national income accounting

National Income Accounting

By Prof K. Bhargavi

The labour and capital of a country acting on its natural resources produce annually a certain amount of goods and services which is called the National income of the country .

It is a monetary measure includes only final goods

National Income

National income has three interpretations : It represents total value of production and

hence represents a receipts total and an expenditure total.

Every expenditure is at the same time a receipt , therefore the amount spent is equal to the amount received

National Income

But as goods and services are valued at their market prices we have a three fold identity.

a. The sum of value of all final goods and services produced .

b. Sum of all incomes in cash and kind accruing to the factors of production in a year.

c. Sum of consumption expenditure, net investment expenditure and government expenditure on goods and services .

National Income

Sum of all income, sum of values of all final production and sum of all expenditures will be the same reflecting the three basic activities of the nation’s economy that is production , distribution and expenditure

National Income

Total demand for domestic output is made up of four components :

- Consumption spending by households - Investment spending by Businesses - Government- Foreign demand

Outlays and Components of Demand

These four categories account for all spending.

The fundamental national income accounting identity is

Y= C+I+ G+ NX


Consumption Spending It includes anything from food to golf lessons ,

investment , consumer spending on durable goods such as automobiles

Higher consumption or lower saving means either less investment or larger trade deficits

Government Purchases It includes items such as national Defence

expenditures, road paving by state and local governments and salaries of government employees


Government spending Government spending on goods and

services as purchases of goods and services

Government makes transfer payments , that are made to people without they providing a current service in exchange

Transfer payments include social security benefits and unemployment benefits.


Transfer payments are not counted as part of GDP because transfers are not part of current production.

Transfers + Purchases = Government Expenditure

Outlays and Component of Demand

Investment Spending Investment means additions to the physical stock

of capital Investment includes housing construction

building of machinery etc Net investment is gross investment –

Depreciation Domestic means investment spent by domestic

residents but not necessarily spending on goods produced within this country

Consumption and government spending may also be for imported goods


Net Exports Domestic spending on foreign goods and

foreign spending on domestic goods constitute ‘Net exports’.

Difference between exports and imports is called net exports .


Across a simple economy Across a three sector economy Across a four sector model with Government

and foreign trade.

Some Important Identities

The first key identity is that output produced equals output sold.

The Output unsold is treated as accumulation of inventories and a part of investment(as if the firms sold the goods to themselves to add to their inventories.)

Output sold can be expressed as : Y= C+I (1) Income is also partly allocated between

saving and consumption.

A simple economy

Y= S+ C. (2) Identities (1) &(2) can be combined to read C+I =Y= C+ S (3) The left hand side of the identity shows the

components of demand and the R.H.S shows the allocation of income.

The identity emhasizes that output produced is equal to output sold

A simple economy

The value of output produced is equal to income received ,and income received, in turn is spent on goods or saved.

Subtracting consumption from each of the identity we have

I=Y-C=S In a simple economy investment is

identically equal to saving.

A simple economy

Three Sector model

Four sector model with Government and foreign Trade.

We start with the fundamental identity: Y=C+I+ G+ NX (1) We now establish the relation between

Output and disposable income A Part of the income is spent on taxes and

the private sector receives net transfers(TR) in addition to national income. Disposable income (YD) is thus equal to income plus transfer less taxes:

YD = Y+ TR-TA (2)

Four Sector model.

Disposable income, in turn is allocated to consumption and saving:

YD= C + S (3) Rearranging identity (2) and inserting for Y

in identity (1) we have YD-TR +TA = C+I+G+NX (4) Putting identity (3) in (4) yields C+S-TR+ TA = C+I+ G+NX (5) By rearranging we get S-I = (G +TR –TA)+ NX (6)

Four sector model with Government and foreign Trade.

Identity (6) states that excess of saving over investment in the private sector (S-I) is equal to the government budget deficit plus the trade surplus.

(G+TR-TA) is the government budget deficit. G+ TR is equal to total government expenditure,

consisting of government purchases of goods and services(G) +government transfer payments (TR).

TA is the amount of taxes received by the government.

The difference (G+TR-TA) is the excess of the government’s spending over its receipts ,or its budget deficit

Saving , Investment, The government and Trade

(The budget deficit is a negative budget surplus,BS= TA-(G+TR).)

NX is called the trade surplus . When Net exports are negative, we have a

trade deficit.

Saving , Investment, The government and Trade

GNP GDP NNPMP NNPFC Personal Income Disposable Income

Concepts of National Income

GDP is the value of all final goods and services produced in the country

It is the value of only final goods and services produced to make sure we do not double count

Double counting is avoided by working with value added . At each stage of the manufacture of the good only the value added to the good at that stage of manufacture is counted as part of GDP

Gross Domestic Product

GDP consists of Value of output currently produced

GDP values goods at market prices

The market price of many goods include indirect taxes and thus the market price of goods is not that same as the price the seller of the goods receives


GDP is valued at market prices and not at factor cost

Valuation of market principle is not uniformly applied as some components of GDP are difficult to value

e.g – Services of home makers


Gross National Product it is defined as the total market value of all final goods and services produced in a year in a country

It includes only final goods and ignores transactions involving intermediate goods

GNP includes only currently produced goods in a year . It is a flow measure of output of goods and services per time period

Concepts on National Income

GNP is the value of final goods and services produced by domestically owned factors of production within a given period

The difference between GDP and GNP arises because the sum of the output produced within a given country is made by factors of production owned abroad

Gross National Product

Sale of assets such as stocks and bonds excluded from GNP of the year

GNP refers to the value of goods and services currently produced by normal residents of a country which include national or non – national companies

Market transactions involving goods produced in previous periods not included in GNP of the current year

Concepts of GNP

Value of output of government which is taken to be equal to the value of purchases of goods and services denoted by (G)

Net exports (X) – Value of goods imported (M)

Net factor income from abroad ( is the difference between the factor income received from abroad from normal residents in India for rendering factor services in other countries on the one hand and the factor incomes paid to the foreign residents for the factor services rendered by them in the domestic territory in India

Components of GNP

Value of consumer goods and services Value of final consumer goods and services produced in a year and consumed by households denoted by consumption (C)

Value of new capital goods produced and addition to the inventory of goods such as raw materials , unfinished goods and consumer goods produced but not sold during a year called the gross private investment (I)

Components of GNP

GNP at mp =GDP at mp + Net factor income from abroad

GDP at mp =GNP at mp – Net factor income from abroad

GDP = C + I +G +XN NNP at mp = GNP – depreciation( the consumption of

fixed capital or fall in the value of fixed capital due to wear and tear is called depreciation )

NNP at fc – It is called national income . It means the sum of all incomes earned by resource suppliers for their contribution of land , labour ,capital and entrepreneurial ability which goes into the year`s net production

NNP at fc = NNP at mp – indirect taxes + subsidies

National income or NNP at FC

Net of indirect taxes and subsidies is called net indirect taxes

National income = Net national product-net indirect taxes

Personal income = National income – Social security contributions – corporate income taxes- undistributed corporate profits + transfer payments

Disposable income = personal income – personal taxes

National income or NNP at FC

GDP and Personal Disposable Income GDP is a measure of the output of goods

being produced in an economy Personal disposable income is the level of

income available for spending and saving by households in the economy

Personal Income

Nominal GDP measures the value of Output in a given period in the prices of that period (current $)

Nominal GDP changes from year to year for two reasons – the physical output of goods changes and secondly the market prices also changes

Real GDP measures changes in physical output in the economy between different time periods by valuing all goods produced in the two periods at the same price or in constant dollars

Real and Nominal GDP

Changes in Nominal GDP that result from price changes do not tell us anything about the performance of the economy in producing god and services that is why we use Real rather than Nominal GDP as the basic measure for comparing output in different years

Real and Nominal GDP

GDP data are far from perfect measures of either economic output or either welfare

There are specifically four problems , some outputs are poorly measured because they are not traded in the market

Eg – Government services and Non market activities such as volunteer work

It is difficult to account correctly for improvements in the quality of goods especially when new products and new models are being invented

Problems of GDP Measurement

Some activities measured as adding to real GDP infact represent the use of resources to avoid or contain`` bads`` such as crime or risks to National security

The accounts do not take environmental pollution and degradation into account

Problems of GDP Measurement

The GDP Deflator The calculation of real GDP gives us a useful

measure of inflation known as the GDP deflator GDP Deflator is the ratio of Nominal GDP in a

given year to real GDP of the year The deflator measures the change in prices that

has occurred between the base year and current year

Since the GDP deflator is based on calculation involving all goods produced in the economy , it is a widely based price index that is frequently used to measure inflation

Price Indexes

The Consumer and Producer Price Index The consumer price index (CPI) measures the

cost of buying a fixed basket of goods and services representative of the purchases of urban consumers

The CPI differs from the GDP deflator in 3 main ways : Deflator measures the prices of a much iwder

group of goods than the CPI CPI measures the cost of a given basket of goods

which is the same form year to year

Price Indexes

CPI includes prices of imports , whereas the deflator includes only prices of goods produced in the United States

The two main indexes used to compute inflation , the GDP deflator and the CPI, accordingly differ from time to time

The producer price index is the third price index that is widely used

PPI is constructed from prices at the level of first significant commercial transaction

Price Indexes

PPI differs from CPI in terms of coverage as it includes raw materials and semi finished goods

This makes the PPI a relatively flexible price index and one that generally signals changes in the general price levels

PPI and one of its sub indexes such as the index of ``sensitive materials”, serve as one of the business cycle indicators that are closely watched by policy makers

Price Indexes