National Income Accounting

1. National Income Accounting

2. Introduction. We have entered the world of National Income, the most vital concept of Macroeconomics. The ultimate goal of all planning bodies , government budgeting , government policies and development studies is to increase National Income. In this , we will study a number of concepts essential for estimating the national income of a country.

3. Contents (1) Concepts of Macroeconomics. • Consumption , • Investment , • Stocks and Flows , • Economic Territory & • Residents. (2) National Income Aggregates. • Domestic Aggregates & • National Aggregates.

4. (1) Concepts of Macroeconomics. (a) Consumption. • Personal consumption expenditures are the largest component of GDP, about 68%. • Consumption expenditures are for • Durable goods, products that last more than one year (cars, appliances). • Non durable goods, products that last less than one year (food, clothing). • Services (medical care, insurance).

5. Capital goods :- Goods capable of being used for producing other goods are called Capital goods. These are used for generating income. Durable goods : Buildings, Machinery ,etc. Non durable goods : Stock of goods ,etc. An asset purchased by Factory is a capital good , where as if it is purchased by a family, it is a consumption good.

6. Intermediate consumption refers to the expenditure incurred by a production unit on purchasing those goods and services from other production units, which are meant for resale or for completely using up during the same year. Intermediate goods refer to those goods and services which are purchased during the year , by one production unit from other production units and completely used up, or resold , during the same year. Final expenditure refers to the on goods and services meant for final consumption and investment. Goods and services purchased, or own produced, for the purpose of consumption and investment are final products.

7. GDP includes the value of only final goods sold. • If a car produced and first sold in 2007 is traded in and resold in 2008, the part of GDP counted is as per the sale in 2007, but not as per 2008. • Sales of intermediate goods are not included in GDP. • If McDonalds buys wheat for Rs 10/ and conversion to dough costs Rs 15/ , and sells a Bread packet for Rs 25/ , the contribution to GDP is Rs 25/ , the value of the final sale.

8. (b) Investment. ..Addition made to the stock of capital during a period of time is called investment. It is also called capital Investment. ..Depreciation refers to the fall in the value of fixed capital goods due to normal wear and tear and foreseen obsolescence. ..Total addition of capital goods to the existing stock of capital during a time period is called Gross investment. By subtracting depreciation from the gross investment gives the Net investment. Gross investment – depreciation = Net investment.

9. (c) Stocks and flows. Stocks :- The variables whose magnitude is measured at a particular point of time are called stock variables. The money in your Savings A/c as on Jan 09 is stock . Flows:- Variables whose magnitude is measured over a period of time are called flow variables. GDP is a flow. • Flow concepts are expressed per unit of time. • Firms produce a certain number of goods and services within a period of time, usually per week, month, quarter, or year.

10. (d) Economic Territory. Economic Territory refers to the Geographical territory administered by a government within which persons, goods and capital circulate freely. The scope of the economic territory includes the following. (a) Political frontiers including territorial waters and airspace. (b) Embassies , consulates , military bases ,etc., located abroad . (c) Ships, aircrafts ,etc ., operated by the residents between two or more countries. (d) Fishing vessels, oil and natural gas rigs, operated by residents in international waters.

11. (e) Residents. A resident, whether a person or an institution, is one whose centre of interest lies in economic territory of the country in which he lives or is located. There is a difference between a resident and a citizen . A person becomes a citizen of a country because he was born in that country or on the basis of some other legal criteria . Even foreigners can be the residents if they pass the above economic test. For example, a large no. of Indian citizens have settled in U.S.A., England, Australia, etc. as residents of these of these countries. For India they are Non-Resident Indians (NRI) but they continue to remain as Indian Nationals (citizens).

12. Examples of Non-Residents : • International organisations like World Bank, World Health Org., I.M.F,etc,. are not treated as residents of any country but of “International area”. • Employees of International Organisations are considered as resident of their own country and not of the “International Area”. • Workers from across the Border , who cross borders regularly to work in the given country are treated as residents of the country where they live and not the country where they work. • Foreign staff of embassies and Members of foreign Armed forces. • Crews of foreign ships, Aircrafts.

13. (2) National Income Aggregates. (a) Domestic Aggregates Gross Domestic product (at market price) :- It is the total value of contribution to production by all the production units located within the economic territory of a country , undiminished by consumption of fixed capital and Net Indirect tax . Net Domestic product (at market price) :- It is the value of contribution to production by all the production units located in the economic territory of a country, Diminished by consumption of fixed capital, but Undiminished by net indirect tax. NDPmp = GDPmp – Consumption of Fixed Capital.

14. Factor cost = Market price – Indirect tax + Subsidies. Indirect tax – Subsidies = Net Indirect Tax. Thus , Factor cost = Market Price – Net Indirect Tax. GDPmp- Consumption of fixed capital = NDPmp. NDPmp- Net Indirect Tax = NDPfc. GDPmp- Net Indirect Tax = GDPfc. Alternatively, GDPmp = NDPmp.+ Consumption of fixed capital. NDPmp = NDPfc.+ Net Indirect Tax. GDPmp = GDPfc.+ Net Indirect Tax.

15. Calculation of Gross Domestic Product. (i) Product method :- GDPmp = GVA of primary sector at market price + GVA of secondary sector at market price + GVA of tertiary sector at market price. GVA = value of output – Intermediary consumption. (ii) Income method :- NDPmp = Compensation to employees + operating surplus (rent, interest, profit) + Mixed Income. GDPmp = NDPmp + depreciation. GDPmp = NDPfc + depreciation.

16. (iii) Expenditure method :- GDPmp = Gross Final Consumption Expenditure (GFCE) + Gross Domestic Capital Formation (GDCF) + Net Exports (Export – Imports). GDFC = Private domestic final consumption expenditure + Government final consumption expenditure. GDCF = Gross domestic fixed capital formation + in stock (closing stock – opening stock).

17. (b) National Aggregates A National aggregate is a statistical measure of the contribution of residents of a country towards economic production carried out both from inside and outside the economic territory of the country. Contribution of residents to domestic product = domestic product – factor income paid to non-residents. National product = domestic product –factor income paid to non-residents + Factor income received residents from abroad. = domestic income + net factor income from abroad.

18. GNP (Gross National Product) :- The value of contributions of residents of a country towards economic production undiminished by consumption of fixed capital and net indirect tax. GNPmp = GDPmp + NFIA. • NNPmp (Net National Product) :- The value of contributions of residents of a country towards economic production diminished by consumption of fixed capital and but undiminished by net indirect tax. NNPmp = NDPmp + NFIA.

19. NNP (Net National Product) :- A measure of factor earnings of the residents of a country , both from economic territory and from abroad is called as Net National Product or National Income. NNPfc = NDPfc + NFIA = National Income GNPmp- Consumption of fixed capital = NNPmp. NNPmp- Net Indirect Tax = NNPfc. GNPmp- Net Indirect Tax = GNPfc. Alternatively, GNPmp = NNPmp.+ Consumption of fixed capital. NNPmp = NNPfc.+ Net Indirect Tax. GNPmp = GNPfc.+ Net Indirect Tax.

20. Calculation of National Income. (i) Product method:- value of output – Intermediary consumption – depreciation – net indirect tax + Net factor income from abroad = NNPfc / National income. (ii) Income method:- Compensation to employees + operating surplus + mixed income + depreciation = GDPmp. NDPfc = GDPmp – depreciation – net indirect tax. NNPfc / N.I= NDPfc + NFIA. (iii) Expenditure method:- PFCE + GFCE + GDFCF + Change In Stock + Net Exports – Depreciation – Net indirect tax + NFIA = NNPfc / N.I.

21. National Income - Income Method • NDP@FC = Income accruing to the govt. ( income from property and entrepreneurship accruing to the govt. + savings of non-departmental enterprises ) + Income accruing to the private sector. • Private income = Income accruing to the private sector + current transfers from govt. + current transfers from rest of the world + national debt interest + net factor income from abroad. • Personal income = Private income – savings of private corporate sector – profit tax. • Personal disposable income = Personal income – direct taxes – miscellaneous receipts of the govt.

22. CIRCULAR FLOW Production of goods and services (Land + Labour + Capital + Entrepreneur) Expenditure ( Consumption expenditure + Investment expenditure ) The Circular Flow Income (Rent + Wages + Interest + Profit) The Circular Flow

23. Chart Showing Value Added Method to Measure National Income Gross value added in the primary sector at mp Gross value added in the secondary sector at mp Gross value added in the tertiary sector at mp + + GDP mp = - consumption of fixed capital NDP mp = • Net indirect taxes • + Net factor income from abroad NNP fc = (National income)

24. Chart Showing Components of Factor Income NNP fc (Income Method) Compensation of employee Rent Interest Profit Mixed income of self-employed Net factor income from abroad • Components • Net compensation • to employees. • Net income from • property and • entrepreneurship. • Net retained • earnings of resident • companies abroad. Wages and Salaries in cash Wages and Salaries in kind Employers contribution to social security + +

25. CLASSIFICATION OF FINAL EXPENDITURE Investment (I) Government purchases of goods and services (G) Private consumption expenditure (C) Net exports (X-M) Addition to the nation’s capital stock of building, equipment etc., (Net expenditure from the foreign sector) = Exports – Imports Household final consumption expenditure Business fixed investment Government spending on goods and services from private producers Exports (X) Consumption expenditure on currently produced goods and services (except house) (plus). Amount spent on purchase of currently produced plant and equipment Plus (Foreigners purchase Indian goods) (Minus) Plus Plus Wages and salaries to its employees Inventory investment Expenditure of non-profit institutions serving households Imports (M) (Indians purchasers foreign goods) Consists of all finished goods on hand, goods in process, and raw materials Plus Residential construction investment Consumer expenditure on new residential structure. Plus Chart Showing the Components of Final Expenditure Public investment All investment carried out by the government such as building of roads, school etc.

26. Are the following included in Domestic Income ? • Profits generated by a foreign firm operating in India. • Salary earned by an Indian working in an American Embassy in India. • Rent received by an Indian resident from a Japanese Embassy in India. • Profits generated by an Indian Company from its branch in Singapore. • Wages paid to an Indian worker working in a foreign company in India. • Remittances sent by a Indian working abroad to his family in India.

27. STATEMENT PROBLEMS • Problem 1:Will the following be included in domestic factor of India ? Give reasons for your answer. • Profits earned by a resident of India from his company in Singapore. • Salaries received by Indians working in American Embassy in India. • Pension on retirement. • Windfall gain. • Commission received by a broker from selling second hand goods. • Employee’s contribution to social security schemes. • Problem 2 : Will the following be a part of domestic factor income of India? Give reasons for your answer. • Old age pension given by the government. • Factor income from abroad. • Profits earned by a company in India, which is owned by a non-resident.

28. Problem 3 : Will the following be included in national income? Give reasons. • Construction of a new house. • Interest on debentures. • Increase in the value of goods with a trader. • Interest on national debt. • Money received from a worker abroad by his family. • Expenditure on road construction. • Expenditure on improvement of fixed capital assets. • New durable consumer goods purchased by household. • Research and development expenditure of business firms. • Expenses on electricity by a factory. • School fees paid by students. • House rent allowance paid to teachers by school management.