Class 12 'National Income Accounting' (economics)

 

CHAPTER 8: NATIONAL INCOME ACCOUNTING

National Income:

The monetary value of goods and services produced in an economy during period of one year is known as National Income. While estimating National Income, raw product and intermediate product are not included. The monetary value of final product is only included, accounted and evaluated in estimation of National Income. The income obtained by country from abroad is also included in the estimation of National Income.

When the depreciation value is subtracted from Gross National Income then the remaining amount of National Income is known as Net National Income. Net National Income is the actual income of the country. There are various components of National Income which can be listed as follows:

1. Gross Domestic Product (GDP)

2. Gross National Product (GNP)

3. Net National Product or Net National Income (NNP/NNI)

4. National Income at Factor Cost (NIatFC)

5. Personal Income (PI)

6. Disposable Income (DI)

7. GNP Per Capita

BASIC CONCEPTS OF NATIONAL INCOME

1. Gross Domestic Product (GDP)

The monetary value of goods and services produced in an economy during the period of one year is known as Gross Domestic Product. The monetary value of raw materials and intermediate product are not included rather the monetary value of final product is only included in the estimation of Gross Domestic Product. The depreciation value is not subtracted from GDP.

GDP focuses on final product of following three sectors:

a. Products of Primary Sector (Agricultural Sector)

b. Products of Secondary Sector (Industrial Sector)

c. Products of Tertiary Sector (Service Sector)

Symbolically,

GDP = C+I+G

Where, C = Aggregate consumption, I = Aggregate Investment expenditure and G = Government expenditure.

GDP shows economic strength of a country.

2. Gross National Product (GNP)

Monetary value of goods and services produced in an economy during the period of one year is known as Gross Domestic Product. When net income from abroad (X-M) or net trade balance or difference between export and import (X-M) is added to GDP then such a concept is known as Gross National Product. Like GDP, the final product monetary value is only included in the estimation of GNP. Products of following four sectors are included, accounted and evaluated in the estimation of GNP and they are:

a. Products of Primary Sector

b. Products of Secondary Sector

c. Products of Tertiary Sector

d. Net Income from Abroad

Symbolically,

GNP = C+I+G+(X-M)

GNP is also described as one of the indicators of economic development.

3. Net National Product/Net National Income (NNP/NNI)

When net income from abroad is added to GDP then such a concept is known as GNP. When depreciation value is subtracted from GNP then such a case is known as NNP/NNI. In fact, NNP is known as true or actual income of country.

Symbolically,

NNP = C+I+G+(X-M) – Depreciation

NNP is also known as NIatMP i.e. National Income at Market Price.

4. Personal Income (PI)

Personal Income is the total money received by individuals and households of a country from all possible sources before direct taxes.

Personal Income = National Income – Corporate Income Taxes – Undistributed corporate profits – Social Security Contribution  + Transfer Payments

5. Disposable Income (DI)

The income left after the payment of direct taxes from personal income is called disposable income. Disposable Income means actual income which can be spent on consumption by individuals and families.

Symbolically,

DI = Personal Income – Direct Taxes

6. Per Capita Income:

The average income of the individuals of a  country is called Per Capita Income.

PCI = National Income

          Total Population

NOMINAL AND REAL GDP:

NOMINALGDP:

When the monetary value of GDP is estimated in an economy then such a case is known as Nominal GDP. GDP calculated in terms of prevailing market prices is known as Nominal GDP. Any change in Nominal GDP reflects combined effects of changes in quantities and changes in prices.

Symbolically,

Nominal GDP = Qty. of Output (Goods and Services) x Current Market Price

Nominal GDP shows economic strength of country at domestic level.

REAL GDP:

It is the measure of value of goods and servicesin terms of base year price. When current price GDP is adjusted for Inflation is described as Real GDP.

Symbolically,

Real GDP = Current Price GDP   X 100

        GDP Deflator

GDP in base year price is reflected through Real GDP in an economy. It is also represented as Real GDP at constant price.

Nominal and Real GDP both are equally needed for evaluation of economic strength of the country.

GDP DEFLATOR:

When Nominal GDP of current price is divided by Real GDP of base year price then such a situation provides magnitude of GDP Deflator. GDP Deflator is a measure of price level calculated as ratio of Nominal GDP to Real GDP and it is always multiplied by 100.

Symbolically,

GDP Deflator = Nominal GDP(Current Year Price)      X 100

Real GDP (Base Year Price)

GDP Deflator helps to estimate the real economic strength of a country between periods of base year and current year.

CALCULATION OF GDP DEFLATOR:

FROM BUDDHA PUBLICATIONS ECONOMICS II, PAGE 155

METHODS OF MEASUREMENT OF NATIONAL INCOME:

National Income can be measured by help of following methods:

1. Product Method

a. Final Goods Method

b. Value Added Method

2. Income Method

3. Expenditure Method

1. Product Method:In this technique the monetary value of goods and services are accounted and evaluated to measure National Income. There are two dimensions of Product Method:

a.Final Goods Method:

In this technique the monetary value of final goods and services are only included in the estimation of National Income. The monetary values of raw and intermediate product are not included at all. In fact, monetary values of final products of following four sectors are essentially included and evaluated which can be listed as follows:

a. Final Products of Primary Sector (Agricultural Sector)

b. Final Products of Secondary Sector (Industrial Sector)

c. Final Products of Tertiary Sector (Service Sector)

d. Net Income from abroad (X-M)

Final Goods Method is a traditional technique but most popular one in the measurement of National Income. Many developing and few developed countries depend on Final Goods Method. Simon Kuznets mentioned this method as ‘Commodity Service Method’.

Final Products	National Income
1. Products of Primary Sector	-
2. Products of Secondary Sector	-
3. Products of Tertiary Sector	-
GDP	-
4. Add: Net Income from Abroad (X-M)	-
GNP	GDP+ (X-M)
5. Less: Depreciation	-
NNP	GNP-Depreciation

 

The main merit of this technique is that is an easy method of measurement of National Income but its serious demerit is that it creates problem of double counting.

b. Value Added Method:

In this techniquethe monetary value of different stages of production are added together to estimate National Income. In the beginning monetary value of raw material is estimated. As raw material is converted into intermediate product and then into final product, the monetary values added at different stages of production are accounted and evaluated in the measurement of National Income. When cost of production is subtracted from monetary values of different stages of production then NNI is estimated through value added method.

This method is the most scientific technique because it minimizes the problem of double counting, however, the weakness of this technique is that it is a costlier process which may not be afforded by poor and backward countries.

Products and Stages	Raw Stage	Intermediate Stage	Selling Price	COP	Value added
1. Bread (KG)	20	30	45	25	20
2. Cloth (Metre)	50	60	80	30	50
3. Medicine (100 ml)	10	40	100	90	10

 

2. Income Method:

In this technique the monetary income of all the residents are added together to estimate National Income. Money Income is obtained by people in the form of factor income such as rent, wage, interest and profit. The undistributed corporate profit is also added in the estimation of National Income. Similarly, direct taxes (income and property tax) and indirect taxes (sales tax, excise duty, VAT) are also included in the estimation of National Income. Likewise, transfer payment (old age pension, unemployment allowance, economic relief to weaker section of society) are also included in the estimation of National Income by Income method.

The National Income from abroad (X-M) is also added together to estimate National Income. The famous Economist Simon Kuznets has described Income Method as ‘Income Received Method’.

Components of Income	National Income
1. Income of all residents	-
2. Undistributed Corporate Profit	-
3. Direct and Indirect Taxes	-
4. Transfer Payments	-
GDP	-
5. Add: Net Income from abroad (X-M)	-
GNP	GDP+ (X-M)
6. Less: Depreciation	-
NNP	GNP-Depreciation

 

3. Expenditure Method:

The concept of measurement of National Income by Expenditure Method was developed by famous Economist J.M. Keynes. According to Keynes following components of expenditure are included to measure National Income and they are:

i. Aggregate Consumption Expenditure (C):According to J.M Keynes consumption expenditure refers to that part of income which is spent by people to fulfill their requirements. Consumption may also be defined as difference between Income and Savings. Keynes pointed that,

Y = C+S

Where, Y = Income, C = Consumption and S = Savings

Or, C = Y-S

ii. Aggregate Investment Expenditure (I):According to J.M. Keynes Investment may be defined as that part of income which is spent by people in productive sector to generate income. Investment may also be defined as difference between Income and Consumption. According to J.M. Keynes,

Y = C+I

Where, I = Aggregate Investment

Or, I = Y-C

iii. Government Expenditure (G):According to J.M. Keynes every government incurs huge expenditure for the benefit of people and country. Keynes pointed that government expenditure can be classified into two categories and they are:

a. General Expenditure or Administrative Expenditure (wages and salary, Drinking Water, Road etc.)

b. Development or Capital Expenditure

Government promotes both the expenditure to fulfill the aspiration of society.

iv. Net Income from Abroad (X-M):The net trade balance or net income from abroad i.e. X-M is essentially added to estimate National Income.

Here,

NI = C+I+G+ (X-M)

GNP = C+I+G+ (X-M)

This method is a scientific method but it has its own complications as well.

Components of Expenditure	National Income
1. Aggregate Consumption Expenditure (C)	-
2. Aggregate Investment Expenditure (I)	-
3. Aggregate Government Expenditure (G)	-
GDP	C+I+G
4. Add: Net Income from Abroad (X-M)	-
GNP	GDP+ (X-M)
5. Less: Depreciation	-
NNP	GNP- Depreciation

 

Difficulties/Problems/Practical Difficulties in Measurement of National Income:

1. Problem of Double Counting: Due to human weakness the raw product, intermediate products are also counted knowingly and unknowingly in the estimation of National Income. Due to double counting National Income is shown at a high scale in the papers in an unwanted manner in different countries of the world.

2.Problem in Selection of Measuring Methods:The National Income is measured either by Product Method or Income Method or Expenditure Method. All these methods have their own weaknesses or defects. Due to defective approach of these methods, accurate measurement of National Income is not possible either in developed or developing countries.

3.Illegal Income:Some people attempt to earn Income through Illegal sources. However, due to fear of law, punishment and society people do not disclose their illegal income. Consequently, actual income of people remains high but Illegal Income is not shown on papers.

4.Capital Gain:An increase in money value or capital gain simply increases money income of the country. However, real production of country remains same. Thus, due to capital gain superficial increase in National Income is observed practically.

5.Depreciation:In order to obtain value of Net National Income, 10% of GNP is subtracted as depreciation practically. However, observation shows that if machine remains new the depreciation remains less than 10% but if machine becomes old then depreciation becomes more than 10%. Thus, depreciation management also creates problem in measurement of National Income.

6.Transfer payments:Government transfer payment as old age pension, unemployment allowance, subsidy for poor people and business transfer payment as retirement pension, provident fund and others are also accounted and evaluated in the measurement of National Income. The theory of National Income raises objection for government transfer payment in measurement of National Income.

7.Fringe Benefits: When extra amount of income is earned by people without providing any extra contribution then such a case is known as fringe benefits. In fact, fringe benefits also creates problem in estimation of National Income.

8.Problems in Developing Countries:

a. Mass Illiteracy

b. Lack of Reliable Data

c. Lack of Occupational Classification

d. Existence of Barter System

Circular Flow of Income:

When aggregate income is spent for consumption, promoting investment and income employment generation then such a flow of income and expenditure in favour of development of country is Circular Flow of Income.

 

 

 

 

 

 

 

 

It is classified into two categories:

Closed Economy:

When National Income of a country is managed through consumption expenditure (C), investment expenditure (I) and government expenditure (G) then such National Income structure of an economy is represented as Closed Economy. It is classified into two categories:

1.Two Sector Economy

When aggregate income (Y) of a country splits into aggregate consumption expenditure (C) and aggregate investment expenditure (I) then such structure is known as Two Sector Economy.

Symbolically,

Y = C+I

Where C = a+bY i.e. a = autonomous consumption and b = slope (rate of change in income due to change in income)

 

 

 

 

 

 

 

 

 

 

 

Household Sector supplies factor services like land, labour, capital and organization to businesss sectors. Business Sector provides respective incomes in the form of rent, wages, interest and profit to household sector. Likewise, business sector provides goods and services to household sector. Household sector makes payment for those goods and services to business sector.

2. Three Sector Economy

When aggregate income of a country splits into components of aggregate consumption expenditure (C), aggregate investment expenditure (I) and government expenditure (G) then such economic structure of a country is described as Three Sector Economy.

Symbolically,

Y = C+I+G

 

 

 

 

 

 

 

 

 

 

 

 

In a three sector economy, main economic agents are household, business and government. Household supply factor inputs to the business and government sector and they goods and services to satisfy their wants. They pay tax to the government. Government provides public goods and transfer payments to the households. Business sector produces goods and services by using inputs supplied by households. It also pays tax to government. Government provides public goods and subsidies to business sector.

Two Sector and Three Sector Economy are technically described as Closed Economy.

Open Economy:

When aggregate income (Y) of a country splits into components of consumption expenditure (C), investment expenditure (I) and government expenditure (G) and net income from abroad (X-M) or foreign trade sector (X-M) then such economic structure of a country is analysed as Four Sector Economy also known as Open Economy because it is connected with Export-Import (X-M) management of rest of the countries of the world.

Symbolically,

Y = C+I+G+ (X-M)

Open Economy is a realistic approach commonly observed in developed and developing countries of world.