National Income Accounting

• Now we will learn the fundamental functioning of a simple economy

Some interesting questions

    What generates the economic wealth of a nation?

            How countries become rich and poor?

• Mere possession of resources does not make a country rich or poor
• Important is the way the resources are put to use, how they go through the Flow of Production
• And the manner in which income and wealth is created from this flow of production
• Example : Many African and Latin American countries are endowed with bounty of natural resources but many of the countries there are very poor
• Same in India like Bihar, Jharkhan, Orissa, Chhatisgarh are mineral rich states but most under developed

Flow of Production

• How it arises ? : People combine their energies with natural and man made environment within a certain social and technological structure to generate a flow of production
• In modern world The flow of production is generated by production of commodities, produced -> sold -> [Final] OR [Intermediate]
• Final Goods : The goods that will not further pass through more stages of production and now permanently out of active economic flow
• It is not in the nature of good but the economic nature of its use that makes it a good Final! 
• Intermediate : They get consumed in further stages of production and loses its original characteristics. There are many such items that do not end up as a final good
• Final Goods are composed of Consumer Goods and Capital Goods
• The consumer goods that are of durable nature are called consumer durable else non durable 
• The Capital Goods have more significance as they aid in production process without getting consumed in it. Thus they are durable!
• They form a part of Capital
• But with time they get wear and tear thus they are preserved maintained replaced/renewed partly or wholly over time
• To have a comprehensive idea of Total flow of production we need a measure of aggregate level of final G&S produced in an Economy
• Every good has its own measuring units so can't be added directly with other good's production output
• But they all are produced for sale and thus has a cost is attached to it
• So money is our measuring rod for measuring aggregate level of final goods and services produced
• The intermediate goods have their cost included in the final goods cost so only count of final goods output makes sense else we will double count IG cost
• Also this measurement has to be done in time period. Like production in a year.
• Because income, output, profit etc makes only sense when there is a time period associated with it
• These all above are flow variables i.e. they are defined over a period of time
• There another concept called stock, Stocks are defined at a particular point of time. But there change over a period of time is again a flow
• The final output consists of Consumer Goods and Capital Goods, All capital goods produce in a economy in an year is Gross Investment
• But all Capital Goods need not to be an addition to the current stock of economy
• There is a percentage that is used for maintenance or replacement
• The Cost of maintenance is called Depreciation
• This need to be deducted from Gross Investment to get assessment of Net Investment
• Net Investment reflects the real proportion of the Capital Goods produced that are an addition to current stock of economy
• If an economy produces more consumption goods, it is producing less capital goods and vice versa
• Capital Goods raises the ability of labourer, with same labourer more production
• Capital Goods helps an economy to expand

Other perspective to understand the Circular Flow

• Demand backed by purchasing power
• The incomes people earn as the owner of factors of production are used by them to meet their demand
• Circular Causation/Flow : Firms demands for factors of production for production and make payments to them, people demand for G&S and make payments to firms in return

Circular Flow of Income

• Here there is no government, no savings and other expenditures and incomes like import and export are blocked
• Only goods available are produced by domestic firms and in return firms demand revenue and factors of productions
• Here The Consumption by Households is equal to Expenditure by them i.e. B = A in picture.
• The entire income of the economy [because of no saving and no tax paid by households] returns to domestic firms in form of sales revenue
• These production firms in return to Factors of production services distributes the revenues from the sell as payment/remuneration in different forms [wage, interest, rent, profit]
• Thus Revenue [Expenditure by Households] A = C Payments [Incomes of Households]
• So we can deduct if there is no leakage in an economy with above constraints then A = B = C
• Thus we can see the income of Economy is going through 2 sectors [firms and households] in circular way
• A : Aggregate Expenditure received by the firms
• B : Aggregate Goods and Services produced by the firms
• C : Aggregate Income
• The aggregate value of Goods and Services produced could be calculated at any of A B or C 
• We can see in above diagram that there are 2 types of flow
• The above 2 arrows show a Goods and Services Market 
• Bottom 2 shows a Factors of Production market
• Few points about above simple economy model
• The firms are working at their full capacity 
• Every household is contributing in production i.e. no one unemployed
• It is in some form of equilibrium 
• But could this economy expand on its own?
• 1st thing comes to me is By producing capital goods
• But from where the demand will come?
• And New capital to back this demand?
• There must be increase in salaries of people
• Book says people spend more so it gives rise at other points [for this model they say ignore the source for extra money]
• Book concludes that rise in flow at one point gives rise in all remaining because income of flowing in circular manner
• A thumb rule from book : No matter how complex the economic model gets, the estimation of annual aggregate production of Goods and Service done by any of the three methods is always same and equal. Think of Introducing savings to model.

Product or Value Added Method [the phase of production]

• There are few over heads like Investment and Depreciation
• The Value addition has to address these over heads
• Value addition is the net contribution by a firm : Value of production - value of intermediate goods
• Above notion is Gross value added
• Net Value Addition : GVA - Depreciation
• While calculating GDP we take GVA
• GVA by a firm includes sales to domestic as well as export
• Inventory : a stock variable which reflects the aggregate value to unsold Finished products, semi finished products and raw material from previous year.
• The change in inventory is an investment or dis-investment. A Flow variable
• GVA [in general] = Production - Intermediate goods
• Production = Sales + Change in Inventory
• Change in Inventory = Production - Sales
• Example : 
• P=150, Sales =200, Change in Inventory = -50 i.e. disinvestment
• IG =100, GVA = 150 - 100 = 50
• So production itself takes care of the Change in Inventory
• Some terms related to Change in Inventory : Planned, unplanned, accumulation, decumulation 

Expenditure Method [the phase of disposition]

• The expanses that are done to purchase the final goods are considered for the expenditure method
• Any expanse made to buy an intermediate good is not considered in this method
• If a baker buys wheat to bake bread, expanse of baker will be ignored. But if a household buys a bread for self consumption, its expanse will be considered.
• Components of Expenditure Method [Firm i is a domestic firm]
• Consumption Ci : The Firm i makes expenditure of consumable final goods and services [Mainly households but enterprises too do]
• Investment Ii : The money received by firm i, against the Capital Goods it produces, from other firms
• Government Gi : The money received by firm i, against G&S it produces, from the Government
• Exports Xi : The money earned by Firm i from external trade
• If there are N firms in a domestic market then GDP = sum 1 to N (Ci) + sum 1 to N (Ii) + sum 1 to N (Gi) + sum 1 to N (Xi)
• Let C, I, G, X is the aggregate value of all the components in an economy, it includes the imports(m) which are not included in above equation
• So
• sum 1 to N (Ci) = C - Cm
• sum 1 to N (Ii) = I - Im
• sum 1 to N (Gi) = G - Gm
• Thus GDP = C - Cm + I - Im + G - Gm + X
• GDP = C + I + G + X - (Cm + Im + Gm)
• GDP = C + I + G + X - M
• GDP ≡ Sum total of all the final expenditure received by the firms in the economy
• Out of all 5 variables on RHS, Investment is most unstable

Income Method [the phase of distribution]

• The value added or the expenditure received by the firms must be distributed among the all factors of production i.e. Wages, Profit, Rent and Interest
• So the GDP = W + P + In + R

• GDP  ≡ GVA  ≡ C + I + G + X - M ≡ W + P + In + R
• All above calculations are based on market price of variables

Net Production Taxes : These taxes do not depend on the volume of production but paid or received based on setup of production

• Net Production tax = tax - subsidies
• Examples : land revenue, stamp, registration fees

Net product taxes : Paid or received per unit. 

• Net Product tax = tax -subsidies
• Examples : excise tax, service tax, export and import duties

Market Price : Price at which product is sold 

• price inclusive of net production and net product taxes

Basic Price : Market Price - net product taxes

• price at which production occurs
• includes only net production taxes

Factor Cost : Basic Price - Net Production taxes

• The payments made to the factors of production
• Revenue after paying all indirect taxes

• Central statistics office of government of India declares GDP
• Before January 2015 GDP at factor cost was the main highlight and other release perspective was GDP at market price
• After January 2015 GDP at market price or simply GDP was the main highlight and other was GDP at basic price

Some Macroeconomics Variables

• GDP is a way to estimate the Aggregate Final G&S produced in a domestic economy
• A foreign asset earning or producing here has contribution in domestic economy GDP calculation
• But Earning accrue by them does not benefit the locals
• Also we have assets abroad
• Gross National Product = GDP + Factor incomes from abroad - Factor income of foreign assets in domestic economy
• GNP = GDP + net Factor income from abroad
• Net National Product = Net Domestic product + Net Factor Income from Abroad
• These calculations are at Market Price, which includes indirect taxes
• Indirect taxes accrue to Govt and not Factors of Production (FoP)
• Subsidies paid by govt and benefits FoP
• Net National Product at factor cost or National Income accounts for what the domestic FoP got paid
• National Income = NNP(MP) - Net Indirect taxes
• This NI is the revenue earned by Firms and Govt enterprises
• Personal Income of Households = NI - Undistributed Profit - Corporate taxes - Net Interest (paid or received by HH) + Govt Transfers(scholarship, pension, awards etc)
• The income out of PI which is disposable by Households after paying personal taxes(income tax etc) and Non taxes(fines) is Personal Disposable Income
• PDI = PI - PT - NT
• National Disposable Income
• Private Income

Nominal Vs Real GDP

• We have till now not compared a years GDP with another year or of 2 countries
• Let GDP of 2019 be 2000 Cr and 2018 be 1900 Cr, does it reflects the production has increased ?
• No this surge could be due to increase in prices of the goods while the aggregate output was same
• We need to eliminate the change in price so that it can be made sure in comparison that the surge/dip actually reflects increase or decrease of aggregate output
• In above case we call 2018 the base year and take its prices not the 2019 market values to calculate GDP which will be Real GDP for 2019
• The GDP at current prevailing Market prices is Nominal GDP for 2019
• The difference in real GDP for 2019 and Nominal GDP for 2018 give us surely the idea about change in aggregate production
• Nominal GDP of a year and Real GDP for same year base to some previous year give us an idea how the prices have moved in comparison to base year
• The above fact could be better reflected by ratio also : GDP Deflator = Nominal : Real(Base year)
• This deflator does not gives idea about an individual product but represent over all change in prices across all sectors
• Individual or representative group of products prices change could be estimated by Consumer Price Index or Whole Sale price index

GDP and Welfare

• GDP cannot be taken as the comprehensive Indicator of Welfare of people of a country
• Non uniform Distribution
• Cannot cover non monetary exchanges
• Externalities