National Income Accounting

3 C HAPTER (cid:1) (cid:7)(cid:4) (cid:7)(cid:2) (cid:13) (cid:2)(cid:3)(cid:4)(cid:5)(cid:1)(cid:2)(cid:6) (cid:1)(cid:8)(cid:5)(cid:9)(cid:10) (cid:8)(cid:8)(cid:5)(cid:11)(cid:1)(cid:3)(cid:4)(cid:1)(cid:12) (cid:8) (cid:7) (cid:7)(cid:9) (cid:5)(cid:1)(cid:8)(cid:10)(cid:14)(cid:3)(cid:15) (cid:2)(cid:1)(cid:16) (cid:10)(cid:2)(cid:15)(cid:11)(cid:17)(cid:10)(cid:9)(cid:10)(cid:1)(cid:3) The structure of the macro economy has aggregate output equals the value of been portrayed in the circular flow of aggregate income, which in turn must output and income as dealt with in the equal to the aggregate expenditure. previous chapter. This circular flow Based on this, national income depiction of macroeconomic activities measurement can be categorised into provides logical foundation for the three approaches : output or product concepts and measurement of national approach, income approach and income aggregates. A strikingly unique expenditure approach. All these must, feature of national income concepts is in principle, yield the same result. that they are quantifiable and are not Measuring Gross Domestic Product abstract ones. Hence, they render as Let us first take up the measurement much precision as feasible in the of the value of all that is produced in national income statistics, given the the economy. This is expressed as Gross limitations in the estimation of national Domestic Product. Here, the income aggregates and in the measurement procedure is actually construction of national income three-fold. We use the product method, accounts. There have been many the income method and the expenditure attempts in the past to evolve methods method to compute the Gross Domestic of national income accounting and these Product. As this aggregate is held to be efforts have contributed to the system very important for macroeconomic that we have at present. In this chapter, assessment, greater attention is called we shall present principal methods to for in the computation of this measure. measure national income aggregates. It Gross Domestic Product : The Output is pertinent at this juncture to remind Approach ourselves of an important observation made in respect of the circular flow of Gross Domestic Product (GDP) is a macroeconomic activities. We have, in summary statistic, which is widely used that context, stated that the value of by economists and policy analysts to 18 INTRODUCTORY MACROECONOMICS assess the rate of growth of an economy taken into account in the measurement during a year. GDP is generally of GDP. recognised to be the primary measure. Intermediate goods are those GDP is defined as the market value goods that are used to produce other of all final goods and services produced goods and therefore they always move by the factors of production located in from one stage of production to another the country during a period of one year. in the manufacture of a final product. A key phrase in this definition is ‘final Let us now show the difference goods and services’ which require some between final and intermediate goods with elaboration. the example of producing an automobile. The industrial process to Final goods are those that are meant manufacture an automobile involves for final use by consumers or firms. These materials such as steel, paint, rubber, goods are not required to enter into foam, plastic, glass, cables, battery, etc. further stages of production or resale to and a variety of component parts. All change their form and content. They are these items are produced by the finished goods meant only for final respective firms only to be used in the consumption and investment. production of another product; in our Measurement of GDP includes only example it is the automobile. But once the aggregate value of final goods. Also, the process of producing an automobile from a development perspective, the starts, all these are converted into strength of an economy is seen in its integral parts of an automobile. So, capability of producing final goods and these goods are not important in their services. own right; they are just a means to an It may be useful at this stage to draw end. Such goods are called intermediate a distinction between final goods and intermediate goods. The latter are not goods. The automobile that is produced Clip 3.1 PIONEERS IN NATIONAL INCOME ANALYSIS In the contemporary world now, national income concepts and accounting methods are widely recognised and applied to measure the economic performance of countries. However, these concepts and methods became popular only a few decades ago. A seminal contribution to the field of National Income and Product Accounts (NIPA) made by Simon Kuznets (1901–1985) set the trend of using national income aggregates to measure the direction of growth of economies. He was a great pioneer in this field and due to his research efforts, the first national income figures for the US economy was published in 1934 as an official document of the US Senate. This helped immensely to understand the severe impact of the Great Depression in 1929. His monumental book of two exhaustive volumes, National Simon Kuznets Income and its Composition, 1919-1938 (New York; NBER, 1941) NATIONAL INCOME ACCOUNTING : CONCEPTS AND MEASUREMENT 19 earned him the worldwide recognition. This was followed by two of his landmark contributions, namely, National Product since 1869 (New York; NBER, 1947) and Economic Growth of Nations : Total Output and Production Structure (Cambridge Mt, Harvard University Press, 1971). For his contributions, Kuznets was honoured with the Nobel Prize in 1971 in recognition of his empirical interpretation of economic growth. Another important contribution in this field is that of Richard Stone (1913-1991). Stone worked with John Maynard Keynes as a research assistant. Stone during the early 1940s prepared a statistical profile of the British economy. After the World War II, Stone headed a United Nations project to develop standard national income accounting model. In India, prior to 1947, the estimation of national income was attempted by individual economists and scholars for Richard Stone specific years. V.K.R.V. Rao P.C. Mahalanobis D.R. Gadgil Among these, the most systematic work was that of V.K.R.V. Rao in his book National Income in British India 1931-32 (London; MacMillan 1940), which formed the basis of national income estimation in the post-independence period. In 1949, the Government of India formed the National Income Committee under the Chairmanship of P.C. Mahalanobis, with V.K.R.V. Rao and D.R. Gadgil as members. From then onwards the national income estimation has been steadily strengthened. Now, the Central Statistical Organization (CSO) is entrusted with the task of publishing National Accounts Statistics (NAS). in the final stage of the assembly line is is, no product should be counted two the final good. or more times. Double counting will Hence, the rationale for not taking only exaggerate or over-estimate the into account the value of intermediate value of GDP. goods in the measure of GDP is to avoid The procedure by which we eliminate the problem of double counting. That the values of intermediate goods from GDP 20 INTRODUCTORY MACROECONOMICS is through the method of value added. a good’s value increases at each stage This is discussed in the following section. until its final value is obtained in the last stage. It follows therefore that the Concept and Measurement of Value value of final good will have to be equal Added to the sum of the value-added at each stage of production. This is shown with The concept of value added is very basic a numerical illustration in Table 3.1. to the measure of GDP. Value-added is defined as the difference between total Consider the production and sale value of output of a firm and value of of a cake to the Household sector for inputs bought from other firms. It thus final consumption. The process of measures the value, which the firm production starts with a farmer raising concerned has added by its process wheat crop and harvesting it. Since we of production. are starting with the stage of wheat Most goods go through multiple cultivation, let us not go into the stages of production. This means that backward production linkages of the Table 3.1 : Numerical Illustration of GNP Measurement using Value Added Method Stage I Stage II Stage III Stage IV (Wheat) (Flour) (Cake at Bakery) (Cake at Retailer) Farmer Black’s Purchases Miller White’s Baker Brown’s Retailer Green’s from other firms None Value AddedRs. 1.00 Purchases Rs. 1.00 Purchases Rs.1.50 Purchases Rs. 2.00 from Farmer from Miller from Baker Value Rs. 0.50 Added Value Rs.0.50 Added Value Rs. 0.50 Added Break-up of Value of Final valueadded good = Rs.2.50 Profit =0.20 + 0.25 – 0.40 + 0.28 = 0.33 Wages =0.60 + 0.10 + 0.70 + 0.05 = 1.45 Rent =0.05 + None + None +None = 0.05 Interest =0.05 + 0.10 + 0.01 + 0.02 = 0.18 Depreciation=0.02 + 0.02 + 0.09 + 0.07 = 0.20 Property and=0.08 + 0.03 + 0.10 + 0.08 = 0.29 sales taxes Sum of value added Total (in Rs.) 1.00 + 0.50 + 0.50 + 0.50 2.50 NATIONAL INCOME ACCOUNTING : CONCEPTS AND MEASUREMENT 21 farmer. Therefore, the farmer’s value- (iii) Net-value added at Market Price = added in the cultivation stage will be Gross value added at Market price just the value of his output as such (that – Consumption of fixed capital is one rupee). In the second stage, the (Depreciation) miller buys the wheat from the farmer (iv) Net-value added at Factor Cost = and grinds it into flour, and sells it to Net value added at Market Prices – the baker for Rs.1.50. By this, he adds Net indirect taxes (Net Indirect Taxes a value of 50 Paise. The baker makes = Indirect Taxes – subsidies) the cake and sells it to the retailer for (v) Net value added at factor cost = Total Rs. 2.00, thereby adding a value of 50 Factor Income paise. The retailer who buys the cake Now, let us look into the from the baker sells it to the final computation of value added as shown in the illustration below: consumer for Rs. 2.50, thereby adding Example 1: From the following data a value of 50 paise. This means that the calculate the value added by Firm A and value of the final good, namely, the cake is Rs. 2.50 at the retail store. This final Firm B. value of the cake is the sum of the value (Rs. in Lakhs) added from the stage of cultivation to (i) Closing stock of Firm A 20 that of retail sale at the shop, that is, (ii) Closing stock of Firm B 15 total value added equals Rs.1.00 + 50 (iii) Opening stock of Firm A 5 Paise + 50 Paise + 50 Paise = Rs. 2.50. (iv) Opening stock of Firm B 10 On the other hand, if we had (v) Sales by Firm A 300 included the value of all the (vi) Purchases by Firm A from 100 intermediate stages, preceding the retail Firm B sale, cake’s value would have increased (vii) Purchases by Firm B from 80 manifold, due to the problem of double Firm A - counting. That is, wheat would have (viii) Sales by Firm B 250 been counted four times, floor three (ix) Import of raw material 50 times and baked items twice. This is the by Firm A reason why we take the final value of (x) Exports by Firm B 30 the output as a sum of all values added As first step calculate the value of in producing a good. output for each Firm. Then find the This procedure of value added value added. method demonstrated for an individual Step 1. Value of output of Firm A product is applied at the aggregate level = Sales + Change in stock for the measurement of GDP. (Closing stock – Opening stock) Concepts of Value Added = 300 + (20 – 5) (i) Value of output by a Firm = Sales + = Rs. 315 lakhs Change in Stock Step 2. Value added by Firm A (ii) Value Added = Value of output – Intermediate goods cost = Value of output – purchases 22 INTRODUCTORY MACROECONOMICS from Firm B – imports by goods and services that are purchased Firm A by households and non-profit = 315 – 100 – 50 institutions for current use during a = Rs. 165 lakhs time period. Considering the fact that Repeat the same procedure for Firm B consumption expenditure is a significant part of GDP, it requires Step 3. Value of output of Firm B special attention by economists and = Sales + Change in stock government. Private consumption is the (Closing stock – Opening stock) demand for consumer goods and + Exports by Firm B services. While goods are tangibles, = 250 + (15 – 10) + 30 (that is, you can see a car) the services = Rs. 285 lakhs are intangibles (that is, you cannot see Step 4. Value added by Firm B a service such as car insurance). = Value of output – purchases Further in the case of goods, from Firm A consumption or use of a good can be = 285 – 80 separated from the place of its = Rs. 205 lakhs production and can be separated in Gross Domestic Product : As Sum of time, that you can consume or use a Expenditure good at your convenient place or time. But services should necessarily be used GDP can be measured by taking into at the time and place in which they are account all final expenditures in the produced. For instance, banking service economy. There are three distinct types will take place at the place and time of expenditure as they are committed specified by the banker and customers by Households, Firms and Government utilise their banking facilities accordingly. respectively. These expenditures are Consumption can be divided into classified into following types : three sub-categories such as, (i)Private Consumption (C) consumer services, consumer non- Expenditure durable goods and consumer durable (ii)Investment Expenditure (I) goods. Non-durable goods are used up immediately or within a short span of (iii) Government Purchases of (G) time. Durable goods in contrast could Goods and Services be used for a longer period of time. (iv) Net Exports (X – M) Food items are non-durable Let us discuss these items of final consumption goods whereas furniture, expenditures with respect to the sectors stereo equipment, washing machines concerned. are durable consumption goods. But usually this distinction is based only (i) Private Consumption expenditure on the given length of time within which The private consumption component of consumer goods are used. Durability GDP measures the money value of does not imply a state of permanence. NATIONAL INCOME ACCOUNTING : CONCEPTS AND MEASUREMENT 23 Durable goods also have their limited (b) Inventory investment period of use value, after which they are (c) Residential construction investment given up. Private final consumption will (d) Public investment include expenditure on all these three (a) Business Fixed Investment (BFI) is categories mentioned here. the amount spent by business units on (ii) Investment purchase of newly produced plant and equipment. The two measures of BFI are Investment is an addition to the stock of Gross Business Fixed Investment (GBFI) capital during a period. The Gross Private Domestic Investment shows the and Net Business Fixed Investment aggregate value in this regard. Unlike (NBFI). Gross Business Fixed investment the intermediate goods which are used is the gross amount spent on newly up entirely in the process of making provided plant and equipment, that is, other goods, capital is only partially capital goods. If depreciation is depleted in making other goods. That deducted from it, then we obtain Net is, a steel mill may have a useful life of Business Fixed Investment. say, 50 years. In providing steel in any The inclusion of capital goods in the one year, only a small portion (1/50th) final product along with the goods and of the mill is used. This using up of services produced by them would capital is called depreciation. involve double counting. For this reason Depreciation is the value of the existing it is important to make provision for capital stock that has been consumed depreciation. If in every year we deduct or used up in the process of producing from investment (and therefore from output. Usually an asset is depreciated domestic product) the amount by which at a predetermined rate and monetary capital stock has been used up over the value is assigned to the rate of year, then over the whole lifespan of the depreciation of a physical asset in capital good, we will have deducted one year. This is also described as from the domestic product the whole capital consumption allowance1. When value of the capital good. In this way investment is expressed as Gross we will have avoided counting in the Investment or Net Investment it means domestic product both the asset and whether investment has or has not been the goods produced by it and so shall adjusted against depreciation. Gross have avoided double counting. BFI is term includes depreciation while Net usually the result of a conscious term is obtained after deducting the decision by firms to augment their depreciation amount. productive capacity. Investment component could be classified under four categories : they are (b) Inventory Investment is the net (a) Business fixed investment change in inventories of final goods 1 The usage of fixed assets lead to their wear and tear; so, we must provide for consumption of fixed capital as a prerequisite in accounting the product. 24 INTRODUCTORY MACROECONOMICS awaiting sale, semi-finished goods, or Now the investment component as of materials used in the production a whole can be thought of in the process (inputs). These must be following two ways : included since they represent currently Gross Investment = Gross Business produced output not included in the Fixed Investment + Gross Residential current sales of final output. Construction Investment + Gross Public Changes in inventory are usually the result of unintentional short run Investment + Inventory Investment deviations between supply and Net Investment = Net Business Fixed demand. Stock changes play a crucial Investment + Net Residential role in income determination. For Construction Investment + Net Public example, if there is a sudden doubling Investment + Inventory Investment of the demand for television sets, it is As pointed out earlier, the difference unlikely that the production of them will between gross investment and net also double overnight. So, the first effect investment is depreciation. of the increase in demand relative to supply will be a fall in the inventory of (iii) Government Purchases of television sets normally held in the Goods and Services economy (inventory that is held by the This component summarises the producer, wholesaler or retailer), in the government spending on goods and attempt to satisfy the sudden increase services. Remember that government in demand. This process will continue purchases is a proxy measure for until production is augmented to government output. match the increased demand. As a matter of fact, government Conversely, a sudden fall in demand will purchases from private producers lead to a rise in inventories of television would be intermediate goods and sets until production adjusts itself to government wages and salaries would the lower level of demand. be part of the income side of the (c) Residential Construction Investment national accounts. Instead of doing this is the account spent on the building of we take the government purchases as housing units. This is also expressed part of the final product. in terms of either gross or net depending In the above we have understood on whether depreciation has been government as a producer of goods and subtracted or not. services. This is an important function (d) Public Investment includes all of the government. At the same time we capital formation carried out by the should also be aware of another function government such as building of roads, of government – that is, making hospitals, schools etc. This is also given payments to certain categories of people in gross or net value depending on or firms to compensate them as a matter whether depreciation has been of its social obligation. This is called subtracted or not. Government Transfers, which refer to the NATIONAL INCOME ACCOUNTING : CONCEPTS AND MEASUREMENT 25 total value of payments made by did on the product side. While measuring government sector towards households GDP we must include only those income and firms as income supplements and flows that originate with the production subsidies respectively. This is also known of the goods and services within the as Transfer Payments, and they are not particular time period. counted in the GDP because there is no The components of factor income are: production of goods due to them. 1. Employee compensation Transfer Payments are basically welfare- 2. Profits oriented expenditures of the 3. Rent Government. 4. Interest (iv) Net Exports 5. Mixed income This is the difference between Exports (X) Now let us look into the details of and Imports (M) of a country, that is each one of these. (X – M). Based on the expenditure flows 1. Employee Compensation in the economy, Gross Domestic Compensation to employees in the form Product is the total value of the sum of wages, salaries and benefits makes of consumption and investment up the largest single component of expenditure along with government income generated with production of purchases and net exports. GDP. Wages and salaries are payable In other words in cash, kind or both. GDP = C + I + G + (X – M) Where, 2. Profits C = Consumption expenditure by Profits are the reward the owners of households firms receive for being in business. I = Investment expenditure by firms Firms’ desire to earn profits is the main G = Government purchases of goods motivating force behind production in and services. a market economy. X-M= Net Exports. 3. Rent Rental income is, for example, income Gross Domestic Product : A Measure earned by owners of rental housing. The of Income meaning of rent in the national income The third approach to the measurement accounts is that it is a charge for the of GDP is to compute it by addition of all temporary use of some capital asset. factor incomes generated in the 4. Interest production of goods and services. Households both receive and pay Because each rupee of goods and interest. We include in GDP only the net services produced is matched by a rupee interest, that is the difference between of income, we can arrive at the same interest amount paid and the interest figure for GDP on the income side as we income received by households. 26 INTRODUCTORY MACROECONOMICS 5. Mixed Income to non-residents working in the domestic territory during a given Mixed income will include the income of accounting year. Hence, the components own account workers and profits and of Net Factor Income from abroad are : dividends of unincorporated enterprises. (i) Net compensation to employees In other words, it may be called as mixed (ii) Net income from property and income of the self employed. entrepreneurship, which includes All the above mentioned components rent, interest, dividends, etc. of income measure of the GDP have an (iii) Net retained earnings of resident important implication for the economy companies abroad as such. Their relative share in GDP shows the manner in which each of Hence, these income flows changes overtime. Gross Domestic Product + Net Factor It is possible to show by way of an Income from abroad = Gross National illustration as to how the sum of value Product added is equal to the total of the above Now we may distinguish between types of income earned during the Gross National Product and Gross process of production. This is shown Domestic Product. The difference in Table 3.1 between the two arises from Net Factor GDP as measured by the Income from Abroad. Note that the aggregation of factor incomes is also (X – M) component of GDP represents called as Gross Domestic Income (GDI). only goods and services other than Gross National Product factor incomes. After getting GDP we can add Net Factor Real and Nominal GNP Income from abroad to estimate the Having presented the measurement of value of Gross National Product (GNP). GNP it remains to be seen as how the How is Net Factor Income from Abroad changes in the GNP value are expressed defined? What are included in it? in relation to price level changes as price Net Factor Income from Abroad is changes affect the value of the national the difference between the factor income income aggregates. For this we must received from the rest of the world, i.e. explain the two ways of computing abroad for rendering factor services, and national income data at current market the income paid for factor services prices and constant prices. rendered by non-residents inside the Current Market Prices domestic territory of the country. As we know that factor incomes include If the GNP (or any other related compensation to employees and income aggregates) is measured in terms of from property and entrepreneurship, current market prices, then it is referred then Net Factor Income from abroad is to as Nominal GNP. Since the nominal the difference with respect to these items GNP measures the value of currently received by residents abroad and given produced goods and services at market NATIONAL INCOME ACCOUNTING : CONCEPTS AND MEASUREMENT 27 prices, GNP will change when either the (c) Real GNP is also often used in overall price level changes or when the making international comparisons actual volume of production changes of economic performance across the or when both change simultaneously. countries. Having explained the concepts of Constant Prices Nominal and Real GNP, let us proceed However, for certain purposes we may to know the method by which we obtain want to have a measure of output that the value of Real GNP through the changes only when the quantity of goods constant prices. produced changes. This measure of only The purpose of using constant quantity change, not prices, is the method prices is to eliminate the effect of price of using constant prices. Accordingly, changes. For this, we are supposed to GNP that is computed at constant prices express the value of current year’s GNP will be called the Real GNP. Usually, (Nominal GNP) in terms of prices under this method GNP value is expressed in terms of prices prevailing in prevailing during a reference year in the a year chosen to be the base year. past, which is called the Base year. That Real GNP has the following is, the account for the value of current advantages: year’s GNP as if the price level is same (a) It is useful in finding out the effect of as that of the base year. As you may be increased production of goods and aware that the price level is usually services on the real development measured by the Wholesale Price Index capacity of the economy in general. or the Consumer Price Index Number.2 But the nominal GNP cannot show If the GNP in the current year is this as we cannot segregate the valued at current market prices, it will change in output alone, since, the not be possible for us to find out how current market prices in terms of much of the increase in GNP is due to which it is measured prevent such increase in prices (inflation) and how an exercise; much of the increase is due to an (b) Real GNP also enables one to make increase in the production of goods and a year-to-year comparison of the services. To know whether GNP changes in the growth of output of increase actually means an increase in goods and services. An expansion the output of goods and services, we phase of the economy is a period of must eliminate the effect of price rising real GNP. On the contrary a increases. recession is a period in which real We shall explain, through the GNP falls consecutively; and following illustration, the calculation of 2 An index number is a representative number to decode the changes in price level. The consumer price index number is used to represent the average change over time in the prices paid by the final consumer of a specified group of goods or services. 28 INTRODUCTORY MACROECONOMICS nominal GNP and real GNP as well as Let us take up the calculation GNP deflator (Table 3.2). of nominal GNP through the expenditure approach. Let us therefore Let us assume that our imaginary find out the expenditure on each good economy has only three final goods : and obtain the total expenditure at Oranges - Consumption good current prices. Computers - Capital good Consumption expenditure (oranges) and Government purchases of cloth. is Rs. 4452, investment (computers) is Table 3.2: Nominal GNP, Real GNP and the GNP Deflator Current Period Base Period Item Quantity Price Expenditure Price Expenditure (Rs) (Rs) (Rs) (Rs) Oranges 4,240 Kgs. 1.05 per kg. 4,452 1 per Kg 4,240 Computers 5 2100 each 10,500 2000 each 10,000 Government 1,060 1 per 1,060 1 per meter 1,060 Purchases meters meter of Cloth Nominal GNP 16,012 Real GNP 15,300 Deflators for the current period NominalGNP×100 Rs.16012 GNPDeflator= = ×100=104.7 RealGNP Rs.15300 Consumption Expenditure Deflator Currentperiodconsumption expenditure Rs.4452 = ×100= ×100=105.0 Baseperiodconsumption Rs.4240 expenditure Currentperiodinvestment Rs.10500 InvestmentDeflator= ×100= ×100=105.0 Base period investment Rs.10000 CurrentperiodGovernment purchases Rs.1060 GovernmentPurchases= ×100= ×100=100.0 Base period Government Rs.1060 purchases NATIONAL INCOME ACCOUNTING : CONCEPTS AND MEASUREMENT 29 GNP MP abroad (-)net income from (– ) n e t in d ire c t ta x e s GNP GDP MP FC (–) n et in d irect ta x es (–) n et in d irect ta x es (–) n et in d irect taxes from abroad (–)net income NNP MP d)–( e d- e p oit ai c er p n oit ai c er n GDP NNP FC FC d)-( e p er c ai oit n NDP FC from abroad (–)net income NDP MP from abroad (–)net income Rs. 10,500, and government expenditure measures the average level of the prices of is Rs. 1,060, so the nominal GNP is Rs. all the goods and services that make up 16012. GNP. It is calculated as the ratio of nominal Now, let us calculate real GNP. This GNP to real GNP, multiplied by 100. is, as mentioned before, calculated by In the above example, we divide valuing the current period quantities at nominal GNP (Rs.16,012) by real GNP the base period prices. Accordingly, the (Rs. 15,300) and multiply the results by consumption expenditure is Rs. 4240, 100. We obtain GNP deflator as 104.7. investment is Rs.10,000 and government It is also possible to calculate expenditure is Rs.1,060. So the real deflator for specific expenditures as we GNP is Rs.15,300. would like to know the real value of Finally, the concept of GNP deflator these expenditures. This is also shown requires explanation. The GNP deflator in Table 3.2. d )-( e p er c ai oit n Fig 3.1: Relationships between Different aggregates of National Income3 3 Wilfred Beckerman, An Introduction to National Income Analysis, 3rd Edition, Universal Book Stall, New Delhi, 1999. 30 INTRODUCTORY MACROECONOMICS Important National Accounts 5. GNP at Factor Cost (GNP ) = GDP FC MP Aggregates + Net Factor Income from Abroad – Net Indirect taxes Gross National Product is the core concept of national income accounting. 6. NNP at Factor Cost (NNP ) = FC From this several other measures are GNP – Depreciation FC derived, each having its specific purpose 7. GDP at Factor Cost (GDP ) = GDP FC MP to interpret the performance of a given – Net Indirect taxes economy. All these concepts and 8. NDP at Factor Cost (NDP )= GDP measures are interrelated which is FC FC – Depreciation shown in Figure 3.1. From this, we may National5 Disposable Income observe eight major national accounts concepts as given below and they may In addition to the above, we may also be derived following the direction given include the concept of National in the diagram. Disposable Income. National Disposable Income is the income from all sources to 1. GNP at Market Prices (GNP )4 = the residents of a nation for spending on MP Value of all the final goods and consumption as well as saving during a services produced in the economy year. It is given by the following : + Net Factor Income from Abroad National Disposable Income 2. NNP at Market Prices (NNP ) = = NNP + Other Current Transfers MP MP GNP –Depreciation from the rest of the world6 MP 3. GDP at Market Prices (GDP ) = This is the maximum available income MP for a country. National Disposable GNP – Net Factor Income from MP Income for a country is what the Abroad Personal Disposable Income (Personal 4. NDP at Market Prices (NDP ) = Income – Personal Taxes) is for an MP GDP – Depreciation individual. MP 4 A particular value may be expressed at Market Prices or at Factor Cost. If a quantity is expressed in terms of its current prices it is referred to as market price. Suppose the total value added is computed on the basis of current prices of inputs then we may call this as value added at Market Prices. On the other hand, if the value added is arrived at by adding the payments to factors (land, labour, capital and entrepreneurship) such as rent, wages, interest and profit, (as was done in Table 3.1) then it is described as value added at Factor Cost. In the same manner, all the concepts of national income may be shown either at market prices or at factor costs. 5 It may be necessary to give the meaning of ‘Domestic’ and ‘National’ used in National Income aggregates. Domestic here simply means ‘domestic territory’. So, domestic product would imply the value of all goods and services produced by the normal residents of a country. ‘National’ refers to the addition of the net factor income from abroad to the domestic product. 6 Current transfers from the rest of the world may include gifts, cash, consumer goods and even military equipment. NATIONAL INCOME ACCOUNTING : CONCEPTS AND MEASUREMENT 31 The above definitions may be Government purchases of goods and understood as general principles of how services + Net exports (Exports – imports) these measures are conceptualised. In + Net factor income from abroad. practice each country follows its own (ii) Income Method method of compilation and hence GNP = Employee compensation Mp definition of specific items, which (wages and salaries + employers’ constitute an aggregate measure, will contribution towards social be different from others. In India, the security schemes) + profits + rent + national accounts are prepared in interest + mixed income + accordance with System of National depreciation + net indirect taxes Accounts (SNA) since 1975. (Indirect taxes – Subsidies) + Net Subsequently, there has been a factor income from abroad. significant improvement in the (iii) Value Added Method statistical statements in terms of GNP = (Value of output in primary database and coverage. Presently the secto M r p – intermediate consumption SNA 1993 is being used. of primary sector) + (value of output Concepts of National Product and in secondary sector – intermediate National Income: A Summary consumption of secondary sector) + (value of output in tertiary sector GNP =Value of all final goods and MP – intermediate consumption of services produced in the tertiary sector) + Net factor income economy+Net factor income from aboard. from abroad The following numerical examples will NNP =GNP – Depreciation Mp Mp help us to understand various national GDP =GNP – Net factor income Mp Mp income aggregates. from abroad NDP =GDP – Depreciation Example 1: From the following data Mp Mp GNP =GNP – Net indirect taxes calculate the Gross National Product at Fc Mp NNP =GNP – Depreciation = Market Price through the Expenditure Fc Fc Method National income GDP =GDP – Net indirect taxes (Rs. in crores) Fc Mp i. Inventory Investment 10 NDP =GDP – Depreciation Fc Fc ii. Exports 20 Three Methods of Measurement of iii. Net factor income from abroad (–5) iv. Personal consumption 350 National Product expenditure (i)Expenditure Method v. Gross residential 30 GNP = Personal consumption construction investment expe M n p d iture + Gross Investment vi. Government purchases of goods and services 100 (Gross business fixed investment + vii. Gross public investment 20 Inventory investment + Gross viii. Gross business fixed 30 residential construction investment investment + Gross public investment) + ix. Imports 10 32 INTRODUCTORY MACROECONOMICS Solution: + Mixed Income = 400 + Depreciation = 50 GNP Pers M o p n = al consumption = 350 + Net Indirect taxes which = 200 expenditure include + Gross Investment = 90 Indirect taxes = 300 which include: Subsidies = 100 Gross Business Fixed = 30 + Net Factor Income from Abroad = –10 Investment GNP =1930. Gross Residential = 30 So th Mp e GNP is Rs.1930 crores Construction Investment Mp Gross public Investment = 20 Example 3: From the following data Inventory Investment = 10 calculate the Gross National Product at + Government purchases of = 100 Market Price via the Value Added method goods and services + Net exports = 10 (Rs. in croroes) which include: i. Value of output in primary 1,000 Exports = 20 sector Imports = 10 ii. Net factor income from abroad –20 +Net Factor Income From Abroad = –5 iii. Value of output in tertiary sector700 GNP = 545 Mp iv. Intermediate consumption 400 So, GNP is Rs. 545 crores. Mp in secondary sector Example 2: From the following data v. Value of output in secondary 900 calculate the Gross National Product at sector Market Price via the Income method vi. Intermediate consumption in 500 (Rs. in crores) primary sector i. Wages and Salaries 700 ii. Rent 100 vii. Intermediate consumption in 300 iii. Depreciation 50 tertiary sector iv. Net factor income from abroad –10 Solution: v. Mixed income 400 vi. Subsidies 100 Value of output in primary sector = 1,000 vii. Profits 400 – Intermediate consumption of viii. Indirect taxes 300 primary sector = 500 ix. Employers contribution 50 + Value of output in secondary = 900 to social security schemes sector x. Interest 40 – Intermediate consumption in = 400 Solution: secondary sector Employee Compensation which + Value of output in tertiary = 700 include = 750 sector Wages & Salaries = 700 – Intermediate consumption = 300 Employers’ contribution to = 50 of tertiary sector social security schemes + Net factor income from abroad = –20 + Profits = 400 + Rent = 100 GNP = 1380 MP + Interest = 40 So, GNP is Rs. 1380 crores. Mp NATIONAL INCOME ACCOUNTING : CONCEPTS AND MEASUREMENT 33 Example 4: From the following data So, GDP = Rs. 545 crores FC calculate the GNP, GDP, NNP, NDP at both h) NDP = GDP –Depreciation FC FC factor cost and market prices. = 545 – 15 = 530 (Rs. in crores) So, NDP = Rs. 530 crores FC i. Gross Investment 90 Items that are Excluded from GNP ii. Net exports 10 Measurement iii. Net indirect taxes 5 iv. Depreciation 15 It may be recalled that GNP is the v. Net factor income from abroad –5 measure of the value of the final goods vi. Personal consumption 350 and services produced in one year. But expenditure in reality many transactions occur in vii. Government purchases of 100 the economy that have either nothing goods and services to do with the final goods and services Solution: produced or that they are non-market activities or illegal activities whose a) GNP = Persona M l P consumption expenditure= 350 measurement has its own limitations, + Gross investment = 90 both conceptual and empirical. We shall + Government purchases of = 100 now enumerate a few of these goods and services transactions that are excluded in the + Net exports = 10 estimation of GNP. + Net factor income from abroad = –5 1. Purely Financial Transactions GNP = 545 There are three generate types of purely MP financial transactions. They are So, GNP is Rs. 545 crores MP (a) Buying and Selling of securities b) NNP = GNP – Depreciation MP = 545 – M P 15 = 530 (b) Government Transfer Payments So, NNP = Rs. 530 crores (c) Private Transfer Payments MP c) GDP = GNP – Net Factor Now, let us examine these MP MP Income from Abroad transactions in detail. = 545 – (–5) = 545 + 5 = 550 (a) Buying and selling of securities So, GDP = Rs. 550 crores MP In the financial markets as shown d) NDP = GDP – Depreciation MP MP earlier in circular flow model, potential = 550 – 15 = 535 So, NDP = Rs. 535 crores savers and investors buy and sell MP e) GNP = GNP – Net indirect financial assets such as shares and FC Mp taxes bonds. While someone buys a share = 545 – 5 = 540 there is only a transfer of ownership So, GNP = Rs. 540 crores FC right. It is a claim to ownership of assets. f) NNP = GNP – Depreciation FC FC In the case of bonds, it is = 540 – 15 = 525 acknowledging a debt transaction. So, NNP = Rs. 525 crores FC There is no production activity but only g) GDP = GDP – Net indirect FC Mp taxes exchange of funds for financial claims. = 550 – 5 = 545 Trading in financial instruments does 34 INTRODUCTORY MACROECONOMICS not imply production of final goods and transaction – vegetables can be grown services. As such these are not included in the backyard instead of bought in in the GNP. the super market, or an electrical fault can be repaired by the house owner (b) Government Transfer Payments himself or herself instead of hiring an As defined earlier, transfer payments electrician. These are examples of non- are payments for which no goods or marketed goods and services that have services are provided in exchange. been consumed without using Pension payments, Employees’ social organised markets. But GNP includes security measures, adhoc assistance only those transactions that occur due to certain exigencies like floods, through market activities. Barter drought, etc. and subsidies are transactions and production for self- examples for government transfer consumption by household are not payments. As there is no production of included in the GNP. It is in this context, final goods and services in response to there is a debate as to whether transfer payments, the transfer housewives services should be included payments are not included in the GNP. or not. If so, how do we value their (c) Private Transfer Payments services at current market prices? Items such as pocket money given by 4. Illegal Activities parents to their children, elders gifting GNP does not include trade in illegal money to the young ones are private goods and services even though they transfer payments. This is merely a are final products and are purchased transfer of money from one individual in market transactions. Activities such to another. Hence this is also not as smuggling, gambling, crime for hire, included in the GNP. drug trafficking, illegal arms sale are 2. Transfer of Used Goods some cases in point. These illegal activities create an GNP refers to the value of the final goods ‘underground economy’ wherein and services produced in a given year. ‘production’ is unreported or Hence, goods produced in the previous unaccounted either because it is time period cannot be included in the unlawful or those involved want to GNP. For instance, when a person buys evade the government tax-net. As a a used car, it cannot be recognized in result these illegal and concealed GNP measurement as the car was transactions create a huge volume of produced in an earlier year. Spending unaccounted money that is popularly on a used car simply reflects a change in called the black money. Black money the ownership of a pre-existing output. is the main driving force of 3. Non-market Goods and Services underground economy or “parallel Many final goods and services are not economy”. As in the case of non-market acquired through regular market goods, it is difficult to fix exact market NATIONAL INCOME ACCOUNTING : CONCEPTS AND MEASUREMENT 35 value for transactions in the Does GNP Measure Economic underground economy. Technically, as Welfare? per the law of the land, these activities For a very long period of time are classified under economic offenses. economists have used GNP quite Hence their exclusion from GNP. uncritically as the principal measure of 5. The Value of Leisure economic growth and development. Maximisation of national income was Leisure is regarded as an economic good. It may be that, other things being taken synonymous with maximisation equal, more leisure is better than less of growth; hence rising GNP is good and leisure. When the levels of income declining GNP is bad for the economy. increase, the resultant state of affluence But a whole range of questions would induce people to prefer more concerning it are being raised these leisure than less of it. This means that days. They are such as, what is or ought with higher economic security the richer to be growth? What happens to segment of our society would cut down distribution of income and wealth with their work effort, which in turn means an increase of GNP? What does an producing less GNP. But that would not increasing GNP do to the use of non- imply or suggest that people become renewable natural resources? Is there worse off than before. In fact, choice of a necessary association between more leisure is simply an increase in increase in national income and utility. However, it would be very national welfare? Can the increase in difficult to measure the intangible item national income accomplish good like leisure and include it in the GNP. quality of life and human development? Nevertheless, in a modern economy, All these and other questions have been there is wide range of business researched into in the recent past and opportunities to provide for leisure time at present GNP measure is under close activities. So, though leisure as such scrutiny by economists and policy cannot be measured, the services makers. In recent times more and more provided by the business sector to economists have shown keen interest to capture the demand for leisure-time critically look at GNP as the indicator of activities could be brought under final growth and development of a nation. services for inclusion in the GNP. Measurement of GNP is subject to Leisure-time activities are in great the rules of national income accounting. demand from the middle and richer These rules may rigidly classify classes of society. production activities to be included in However, leisure per se cannot be or excluded from GNP. Hence GNP as a brought within the treatment of national statistic can be misleading as the basis accounts mainly because there is no of overall development of an economy. valuation possible and imputing value Therefore, the main question that needs is both difficult and not useful for any to be discussed is : Does the GNP analysis. measure economic welfare? 36 INTRODUCTORY MACROECONOMICS J.R. Hicks once wrote that, “The GNP as the sole objective of development purpose of income calculation... is to will be counter productive. It is give people an indication of the important to test whether growth in amount they can consume without GNP results in equitable distribution of impoverishing themselves”7. income, sustainable development and In the contemporary economies, good quality of life for people. The particularly in the developing process of development must create countries, we are confronted with the sustainable societies without serious issue of inequality in the endangering the natural resources and income distribution, environmental ecological systems. degradation, and deterioration in the Therefore, attempts to enhance GNP quality of life. All these and related at any cost may create economic ‘bads’ problems have not only introduced such as poverty and pollution. This gaps between different classes of people requires an alternate measure, which in terms of their social and economic would allow GNP to measure human status but also between nations, involving categorisation such as welfare. Some economists have suggested developed, developing, less developed the concept of “green” GNP. Such a ‘green and least developed countries. GNP’ would help attain a sustainable use It is beyond the scope of this of the natural environment and equitable chapter to probe into the development distribution of the benefits of debates over the questions narrated development. It may be useful to debate above. Suffice it to say that increase in these issues related to GNP. SUMMARY (cid:1) Circular flow of income forms the basis for measurement of macroeconomic activities. (cid:1) Product approach, Income approach and Expenditure approach are three ways in which Gross National Product can be measured. (cid:1) In the product approach, only the final goods and services are included to facilitate the aggregation of the value added by the producing units. (cid:1) Income approach is concerned with summation of factor incomes which in turn must equal to total value added. Hence product is also income in national accounts. (cid:1) Aggregate expenditure is obtained by adding all expenditures on consumption, investment and government purchases of goods and services. (cid:1) Real GNP and Nominal GNP are outlined by taking the value of national product at constant prices and current prices respectively. (cid:1) GNP deflator is used to measure the average level of the prices of all goods and services. (cid:1) Purely financial transactions, government and private transfers, used goods, illegal activities, non-market goods, etc. do not get included in the GNP. 7 J.R.Hicks, Value and Capital, Oxford University Press, 1975, Page 172. NATIONAL INCOME ACCOUNTING : CONCEPTS AND MEASUREMENT 37 EXERCISES Section I 1. Define: (i) GNP at market prices (ii) NNP at market prices (iii) GNP at factor cost (iv) NNP at factor cost. 2. Define the concept of value added. 3. Show how the sum of value added is equal to sum of factor incomes. 4. What is the difference between final good and intermediate good? 5. What is depreciation? 6. What are the components of aggregate expenditure? 7. What are factor incomes? 8. What is meant by double counting? Why should it be avoided? 9. What are transfer payments? 10. Explain the meaning of non-market activities. 11. What is called ‘Green GNP’? 12. Differentiate between national income at current price and constant price. 13. Define: (a) Nominal GNP and (b) Real GNP 14. What is a GNP deflator? 15. Give reasons for not including leisure in GNP. Section II 16. Explain product and income approaches to measure national income. 17. Explain the value-added method with the help of an example. 18. What are the items that are excluded from GNP? Give reasons. 19. Does GNP measure national welfare? 20. Explain the components of factor income. 21. Explain the following terms: (a) Business fixed investment (b) Inventory investment (c) Residential construction investment (d) Public investment. Section III 22. Calculate the value added by Firm A and Firm B from the following data: (Rs. in lakhs) (i) Purchase by Firm A from the Rest of the world 30 (ii) Sales by Firm B 90 (iii) Purchases by Firm A from Firm B 50 38 INTRODUCTORY MACROECONOMICS (iv) Sales by Firm A 110 (v) Exports by Firm A 30 (vi) Opening stock of Firm A 35 (vii) Closing stock of Firm A 20 (viii) Opening stock of Firm B 30 (ix) Closing stock of Firm B 20 (x) Purchases by Firm B from Firm A 50 23. Calculate value added by Firm X and Firm Y from the following data: (Rs. in lakhs) (i) Sales by Firm X 100 (ii) Sales by Firm Y 500 (iii) Purchases by households from Firm Y 300 (iv) Exports by Firm Y 50 (v) Change in stock of Firm X 20 (vi) Change in stock of Firm Y 10 (vii) Imports by Firm X 70 (viii) Sales by Firm X to Firm Y 250 (ix) Purchases by Firm Y from X 200 24. From the following data calculate the Net National Product at Market Prices by (a) Expenditure Method (b) Income Method: (Rs. in Crores) (i) Personal consumption expenditure 700 (ii) Wages and salaries 700 (iii) Employers contribution to social security schemes 100 (iv) Gross Business fixed investment 60 (v) Gross Residential construction investment 60 (vi) Gross public investment 40 (vii) Inventory investment 20 (viii) Profits 100 (ix) Government purchases of goods and services 200 (x) Rent 50 (xi) Exports 40 (xii) Imports 20 (xiii) Interest 20 (xiv) Mixed income 100 (xv) Net factor income from abroad –10 (xvi) Depreciation 20 (xvii) Subsidies 10 (xviii) Indirect taxes 20 25. From the following data calculate the Gross Domestic Product at Factor Cost by (a) Expenditure Method (b) Income Method: (Rs. in Crores) (i) Personal consumption expenditure 700 (ii) Wages and salaries 700 NATIONAL INCOME ACCOUNTING : CONCEPTS AND MEASUREMENT 39 (iii) Employers’ contribution to social security schemes100 (iv) Gross business fixed investment 60 (v) Profits 100 (vi) Gross residential construction investment 60 (vii) Government purchases of goods and services 200 (viii) Gross public investment 40 (ix) Rent 50 (x) Inventory investment 20 (xi) Exports 40 (xii) Interest 20 (xiii) Imports 20 (xiv) Net factor income from abroad –10 (xv) Mixed income 100 (xvi) Depreciation 20 (xvii) Subsidies 10 (xviii) Indirect taxes 20 26. From the following data calculate the Gross Domestic Product at Market Prices: (Rs. in crores) (i) Value of output in primary sector 2,000 (ii) Intermediate consumption of secondary sector 800 (iii) Intermediate consumption of primary sector 1000 (iv) Net factor income from abroad – 30 (v) Net indirect taxes 300 (vi) Value of output of tertiary sector 1,400 (vii) Value of output of secondary sector 1,800 (viii) Intermediate consumption of tertiary sector 600