National Income Fundamentals

8/18/2019 National Income Fundamentals

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National Income Accounting

National income accounting –

A set of rules and definitions for measuring economicactivity in the aggregate economy – that is, in theeconomy as a whole.

National income accounting is a way of measuring total,or aggregate production.


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Gross National Product (GNP)

GNP stands for the monetary value of all goods andservices that are: – Currently produced,

– Sold through the official market,

– Not resold or used in further production,

– Produced by the nationally owned resources (factors of

production), and – Valued at the market prices (current or constant).

– GNP belongs to the nation, and thus, it must be

produced by its owned factors of production only. Thus,if an Indian professor takes up a four month VisitingProfessorship in a US University, his income in USA isthe part of India’s GNP and similarly the profit that aMNC makes in India, is not a part of India’s GNP.


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Gross National Product (GNP)

GNP at market price is inclusive of the indirect taxes (Ti),

net of subsidies (S) as it values the goods at the prices paid by the end users. To get GNP at factor cost (GNPF), one

must deduct net indirect taxes from GNPM:

GNPF = GNPM + S - Ti

GNP@ market price = GNP@ factor cost – Subsidies +

Indirect Taxes

GNP@ factor cost = GNP@ market price + Subsidies -

Indirect Taxes


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Net National Product (NNP) & National Income

NNP is equal to: Gross National Product (GNP) less

Allowances for Capital Consumption.

National Income (NI) is the total net value of all goods and

services produced within a nation over a specified periodof time, representing the sum of wages, profits, rents,

interest, and pension payments to residents of the nation.

You can simply calculate NI by subtracting capital

depreciation and indirect tax from GDP.

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Gross Domestic Product (GDP)

It refers to the value of the goods and services produced within thenation’s

geographical territory, irrespective of the ownership of theresources. Therefore, salary of an Indian visiting professor in USAis the GDP of USA and the dividend earned by a foreign company inIndia constitutes GDP of India.

In view of this, while GNP consists of income produced by thenation’s owned resources irrespective of the place of production,GDP refers to income produced within the nation’s territoryirrespective of the ownership of the resources that produced it.

The difference between the two concepts is accounted for by the netfactor income earned abroad (NIA). Thus,

GDPF = GNPF -NIA

From the point of view of the employment generation at home, GDPis more relevant than GNP, and hence, the former often receives a

greater attention than the latter.


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Gross Domestic Product (GDP)

The monetary value of all the finished goods and servicesproduced within a country's borders in a specific time period.

GDP is usually calculated on an annual basis. It includes all of private and public consumption, government outlays, investmentsand exports less imports that occur within a defined territory.

GDP = C + G + I + NX,

where:

"C" is equal to all private consumption, or consumer spending, ina nation's economy

"G" is the sum of government spending

"I" is the sum of all the country's businesses spending on capital

"NX" is the nation's total net exports, calculated as total exports

minus total imports. (NX = Exports - Imports)


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GDP at Market Price

What is GDP@ market price?GDP@ market price =GDP@ factor cost – Subsidies +

Indirect Taxes

GDP@ market price refers to:

– The total final output of all final goods and services produced

within the national frontiers of a country by its citizens and

– The foreign residents who reside within those frontiers that aresold at market prices in various markets.


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GDP at Factor Price

nGDP@ factor cost =

nGDP@ market price + Subsidies -Indirect Taxes

nFactor costs: are the actual production costs at which goodsand services are produced by the firms and industries in aneconomy.

Factor costs are really the costs of all the factors of production such as labor , capital, energy, raw materials like steel etc thatare used to produce a given quantity of output in an economy.

Thus the term GDP@ factor cost refers to the total final

output of all final goods and services produced within thenational frontiers of a country by its citizens and the foreignresidents who reside within those frontiers that are assessedat production or factor cost prior to leaving their respectivefactory gates for various markets where they are bought

and sold.


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GDP: Nominal vs. PPP

PPP (Purchasing Power Parity):

The long term equilibrium exchange rate should equal theratio of the prices in different countries for the same goods/services.

Big Mac IndexThe Economist's Big Mac index is based on the theoryof purchasing-power parity (PPP) according to whichexchange rates should adjust to equalize the price of a basketof goods and services around the world.

The real PPP exchange rate calculation

– Takes into account a broad range of goods and services

– Including both tradable and non-tradable goods/services

– Should be updated frequently


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Things not included in GDP

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Work that is provided in an economy by non-markettransactions such as homemakers and military personnel.

These factors are too difficult to measure.

Illegal activities such as gambling and drug trafficking.These factors are also difficult to estimate; in addition theyare a "dis-service" to the economy.

Goods and services that are bartered. These were excludedbecause they cannot be measured.

Sale of intermediate goods (raw materials). Sale of used goods (used cars, furniture, etc.).

Purely financial transactions such as sale of stocks andbonds.

Imports (goods made outside the India).


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Problems if they are included in GDP

Counting the sale of final goods and intermediate products

would result in double and triple counting.

There are two ways of eliminating intermediate goods.

– The first is to calculate only final output.

– A second way is to follow the value added approach.


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Value Added Approach Eliminates Double Counting


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Calculating GDP: Some Examples

Selling your two-year-old car to a neighbor does not add to GDP.

– Selling your car to a used car dealer who then sells your carto someone else for a higher price, adds to GDP. The value of

the dealer's services is added to GDP.

Selling a stock or bond does not add to GDP.

– The stock broker's commission from the sales does add toGDP.

Social security payments, welfare payments, and veterans'

benefits, are not included in GDP.

– Only the cost of transferring is included in GDP. The work of unpaid house-spouses does not appear in GDP

calculations.

– GDP only measures market activities so unpaid value added is

not included in GDP.


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Shortcomings of GDP as a measure of economic

well-being:

Only Market Activity is Included in GDP

GDP places no value on leisure

“Bads” counted as well as “Goods”

For example, when there is a natural disaster,

increased spending to solve the problems of the disaster

are counted as increased GDP.

No account for ecological costs


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Net Domestic Product

NDP , or Net Domestic Product , unlike GDP, takes account ofcapital depreciations, capital goods or part of capital goods thathave been consumed over the year in forms of housing, vehicle,machinery deterioration and so forth. By subtracting the annualcapital depreciation from the GDP, NDP is more accurate inmeasuring economic output.

Capital Consumption Allowances: are the total or aggregate costsof the wear and tear or depreciation of the capital stock iemachinery, tools, plants, roads, power grids, buildings, bus fleet,trains, railways etc within an economy usually within a given year.

Another name for the CCAs is the depreciation of capital stock or

its depreciation costs.

The reason we use GDP rather than NDP: The capital depreciationis too difficult to spot from capital goods investments.

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Personal Income

It is the sum of all incomes actually received by all

individuals or household during a given period.

PI = NI – social security contributions – corporate income

tax –

undistributed corporate profits + transfer payments

Disposable income

Disposable Income for individuals is the part of total earnings

deprived of all taxes paid and profit reserved for companies,

which is the amount available for spending or saving.

DI = PI - Personal Taxes


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Worked Out Example

NDP at Market Price 25,21,700

Net Indirect Taxes 3,06,087

Net factor Income from Abroad -41,482

Depreciation 78,821Transfer Payments 33,873

Population 98.7 crores

You have following information (Rs. Crores)

Calculate: (i) GDP at Market Price, (ii) NI (iii) Per Capita Income

(i) GDP at Market Price = 26,00,521

(ii) NI = 21,73,771

(iii) Per Capita Income = 22,024.022

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National Income Fundamentals