National Income Accounting

This is the branch of macroeconomics that deals with measures of macroeconomic aggregates related to national income and output. The most important and comprehensive measure of an economy’s goods and services is gross domestic product (GDP). It is an indicator of how an economy is doing.

GDP is defined as the market value of all final goods and services produced within a country in a given period of time. Important aspects of GDP calculation are,

GDP is measured in terms of market value because otherwise goods and services measured in terms of different units cannot be summed up. Market value is expressed alternatively in terms of current prices and constant prices. Constant prices are considered in order to compare GDP across time.

GDP does not include products sold or purchased illegally and those that do not enter the market, for instance, household services provided by the family members, home grown fruits and vegetables for one’s own consumption etc.

GDP considers values of only final products and not intermediate products because the costs or prices of intermediate products are already included in the value of final product. Considering intermediate products separately will result in the problem of double counting. However, if intermediate goods are produced but not sold, rather they are held in the inventory, then for that period they are considered to be final products and included in the calculation of GDP.

GDP does not consider current transactions of goods produced before the time period under consideration. For instance, resale value of old cars is not considered in GDP.

GDP measures the value of production within the geographic confines of a country. Finally, GDP measures the value of production that takes place within a specific interval

of time.

GDP measures two things at once: the total income of all the people in the economy and total expenditure on the economy’s goods and services. This is because for an economy as a whole income must equal expenditure. On the product side, the flow of goods and services currently produced is measured by expenditures on these goods and services by consumers, businesses, government and foreigners. The income side measures the factor incomes earned, i.e. income received by factors of production in compensation for producing the final product. This can be shown using the circular flow diagram below.

Thus, there are three alternative approaches to measure GDP: expenditure approach, income approach and output or value added approach. The first and the second give us the basic GDP identity as discussed above. Following the expenditure approach GDP is divided into four components: Y = C + I + G + X – Mwhere Y is GDP (nominal)

C is consumption expenditure by households on goods and services. Consumption consists of goods and services bought by households. It is divided into three subcategories: nondurable goods, durable goods and services. I is investment expenditure on capital equipments, structures and inventories. Thus, investment consists of goods bought for future use. This is also divided into three subcategories: business fixed investments, residential fixed investments and inventory investment. Business fixed investments are purchase of new plants or equipments by firms. Residential fixed investment is purchase of new houses by household sector and inventory investment is increase in the firm’s inventory of goods. G is government expenditure on goods and services by central, state and local governments. This category includes items such as military equipments, expenses on infrastructure and the services rendered by the government employees. It does not include transfer payments to individuals such as social security and welfare expenses. Because transfer payments are not made in exchange of goods and services produced during a particular time interval.X – M measures net exports; i.e. expenditure on domestically produced goods by foreigners minus the domestic purchases of foreign goods.

Following income approach GDP at factor cost is measured as the sum of Y = C + S + T where C is consumption expenditure, S is total saving by consumers and businesses and T is net tax payments (total tax receipts less transfer, interest and subsidy payments by governments).

Gross national product (GNP), a closely related alternative measure is defined as GDP plus net factor income from abroad; i.e. it adds to GDP any income by Indian residents earned abroad, minus income earned within the domestic economy by overseas residents. GNP and other national income measures are shown below:

GNP less Capital Consumption Allowance/DepreciationNet National Product (NNP) less Indirect Business Taxes plus Business Transfer Payments plus Net Subsidies to Government Employees

National Income (NI):Compensation of EmployeesProprietors’ IncomeRental Income of PersonsCorporate ProfitsNet Interest

less Corporate Profits less Net Interest less Contribution for Social Insurance plus Government Transfer Payments plus Personal Interest Income plus Dividends plus Business Transfer PaymentPersonal Income less Personal Income Tax PaymentsDisposable Personal Income less Personal Savings less Transfers to Foreigners less Interest Paid by Consumers to BusinessConsumer Expenditure

In the Indian context GDP at factor cost is measured sector wise. Following are the sectors and subsectors considered:

Primary SectorAgriculture, forestry and fishing

Secondary or Industry SectorMining and quarryingManufacturing

Tertiary or Services SectorElectricity, gas and water supplyConstructionTrade, hotels, and restaurantsTransport, storage and communicationFinancing, insurance, real estate and business servicesCommunity, social and personal services

Public administration and Defence

From 2011-12 onwards a new series has been introduced as Gross Value Added (GVA) at basic prices and GDP (or GVA) at factor cost is discontinued. The relationship between GVA at factor cost, GVA at basic prices, and GDP (at market prices) is given below: GVA at basic prices = CE + OS/MI + CFC + production taxes less production subsidies GVA at factor cost = GVA at basic prices - production taxes less production subsidies GDP = ∑ GVA at basic prices + product taxes - product subsidies

The product side of GDP following expenditure method includes the below mentioned components:Total Final Consumption Expenditure

PrivateGovernment

Gross Capital FormationFixed Capital Formation

ConstructionMachinery & Equipments

Change in StocksValuables

ExportsImports (subtracted)

Consumption includes the following components

So far we have considered nominal GDP. Nominal GDP is measured in terms of current market price. On the other hand, by holding prices constant at base-year levels, real GDP reflects only the quantities produced. From these two statistics, GDP deflator is computed which reflects the prices of goods and services but not the quantities produced. GDP deflator measures the current level of prices relative to the level of prices in the base year.

GDP Deflator =Nominal GDP

Real GDP×100

Problems of GDP as a measure of economic well-being – GDP, though a well accepted measure of economic activity in an economy, it suffers from certain drawbacks. For instance,

i) GDP excludes all activity that takes place outside the marketii) GDP does not include certain qualitative measures, like pollution, corruption etciii) GDP is most inappropriate representative of economic progress in economies

characterized with unequal distribution of income and wealth.