Macroeconomics

Lecture 3 – National Income Accounting

Santosh K. Dash
IRMA, Anand
13-12-2023
Agenda for Today’s Session
• National Income Accounting Framework
• Measures of National Income
▪ GDP and Others
• Nominal GDP and Real GDP
▪ Current Price Vs Constant Price
▪ GDP Price Deflator
• Estimation of GDP thorough various Approach
• Drawbacks of GDP

13-12-2023 Lecture 3 - National Income Acoounting 2

National Income Accounting: An
Introduction
• National Income of a nation during a specific time period provides a measure
of the economic activities. It takes into account all activities that generate
economic value.
• National income is the total of all factor incomes accruing to the residents of
country during a given year.
▪ The Central Statistical Organization (CSO) defines it as the sum of profits,
interest, wages, and rents during an accounting/financial year.
▪ Economists Simon Kuznets defined it as the value of final goods and services
produced during a given year.
• National Income Accounts (NIA) are considered to be the aggregate
statistics that provide the basis for choosing and assessing economic
policies as well as making predictions.

13-12-2023 Lecture 3 - National Income Acoounting 3

• Combined with population data, NIA can provide a measure of the well-being
of the citizens of a nation through per-capita income and its growth rate over
time.
• Also, NIAs combined with labour force data, can be used to assess the level
and growth rate of productivity.
• Associated with monetary data, NIA can be helpful in providing a guide to
inflation policy.

13-12-2023 Lecture 3 - National Income Acoounting 4

Measures of National Income
• Gross Domestic Product
• Gross National Product
• Net Domestic Product
• Net National Product
• Private Income
• Personal Income
• Personal Disposable Income
• Net National Disposable Income

13-12-2023 Lecture 3 - National Income Acoounting 5

 The Circular Flow
Income (Y) =
Income ($)
Output (Q) =
Expenditure (E)
Labor

Households Firms

Goods
(Output)

Expenditure ($)

13-12-2023 Lecture 3 - National Income Acoounting 6

Gross Domestic Product:
Expenditure and Income
Two definitions:
▪ Total expenditure on domestically-produced final goods and services.
▪ Total income earned by domestically-located factors of production.
▪ Expenditure equals income because every dollar spent by a buyer
becomes income to the seller.

13-12-2023 Lecture 3 - National Income Acoounting 7

Gross Domestic Product (GDPMP)
• Gross Domestic Product is the market value of all the final goods and services
produced in a country at a given time period.
• To understand the connotation, we evaluate market value, final goods and
services, geographic territory, measured during a given time period.
• Market Value:
▪ Represents the value (price multiplied by the quantity sold) of all goods and services
produced in the economy. This is an aggregate measure and allows us to aggregate across
various commodities (rice, vegetables, cars, etc.).
▪ GDPMP values items at their market value – the price at which items are traded in
markets.

13-12-2023 Lecture 3 - National Income Acoounting 8

• Final Goods and Services:
▪ We need to take into account the final goods and services while computing the GDP.
Intermediate goods are not included.

• Geographic Territory:
▪ Only goods and services which are produced within a country are eligible for calculation
under a country’s GDP.
▪ For example, Nike Corporations, a U.S. firm, produces sneakers in Vietnam. Then the
market value of those shoes is a part of Vietnam’s GDP, not a part of the United States.

• Given period of time:

▪ The market value of the goods and services should correspond to the financial year for
which we are interested in calculation of the GDP. Therefore, if we want to estimate the
value of a house in Anand city, we shall only focus on the market value of houses
constructed and sold during a specific year.

13-12-2023 Lecture 3 - National Income Acoounting 9

Gross Domestic Product at Factor Cost
(GDPFC)
• GDP can also be calculated at the factor cost. Land, Labour, Capital and
Entrepreneurship constitute the broadly defined factors of production.
▪ Therefore, GDPFC is the total production valued at factor cost – although not ignoring the
cost of raw materials and intermediate goods consumed during the production process.
• GDP at market prices can be connected to GDP at factor costs in the following
manner:
▪ GDPFC = GDPMP – Net Indirect Taxes
▪ Net Indirect Taxes = Indirect Taxes - Subsidies
▪ Indirect taxes include excise duties, custom duties, sales tax, value added tax,
service tax etc.
▪ Subsidies are provided on fertilizers, food, fuel, exports, irrigation facilities, and
so on.

13-12-2023 Lecture 3 - National Income Acoounting 10

• Example:
• In year 2023, GDPFC = Rs 100 Cr. Indirect = Taxes Rs 20 Cr and Subsidies cost
the government Rs 27 Cr.
• Therefore, GDPMP = Rs (100 + 20 - 27) Cr => GDPMP for the period 2022-23
was Rs 93 Crore.
• Question: According to the Economic Survey the Indian Economy has grown
7.2% in the financial year 2022-23. What does it broadly indicate?
▪ It means that the real (inflation-adjusted) value of India’s GDP (total value of
goods and services) has risen at a rate of 7.2% over the last fiscal year.

13-12-2023 Lecture 3 - National Income Acoounting 11

Real and Nominal GDP
• GDP is the value of all final goods and services produced.
▪ Nominal GDP measures these values using current prices.
▪ Real GDP measure these values using the prices of a base year.

• Nominal GDP (measured at Current Prices) measures the value of

output in a given period at the current price levels.
▪ If we want to estimate the GDP for the year 2022-23, then the value of the goods
produced in the year 2022-23 is considered at the prevailing market prices.
• Real GDP (measured at Constant Prices) measures the physical volume
of an economy’s final production using the prices of a base year.
▪ It enables the measurement of changes in physical output in the economy
between different time periods by valuing all goods produced in the different
time periods, at the same prices.

13-12-2023 Lecture 3 - National Income Acoounting 12

Practice problem, part 1
2006 2007 2008
P Q P Q P Q
good A $30 900 $31 1,000 $36 1,050

good B $100 192 $102 200 $100 205

• Compute nominal GDP in each year.

• Compute real GDP in each year using 2006 as the base
year.

13-12-2023 Lecture 3 - National Income Acoounting 13

Answers to practice problem, part 1
• nominal GDP multiply Ps & Qs from same year
2006: $46,200 = $30 * 900 + $100 * 192
2007: $51,400
2008: $58,300
• real GDP multiply each year’s Qs by 2006 Ps
2006: $46,200
2007: $50,000
2008: $52,000 = $30 * 1050 + $100 * 205

13-12-2023 Lecture 3 - National Income Acoounting 14

Real GDP controls for inflation
• Changes in nominal GDP can be due to:
▪ changes in prices.
▪ changes in quantities of output produced.
• Changes in real GDP can only be due to changes in quantities,
▪ because real GDP is constructed using constant base-year prices.

13-12-2023 Lecture 3 - National Income Acoounting 15

Real GDP has a few problems
GDP Deflator
• Real GDP measures the value of goods and services that are traded in the
market but value of goods and services produced in informal sector, home
produced goods, pollution, underground economic activity and changes in
environment quality are not effectively taken into account.
• GDP price deflator accounts for inflation by converting output measured at
current prices (Nominal GDP) into constant prices (Real GDP).
• If, for example, an economy has a nominal GDP of Rs. 10 billion and has a real
GDP of Rs. 8 billion, the economy's GDP price deflator would be derived as:
▪ 10/8 x 100, = 125 billion.
▪ This means that the aggregate level of prices increased by 25% from the base
year to the current year

13-12-2023 Lecture 3 - National Income Acoounting 16

• The inflation rate is the percentage increase in the overall level of
prices.
• One measure of the price level is the GDP deflator, defined as

Nominal GDP
GDP deflator = 100 ×
Real GDP

▪ The GDP deflator is so named because it is used to “deflate” (remove the

effects of inflation from) GDP and other economic variables.

13-12-2023 Lecture 3 - National Income Acoounting 17

Practice problem, part 2
GDP Inflation
Nom. GDP Real GDP
deflator rate
2019 ₹46,200 $46,200 n.a.
2020 51,400 50,000
2021 58,300 52,000
• Use your previous answers to compute
the GDP deflator in each year.
• Use GDP deflator to compute the inflation rate from
2020 to 2021, and from 2021 to 2022.

13-12-2023 Lecture 3 - National Income Acoounting 18

Practice problem, part 2
GDP Inflation
Nom. GDP Real GDP
deflator rate
2019 ₹46,200 $46,200 100 n.a.
2020 51,400 50,000 102.8 2.8%
2021 58,300 52,000 112.1 9.1%

13-12-2023 Lecture 3 - National Income Acoounting 19

Gross National Product
• GNP refers to the value of the goods and services produced by a nation’s
factors of production irrespective of the location/territory where these goods
and services have been produced.
• The value of final goods and services produced by all factors of production
owned by a nation within a given time period.
▪ If Nike Corporation invests in Vietnam and produces shoes, then the profits of
Nike will be part of the GNP of the United States as they represent incomes
accruing to its factors of production located in Vietnam. The GDP of Vietnam will
however include the full value of shoes manufactured. However, its GNP will be
lesser by the profits generated by Nike.
▪ Similarly, value of Ford Cars produced in India will be a part of the Indian GDP
and profits earned by Ford Motors will not be included while calculating India’s
GNP but will part of GNP of the US.

13-12-2023 Lecture 3 - National Income Acoounting 20

 ▪ However, Maruti-Suzuki represents a different scenario since the capital is from
two sources. While the profits from Suzuki’s share will be part Japanese GNP, the
profits from Maruti’s share will be part of Indian GNP.

• In other words,
▪ Gross National Product (GNP): Total income earned by the nation’s factors of
production, regardless of where located.
▪ Gross Domestic Product (GDP): Total income earned by domestically-located
factors of production, regardless of nationality.

13-12-2023 Lecture 3 - National Income Acoounting 21

GNP vs. GDP
• The difference between GDP and GNP corresponds to the net factor income earned
abroad (by foreigners), which is also known as NFIA. Therefore,
▪ GNP = NFIA + GDP
▪ (GNP–GDP) = (factor payments from abroad)
– (factor payments to abroad)
• Discussion question:
▪ In your country, which would you want to be bigger, GDP, or GNP? Why?
• Group Assignment
▪ Prepare a table of (GNP – GDP) as a percentage of GDP
selected countries,
▸ by income groups of countries.
▸ For last 10 years
▸ sources:
▸ Data Source: World Development Indicators, World Bank
▸ Use PivotTable

13-12-2023 Lecture 3 - National Income Acoounting 22

How to Measure GDP?
• Given the circular flow model we understand that in equilibrium:
▪ Income = Expenditure = Output
• We have three different ways to measure and analyse national
income:
▪ The Income Approach
▪ The Product Approach or the Value Added Approach
▪ The Expenditure Approach

13-12-2023 Lecture 3 - National Income Acoounting 23

The Value Added Approach
• A firm’s value added is the value of its output minus the value of the
intermediate goods the firm used to produce that output.
• The Product Approach of valuing GDP
▪ Under the production approach, GDP at factor cost provides us the sum of the
final values goods and services produced.

▪ 𝐺𝐷𝑃𝐹𝐶 =
𝑃1𝑄1 + 𝑃2𝑄2 + 𝑃3𝑄3 + … + 𝑃𝑛𝑄𝑛

▸ where, 𝑃𝑖 = Price of the final good 𝑖,

▸ 𝑄𝑖 = Output of the final good 𝑖,
▸ 𝑛 = number of the goods and services produced in an economy.

• The above equation assumes that all the production taking place in an economy and
can be valued in monetary terms.

13-12-2023 Lecture 3 - National Income Acoounting 24

Example
GDP: Value Added Method
Production Generated Value added

Farmer Harvest Wheat 100 100

Miller Makes into 200 100

Flour
Baker Makes into 300 100
Bread
Value added ₹ 300 ₹ 300
(GDP)

13-12-2023 Lecture 3 - National Income Acoounting 25

Final goods, value added, and GDP
• GDP = value of final goods produced
= sum of value added at all stages of production.
• The value of the final goods already includes the value of the intermediate
goods, so including intermediate and final goods in GDP would be double-
counting.

13-12-2023 Lecture 3 - National Income Acoounting 26

The Income Approach
• Since the National Income of an economy equals the sum of the costs of
production of final goods and services, this implies that the summation of
income earned through all the factors of production should provide us the
National Income of the economy.
• Therefore, if we add the incomes received including profits and also the taxes
paid to the government, we have the National Income.
• Throughout the world, Income approach of GDP calculation entails adding the
following incomes – compensation to employees, proprietor's income, rental
income of persons, corporate profits, net interest, taxes on production and
imports, business current transfer payments, current surplus of government
enterprises.
• In India, we get the Net Domestic Product as the sum of wages earned, profits
for entrepreneurship, and income for self employment. It is difficult to
calculate the exact magnitude of income earned from self-employment since
the size of the informal sector is measured with much error.
13-12-2023 Lecture 3 - National Income Acoounting 27
Example
GDP: Income Approach
Item Symbol Value
Compensation for
COE 100000
Employees
Operating Surplus OS 300000

Depreciation D 30000

Net Indirect Taxes NIT 35000

Gross Domestic Product GDP 465000

13-12-2023 Lecture 3 - National Income Acoounting 28