National Income accounting
Introduction-
Some basic terms/concepts to understand national income accounting
1.Consumption goods-
- These are the goods which are used for final consumption. They do not increase production capacity.
- Example-mobile phone purchased for personal use.
2.Capital goods-
- These are the goods which are used as investment in the business and they help in increasing production.
- Example- computer use for your office.
3.Final Goods-
- These are those goods which are used either for final consumption or for investment.
4.Intermediate Goods -
- It refers to those goods and services which are used as a raw material for further production or for resale in the same year.
5.Investment -
- Addition made to the physical stock of capital during a period of time is called investment.
6.Capital formation-
- Change in the stock of capital is also called capital formation.
7. Depreciation -
- It means fall in value of fixed capital goods due to normal wear and tear and expected obsolescence.
- It is also called consumption of fixed capital.
8.Gross investment-
- It is part of our final output that comprises of capital goods constitutes gross investment of an economy.
9.Net Investment-
- When we subtract depreciation from gross investment than we get net investment.
Net Investment = Gross investment – Depreciation
10.Circular flow of income-
- The circular flow of income is a continuous exchange of goods, services, and money between different sectors of the economy.
- It is circular in nature, with no definitive start or end point.
- Understanding the circular flow of income is crucial to comprehending how the economy functions.
11.Money flow -
- Money flow refers to the flow of factor income, as rent, interest, profit and wages from the producing sector to the household sector as monetary rewards for theirfactor services.
12.Production taxes and production subsidies-
- Taxes paid or subsidy received with relation to production and are independent of the volume of actual production.
13.Product taxes or subsidies-
- Taxes paid or subsidy received on per unit of product.
- It is independent of production and taxes or subsidy on each product is taken into consideration
14.Factor Cost (FC)-
- Factor Cost (FC) pertains to the payment made to the factors of production for their involvement in the process of production.
15.Market Price (MP)-
- It refers to the price at which product is actually sold in the market.
16.Basic Price-
- Basic price refers to the price a producer anticipates receiving from the sale of one unit of product to a consumer.
- This price does not include any taxes but includes subsidies.
- The basic price is the amount that the producer expects to receive directly from the consumer.
Basic price = factor cost + Production taxes – Production subsidy
Relation between factor cost and market price
- Factor cost=Market Price-Indirect taxes +Subsidies
17.Indirect tax-
- It is collected by one entity in the supply chain and paid to the government, but it is passed on to the consumer.
18.Factors of Production -
Resources available at nation's disposal for its economic needs are called factors of production and it includes-
Land-
- All natural resources, for example, soil, water, forests, mountains, mines, deserts, air, sun, etc available to mankind. Associated cost of land. Resource is rent.
Labour-
- Physical or mental effort of human being in the process of production.
- The remuneration given to labour is called wages.
Capital-
- Machines, tools, buildings, roads, bridges, raw material, trucks, factories, etc are included in capital.
- Its remuneration is interest.
Entrepreneur-
- Firms undertake risk of hiring other three factors of production, bring them together organize and coordinate them to earn.
- Its remuneration is profit
19.Economic territory-
- Geographical territory administered by a government within which persons, goods and capital circulate freely.
20.Citizenship-
- It is based on the place of birth of the person or some legal provisions allowing a person to become a citizen.
21.Resident ship-
- It is based on the basic economic activities performed by a person.
National Income Accounting-
- National Income refers to the total income generated by residents of a country in a year.
- It measures monetary value of total output of goods and services produced in one year.
Methods of calculating National income
A.Gross value added (GVA)
- Gross Value Added (GVA) is a crucial measure of output and income in an economy.
- It can be calculated by subtracting the value of intermediate consumption from the value of output.
- GVA reflects the true contribution of each sector to the economy, as it takes into account the value added at each stage of production.
- At the macro level, from a national accounting perspective, GVA is the sum of a country’s GDP and net of subsidies and taxes in the economy.
Gross Value Added = GDP + subsidies on products - taxes on products
B .Gross Domestic Product-
- The Gross Domestic Product (GDP) represents the monetary value of all final goods and services that are produced within a country's borders during a specific time frame, typically one year. This metric is used to measure a nation's economic output and can provide insights into its overall economic health.
Features-
- ‘Product’ in GDP signifies that only final goods and services have to be included and intermediate goods should not be included to avoid the double counting.
- Only newly produced goods are counted.
- Transaction goods previously produced such as buying and selling of second-hand goods are not included
- Sale of goods that were produced outside domestic borders are not included in its calculation
Different subtypes of GDP
1.Gross Domestic Product at Market Price (GDPMP)-
- Gross domestic product at market prices is the sum of the gross values added of all resident producers at market prices, plus taxes less subsidies on imports
GDP at Market Prices = ∑ GVA at basic prices + product taxes – product subsidies.
2.GDP at Factor Cost-
- The Gross Domestic Product (GDP) at factor cost refers to the overall monetary value of goods and services produced by all production units in a given country over the course of a year.
3.GDP at current prices-
- Current price reflects prevailing market prices (i.e. Effect of inflation is taken into account). When GDP is measured at current prices it is called Nominal GDP.
4.GDP at constant prices or base year prices-
- When measured at constant prices it is called Real GDP.
- Real GDP is calculated in a manner that goods and services are evaluated at some constant set of prices and as the prices remain fixed, it reflects changes in volume of production
The difference between the constant and current prices is only that of the impact of inflation
GDP Deflator-
GDP Deflator = Nominal GDP/Real GDP
- Sometimes the deflator is also denoted in percentage terms. In such a case deflator = (GDP /gdp )× 100 per cent.
Uses of GDP
- GDP is used to measure the growth rate of any economy.
- It reflects the present condition of Indian economy in term of quantitative data.
Facts about GDP-
- GDP can not be used to measure the qualitative aspect (ex. Like health, education etc.) of any economy.
- It does not give any idea about prevalence of poverty, environmental degradation etc.
Difference between GDP & GVA
- GVA is the value added to the product to enhance the various aspects of the product whereas GDP is the total amount of products produced in the country.
- GVA and GDP provide different perspectives of the economy: GVA from the supply side and GDP from the demand side.
- GVA is a superior indicator of economic activity compared to GDP.
- GVA offers insight into the production and output of goods and services.
- GDP offers insight into the expenditure on goods and services by consumers.
- GVA is more accurate in measuring economic growth, as it takes into account the value added at each stage of production.
- GDP may not accurately reflect the economic activity if there are significant trade imbalances or when income levels are skewed.
C.NDP Net Domestic Product
- It is the GDP calculated after adjusting the weight of the value of ‘depreciation’.
- NDP = GDP – Depreciation.
- It is used to measure the economic losses due to depreciation in any country.
D.Gross National Product (GNP)
- Gross National Product (GNP) is the GDP of a country added with its ‘income from abroad’ minus Factor income earned by the factors of production of the rest of the world employed in the domestic economy.
- It is more exhaustive method as comparison to GDP as it takes into account both Quantitative as well as Qualitative aspects.
- It also helps to measure our trade related data at international market.
GNP = GDP + Factor income earned by the domestic factors of production employed in the rest of the world – Factor income earned by the factors of production of the rest of the world employed in the domestic economy
- Income from Abroad includes Private Remittances, Interest on External Loans, External Grants
GNP ≡ GDP + Net factor income from abroad
- It becomes GNP = GDP + (– Income from Abroad), i.e., GDP – Income from Abroad, in the case of India. This means that India’s GNP is always lower than its GDP.
Subtypes of GNP-
1.Gross National Product at MP(market price)-
- The Gross National Product at MP (market price) is a measure of the total income earned by the regular residents of a country in a given accounting year, which includes depreciation and net indirect taxes.
2.Gross National Product at FC-
- It is the sum total of factor incomes earned
by normal residents of a country along with depreciation , during an accounting
year by normal residents of a country along with depreciation, during an accounting year.
E.Net National Product (NNP)-
- It is Calculated by deducting depreciation expense from gross national product.
NNP= GNP-Depreciation
- NNP is the most genuine representation of a country's income.
- The per capita income (PCI) can be calculated by dividing NNP by the total population of a country.
- NNP and PCI are important indicators of a country's economic well-being.
- It is essential to ensure that NNP and PCI are calculated accurately and without any form of plagiarism.
Subtypes of NNP
1.Net National Product at FC (National Income)-
- It is the sum total of factor incomes (compensation of employees + rent + interest + profit) earned by normal residents of a country in an accounting year or
NNP(FC) = NDP(FC) + Factor income earned by normal residents from abroad
2.Net National Product at MP-
- It is the sum total of factor incomes earned by the normal residents of a country during an accounting year including net indirect taxes. OR
NNPMP = NNPFC + Indirect tax – Subsidy
F.Personal income
- Personal income (PI) =NI – Undistributed profits – Net interest payments made by households – Corporate tax + Transfer payments to the households from the government and firms.
G.National Disposable Income-
- National Disposable Income = Net National Product at market prices + Other current transfers from the rest of the world
Methods of calculating GDP
1. The Product Method
- In product method we calculate the aggregate annual value of goods and services produced all goods and services produced during the year in various industries are added up.
- This is also known as value-added to GDP
2.The Expenditure Method
- It is an alternative way to calculate the GDP is by looking at the demand side of the products .
- In this method we add the final expenditures that each firm makes.
- Final expenditure is that part of expenditure which is undertaken not for intermediate purposes
It is stated as GDP at MP=C+I+G+(X-M).
Where, C- Private sector's expenditure on final consumer goods, I- Firm's investment or capital expenditure, G=Government's expenditure on final consumer goods, X-Exports, M-Imports, X-M Net exports or the export revenues.
3.Income Method-
- In this method we calculate the earning/income of the people to calculate GDP.
- GDP = wages and salaries (employee compensation) + rent + interest + benefit.
- The aggregate of incomes received by the households is equal to the expenditure received by the firms because the income method and expenditure method would give us the same figure of GDP.
Base Year-
- A base year is used for comparison in the measure of a business activity or economic index.
- The base year of the national accounts is chosen to enable inter-year comparisons
BASE YEAR for gdp calculation- 2011-12
4.New method
- In new method GDP will be calculated by taking into account GVA at basic price.
GDP = GVA at basic prices + product taxes – product subsidies
GVA at basic prices = Compensation of Employee (like wages, salary etc.) + Operating surplus(means business profit)/Mixed Income + consumption of fixed assets + production taxes -production subsidies.
GVA at factor cost = GVA at basic prices – production taxes + production subsidies.
Important one liner Question and answers on National Income accounting.
What are consumption goods?
Goods used for final consumption and don't increase production capacity.
What are capital goods?
Goods used as investment in a business and help in increasing production.
What are final goods?
Goods used for final consumption or for investment.
What are intermediate goods?
Goods used as raw material for further production or for resale in the same year.
What is depreciation?
Fall in the value of fixed capital goods due to normal wear and tear and expected obsolescence.
What is gross investment?
Part of final output comprising capital goods that constitute gross investment of an economy.
What is the circular flow of income?
Continuous exchange of goods, services, and money between different sectors of the economy.
What is money flow?
Flow of factor income, such as rent, interest, profit, and wages from the producing sector to the household sector as monetary rewards for their factor services.
What are production taxes and production subsidies?
Taxes paid or subsidies received with relation to production and are independent of the volume of actual production.
What are product taxes or subsidies?
Taxes paid or subsidies received on a per unit of product basis, independent of production.
What is factor cost (FC)?
Payment made to the factors of production for their involvement in the process of production.
What is market price (MP)?
Price at which a product is actually sold in the market.
What is basic price?
Price a producer anticipates receiving from the sale of one unit of product to a consumer.
What are factors of production?
Resources available to a nation for its economic needs, including land, labor, capital, and entrepreneurship.
What is economic territory?
Geographical territory administered by a government within which persons, goods, and capital circulate freely.
What is National Income?
Total income generated by residents of a country in a year.
What does National Income measure?
Monetary value of total output of goods and services produced in one year.
What is Gross Value Added (GVA)?
Measure of output and income in an economy, calculated by subtracting the value of intermediate consumption from the value of output.
How is Gross Value Added calculated?
GDP + subsidies on products - taxes on products.
What is Gross Domestic Product (GDP)?
Monetary value of all final goods and services produced within a country's borders during a specific time frame, typically one year.
What does the "product" in GDP signify?
Only final goods and services should be included, and intermediate goods should not be included to avoid double counting.
What is Gross Domestic Product at Market Price (GDPMP)?
Sum of the gross values added of all resident producers at market prices, plus taxes less subsidies on imports.