LESSON 3:

METHODS OF NATIONAL INCOME ACCOUNTING

Objectives:
After studying this lesson, you will be able to understand

• The definition of national income accounting

• Different types of national income accounting methods

• The main objectives of each accounting method

• The importance and limitations different accounting methods in national income

accounting

3.1 Introduction

3.2.1 Social Accounting

3.2.2 Input-Output Accounting

3.2.3 Flow of Funds Accounting

3.2.4 Balance of Payments Accounting

3.2 Summary

3.4 check your progress

3.5 Key Concepts

3.6 Self Assessment Questions

3.7 Answers for check your progress

3.8 Suggested Readings

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3.1 Introduction:
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In the previous lesson, a mention was made about the Circular flow of income and
expenditure refers to the process whereby the national income and expenditure of an
economy flow in a circular manner continuously through time. Now, in this lesson, we
made an attempt to understand the various methods in national income accounting and
their uses in computing national income. National income of an economy can be
measured by following two methods; they are traditional methods of measurement and
modern methods of measurement. The following three methods are – like Product,
Income and Expenditure methods fall under the first category, followed by Social
accounting, input-output accounting, flow of funds accounting and balance of payments
accounting methods which are belongs to the second category. In this lesson, we will
cover the modern methods of measurement since the traditional measurement methods
already discussed in an earlier lesson.

3.2.1 Social accounting:

J R Hicks first introduced the term ‘social accounting’ into economics, in 1942. Social
accounting is a method to present statistically the inter-relationships between the different
sectors of economy for a through understanding of the economic conditions of the entire
economy. In the words of Edey, Peacock and Cooper, “Social accounting is concerned
with the statistical classification of the activities of human beings and human institutions
in ways which help us to understand the operation of the economy as a whole. In other
worlds, social accounting describes statistically the economic activities of the different
sectors of the entire economy, indicates their mutual relationship and provides a
framework for analysis.

We aware about the the principle forms of economic activity. they are production,
consumption, capital accumulation, government transactions and transactions with the
rest of the world. These in general we consider as the components of social accounting. If
the incomings and outgoings of a country relating to these five activities are shown in the
form of accounts, they show a closed network of flows representing the basic structure of
the economy. We can arrange individual account wise activities, which are provided in
the form of accounts. We classify these individual accounts flows are as follows:

a) Production Account

b) Consumption Account

c) Government Account

d) Capital Account

e) Foreign Account

Let us try to understand the meaning of each and every sub-account in the social
accounting method. The production account includes all forms of productive activity
i.e., manufacturing, trading etc, it covers public and private companies, proprietary
firms and partnerships, and state –owned business undertakings. Since all productive
activity takes place within this sector, all payments flow from it the other sectors.
Similarly, receipt side of the production account include sales of goods and services,
government purchases etc are all flows into this sector. The total of all payment and
receipts side items given GNP by income and expenditure.

The second one is the consumption account, which refers to the income and
expenditure account of household sector. The major items include the payments for
consumption to house hold sector and, to government sector, transfer to foreigners
and personal savings are all fall under expenditure side and the receipts from business
and from government sector are related to the income side of consumption account.

The third sector i.e., Government account relates to the outflows and inflows of the
government sector. The items on the payments side are payments to business,
persons, foreigners and personal savings. Similarly, on the receipts side, receipts from
business and persons.

Capital account is the fourth one, which shows that saving equals domestic and
foreign investment. On the side of gross investment includes gross private domestic
investment and net foreign investment. Receipts include the business savings,
personal savings and government surplus.

Last and final account is the foreign account shows the transactions of country with
the rest of the world. This account covers international movements of goods and
services and transfer payments and corresponds to the current account of the
international balance of payments.

The five-account system detailed above relates to flows of the economy in terms of
production, consumption, government transactions, capital accumulation and
transactions with the rest of the world. The accounts based on them are known as
functional accounts, as they are based on a classification of transactions according to
their functions. The incomings and outgoings of a country relating to these five
activities are shown in the form of accounts in the below, based on which, we can
prepare the social accounts table.

Table 1 Social Accounting – Income and Expenditure method

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Items Rs (in Crores) Income Exp
-------------------------------------------------------------------------------------
1. Payments to Household sector 279 HHs Bs
2. Payments to government sector 12 Gs Bs
3. Business savings 9 Gs Bs
4. Imports of Goods and Services 9 Fs Bs
5.Consumption expenditure 219 HHs Bs
 6.Government purchases 30 Bs Gs
7.Gross Private Domestic investment 36 Bs Cs
8.Exports of Goods and Services 24 Bs Fs
9.Payments to government sector by
Household sector 45 Gs HHs
10.Personal savings 15 Cs HHs
11.Transfer to foreigners 6 Fs Gs
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Based on the information furnished in the table, we can prepare the Sector-wise tables
by following income- expenditure method. In the beginning, one has to identify
sector-wise activity and its payments and receipts. Later it is easy to find out through
which activity and which sector is paying and receiveing income. Once this process is
over, we can prepare sector-wise activities and accounts. For simple understanding,
we cam see at the production account of the business sector in the following table:

Table 2: Production account of business sector

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Payments Receipts
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(1)Payments to household sector 279 (5) consumption Expenditure 219
(2) Payments to Govt Sector 12 (6) Govt Purchases 30
(3) Business 9 (7) Gross Private Domestic
Investment 36
(4)Imports of Goods and Services 9 (8) Exports of Goods and
Services 24
----- -----
Gross National Income 309 Gross National Expenditure 309
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Taking it as an example, we can prepare sector-wise accounts for remaining activities in
an economy from the data furnished in table 1.

Social accounts are also present in the form of transaction matrix. A transaction
matrix is used for social accounts in which each row contains payments to their
sectors and each column contains receipts from other sectors. Every single entry is
both in a particular row and in a particular column. For balancing social accounts a
row- total must equal its corresponding column-total. A matrix of social accounts is
shown in the following table prepared based on the information furnished in the table
1:

Table 3: Flow Matrix of Social Accounts

(Rs in Crores)
Receipts Accounts
Payments 1 2 3 4 5 6
 Product- Consumption Govt Capital Foreign Total
Tion
Production - 279 12 9 9 309
Consumption 219 - 45 15 6 285
Government 30 6 - 15 6 57
Capital 36 - - - 3 39
Foreign 24 - - - - 24
Total 309 285 57 39 24 714

The social accounts matrix presented in table reveals three things. First, each cell
shows the equality of the payments to one sect oral account and the receipts from
another sect oral account. For example payment of Rs. 279 crores by the production
sector to the consumption sector, reading row-wise in the table is shown as the receipt
of the consumption sector, reading column wise, second, the total payments of each
sect oral account equal the total receipts of this sector, for example the payments of
the production sector, reading row-wise amount to Rs. 309crores which equal the
total receipts of this sector, reading column wise. Third, the total payments of all
sectors equal the total receipts of all sectors in the social accounting matrix. They are
Rs. 714crores both row-wise and column wise in the table.

Importance of Social accounting:

Its importance involves here is due to the innumerable transaction takes place in a
country relating to buying and selling, paying and receiving income, exporting and
importing, paying taxes etc. the great merit of social accounting lies in classifying and
summarising these different kinds of transactions properly, and deriving from these
such aggregates as national income ,national expenditure, saving etc., and throw light
on the relative importance of different sectors and flows in the economy.

Difficulties in social accounting:

In preparing social accounts, imputation is essential but there are many goods and
services which are difficult to impute in terms of money. Another important
difficulty in preparing social accounts is of double counting. It arises from the failure
to distinguish between final and intermediate goods. Not only these, there are several
problems like estimation of a number of public services in social accounts, inventory
adjustments in the firms production and estimation of depreciation rate of a capital
asset.

3.2.2 Input-Output Accounting:

 The input-output analysis was first developed by W W Leontief. It explains about the
industrial interrelationships and inter-dependencies in the economic system. It means
that the inputs of one industry are the outputs of another industry and vice versa, and
in the process of production, not only inputs, outputs but also intermediate goods
production also takes place for further use in the producing outputs. so that ultimately
their mutual relationships lead to equilibrium between supply and demand in the
economy as a whole. However, the input-output analsyis implies that in equilibrium
the money value of aggregate output must equal the sum of the money values of inter
industry inputs plus the sum of the money values of inter industry outputs.

The input-output analysis analyses the inter-indusry flows of outputs and their
relationships with the gods and services demananded. It is, thus, an improvement over
the national income accounting method.

Input-Output Table

Estimation of the national income by following input-output accounting method is

presented based on a transaction matrix. A transactions matrix depicts how the total
output of one industry is distributed to all other industries as inputs and for final
demand. In the table, industrial breakdowns of the final expenditure and income
payments that enter into the national income accounts are provided. A hypothetical
input-output matrix is shown in table. In which presented the breakdown of industries
both horizontally & vertically, and in the table rows show the amount of each
industry’s output sold to every other industry and to final buyers. Similarly, the
columns show the amount of each industry’s inputs bought from every other industry,
and from imports and factor services, known as primary inputs because they are not
produced by the industries in the country.

Table 4: Input-Output Transaction Matrix

(Rs in Crores)
--------------------------------------------------------------------------------------------------
Purchasing Inputs to Total
sector ---------------------------------------------- Gross
Selling Sector Agriculture Manufac Others Final Output
turing demand
------------------------------ ----------------------------------------------------------------
Agriculture - 15 5 22 42
Manufacturing 12 - 17 16 45
Others 8 12 - 30 50
Imports 7 5 8 7 27
Primary inputs 15 13 20 - 48
Gross total inputs 42 45 50 75 212
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For example, in this table, first row (horizantally) explains about the agricultural sectors
output . It consists of Rs.15 crores to the manufacturing sector, Rs. 5 crores to the other
sectors, and RS.22 crores to satisfy the final demand, which comprises exports, capital.
Government and personal consumption thus the total gross output of the agriculture
sector is Rs 42 crores. Of which Rs 20 crores of intermediate products and Rs 22 crores
of final demand. Similarly other rows also depict the same. It may be noted that the row
total must equal the column total of the economy in the input output table. It means that
total gross output must equal the total gross input of the economy.

Importance of Input-Output Accounting:

The input output table has come to be used for national income accounting “because it
provides a more detailed break-down of the macro aggregates and money flows. This
analysis is also used for national economic planning. The input-output model provides
the necessary information about the structural co-efficient of the various sectors of the
economy during a period of time or at a point of time, which can be utilized for the
optimum allocation of the economy’s resources towards a desired end.

Shortcomings of input-output accounting analysis:

The analysis rests on the assumption of constant co-efficient of production is unrealistic.

In fact, individual industrialists may use different capital structures so that also
assumption is not valid. Secondly, it does not tell us why the inputs and outputs are of a
particular pattern in economy. Thirdly, the assumption of fixed coefficients of production
ignores the possibility of factor substitution.

3.2.3 Flow of funds Accounts:

Professor Morris Copeland developed the flow of funds accounts in 1952.. National
income accounts do not tell anything about monetary or financial transactions whereby
one sector places its saving at the disposal of the other sectors of the economy by means
of loans, capital transfers, etc the flow of funds accounts were developed to overcome
this weakness of the national income accounting.

The flow of funds accounts shows the financial transactions among different sectors of
the economy and the link between saving and investment aggregates with lending and
borrowing by them. Further, this sort of accounts is concerned with the sources and uses
of funds by the various sectors of the economy. Each sector’s account reveals all the
sources of funds and all the uses to which the funds are put this way of looking at
transactions in their entirety has come to be known as the flow of funds approach, or
sources and uses of funds.
 As was presented in Input-Output Accounting, here in this method also, accounts are
presented in the form of matrix, which is dividied into a number of sectors, such as
household, corporate business, non corporate business etc.,

But for simple understanding, we take a hypothetical flow of funds accounts in the matrix
form which is divided into for sectors: households, non-financial corporations, financial
institutions and government. Same are presented in table.

Table 5: Flow of Funds Accounts Matrix

Sectors transactions House Non- Finn- Govern- Saving

Category Holds Financial Coal Mint Invest-
Corporations Institute- Mint
U S Tins
U S U S U S
1 Gross saving - 2 - 17 - - - 4 40
2 Gross Investment 7 28 - - - 0 40
3 Net Financial 12 - -11 - - - - - 0
Investment 15 - -4 -
4 Financial uses (net) 3 - 6 - 34
(6+7+8+9+10) 25 -
5 Financial Sources (net) - 14 - 6 34
(6+7+8+9+10) - 10 4
6 Demand Deposits -1 - - 6 0
7GovernementSecurities 7 - 2 - -2 - - - 0
8 Corporate Securities 4 - 14 - - - -4 0
9 Mortgages 14 - - - 8 - - - 0
10 Net increase in - 10 2 - + - - - 0
foreign assets - - 2 - 0
-2 -

In the table, sectors were given horizantally and, transactions presented in vertically. For
example in the table, row I relates to gross saving which is a source of funds for
households and non-financial corporations and the minus figure for the govt which
indicates deficit in its budget. Row II relates to gross investment, which is a use of funds
by households and non-financial corporations. The last column of the table shows that
saving and investment are equal to Rs. 40 each. The figures of saving and investment are
supposed to have been taken from the national income accounts of the economy. Based
on the above analysis, we can understand relates to other rows.
From the above analysis, two important points should be noted : first, financial uses and
financial sources of the economy must equal. They are Rs. 34 crores in our table. Second,
changes in assets and liabilities of each type of fund must total up to zero. The last
column of the table in relation to rows 6,7,8,9,10 reveals this. In the case of row 10 we
have taken net increase in foreign assets to be zero for the sake of convenience. If it is a
positive figure the balance will show surplus in the international current account of the
national income accounts, and a negative figure will show a deficit.

Importance of flow of funds accounts:

The flow of funds accounts present a comprehensive and systematic analysis of the
financial transactions of the economy. Even though national income accounts are fairly
comprehensive, yet they do not reveal the financial transactions of the economy.

It also shows how the government finances its deficit or surplus budget and acquires
financial assets. They also show the results of transactions in government and corporate
securities net increase in deposit and foreign assets in the economy.

3.2.4 Balance of payments accounting:

Balance of payments account of a country is a systematic record of all its economic

transactions with the outside world in a given year. It is a statistical record of the
character and dimensions of the country’s economic relationships with the rest of the
world. In this respect, it is similar to flow of funds accounting except that it is limited to
transactions between nations rather than within the nation.

As we aware the balance of payments account of a country is constructed on the principle

of double-entry bookkeeping like business accounts. But balance of payments accounting
differ from business accounting in one respect, business accounting debits are shown on
the left side and credits on the right side of the balance sheet whearas, in balance of
payments accounting the practice is to show credits (payments received) on the left side
and debits (payments paid) on the right side of the balance sheet.

In the balance of payments account, the principal items shown on the credit side are ; a)
exports of goods and services, unrequited receipts in the form of gifts etc. from
foreigners, b) borrowings from abroad, investments by foreigners in the country, and c)
official sale of reserve assets including gold to foreign countries or international agencies.

The principal items on the debit side are: a) import of goods ands services, b) transfer
payments to foreigners, including to foreign countries, investments by residents to
foreign countries, and c) official purchase of reserve assets or gold to foreign countries or
international agencies.
In the balance of payments account, these debit and credit items are shown vertically
according to the principle of double–entry book keeping. Horizontally, they are divided
into three categories the current account, the capital account, and official settlements
account or the official reserve assets account. Above mentioned three accounts of a
country A are shown in table 6.

Table 6 : Balance of Payments Account of Country A

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1. CURRENT ACCOUNT
Credits
a) Exports of Goods and Services:
Merchandise exports +30
----- +30
Travel & Transportation Services: +2.5
Income on investments abroad +4.5
Other +2.4
----- +9.4 Total
exports of goods and services +39.4

Debits
B) Imports of goods and services -25.5
-------- -25.5
Services:
Travel and Transportation -4.6
Income from foreign investments in the
Country -2.4
Other -4.8
------- -11.8
-37.3
Total imports of goods and services
Balance on goods and services
(total of A-B) +2.1
Unilateral Transfers ( net) -0.9
--------------===----------
Current account balance +1.2
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2. CAPITAL ACCOUNT

A) Transaction in country A’s assets and

investments abroad(net)
a)Private
Direct -2.5
Portfolio -1.6
 Short term -0.8
---------- -4.9
b) Government excluding official reserve
Assets -1.7
-----
Total (a+b) -6.6
-----
B)Transaction in foreign assets and investments Credits
In country A (net) relate to “Credits”
a) Private
Direct +0.2
Portfolio +1.8
Short term +2.4
------ +4.4
b) government excluding official reserve assets +1.2
-----
Total (a+b) +5.6
------
capital account balance (A-B) -1.0

1 OFFICAIL SETTLEMENTS ACCOUNT

Transactions in country A’s Official Reserve assets +0.5
-----
Errors and Omissions (net) -0.7
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The most importnat items. In the current account are, merchandise exports and imports.
The difference between exports and imports of a country is its balance of trade. If exports
exceed imports, the balance of trade is favourable in the opposite case it is unfavourable.
In our table, the balance of trade is favourable.

In the capital account two types of transactions have been shown, private and government
excluding official reserve assets. Private transactions include all types of investments:
direct : portfolio and short term. Government investments consist of loans to and from
foreign official agencies. The capital account balance shows a deficit.

The official settlement account show a transaction in country A’s official reserve assets
(net). It has been shown as a credit item. However, total credits and debits of the three
accounts must equal in accordance with the theory of double-entry book-keeping because
the balance of payments of a country always balances in the accounting sense.

3.3 Summary
In this lesson you learnt about the various methods of national accounting pursued by an
economy. The important methods are : Social accounting, input-output accounting, flow
of funds accounting and balance of payments accounting. Each method has its own
limitations and importance from the point of view of national income accounting. Social
accounting helps in understanding the structure of an economy and relative importance of
the different sectors and flows whear as the input-output method provides the necessary
information about the structural co-efficients of the various sectors of the economy
during a period of time and the flow of funds accounts present a comprehensive and
systematic analysis of the financial transactions of the economy but the balance of
payments account is systematic record of all transactions of not only the economy but
also with the outside world in a given year. Therefore, in the estimation of national
income of a particular economy, one can use any one of the methods which is most
suitable to their economy

3.4 check your progress

state whether the following statement are true or false

a) National Accounting Statistics provides factual informa

tion about the performance of the economy
b). Social accounts can be presented only in the form of flow matrix
b) Input-Output analysis has been developed by WW Leontief
c) Flow of fund Accounts reveals that lending and borrowings in the economy
d) Balance of payments accounts present the transactions held with in the economy

3.5 Keywords

Social accounting
Production Account
Capital Account
Foreign Account
Final Demand
Transaction Matrix
Flow of Funds
Current account
Capital account
Official settlements account

3.6 Self Assessment Questions

Short answer questions

1. what are the different types of national accounting methods?
2. Explain the various sub component of production account?
3. what do you mean by double counting?
 4. write a note on capital account?

Long answer questions

1. State the importance of a Social Accounting method?

2. Explain the input-output transactions analysis of national income accounting?
3. Discuss the need and importance of flow of funds accounts?
4. Explain, how the balance of payments accounts are relation
to national income accounts?

3.7 Answers to check your progress

a) True b) False c)True d) True d) False

3.8 Suggested Readings:

1. Hicks, J R: Social Frame Work

2. Shapiro Edward: Macro Economic analysis
3. Abraham, WI: National Income and Economic Accounting
4. Rao VKRV: National income Accounting
5. Jhingon ML: Macro economic theory, 11/e