NI acounting _F

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National Income Accounting

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National Income Accounting (NIA)

Why is it necessary to study NIA? (reflected through GDP)

In order to understand the relationship among the key economic variables and amongdifferent sectors of the economy, study of NIA merits great significance as it

i) provides the formal structure of our macro economic models.

Out put of the economy has two sides:

Production side includes the factor payments constitutes the study ofgrowth and

aggregate supply

Demand side includes the consumption / investment etc constitutes the aggregatedemand.

Over all Price level is also assessed which provides the basis for studying the inflation

ii) Through NIA we can link the theory to the real world.

Hence NIA helps us

to assess the economys over all performance,

to facilitate economic forecasting for future and

to provide the basis for policy making

Generally GDP measures two imp components : Income and Expenditure

Always Income =Exp

Why is NIA imp? What are the 2 imp items GDP measures? 2


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Measures of NIAThe most frequently cited measure of national income is GrossDomestic Product (GDP)

GDP is the total market value of all the final goods and servicesnewly produced within a country in a given period of time.

Why is it market value?

One can add the value in terms of money for comparision (onlyservices on payment or which are sold in the markets included);

housewives services, child rearing in the family etc are notincluded.

Why final goods and services not intermediate goods and services?

To avoid double counting; Example: flour for making bread in thesame year is intermediate good, trucks to carry flour to bakery is

intermediate service.

Q: What is the most cited measure of NI?

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GDP and GNP (Gross national income)

GNP is the market value of final goods and services newly producedin another country by using domestic factors of production

during the current period while GDP refers to the production takingplace within a country.

Example: Indian labour and Capital used in USA to produce someout put and earn income and this income is included in GNP of

India not GDP, because they do not represent the production takingplace within India. It is GDP for USA. The relationship is as follows;

GDP=GNP-NFP (net factor payment from abroad)

NFP = Income paid to the domestic factors of production by the rest

of the world minus income paid to foreign factors of production bythe domestic country.

Q: USA constructs road in Egypt. The fees paid by Egypt to USA be included in

GNP or GDP?

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GNP=Market Value of domestically produced

goods and services Plus income earned by

the residents of a country in foreign countriesMinus income earned by the foreigners in the

country

GDP = market value of goods and servicesproduced by the residents in the country Plus

income earned by the foreigners in the

country minus income received by theresidents in a country from abroad

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Components of GDP

Four components:

1.Consumption spending by HHs : C

2.Investment spending by business and HHs: I

3.Govt (central, state and local) purchases of

goods and services : G

4. Net exports :NX

Fundamental National Income Accounting Identity:

Y C+ I + G +NXY=GDP= Total production (output)= total Income=Total expenditure

Q: How many components of GDP we consider? What are these components?

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Estimates of GDP: Three Approaches to measures of GDP

The Product approach : It measures the economic activity byadding the market values of all the final goods and services. This approach

takes into account the value added by the producers.

The Income Approach: It includes all the activities by adding allthe incomes received by the producers of output including wages and salariesreceived by the workers and profits received by the firm owners

The Expenditure approach: Measures the activities by addingthe amount spent by all the ultimate users of output.

These three approaches are the same as they provide the same answer

Total production = Total income =total expenditure as they are measured inthe same units (say Rupees or dollars).

The following simple example will show how these three measure areequivalent giving the same answers

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Equivalence between three methods of GDP calculations

Items Rs per annum

wages paid to the emplyees 15000

taxes paid to govt 5000

Revenue received 35000

oranges sold to public 10000

oranges sold to juice producer 25000

wages paid to the emplyees 10000

taxes paid to govt 2000

Oranges purchased from orange farm 25000

Revenue received from sale of juice 40000

Orange farm transactions

Juice producer transactions

Illustrative examples of GDP calculations

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The production / market approach of GDP measure

It defines the GDP as the market value offinal goods and services newly

produced (goods produced in the previous period excluded) within a nation during a

fixed period. It does not include any intermediate goods and services andmakes use ofvalue added by the producers.

Value added=value of output value of the inputs purchased from other

producers

Under product approach of GDP estimate, the economic activities are

computed by summing up the value added by all the producers.

Inventories gained/ invsted in the current year is included

In the above example:

Orange producers output : 35000 and juice producers 40000. If we add these two it gives75000.00. But 25000 (intermediate good) worth of oranges is purchased from the orange

producers, hence it would be double counted if we include it. So we will sum the value added

rather than the output in order to avoid double counting. In this case juice producers value added

is 15000 (40000-25000) and that of orange is 35000 as it has not purchased any input from

others. The total value added is 50000.00

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Income Approach Income received by the producers: Profits

profit by owners and the wages received(in 000s of Rs)

Before tax :profit= 20 (O)+ 5 (J)=25

Wage income=15(o)+10(J)=25

Total Income =50

After tax : Profit= 15 (O)+3(J) =18

Wage income=15(O)+10(J)=25

Tax received=5(o)+2(J)=7

Total income=18+25+7=50 10


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The Expenditure Approach

Measures the activities by adding the amount

spent by all the ultimate users of output. Inthe present example

Households consumption of oranges= 10

Juice consumption= 40

Total exp=40+10=50

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Value added:Steps in estimation(boundaries need to be defined)

1. Identification of sectors(P,S,T)

2. Classification of out put under each sector

(C, I,G,NX)

3. Measurement of the above output in monetary terms: 2

methods

A. Final output method (Value of final output-value of

intermediate product)

i) Value output (Q*Market price)

ii) Value of Intermediate output (Q*Market price ofintermediate good)

iii) Depreciation (loss due to wear and tear of capital goods)

B. Value Added Method= Value of output- Value of raw materials

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Problems in estimation

Double counting

Estimation of imputed value

Price change

Lack of data and un cleaneddata

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I A h St i ti ti


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Income Approach: Steps in estimation Identification of units

Classification of Income

Estimation of income (income and profit)

Types of income:

Compensation of employeesWages, salaries, contribution to pension, social

security etc by the employer

Proprietors income (self employed)/ Non wageincome

Rental Income

Corporate profit 14


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Net interest= Interest earned-Int. paid

The following categories of income are included

with proper adjustmentsIndirect Business taxes: sales tax , excise tax as

these are already included under Govt revenue

Depreciation: adjusted under corporate sectorscapital consumption etc.

Net Factor payments already included

GDP= All the incomes with proper adjustment

NDP =GDP-Depreciation

NI=NDP + Net Income from abroad15


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Items Rs in crores

Compensation to emplyees 5977

Proprietors income 757

Rental income of persons 142

Corporate profit 787

Net interest 684

Total National Income 8348

Plus Indirect taxes from business 695

Equals Net National Product (NNP) 9043

Plus Consumption of fixed capital 1394

Equals Gross National Product(GNP) 10437

Less Factors Income received from abroad 278

Plus Payments of factor income to rest of the world 289

Equals Gross Domestic Product(GDP) 10446

Income Approach to Measure GDP


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Problems:

Classification of income Change in price

Income of self employed

Imputed value of income

Income from other illegal activities

Windfall income

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Expenditure approach: Steps

1. Boundary fixation

2. Identification of units of expenditure

3. Estimation methods

GDP at MP=PFCE (private final consumption

exp)+GFCE+GDI(gross domestic investment)+

Net of exports

GNP=GDP+Net Factor income from abroad

NDP=GNP-Depreciation

NDP at factor cost=NDP-Net indirect taxes

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I.Consumption expenditure:Spending by the households on final goods and servicesThree categories of Consumption expenditure1. Consumer durables(cars, TV, furniture, major such appliances but not

houses)2. Non durables (food, clothing, fuel etc)3. Services(education, health care, financial services, transportation etc)Q: Is the purchase of a house included under this exp? Is the income by the agent to

sale a house included here ?

II.Investment expenditure:

1. Business fixed Investment : Spending by businesses on structures (likefactories, ware houses and office building etc), and Equipment (machines,computers,furniture) and software

2. Residential Investment: Spending on construction of new houses, apartmentand the like as they provide services (shelter) over a long period of time.

NB: Investment in inventories are included in investment spending.

Q: Company has Rs 1000 inventory last yr and it became Rs 1100 this year. Whichwill be part of investment exp?


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III.Govt expenditure : It include the salaries of

employees, spending on public works (roads,

irrigation etc). But the payments for socialsecurity to elders are not included under GDP

as these are transfer payments not in

exchange of production of any goods and

services. Similarly interest payment on

national debt are not included in Govt

purchase.

Q: Is Exp by govt on pension included? Yes/No.

Why?

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IV. Net of Exports=Export minus Imports

Exports refer to the goods produced in the

country purchased by the foreigners andimports are the goods produced abroad

purchased by the residents within the country.

The purchasing of imported goods aresubtracted from the exports because these

are included in other components of GDP.

Example: car purchase from abroad already

included under consumption.

Q: if a car is purchased from Japan for Rs 60

lakhs, will Rs 60 lakhs be included in GDP?21


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Problems Measurement of consumer durables

Difficult to differentiate in respect of Govt exp

between consumption and investment

Non availability of adequate data on change of

inventories

Non inclusion of interest on national debt

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Items of exp Value in Crores of Rs

1.Personal Consumption Exp (C)

Consumer durables 871.9

Non Durables 2115

Services 4316.8

Total of C 7303.7

2.Gross Private domestic investment (I)

Busines fixed investment 1117.4

Non residential structures 269.3

Equipment and software 848.1

Residnetial investment 471.9

Inventory investment 3.9

Total of I 1593.2

3.Govt Purchase of goods and services (G)

Central 693.7

national defense 447.4

non defense 246.3

State and local 1279.2total of G 1972.9

4. Net of Exports (NX)

Exports 1014.9

Imports 1438.5

Total of NX -423.6

Total GDP (Y) 10446.2

Expenditure approach to Estimate GDP


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GDP at market prices

GDP= Value of all output-Value ofintermediate goods and servicesNDP=GDP-depreciation

NDP at factor cost=NDPmp-Net IndirectTaxNI=NDP(FC)of all sectors + Net of

factor income from abroad

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Real Vs Nominal GDP

Nominal GDP uses the current prices to value

the goods and services.

Real GDP uses the constant base year prices to

value the goods and services

Real GDP is a better measure over the nominal

GDP as it (real GDP) is not affected by

changes in prices

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Estimation of Real and Nominal GDP (HypotheticalExample)

Year price quantity Nominal GDP Real GDP

2001 100 20 2000 2000

2002 150 25 3750 2500

2003 200 20 4000 2000

2004 220 27 5940 2700

2005 250 22 5500 220026


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GDP Deflator =[Nominal GDP/Real

GDP]*100

GDP deflator reflects the prices of goods

and services but not the quantities. It isone type of Price index

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C P i I d (CPI)


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Consumer Price Index (CPI) CPI reflects the prices of all goods and services

bought by the consumers. It monitors thechanges in cost of living.

Steps in computing CPI

i) Identify the basket of goods in order ofimportance for the consumers and fix the

basket of goods

ii) Find out the prices of the goods in the basketiii) Select one year as base year

iv) Compute the cost of the food basket at

different times 28


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CPI=Current/Base *100

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Year price quantity Price current yr/base yr clo5*100

2001 10 22 220 1 100

2002 15 25 375 1.704545455 170

2003 20 30 600 2.727272727 273

2004 25 30 750 3.409090909 341

2005 30 35 1050 4.772727273 4770.398827 2005 0ver 2004

40 % rate of inflation

CPI d GDP d fl


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CPI and GDP deflator

Both provides the similar pattern of change in

prices, But there are differences:

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GDP Deflator CPI

1.Prices of all goods and

services produced domestically

Ex: Purchase of Air craft

produced in India for defense

included in GDP not CPI

1.Prices of all goods and

services bought by the

consumers

Ex: Purchase of imported car by

consumers included in CPI not

GDP

2. It compares the prices of

currently produced goods and

services with prices of same

goods in the base year

2. It compares the price of a

fixed basket of goods and

services with the price of the

basket in the base year


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PPI: Producers price index

It includes the prices of raw materials and

semi finished goods for estimating the priceindex

It provides the direction of changes that takes

place before the goods used for finalconsumption by the consumers

Hence it is one of the significant indictors of

business cycle which policy makers take intoaccount

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NI Identities

Simple economy

Y=C+I

Y=S+C,

Hence C+I Y S+C or I=S

I= Exp. approach of GDP (GDP-C)

S=Income approach of GDP (GDP-C)

Introduce Business, Govt and Net exportIn = gross investment=domestic gross

investment (I) + net foreign investment (X)

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Gross saving=S= net personal saving(NPS) +


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Gross saving=S= net personal saving(NPS) +

Gross Business saving (GBS)+ net govt saving

(NGS)

Now the identity will be

I= NPS+GBS+NGS= Total saving

GDP= C+I+G Product side

GDP=DI+GBS+Tx-Tr Earning or cost side

DI=C+NPS

GDP=C+(NPS+GBS)+(Tx-Tr)-G+G= C+ (NPS+GBS+NGS)+ G

=C+I+G, Hence Product side=Income side of GDP

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