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National Income Accounting
By Prof K. Bhargavi
The labour and capital of a country acting on its natural resources produce annually a certain amount of goods and services which is called the National income of the country .
It is a monetary measure includes only final goods
National Income
National income has three interpretations : It represents total value of production and
hence represents a receipts total and an expenditure total.
Every expenditure is at the same time a receipt , therefore the amount spent is equal to the amount received
National Income
But as goods and services are valued at their market prices we have a three fold identity.
a. The sum of value of all final goods and services produced .
b. Sum of all incomes in cash and kind accruing to the factors of production in a year.
c. Sum of consumption expenditure, net investment expenditure and government expenditure on goods and services .
National Income
Sum of all income, sum of values of all final production and sum of all expenditures will be the same reflecting the three basic activities of the nation’s economy that is production , distribution and expenditure
National Income
Total demand for domestic output is made up of four components :
- Consumption spending by households - Investment spending by Businesses - Government- Foreign demand
Outlays and Components of Demand
These four categories account for all spending.
The fundamental national income accounting identity is
Y= C+I+ G+ NX
Outlays and Components of Demand
Consumption Spending It includes anything from food to golf lessons ,
investment , consumer spending on durable goods such as automobiles
Higher consumption or lower saving means either less investment or larger trade deficits
Government Purchases It includes items such as national Defence
expenditures, road paving by state and local governments and salaries of government employees
Outlays and Components of Demand
Government spending Government spending on goods and
services as purchases of goods and services
Government makes transfer payments , that are made to people without they providing a current service in exchange
Transfer payments include social security benefits and unemployment benefits.
Outlays and Components of Demand
Transfer payments are not counted as part of GDP because transfers are not part of current production.
Transfers + Purchases = Government Expenditure
Outlays and Component of Demand
Investment Spending Investment means additions to the physical stock
of capital Investment includes housing construction
building of machinery etc Net investment is gross investment –
Depreciation Domestic means investment spent by domestic
residents but not necessarily spending on goods produced within this country
Consumption and government spending may also be for imported goods
Outlays and Components of Demand
Net Exports Domestic spending on foreign goods and
foreign spending on domestic goods constitute ‘Net exports’.
Difference between exports and imports is called net exports .
Outlays and Components of Demand
Across a simple economy Across a three sector economy Across a four sector model with Government
and foreign trade.
Some Important Identities
The first key identity is that output produced equals output sold.
The Output unsold is treated as accumulation of inventories and a part of investment(as if the firms sold the goods to themselves to add to their inventories.)
Output sold can be expressed as : Y= C+I (1) Income is also partly allocated between
saving and consumption.
A simple economy
Y= S+ C. (2) Identities (1) &(2) can be combined to read C+I =Y= C+ S (3) The left hand side of the identity shows the
components of demand and the R.H.S shows the allocation of income.
The identity emhasizes that output produced is equal to output sold
A simple economy
The value of output produced is equal to income received ,and income received, in turn is spent on goods or saved.
Subtracting consumption from each of the identity we have
I=Y-C=S In a simple economy investment is
identically equal to saving.
A simple economy
Three Sector model
Four sector model with Government and foreign Trade.
We start with the fundamental identity: Y=C+I+ G+ NX (1) We now establish the relation between
Output and disposable income A Part of the income is spent on taxes and
the private sector receives net transfers(TR) in addition to national income. Disposable income (YD) is thus equal to income plus transfer less taxes:
YD = Y+ TR-TA (2)
Four Sector model.
Disposable income, in turn is allocated to consumption and saving:
YD= C + S (3) Rearranging identity (2) and inserting for Y
in identity (1) we have YD-TR +TA = C+I+G+NX (4) Putting identity (3) in (4) yields C+S-TR+ TA = C+I+ G+NX (5) By rearranging we get S-I = (G +TR –TA)+ NX (6)
Four sector model with Government and foreign Trade.
Identity (6) states that excess of saving over investment in the private sector (S-I) is equal to the government budget deficit plus the trade surplus.
(G+TR-TA) is the government budget deficit. G+ TR is equal to total government expenditure,
consisting of government purchases of goods and services(G) +government transfer payments (TR).
TA is the amount of taxes received by the government.
The difference (G+TR-TA) is the excess of the government’s spending over its receipts ,or its budget deficit
Saving , Investment, The government and Trade
(The budget deficit is a negative budget surplus,BS= TA-(G+TR).)
NX is called the trade surplus . When Net exports are negative, we have a
trade deficit.
Saving , Investment, The government and Trade
GNP GDP NNPMP NNPFC Personal Income Disposable Income
Concepts of National Income
GDP is the value of all final goods and services produced in the country
It is the value of only final goods and services produced to make sure we do not double count
Double counting is avoided by working with value added . At each stage of the manufacture of the good only the value added to the good at that stage of manufacture is counted as part of GDP
Gross Domestic Product
GDP consists of Value of output currently produced
GDP values goods at market prices
The market price of many goods include indirect taxes and thus the market price of goods is not that same as the price the seller of the goods receives
Gross Domestic Product
GDP is valued at market prices and not at factor cost
Valuation of market principle is not uniformly applied as some components of GDP are difficult to value
e.g – Services of home makers
Gross Domestic Product
Gross National Product it is defined as the total market value of all final goods and services produced in a year in a country
It includes only final goods and ignores transactions involving intermediate goods
GNP includes only currently produced goods in a year . It is a flow measure of output of goods and services per time period
Concepts on National Income
GNP is the value of final goods and services produced by domestically owned factors of production within a given period
The difference between GDP and GNP arises because the sum of the output produced within a given country is made by factors of production owned abroad
Gross National Product
Sale of assets such as stocks and bonds excluded from GNP of the year
GNP refers to the value of goods and services currently produced by normal residents of a country which include national or non – national companies
Market transactions involving goods produced in previous periods not included in GNP of the current year
Concepts of GNP
Value of output of government which is taken to be equal to the value of purchases of goods and services denoted by (G)
Net exports (X) – Value of goods imported (M)
Net factor income from abroad ( is the difference between the factor income received from abroad from normal residents in India for rendering factor services in other countries on the one hand and the factor incomes paid to the foreign residents for the factor services rendered by them in the domestic territory in India
Components of GNP
Value of consumer goods and services Value of final consumer goods and services produced in a year and consumed by households denoted by consumption (C)
Value of new capital goods produced and addition to the inventory of goods such as raw materials , unfinished goods and consumer goods produced but not sold during a year called the gross private investment (I)
Components of GNP
GNP at mp =GDP at mp + Net factor income from abroad
GDP at mp =GNP at mp – Net factor income from abroad
GDP = C + I +G +XN NNP at mp = GNP – depreciation( the consumption of
fixed capital or fall in the value of fixed capital due to wear and tear is called depreciation )
NNP at fc – It is called national income . It means the sum of all incomes earned by resource suppliers for their contribution of land , labour ,capital and entrepreneurial ability which goes into the year`s net production
NNP at fc = NNP at mp – indirect taxes + subsidies
National income or NNP at FC
Net of indirect taxes and subsidies is called net indirect taxes
National income = Net national product-net indirect taxes
Personal income = National income – Social security contributions – corporate income taxes- undistributed corporate profits + transfer payments
Disposable income = personal income – personal taxes
National income or NNP at FC
GDP and Personal Disposable Income GDP is a measure of the output of goods
being produced in an economy Personal disposable income is the level of
income available for spending and saving by households in the economy
Personal Income
Nominal GDP measures the value of Output in a given period in the prices of that period (current $)
Nominal GDP changes from year to year for two reasons – the physical output of goods changes and secondly the market prices also changes
Real GDP measures changes in physical output in the economy between different time periods by valuing all goods produced in the two periods at the same price or in constant dollars
Real and Nominal GDP
Changes in Nominal GDP that result from price changes do not tell us anything about the performance of the economy in producing god and services that is why we use Real rather than Nominal GDP as the basic measure for comparing output in different years
Real and Nominal GDP
GDP data are far from perfect measures of either economic output or either welfare
There are specifically four problems , some outputs are poorly measured because they are not traded in the market
Eg – Government services and Non market activities such as volunteer work
It is difficult to account correctly for improvements in the quality of goods especially when new products and new models are being invented
Problems of GDP Measurement
Some activities measured as adding to real GDP infact represent the use of resources to avoid or contain`` bads`` such as crime or risks to National security
The accounts do not take environmental pollution and degradation into account
Problems of GDP Measurement
The GDP Deflator The calculation of real GDP gives us a useful
measure of inflation known as the GDP deflator GDP Deflator is the ratio of Nominal GDP in a
given year to real GDP of the year The deflator measures the change in prices that
has occurred between the base year and current year
Since the GDP deflator is based on calculation involving all goods produced in the economy , it is a widely based price index that is frequently used to measure inflation
Price Indexes
The Consumer and Producer Price Index The consumer price index (CPI) measures the
cost of buying a fixed basket of goods and services representative of the purchases of urban consumers
The CPI differs from the GDP deflator in 3 main ways : Deflator measures the prices of a much iwder
group of goods than the CPI CPI measures the cost of a given basket of goods
which is the same form year to year
Price Indexes
CPI includes prices of imports , whereas the deflator includes only prices of goods produced in the United States
The two main indexes used to compute inflation , the GDP deflator and the CPI, accordingly differ from time to time
The producer price index is the third price index that is widely used
PPI is constructed from prices at the level of first significant commercial transaction
Price Indexes
PPI differs from CPI in terms of coverage as it includes raw materials and semi finished goods
This makes the PPI a relatively flexible price index and one that generally signals changes in the general price levels
PPI and one of its sub indexes such as the index of ``sensitive materials”, serve as one of the business cycle indicators that are closely watched by policy makers
Price Indexes
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