NATIONAL INCOME ACCOUNTING

Trends in India’s GDP

GDP by sector: by employment

services (55.2%) 34% industry (26.3%) 14% Agriculture(18.5%) 52% India is 9th according to nominal GDP,

4th according to purchasing power and 109th according to Per capita income

Methods:

Income approach Expenditure approach Final Output approach By the circular flow we know all

approaches will give same result

The Income Approach

The income approach is shown on one half of the circular flow.

Firms make factor payments to households for supplying their services as factors of production.

Households spend the income they earn on goods and services

Output Method;

Adds up the market values of all goods and services produced .

It ignores intermediate goods and second hand sales of goods

This avoids double counting

Expenditure Method:

Consumption Investment Government purchases Net exports: exports less imports Consumption involves spending on

services, durable goods and non durable goods

Expenditure method: Investment is gross private domestic

expenditure on new capital goods , depreciation and inventories.

Investment excludes : household purchases of durable goods purchase of existing buildings and

machines purchase of stock and financial assets.

Expenditure method: Government expenditure includes

spending on goods and services but excludes transfer payments.

Net exports = exports less imports GDP = C+I+G+X-M C+S+NET TAXES=C+I+G+X-M S+M+T=I+G+X LEAKAGES = INJECTIONS

Equality of Income and Expenditure

GDP is calculated either by adding up all values of final output or by adding up the values of all earnings or income.

GDP at market prices equals the sum of market values of all goods produced in the economy

Gross vs Net:

Depreciation or capital consumption is the amount by which an assets value falls in a given period.

Net Investment = Gross Investment less depreciation.

Capital stock at end of period = capital stock at beginning of period +net investment

Qualifications to the Income Accounting Identity

To go from GDP to national income: Add net foreign factor income.

National income is all income earned by citizens of a nation and is equal to GNP.

To move from "domestic" to "national" we add net foreign factor income.

Subtract depreciation from GDP. Subtract indirect business taxes from

GDP.

The Income Approach

National income is the total income earned by citizens and businesses in a country in one year.

It consists of employee compensation, rent, interest, and profits.

NNP at factor cost = National Income

GDP and GNP: GNP is total value of goods and services

produced in a year by domestically owned factors of production (only final goods) regardless of where the output is produced

E.g. German owned car factory in US is a part of German GNP.

GDP is value of final goods and services produced within a country’s borders.

GDP and GNP:

Output of the Honda plant in USA is a part of US GDP but Japanese GNP

Wages paid to American employees is a part of US GNP

Profits from the plant are a part of Japanese GNP but not GDP

National income National Income = net national product

at factor cost NNP at factor cost = GDP at market prices

less indirect taxes plus subsidy+ NFIA less depreciation NFIA can be positive or negative= receipt

of factor income from the rest of the world minus the payment of factor income to the rest of the world.

National income:

Total of income earned by the factors of production , owned by a country’s citizens.

=compensation to workers+ proprietors income (income of unincorporated business)

+ corporate profits+ net interest (paid by business)+ rental income

Personal Income

Personal income (PI) is national income plus net transfer payments from government minus amounts attributed but not received.

PI = NI + Transfer payments from government + Net non-business interest income

– Corporate retained earnings– Social security taxes

PERSONAL INCOME GDP + NFIA = GNP Less depreciation = NNP Less indirect taxes plus subsidies =national income (NNP at factor cost)Less (corporate taxes+ retained profits)Plus interest income received from

government Plus transfer payments = Personal Income

Disposable Income:

Disposable personal income is personal income minus personal income taxes and payroll taxes.

Disposable personal income is what people have readily available to spend.

DPI = PI - Personal taxes

Uses of GDP Accounting: GDP figures are used to make comparisons

among countries and to measure economic welfare over time.

GDP gives a measure of economic size and power.

Per capita GDP is another measure often used to compare nations' GDP.

Because of differences in non-market activities, per capita GDP can be a poor measure of the living standards in various nations.

GDP figures leave out the following: Illegal drug sales. Under-the-counter sales of goods to

avoid income and sales taxes. Work performed and paid for in cash. Unreported sales. Prostitution, loan sharking, extortion,

and other illegal activities.

GDP as an indicator of economic welfare:

GDP excludes unpaid economic activity Comparisons between countries are

distorted by changes in exchange rates. In countries with a large underground

economy , underestimation is likely GDP does not give indication about

standards of living It ignores distribution of income.

GDP as an indicator of economic welfare:

Nominal GDP values ignore inflation

High GDP values are often correlated with negative externalities such as pollution

Natural disasters raise GDP values but does not indicate a healthy economy.

Limitations of National Income Accounting

Measurement problems exist. GDP measures economic activity, not

welfare. Subcategories are often

interdependent. Non market activities are not

accounted for.

Real vs nominal GDP Just because GDP rose does not mean

welfare rose – it could be only prices rose. Comparing output over time is best done

with real output which is nominal output adjusted for inflation.

Nominal GDP is GDP calculated at existing prices.

Real GDP is nominal GDP adjusted for inflation.

Real GDP Real GDP is

arrived at by dividing nominal GDP by the GDP deflator.

GDP DEFLATOR:

Ratio of nominal to real GDP

Prices of current and base year are weighted by quantities of current year.

Nominal GDP has gone up by 58.7%but GDP at year 1 prices =15.10 .So an increase of 24.8%

qty1

qty2 prc1 prc2 gdp1 gdp2

A 6 11 .5 .4 3 4.4

B 7 4 .3 1 2.1 4

C 10 12 .7 .9 7 10.8

12.1

19.2

Purchasing Power Parity:

Purchasing power parity is used to get around the problems of per capita GDP.

Purchase power parity adjusts for different relative prices among nations before making comparisons.

E.g. McDonald Index

Laspeyre’s Index:

Cost of purchasing base year basket at current year prices divided by cost of base year basket at base year prices

New WPI LAUNCHED