What is National Income Accounting?
National Income Accounting is a technique to measure the income and production of an economy. National Income Accounting is the study of a larger picture and managing the whole nation. While calculating National Income accounting, we consider two significant terms – Microeconomics, deals with individuals and organizations, and macroeconomics deals with the nation's economy as a whole.
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Important Terminology Related to Macroeconomics and National Income Accounting in India
Fun Fact: The systematic keeping of national accounts only began in the 1930s in the United States and some European countries.
Goods:
Goods are products that satisfy human wants, needs, and desires. Goods can be classified into various categories like:
Tangible and Intangible Goods: Goods like grocery, transport, garments that can be touched and felt are tangible goods and goods that cannot be felt or touched like medical, law, engineering, etc.
Economic goods are the ones that come at a price and are affected by demand and supply.
Non-economic goods are free of cost.
People directly consume consumer goods, further classified into non-durable goods like fuel, furniture, garments, etc., and durable like milk, rice, bread, etc.
Producer goods are those that help in producing other goods like cotton, jute, machines, etc.
Intermediate goods are bought by production units and are resold in different forms: bread, curd, etc.
Final goods are produced for final consumption and not for reselling, for example, furniture in the house, food for consumption, etc.
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Income and Output
This is one of the most significant concepts of macroeconomics.
National output is the cumulative amount of goods and services generated during a specific period in a country.
National Income is the cumulative income that is earned by selling these goods and services.
National Output is generally termed as GDP – Gross Domestic Product, which means the income earned from the output produced by a country.
GDP can be affected by upgrades in technology, increase in capital, increase in output and income, acquisition of updated equipment, organizations and units, and much more. This can also be negatively impacted by inflation, market factors, and recession.
Unemployment
Unemployment is the percentage of people without jobs. Unemployment can be further categorized as:
Classic – wages are too high to be paid to the employee
Structural – mismatch between the required skills and actual skills of an employee
Frictional – when it takes a long time to search for an appropriate employee for a job.
Cyclical – when the growth of the national economy is stagnant.
Inflation and Deflation
Inflation is when the economy grows too quickly. Deflation is when the economy takes a dive and declines over a period. Both these situations can be harmful to an economy, wherein Inflation leads to negative results and deflation leads to low economic output.
Gross National Product
GNP is the total value of goods and services produced by a country in a specified period. Income earned by residents by foreign individuals is subtracted from the total value. Similarly, income earned by citizens working abroad is added to the total value.
This addition and subtraction of International income differentiate between GNP and GDP.
Fun Fact: Gross National Product is the most common technique to calculate a nation's output, which includes goods and services.
Net National Product
NNP considers the depreciation factor. Depreciation is the wear and tear of fixed assets. It is also the capital used to maintain existing stocks. In simple words:
NNP = GNP – Depreciation.
Also, while calculating NNP, economics subtract the taxes and add the government subsidies granted to encourage the production of goods and services.
Thus, National Income Accounting = NNP – Taxes + Subsidies.
National Disposable Income and Private Income
The national disposable income refers to the total income a country possesses to cater to its consumption and expenditure without having to dispose of any of its assets.
Private income is the net income earned by Residents and individuals. Private income includes income earned privately from abroad, national debt interest, current transfers from government, and net transfers from the rest of the world.
Fun Fact: National Income accounting is an invaluable tool for budget makers and economic planners.
Important Policies Regarding Macroeconomics
Fiscal Policy
This policy has the power to control the income and expenditure of an economy. This is under the government's direct control and is generally not preferred by economists as Political intentions could influence it.
Monetary Policy
This policy is controlled by the monetary authority that is the Central Bank. This policy aims to enhance the strength of the country’s currency and to stabilize prices. It also balances the GDP and reduces unemployment. The central bank can buy and sell bonds to circulate wealth and create an equilibrium. This is a much-preferred policy by economists as the controlling power is in the hands of the Central Bank – an independent organization.
How to Calculate National Income Accounting in India?
The National's Economic growth rate is measured by calculating the National Income accounting, and there are several methods to do it:
Income Method
This method focuses on the production of goods and services involving capital, land, labour, etc. Income is generated through interest, profit, rent, wages, etc. Another parameter is mixed-income, which is earned by businessmen and self-employed professionals.
Thus: National Income = Interest + Profit+Rent+Wages+Mixed Income
Solved Example:
Q. Calculate the National Income of country X and identify which of the following is not considered while calculating National Income using the Income Method?
Rent accrued – Rs. 20000
Salaries – Rs. 10000
Sale from secondhand goods – Rs. 5000
Interest earned on Loan – Rs. 10000
Correct Answer: National Income = Interest + Profit+Rent+Wages+Mixed Income
So National Income = 20000+10000+10000 = Rs. 40000.
Option C will not be considered as income generated from land and labour and not from goods. So, option C would not be considered.
Expenditure Method
This method considers the purchases made by Governments, Residents, organizations, etc. The components are:
C = Expense on consumer goods and services by residents and households
G = Expense of the Government on goods and services
I = Expense of the business organizations on capital goods and stocks
NX = Net exports, which mean exports – imports
Thus National Income = C+G+I+NX.
Value Added Method
Under this method, the economy is divided into various industries like transport, communication, agriculture, etc. National Income is calculated by calculating the NVAFC, which is the value-added at each stage. While calculating the same for each industry, we must subtract:
Net Indirect Taxes
Consumption of Capital
Consumption of Raw Materials
Now NVAFC = when it is added for all enterprises.
NDPFC= when NVAFC of industries is added, it is called the net domestic product at factor cost
Finally, the net income from international states should be added.
Thus National Income accounting in India = National Income = (NDPFC) + Net factor income from abroad
Fun Fact: The National Product and Income are calculated considering value-added tax figures, incomes and expenditure, income and corporation tax returns, and different methods of valuation and definitions.
Solved Examples
Question 1. Does the GNP consider Depreciation on the production of goods and services?
Correct Answer – No, NNP = GNP – Depreciation.
Question 2. The market value of all finished goods – Rs. 50000
The market value of all finished services – Rs. 20000
The depreciation of those goods and services – Rs. 10000
Calculate the Net National Product?
Answer: The market value of all finished goods + the market value of all finished services - the depreciation of those goods and services = net national product.
The gross national product - depreciation = net national product.
So, the answer is 50000+20000-10000
NNP = Rs. 60000
FAQs on National Income Accounting Made Simple
1. What is National Income Accounting and why is it important for an economy?
National Income Accounting is a set of principles and methods used by governments to measure the income and production of a country over a specific period. It is crucial because it provides a comprehensive overview of economic performance, helps in policy formulation (like budget and monetary policies), facilitates international comparisons, and allows for the analysis of structural changes within the economy. Key indicators like GDP and GNP are derived from this accounting.
2. What is the main difference between final goods and intermediate goods?
The main difference lies in their end use. Final goods are those purchased for final consumption by consumers or for investment by firms (e.g., a car bought by a household). They have crossed the production boundary. In contrast, intermediate goods are those used up in the production process to create other goods (e.g., steel used to make a car). They remain within the production boundary and their value is not counted separately in national income to avoid double counting.
3. Can you explain the three main methods used to calculate National Income?
There are three primary methods to calculate the National Income of a country, and all should ideally yield the same result:
- Value Added (or Product) Method: This method measures the value of all final goods and services produced in an economy during a year. It sums up the net value added at each stage of production.
- Income Method: This method measures national income from the side of payments made to the primary factors of production. It sums up all the factor incomes, such as rent, wages, interest, and profit.
- Expenditure Method: This method measures the total expenditure on all final goods and services produced in the economy. It includes private consumption, investment, government spending, and net exports (exports minus imports).
4. Why is the value of intermediate goods not included when calculating a country's GDP?
The value of intermediate goods is excluded to avoid the problem of double counting. The market value of final goods already incorporates the value of all intermediate goods used in their production. For example, the price of a loaf of bread already includes the cost of the flour, which in turn includes the cost of the wheat. Including the value of flour and wheat separately along with the bread would inflate the GDP figure inaccurately.
5. How do 'stocks' and 'flows' differ in the context of macroeconomics?
In macroeconomics, the key difference is the time dimension. A stock is a variable measured at a specific point in time, like a snapshot. Examples include a country's total wealth, capital stock, or money supply on a particular date. A flow is a variable measured over a period of time. Examples include national income, investment, or consumption during a year. For instance, the amount of water in a bathtub is a stock, while the water coming from the tap per minute is a flow.
6. What is the difference between GDP at Market Price (MP) and GDP at Factor Cost (FC)?
GDP at Market Price (MP) is the market value of all final goods and services produced within a country's domestic territory. It includes the impact of indirect taxes and subsidies. GDP at Factor Cost (FC), on the other hand, measures the same production value in terms of the costs of the factors of production. The relationship is: GDP at FC = GDP at MP - Net Indirect Taxes (where Net Indirect Taxes = Indirect Taxes - Subsidies).
7. Why are services provided by a homemaker not included in the calculation of National Income?
Services provided by a homemaker, despite being highly valuable, are not included in National Income because they are non-market transactions. National Income Accounting primarily measures economic activities that have a market value and involve a monetary exchange. Since these services are not sold in the market and do not have an easily ascertainable monetary value, they are excluded from official GDP estimates. This is considered one of the significant limitations of GDP as a measure of total production and welfare.
8. What is the significance of distinguishing between Real GDP and Nominal GDP?
Distinguishing between Real and Nominal GDP is crucial for understanding an economy's true growth. Nominal GDP is calculated using current market prices and can increase due to either a rise in production or a rise in prices (inflation). Real GDP is calculated using prices from a constant base year, thereby removing the effect of inflation. Therefore, Real GDP provides a more accurate measure of the actual increase in the output of goods and services, reflecting the true growth of an economy.
9. Is it correct to assume that a rising GDP always indicates an increase in social welfare?
No, that is not always correct. While a rising GDP often correlates with improved living standards, it is not a perfect measure of social welfare due to several limitations. These include:
- Distribution of Income: GDP does not show how income is distributed. An increase in GDP could be concentrated in the hands of a few, while the majority remain poor.
- Non-Monetary Exchanges: It ignores valuable non-market activities like household services and volunteer work.
- Externalities: GDP does not account for negative externalities like pollution or positive externalities like better public health, which significantly impact welfare.
- Composition of Production: An increase in the production of harmful goods like weapons would increase GDP but not welfare.
