties in Measuring National Income

● Non- availability of reliable statistics

● The services of housewives is not included in national income because their service is not sold in the market

● Individuals don't keep correct account of their consumption

● Illiteracy and ignorance

● lack of proper criteria for measuring the value of services

Nominal versus Real GNP

GNP calculate at constant prices is called as Real GNP .

GNP calculated at current prices in called Nominal GNP

Lets understand this with the help of a table:

Nominal and Real GNP, Wholesale Price Index, Consumer Price Index, and the Deflator

GNP is estimated at both current & constant prices GNP estimated at the current prices is called Nominal GNP GNP estimated at constant prices is called Real GNP Consumer Price Index is a measure of the average change in prices

paid for a fixed market basket of consumer goods and services over a stated period of time.

Wholesale price indexes measure the changes in commodity prices at a selected stage or stages before goods reach the retail level; the prices may be those charged by manufacturers to wholesalers or by wholesalers to retailers or by some combination of these and other distributors

Deflator is a measure of the change in prices of all new, domestically produced, final goods and services in an economy.

Real & Nominal GNP

Composition of WPI

Weights assignedPrimary items 22.02Fuel 14.23ManufacturedProducts 63.75Each good's price level in the base period is

100 and weights are assigned to them according to their relative importance.

Multiplying the price indices of all goods with weights gives the overall price index

Consumer Price Index

CPI for Industrial WorkersCPI for Agricultural LabourersCPI for Rural LabourersCPI for Urban Non-manual Employees

Commodity basket comprises of:1.Food & Beverages2.Fuel & Light3.Housing4.Clothing, bedding & foot-wear5.MisclPrimarily used for indexation of wages/salaries

Calculation 1. In an economy the NDP at Factor cost is Rs

20,000 crore, indirect taxes are Rs 3,000 crore and subsidy is Rs 500 crores. What is NDP at Market prices?

2. The following information pertains to an economy for the year 2007-2008.

What is the NDP at factor cost?

Particulars Rs. in crore

GNP at factor cost 2,10,000

Indirect Taxes 30,000

NDP at market prices 2,60,000

Subsidies 40,000

Solution1. NDP at market price= NDP at factor cost + indirect

taxes – subsidies

=20,000 +3,000 – 500

=Rs 22,5000

2. NDP at factor cost= NDP at market price – Indirect taxes+ subsidies

= 2,60,000 -30,000+40,000

= Rs 2,70,000

Calculation 3. The following information is taken from the

National Income Accounts of an economy for the year 2008: Calculate the Personal Income for the economy ?

Particulars Rs. in crore

Indirect taxes 14,000

NDP at market prices 1,00,422

NNP at market prices 1,00,000

Subsidies 2,000

Corporate profit taxes 6,500

Retained profit 30,000

Solution

NI= NNP at factor Cost

NNP at factor cost= NNP at market price – Indirect taxes+ subsidies

= 1,00,000- 14,000 +2000

= 88,000

PI= NI- Corporate Profit Taxes- Retained Profits

= 88,000-6,500-30,000

= 51,500

Calculation

4. The following information is extracted from the National Income Accounts of an economy: Calculate the Net Exports of the economy?

Particulars Rs. in crore

Consumption 3,000

National income 5.000

Investment 600

Government expenditure 200

Solution

4. Net Exports= Y-C-I-G

= 5,000- (3,000+600+200) = 1,200