Measuring National output / Income

Measuring National output / Income: Concept of national product, Variants of national product, Methods of measuring national

Income and problems of measuring, Real Vs Nominal, Price indices and its applications.

National Income : National Income The sum total of the values of all goods and services produced in a year. It is the money value of the flow of goods and services available in an economy in a year.

• National Income Committee of India 1951 defines National Income as follows: “ A national income estimate measures the volume of commodities and services turned out during a given period counted without duplication.”

Definition of National Income

Definition of National Income

• Marshall’s Definition: “The labour and capital resources of a country acting on its natural resources produce annually a certain net aggregate of commodities, material and immaterial including services of all kinds…. This is the true net annual income or revenue of the country or the national dividend.”

• National Income: National Income refers to- The income of a country to a specified period of time, say a year includes all types of goods and services which have an exchange value counting each one of them only once.

• National Income Double counting If steel has been evaluated in industrial production, it should not be included while calculating the value of steel products, viz, machines and motor cars. To avoid double counting or multiple counting, two methods are used Final products method &Value added method.

• National Income Final Products method: Adding the value of final products only.

• Value added method: Go on adding the values created at each stage in the manufacture of a commodity Then all such values created are added up together to arrive at the national income of the country.

National Income concepts : 

• National Income concepts: The following are the concepts of national income; Gross National Product – GNP, Net National Product – NNP, Personal Income – PI, Per capita Income – PCI,

• National Income concept: Gross National Product- National Income is the sum total of values of all goods and services produced during a year The money value of this total output is known as Gross National Product – GNP

GNP

• National Income concepts Gross National Product Example: If A,B,C,D,… are goods and services and If a,b,c,d,…are their prices respectively, The GNP is calculated as follows GNP= A*a+B*b+C*c+D*d….,

• GNP is most frequently used national income concept. It is statistically a simpler concept as it takes no account of depreciation and replacement

NNP & PI

• National Income concept: Net National Product - NNP: This refers to the net production of goods and services in a country during a year NNP is also called National Income at Market Prices We get NNP, by deducting the depreciation from GNP Therefore NNP = GNP – Depreciation,

• National Income concept; Personal Income - PI: Income earned by all the individuals and institutions during a year in a country The entire national income does not reach individuals and institutions. A part of it goes by way of corporate taxes Undistributed profits Social security contributions.

• National Income concept: Personal Income – PI People sometimes get incomes without any productive activity They are called Transfer Payments Example: Unemployment benefits, old age pensions etc. Such transfer payments are not included in the National Income However they are added to Personal Income

• National Income concepts Personal Income – PI: PI is computed by using the following formula PI = National Income –(Corporate taxes, undistributed profits, social security contributions) + Transfer Payments,

• National Income concepts Per Capita Income – PCI: If the national income is divided by the total population, we get per capital income PCI = NI/Population.

• National Income concepts Per capita income PCI may be expressed either in money terms or in real terms.

NI – Methods of computation : 

• Three methods to measure the national income, They are- Production method or Census method, Income method & Expenditure method.

Production method : 

• Production method: In this method, The total products produced in the economy are calculated for the year and the value is added without double counting The economy is classified into sectors like Agricultural, industrial, fisheries, forest, direct services and foreign transactions etc. In each sector, we can find the value of final goods and services.

• Production method: In international transactions, net foreign income is calculated by subtracting the total imports from the total exports and added to the national income The results of these sectors, when combined, gives the national income or national product. The census or product method can be expressed through the formula.

• Production method: O = C + I Where O stands for output, C stands for consumption of goods I stands for investment goods

Income Method:

• Income Method: According to this method, Net incomes of individuals and business houses during a year are added to know the national income. Only those incomes earned and received for producing goods and for rendering services are to be counted. Transfer payments such as old age pensions , widow pensions and unemployment benefits etc should not be counted as these are the incomes received without contributing to the production.

• Income Method, People get incomes in the form of Rents, wages or salaries, interest and profit. The formula is Y = C + S Here Y stands for Total Income C stands for consumption and S stands for Savings.

Income = Expenditure

Firms Households

Goods and Services

Labor and Capital

Income = Expenditure

Firms Households

Payments for Goods and Services

Payments for Labor, Capital

Expenditure method : 

• Expenditure method: One man’s income is another man’s expenditure Therefore national income can be arrived at by adding the total expenditure of individual and business firms during a year. Expenditure or outlay on final products takes place in three ways 1. Expenditure by consumers on goods and services 2. Expenditure by entrepreneurs on capital or investment goods & 3. Expenditure by government on consumption and capital goods.

• Expenditure method: The formula for this method is Y = C + I Here Y stands for total expenditure C stands for consumption expenditure I stands for investment expenditure.

Components of National Income

• Consumption by individuals (C) • Consumption and investment by

government (G)• Investment by the private sector (I)• Exports (X)

AD = C + G + I + XAD = C + G + I + X

Importance of national income : • It indicates the prosperity of a nation.• Growth in national income indicates economic

prosperity.• It indicates the standard of living of people of a

country • It indicates the per capita income with which we

can compare the levels of development of all the countries

• Countries can be classified as ‘developed’ and ‘developing’ and ‘under developed’ based on their per capita income only

• Importance of national income NI estimates are very helpful to the Finance Minister. It guides him to make proper and right decisions in regard to taxation and budgets. It is useful to compare the prosperity of a country at different times, It provides an instrument of economic planning, It indicates the trends of inflation and deflation.

• Importance of national income, It helps to know the progress of various sectors in the economy. Imbalanced growth, if any, can be solved.

• It helps in forecasting the economic future and pre-planning is possible. It indicates the economic status of a country among the nations of the world.

Difficulties in the computation of National Income : 

• The following are the practical difficulties in the measurement of national income. The statistics are not fully available, Non-monetized sector is dominant, Most people take out their livelihood from more than one activity in backward economies like India, particularly in the rural sector.

• In backward economies like India, particularly in the rural sector, the cultivators and small producers are illiterate and they do not keep books of account. This is a serious difficulty in the calculation of national income. Avoidance of double counting becomes complicated. The village money lenders maintain absolute secrecy of their transactions.

Trends of national income in India : • Trends of national income in India, during the

plan periods, national income and per capita income are increasing steadily but the rise in the per capita income is rather slow due to population growth.

• Agricultural sector is the most important sector as it is the single largest contributor to the national income.

• In the recent years, the share of the government sector is gradually increasing indicating the increased efficiency of the public sector

Real vs. Nominal GDP• GDP can be measure for a particular year using

the actual market price of that year, this gives us the nominal GDP, or GDP at current prices.

• Real GDP is calculated by tracking the volume or quantity of goods and services produced after removing the influence of changing prices or inflation.

• The difference between nominal and real GDP is called GDP deflator or price of GDP.

Price Indexes and Inflation

• Price index is a measure of the average level of prices or general price level in any economy.

• Inflation explains a rise in the general level of prices.

• Rate of inflation is defined as the rate of change of the general price level.

• Rate of inflation in year t =

Pi=100*pt-pt-1/pt-1.

Price Indexes

• Price index is a weighted average of the price of a basket of goods and services.

• Indexes are Consumer Price Index (CPI), Whole Sale Price Index (WPI), GDP price index, Producer Price Index (PPI)

• Consumer Price Index: it is a measure of the average price paid by the urban consumers for a market basket of consumer goods and services.

Consumer Price Index

• A comprehensive measure used for estimation of price changes in a basket of goods and services representative of consumption expenditure in an economy is called consumer price index.

The calculation involved in the estimation of CPI is quite rigorous. Various categories and sub-categories have been made for classifying consumption items and on the basis of consumer categories like urban or rural. Based on these indices and sub indices obtained, the final overall index of price is calculated mostly by national statistical agencies. It is one of the most important statistics for an economy and is generally based on the weighted average of the prices of commodities. It gives an idea of the cost of living.

Inflation is measured using CPI. The percentage change in this index over a period of time gives the amount of inflation over that specific period, i.e. the increase in prices of a representative basket of goods consumed.

• The overall CPI is meant to represent the cost of a representative basket of goods and services consumed by an average household. However, in India, the existing CPIs refer to specific segments of the population (Rural, Industrial Workers, etc.).

• The prices arranged into the 8 major groups:• Food and beverages• Housing• Apparel• Transportation• Medical care• Recreation• Education & Communication• Other goods and services(haircuts, Funeral

expenses).

Wholesale Price Index (WPI)

• Wholesale Price Index (WPI) represents the price of goods at a wholesale stage i.e. goods that are sold in bulk and traded between organizations instead of consumers. WPI is used as a measure of inflation in some economies.

WPI is used as an important measure of inflation in India. Fiscal and monetary policy changes are greatly influenced by changes in WPI. In the United States, Producer Price Index (PPI) is used to measure inflation.

WPI is an easy and convenient method to calculate inflation. Inflation rate is the difference between WPI calculated at the beginning and the end of a year. The percentage increase in WPI over a year gives the rate of inflation for that year.

• There is no doubt that, conceptually, retail inflation—price rise driven by potential consumer demand and available supply—is a better indicator of inflation for guiding monetary policy decisions than WPI inflation. Even the former RBI governor D Subbarao admitted as much. So far, RBI chose the wholesale price index or WPI over CPI, largely for two reasons. First, until 2011, there was no single CPI, representative of the whole country. There were three or four CPI measures, relevant for different segments of population. Now, we have one representative measure of retail inflation with further disaggregation to see how prices in rural and urban India are changing.

• The conceptual case for moving to CPI rests on two points. First, WPI excludes prices of services such as education, healthcare, and rents. However, services now account for nearly 60 per cent of GDP and a vast majority of these services are not traded with other countries.

• Second, WPI assigns nearly 15% and 10.7% weightage for the fuel group and metal and metal products group, respectively. Any sharp movements in international prices of fuels and metals, therefore, lead to sharp changes in WPI.

• Second, WPI was earlier available with a shorter lag—only a 2-week delay—compared with CPI inflation which came with a 2-month lag. Now, CPI monthly inflation data is released couple of days prior to WPI inflation data for the same month.

• The new RBI governor, Raghuram Rajan, has set up a committee to revise and strengthen the monetary policy framework. This committee is looking to recommend an appropriate nominal anchor (implying a measure of inflation) for monetary policy conduct, among other objectives, in its report scheduled for December 2013. Thus, the January 2014 monetary policy review could reflect the change in RBI’s stance on the appropriate inflation measure.

Producer Price Index (PPI)

•  PPI, It measures average change in selling prices received by domestic producers of goods and services over time. PPIs measure price change from the perspective of the seller. The PPI looks at three areas of production: industry-based, commodity-based, and stage-of-processing-based companies.

GNP and Happiness

• The assessment of gross national happiness was designed in an attempt to define an indicator and concept that measures quality of life or social progress in more holistic and psychological terms than only the economic indicator of gross domestic product (GDP)