NCERT Gist: National Income Accounting | Additional Study Material for UPSC PDF Download

Basic Concepts of Macro Economics

→ The economic wealth or well-being of a country does not necessarily depend on the mere possession of resources; the point is how these resources are used in generating a flow of production and how, as a consequence, income and wealth are generated from that process.
→ The goods and services produced are to be sold to the consumers.
→ The consumer may, in turn, be an individual or an enterprise and the good or service purchased by that entity might be for final use or for use in further production. When it is used in further production it often loses its characteristic as that specific good and is transformed through a productive process into another good.

Final Goods

→ An item that is meant for final use and will not pass through any more stages of production or transformations is called a final good.
→ Two types in final goods are: Consumption Goods and Capital Goods.
→ Goods like food and clothing, and services like recreation that are consumed when purchased by their ultimate consumers are called consumer goods.

Capital Goods

Goods that are of durable character and which are used in the production process are called capital goods. For E.g. tools, implements and machines-^They make production of other commodities feasible. These don’t get transformed in the production process. They are also final goods yet they are not final goods to be ultimately consumed.

Consumer Durables

→ Some commodities like television sets, automobiles or home computers are for ultimate consumption and have one characteristic in common with capital goods - also durable.
→ They are not extinguished by immediate or even short period consumption.
→ They have a relatively long life as compared to articles such as food or even clothing.

Intermediate Goods

Of the total production taking place in the economy a large number of products don’t end up in final consumption and are not capital goods either.
→ Such goods may be used by other producers as material inputs. Examples are steel sheets used for making automobiles and copper used for making utensils.
→ Intermediate Goods are not Final Goods.
→ The sum total of the monetary value of these diverse commodities gives us a measure of final output.
→ We measure only final goods not intermediate goods. It is because as we are dealing with value of output, we should realize that the value of the final goods already includes the value of the intermediate goods that have entered into their production as inputs. Counting them separately will lead to the error of double counting. Whereas considering intermediate goods may give a fuller description of total economic activity, counting them will highly exaggerate the final value of our economic activity.

Flows

Flows are defined over a period of time. Income, or output, or profits are concepts that make sense only when a time period is specified. These are called flows because they occur in a period of time. Therefore, we need to delineate a time period to get a quantitative measure of these.

Stocks

Stocks are defined at a particular point of time. The buildings or machines in a factory are there irrespective of the specific time period. There can be addition to, or deduction from these if a new machine is added or a machine falls in disuse and is not replaced. These are called stocks.

Depreciation

→ Wear and tear of capital is called depredation. Depreciation is the cost of the good divided by number of years of its useful life.
→ New addition to capital stock in an economy is measured by net investment or new capital formation.

Methods of Calculating National Income

Four kinds of contributions that can be there during the production of goods and services
a) Contribution made by human labour, remuneration for which is called wage.
b) Contribution made by capital, remuneration for which is called interest.
c) Contribution made by entrepreneurship, remuneration of which is profit.
d) Contribution made by fixed natural resources (called land), remuneration for which is called rent.
The aggregate consumption by the households of the economy is equal to the aggregate expenditure on goods and services produced by the firms in the economy. The entire income of the economy, therefore, comes back to the producers in the form of sales revenue.
When the income is being spent on the goods and services produced by the firms, it takes the form of aggregate expenditure received by the firms. Since the value of expenditure must be equal to the value of goods and services, we can equivalently measure the aggregate income by “calculating the aggregate value of goods and services produced by the firms”.
When the aggregate revenue received by the firms is paid out to the factors of production it takes the form of aggregate income.

1. Product or Value Added Method

We calculate the aggregate annual value of goods and services produced (if a year is the unit of time).
The term that is used to denote the net contribution made by a firm is called its value added. Value added of a firm is value of production of the firm - value of intermediate goods used by the firm.
The value added of a firm is distributed among its four factors of production, namely, labour, capital entrepreneurship and land. Therefore wages, interest, profits and rents paid out by the firm must add up to the value added of the firm.
Value added is a flow variable.
Depreciation, is also known as consumption of fixed capital.
Since the capital which is used to carry out production undergoes wear and tear, the producer has to undertake replacement investments to keep the value of capital constant.
The replacement investment is same as depreciation of capital.
If we include depreciation in value added then the measure of value added that we obtain is called Gross Value Added.
If we deduct the value of depreciation from gross value added we obtain Net Value Added.
The stock of unsold finished goods, or semi-finished goods, or raw materials which a firm carries from one year to the next is called inventory. Inventory is a stock variable. It may have a value at the beginning of the year; it may have a higher value at the end of the year. In such a case inventories have increased (or accumulated). If the value of inventories is less at the end of the year compared to the beginning of the year, inventories have decreased (decumulated).
The change of inventories of a firm during a year = production of the firm during the year - sale of the firm during the year ^Inventories are treated as capital.
Addition to the stock of capital of a firm is known as investment. Change in the inventory of a firm is treated as investment.

Three major categories of investment:

1. The rise in the value of inventories of a firm over a year which is treated as investment expenditure undertaken by the firm.
2. The fixed business investment, which is defined as the addition to the machinery, factory buildings, and equipments employed by the firms.
3. Residential investment, which refers to the addition of housing facilities.
If we sum the gross value added of all the firms of the economy in a year, we get a measure of the value of aggregate amount of goods and services produced by the economy in a year. Such an estimate is called Gross Domestic Product (GDP).Thus, GDP = Sum total of gross value added of all the firms in the economy.

2. Expenditure Method

An alternative way to calculate the GDP is by looking at the demand side of the products known as Expenditure Method.This includes:
→ the final consumption expenditure on the goods and services produced by the firm.
→ the final investment expenditure, incurred by other firms on the capital goods produced by firm.
→ the expenditure that the government makes on the final goods and services produced by firm.
→ the export revenues that firm it earns by selling its goods and services abroad.

3. Income Method

→ Sum of final expenditures in the economy must be equal to the incomes received by all the factors of production taken together (final expenditure is the spending on final goods; it does not include spending on intermediate goods)
→ Simple idea is that the revenues earned by all the firms put together must be distributed among the factors of production as salaries, wages, profits, interest earnings and rents.
→ 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
→ If we deduct depreciation from GNP the measure of aggregate income that we obtain is called Net National Product (NNP).Thus, NNP = GNP -Depreciation.
→ Net National Product at factor cost or National Income:
NNP at factor cost = National Income (NI ) = NNP at market prices -(Indirect taxes - Subsidies) = NNP at market prices - Net indirect taxes (Net indirect taxes = Indirect taxes - Subsidies)
→ Thus, Personal Income (PI) = NI - Undistributed profits - Net interest payments made by households- Corporate tax + Transfer payments to the households from the government and firms
→ However, even PI is not the income over which the households have complete say.They have to pay taxes from PI. If we deduct the Personal Tax Payments (income tax, for example) and Non-tax Payments (such as fines) from PI, we obtain what is known as the Personal Disposable Income.
→ Thus, Personal Disposable Income (PDI) = PI - Personal tax payments -Non-tax payments

National Disposable Income and Private Income

Apart from these categories of aggregate macroeconomic variables, in India, a few other aggregate income categories are also used in National Income accounting.
→ National Disposable Income = Net National Product at market prices + Other current transfers from the rest of the world
→ National Disposable Income gives an idea of what is the maximum amount of goods and services the domestic economy has at its disposal.
→ Current transfers from the rest of the world include items such as gifts, aids, etc.
→ Private Income = Factor income from net domestic product accruing to the private sector + National debt interest + Net factor income from abroad + Current transfers from government + Other net transfers from the rest of the world.

Price Indices

GDP and Welfare

GDP is the sum total of value of goods and services created within the geographical boundary of a country in a particular year-> It gets distributed among the people as incomes (except for retained earnings).
So we may be tempted to treat higher level of GDP of a country as an index of greater well-being of the people of that country (to account for price changes, we may take the value of real GDP instead of nominal GDP).
But there are at least three reasons why this may not be correct:
1. Distribution of GDP - how uniform it is?
2. Non-monetary exchanges, and Externalities
3. Externalities refer to the benefits (or harms) a firm or an individual causes to another for which they are not paid (or penalised).