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The structure of the macro economy has aggregate output equals the value of
been portrayed in the circular flow of aggregate income, which in turn must
output and income as dealt with in the equal to the aggregate expenditure.
previous chapter. This circular flow Based on this, national income
depiction of macroeconomic activities measurement can be categorised into
provides logical foundation for the three approaches : output or product
concepts and measurement of national approach, income approach and
income aggregates. A strikingly unique expenditure approach. All these must,
feature of national income concepts is in principle, yield the same result.
that they are quantifiable and are not Measuring Gross Domestic Product
abstract ones. Hence, they render as Let us first take up the measurement
much precision as feasible in the of the value of all that is produced in
national income statistics, given the the economy. This is expressed as Gross
limitations in the estimation of national Domestic Product. Here, the
income aggregates and in the measurement procedure is actually
construction of national income three-fold. We use the product method,
accounts. There have been many the income method and the expenditure
attempts in the past to evolve methods method to compute the Gross Domestic
of national income accounting and these Product. As this aggregate is held to be
efforts have contributed to the system very important for macroeconomic
that we have at present. In this chapter, assessment, greater attention is called
we shall present principal methods to for in the computation of this measure.
measure national income aggregates. It
Gross Domestic Product : The Output
is pertinent at this juncture to remind
Approach
ourselves of an important observation
made in respect of the circular flow of Gross Domestic Product (GDP) is a
macroeconomic activities. We have, in summary statistic, which is widely used
that context, stated that the value of by economists and policy analysts to
18 INTRODUCTORY MACROECONOMICS
assess the rate of growth of an economy taken into account in the measurement
during a year. GDP is generally of GDP.
recognised to be the primary measure. Inter mediate goods are those
GDP is defined as the market value goods that are used to produce other
of all final goods and services produced goods and therefore they always move
by the factors of production located in from one stage of production to another
the country during a period of one year. in the manufacture of a final product.
A key phrase in this definition is ‘final Let us now show the difference
goods and services’ which require some between final and intermediate goods with
elaboration. the example of producing an automobile.
The industrial process to
Final goods are those that are meant
manufacture an automobile involves
for final use by consumers or firms. These
materials such as steel, paint, rubber,
goods are not required to enter into
foam, plastic, glass, cables, battery, etc.
further stages of production or resale to
and a variety of component parts. All
change their form and content. They are
these items are produced by the
finished goods meant only for final
respective firms only to be used in the
consumption and investment.
production of another product; in our
Measurement of GDP includes only
example it is the automobile. But once
the aggregate value of final goods. Also,
the process of producing an automobile
from a development perspective, the
starts, all these are converted into
strength of an economy is seen in its
integral parts of an automobile. So,
capability of producing final goods and
these goods are not important in their
services.
own right; they are just a means to an
It may be useful at this stage to draw
a distinction between final goods and end. Such goods are called intermediate
intermediate goods. The latter are not goods. The automobile that is produced
Clip 3.1
PIONEERS IN NATIONAL INCOME ANALYSIS
In the contemporary world now, national income concepts and accounting methods
are widely recognised and applied to measure the economic performance of countries.
However, these concepts and methods became popular only a few decades ago.
A seminal contribution to the field of National Income and
Product Accounts (NIPA) made by Simon Kuznets (1901–1985)
set the trend of using national income aggregates to measure
the direction of growth of economies. He was a great pioneer in
this field and due to his research efforts, the first national
income figures for the US economy was published in 1934 as
an official document of the US Senate. This helped immensely
to understand the severe impact of the Great Depression in
1929. His monumental book of two exhaustive volumes, National
Simon Kuznets Income and its Composition, 1919-1938 (New York; NBER, 1941)
NATIONAL INCOME ACCOUNTING : CONCEPTS AND MEASUREMENT 19
earned him the worldwide recognition. This was followed by two of his landmark
contributions, namely, National Product since 1869 (New York; NBER, 1947) and
Economic Growth of Nations : Total Output and Production Structure (Cambridge Mt,
Harvard University Press, 1971). For his contributions, Kuznets was honoured
with the Nobel Prize in 1971 in recognition of his empirical interpretation of
economic growth.
Another important contribution in this field is that of
Richard Stone (1913-1991). Stone worked with John
Maynard Keynes as a research assistant. Stone during the
early 1940s prepared a statistical profile of the British
economy. After the World War II, Stone headed a United
Nations project to develop standard national income
accounting model.
In India, prior to 1947, the estimation of national income
was attempted by individual economists and scholars for
Richard Stone specific years.
Among these, the most systematic work was that of V.K.R.V. Rao in his book
National Income in British India 1931-32 (London; MacMillan 1940), which formed
the basis of national income estimation in the post-independence period. In
1949, the Government of India formed the National Income Committee under
the Chairmanship of P.C. Mahalanobis, with V.K.R.V. Rao and D.R. Gadgil as
members. From then onwards the national income estimation has been steadily
strengthened. Now, the Central Statistical Organization (CSO) is entrusted with
the task of publishing National Accounts Statistics (NAS).
in the final stage of the assembly line is is, no product should be counted two
the final good. or more times. Double counting will
Hence, the rationale for not taking only exaggerate or over-estimate the
into account the value of intermediate value of GDP.
goods in the measure of GDP is to avoid The procedure by which we eliminate
the problem of double counting. That the values of intermediate goods from GDP
20 INTRODUCTORY MACROECONOMICS
is through the method of value added. a good’s value increases at each stage
This is discussed in the following section. until its final value is obtained in the
last stage. It follows therefore that the
Concept and Measurement of Value value of final good will have to be equal
Added to the sum of the value-added at each
The concept of value added is very basic stage of production. This is shown with
to the measure of GDP. Value-added is a numerical illustration in Table 3.1.
defined as the difference between total Consider the production and sale
value of output of a firm and value of of a cake to the Household sector for
inputs bought from other firms. It thus final consumption. The process of
measures the value, which the firm production starts with a farmer raising
concerned has added by its process wheat crop and harvesting it. Since we
of production. are starting with the stage of wheat
Most goods go through multiple cultivation, let us not go into the
stages of production. This means that backward production linkages of the
Table 3.1 : Numerical Illustration of GNP Measurement
using Value Added Method
Stage I Stage II Stage III Stage IV
(Wheat) (Flour) (Cake at Bakery) (Cake at Retailer)
Farmer
Black’s Purchases Miller White’s Baker Brown’s Retailer Green’s
from other firms
None
Value Added Rs. 1.00 Purchases Rs. 1.00 Purchases Rs. 1.50 Purchases Rs. 2.00
from Farmer from Miller from Baker
farmer. Therefore, the farmer’s value- (iii) Net-value added at Market Price =
added in the cultivation stage will be Gross value added at Market price
just the value of his output as such (that – Consumption of fixed capital
is one rupee). In the second stage, the (Depreciation)
miller buys the wheat from the farmer (iv) Net-value added at Factor Cost =
and grinds it into flour, and sells it to Net value added at Market Prices –
the baker for Rs.1.50. By this, he adds Net indirect taxes (Net Indirect Taxes
a value of 50 Paise. The baker makes = Indirect Taxes – subsidies)
the cake and sells it to the retailer for (v) Net value added at factor cost = Total
Rs. 2.00, thereby adding a value of 50 Factor Income
paise. The retailer who buys the cake Now, let us look into the
from the baker sells it to the final computation of value added as shown
consumer for Rs. 2.50, thereby adding in the illustration below:
a value of 50 paise. This means that the Example 1: From the following data
value of the final good, namely, the cake calculate the value added by Firm A and
is Rs. 2.50 at the retail store. This final Firm B.
value of the cake is the sum of the value (Rs. in Lakhs)
added from the stage of cultivation to (i) Closing stock of Firm A 20
that of retail sale at the shop, that is, (ii) Closing stock of Firm B 15
total value added equals Rs.1.00 + 50 (iii) Opening stock of Firm A 5
Paise + 50 Paise + 50 Paise = Rs. 2.50. (iv) Opening stock of Firm B 10
On the other hand, if we had (v) Sales by Firm A 300
included the value of all the (vi) Purchases by Firm A from 100
intermediate stages, preceding the retail Firm B
sale, cake’s value would have increased (vii) Purchases by Firm B from 80
manifold, due to the problem of double Firm A
- counting. That is, wheat would have (viii) Sales by Firm B 250
been counted four times, floor three (ix) Import of raw material 50
times and baked items twice. This is the by Firm A
reason why we take the final value of (x) Exports by Firm B 30
the output as a sum of all values added
in producing a good. As first step calculate the value of
This procedure of value added output for each Firm. Then find the
method demonstrated for an individual value added.
product is applied at the aggregate level Step 1. Value of output of Firm A
for the measurement of GDP. = Sales + Change in stock
(Closing stock – Opening stock)
Concepts of Value Added
= 300 + (20 – 5)
(i) Value of output by a Firm = Sales + = Rs. 315 lakhs
Change in Stock
(ii) Value Added = Value of output – Step 2. Value added by Firm A
Intermediate goods cost = Value of output – purchases
22 INTRODUCTORY MACROECONOMICS
total value of payments made by did on the product side. While measuring
government sector towards households GDP we must include only those income
and firms as income supplements and flows that originate with the production
subsidies respectively. This is also known of the goods and services within the
as Transfer Payments, and they are not particular time period.
counted in the GDP because there is no The components of factor income are:
production of goods due to them. 1. Employee compensation
Transfer Payments are basically welfare- 2. Profits
oriented expenditures of the
3. Rent
Government.
4. Interest
(iv) Net Exports
5. Mixed income
This is the difference between Exports (X)
Now let us look into the details of
and Imports (M) of a country, that is
each one of these.
(X – M).
Based on the expenditure flows 1. Employee Compensation
in the economy, Gross Domestic
Compensation to employees in the form
Product is the total value of the sum
of wages, salaries and benefits makes
of consumption and investment
expenditure along with government up the largest single component of
purchases and net exports. income generated with production of
In other words GDP. Wages and salaries are payable
GDP = C + I + G + (X – M) in cash, kind or both.
Where, 2. Profits
C = Consumption expenditure by
Profits are the reward the owners of
households
firms receive for being in business.
I = Investment expenditure by firms Firms’ desire to earn profits is the main
G = Government purchases of goods motivating force behind production in
and services. a market economy.
X-M = Net Exports. 3. Rent
Rental income is, for example, income
Gross Domestic Product : A Measure earned by owners of rental housing. The
of Income meaning of rent in the national income
The third approach to the measurement accounts is that it is a charge for the
of GDP is to compute it by addition of all temporary use of some capital asset.
factor incomes generated in the 4. Interest
production of goods and services. Households both receive and pay
Because each rupee of goods and interest. We include in GDP only the net
services produced is matched by a rupee interest, that is the difference between
of income, we can arrive at the same interest amount paid and the interest
figure for GDP on the income side as we income received by households.
26 INTRODUCTORY MACROECONOMICS
prices, GNP will change when either the (c) Real GNP is also often used in
overall price level changes or when the making international comparisons
actual volume of production changes of economic performance across the
or when both change simultaneously. countries.
Constant Prices Having explained the concepts of
Nominal and Real GNP, let us proceed
However, for certain purposes we may to know the method by which we obtain
want to have a measure of output that
the value of Real GNP through the
changes only when the quantity of goods
constant prices.
produced changes. This measure of only
The purpose of using constant
quantity change, not prices, is the method
of using constant prices. Accordingly, prices is to eliminate the effect of price
GNP that is computed at constant prices changes. For this, we are supposed to
will be called the Real GNP. Usually, express the value of current year’s GNP
under this method GNP value is (Nominal GNP) in terms of prices
expressed in terms of prices prevailing in prevailing during a reference year in the
a year chosen to be the base year. past, which is called the Base year. That
Real GNP has the following is, the account for the value of current
advantages: year’s GNP as if the price level is same
(a) It is useful in finding out the effect of as that of the base year. As you may be
increased production of goods and aware that the price level is usually
services on the real development measured by the Wholesale Price Index
capacity of the economy in general. or the Consumer Price Index Number.2
But the nominal GNP cannot show If the GNP in the current year is
this as we cannot segregate the valued at current market prices, it will
change in output alone, since, the not be possible for us to find out how
current market prices in terms of much of the increase in GNP is due to
which it is measured prevent such increase in prices (inflation) and how
an exercise; much of the increase is due to an
(b) Real GNP also enables one to make increase in the production of goods and
a year-to-year comparison of the services. To know whether GNP
changes in the growth of output of increase actually means an increase in
goods and services. An expansion the output of goods and services, we
phase of the economy is a period of must eliminate the effect of price
rising real GNP. On the contrary a increases.
recession is a period in which real We shall explain, through the
GNP falls consecutively; and following illustration, the calculation of
2
An index number is a representative number to decode the changes in price level. The consumer
price index number is used to represent the average change over time in the prices paid by the
final consumer of a specified group of goods or services.
28 INTRODUCTORY MACROECONOMICS
nominal GNP and real GNP as well as Let us take up the calculation
GNP deflator (Table 3.2). of nominal GNP through the
Let us assume that our imaginary expenditure approach. Let us therefore
economy has only three final goods : find out the expenditure on each good
and obtain the total expenditure at
Oranges - Consumption good current prices.
Computers - Capital good Consumption expenditure (oranges)
and Government purchases of cloth. is Rs. 4452, investment (computers) is
Table 3.2: Nominal GNP, Real GNP and the GNP Deflator
Current Period Base Period
Rs. 10,500, and government expenditure measures the average level of the prices of
is Rs. 1,060, so the nominal GNP is Rs. all the goods and services that make up
16012. GNP. It is calculated as the ratio of nominal
Now, let us calculate real GNP. This GNP to real GNP, multiplied by 100.
is, as mentioned before, calculated by In the above example, we divide
valuing the current period quantities at nominal GNP (Rs.16,012) by real GNP
the base period prices. Accordingly, the (Rs. 15,300) and multiply the results by
consumption expenditure is Rs. 4240, 100. We obtain GNP deflator as 104.7.
investment is Rs.10,000 and government It is also possible to calculate
expenditure is Rs.1,060. So the real deflator for specific expenditures as we
GNP is Rs.15,300. would like to know the real value of
Finally, the concept of GNP deflator these expenditures. This is also shown
requires explanation. The GNP deflator in Table 3.2.
GNP
MP
(-)net income from
(–
(-
)n
)d
et
pr e
abroad
in
ec
di
at i
re
io
ct
n
ta
xe
s
NNPMP
GDPMP GNP
FC
(–
) (–
(–)net income
(–)net income
from abroad
from abroad
ne )
ti ne
nd ti
ire nd
ire
(–
-d
ct
)
ct
d
ep
ta
e
xe ta
pr
re
s xe
c
ec
ia
s
i
tio
at
io
n
n
ne
from abroad
ti
ep
nd
re
ir e
cia
ct
tio
ta
n
xe
s
NDPFC
4
A particular value may be expressed at Market Prices or at Factor Cost. If a quantity is expressed
in terms of its current prices it is referred to as market price. Suppose the total value added is
computed on the basis of current prices of inputs then we may call this as value added at Market
Prices. On the other hand, if the value added is arrived at by adding the payments to factors
(land, labour, capital and entrepreneurship) such as rent, wages, interest and profit, (as was
done in Table 3.1) then it is described as value added at Factor Cost. In the same manner, all the
concepts of national income may be shown either at market prices or at factor costs.
5
It may be necessary to give the meaning of ‘Domestic’ and ‘National’ used in National Income
aggregates. Domestic here simply means ‘domestic territory’. So, domestic product would imply
the value of all goods and services produced by the normal residents of a country. ‘National’
refers to the addition of the net factor income from abroad to the domestic product.
6
Current transfers from the rest of the world may include gifts, cash, consumer goods and even
military equipment.
NATIONAL INCOME ACCOUNTING : CONCEPTS AND MEASUREMENT 31
Example 4: From the following data So, GDPFC = Rs. 545 crores
calculate the GNP, GDP, NNP, NDP at both h) NDPFC = GDPFC – Depreciation
factor cost and market prices. = 545 – 15 = 530
(Rs. in crores) So, NDPFC = Rs. 530 crores
i. Gross Investment 90
ii. Net exports 10 Items that are Excluded from GNP
iii. Net indirect taxes 5 Measurement
iv. Depreciation 15 It may be recalled that GNP is the
v. Net factor income from abroad –5 measure of the value of the final goods
vi. Personal consumption 350 and services produced in one year. But
expenditure in reality many transactions occur in
vii. Government purchases of 100
the economy that have either nothing
goods and services
to do with the final goods and services
Solution: produced or that they are non-market
a) GNPMP = activities or illegal activities whose
Personal consumption expenditure = 350 measurement has its own limitations,
+ Gross investment = 90 both conceptual and empirical. We shall
+ Government purchases of = 100 now enumerate a few of these
goods and services transactions that are excluded in the
+ Net exports = 10 estimation of GNP.
+ Net factor income from abroad = –5 1. Purely Financial Transactions
GNPMP = 545 There are three generate types of purely
So, GNPMP is Rs. 545 crores financial transactions. They are
b) NNPMP = GNPMP – Depreciation (a) Buying and Selling of securities
= 545 – 15 = 530 (b) Government Transfer Payments
So, NNPMP = Rs. 530 crores (c) Private Transfer Payments
c) GDPMP = GNPMP – Net Factor Now, let us examine these
Income from Abroad transactions in detail.
= 545 – (–5) = 545 + 5
= 550 (a) Buying and selling of securities
So, GDPMP = Rs. 550 crores
d) NDPMP = GDPMP – Depreciation In the financial markets as shown
= 550 – 15 = 535 earlier in circular flow model, potential
So, NDPMP = Rs. 535 crores savers and investors buy and sell
e) GNPFC = GNPMp – Net indirect financial assets such as shares and
taxes bonds. While someone buys a share
= 545 – 5 = 540 there is only a transfer of ownership
So, GNPFC = Rs. 540 crores right. It is a claim to ownership of assets.
f) NNPFC = GNPFC – Depreciation
In the case of bonds, it is
= 540 – 15 = 525
So, NNPFC = Rs. 525 crores acknowledging a debt transaction.
g) GDPFC = GDPMp – Net indirect There is no production activity but only
taxes exchange of funds for financial claims.
= 550 – 5 = 545 Trading in financial instruments does
34 INTRODUCTORY MACROECONOMICS
not imply production of final goods and transaction – vegetables can be grown
services. As such these are not included in the backyard instead of bought in
in the GNP. the super market, or an electrical fault
can be repaired by the house owner
(b) Government Transfer Payments
himself or herself instead of hiring an
As defined earlier, transfer payments electrician. These are examples of non-
are payments for which no goods or marketed goods and services that have
services are provided in exchange. been consumed without using
Pension payments, Employees’ social organised markets. But GNP includes
security measures, adhoc assistance only those transactions that occur
due to certain exigencies like floods, through market activities. Barter
drought, etc. and subsidies are transactions and production for self-
examples for government transfer consumption by household are not
payments. As there is no production of included in the GNP. It is in this context,
final goods and services in response to there is a debate as to whether
transfer payments, the transfer housewives services should be included
payments are not included in the GNP. or not. If so, how do we value their
(c) Private Transfer Payments services at current market prices?
Items such as pocket money given by 4. Illegal Activities
parents to their children, elders gifting GNP does not include trade in illegal
money to the young ones are private goods and services even though they
transfer payments. This is merely a are final products and are purchased
transfer of money from one individual in market transactions. Activities such
to another. Hence this is also not as smuggling, gambling, crime for hire,
included in the GNP. drug trafficking, illegal arms sale are
2. Transfer of Used Goods some cases in point.
These illegal activities create an
GNP refers to the value of the final goods
‘underground economy’ wherein
and services produced in a given year.
‘production’ is unreported or
Hence, goods produced in the previous
unaccounted either because it is
time period cannot be included in the
unlawful or those involved want to
GNP. For instance, when a person buys
evade the government tax-net. As a
a used car, it cannot be recognized in
result these illegal and concealed
GNP measurement as the car was
transactions create a huge volume of
produced in an earlier year. Spending
on a used car simply reflects a change in unaccounted money that is popularly
the ownership of a pre-existing output. called the black money. Black money
is the main driving force of
3. Non-market Goods and Services underground economy or “parallel
Many final goods and services are not economy”. As in the case of non-market
acquired through regular market goods, it is difficult to fix exact market
NATIONAL INCOME ACCOUNTING : CONCEPTS AND MEASUREMENT 35
J.R. Hicks once wrote that, “The GNP as the sole objective of development
purpose of income calculation... is to will be counter productive. It is
give people an indication of the important to test whether growth in
amount they can consume without GNP results in equitable distribution of
impoverishing themselves”7. income, sustainable development and
In the contemporary economies, good quality of life for people. The
particularly in the developing process of development must create
countries, we are confronted with the sustainable societies without
serious issue of inequality in the endangering the natural resources and
income distribution, environmental
ecological systems.
degradation, and deterioration in the
Therefore, attempts to enhance GNP
quality of life. All these and related
problems have not only introduced at any cost may create economic ‘bads’
gaps between different classes of people such as poverty and pollution. This
in terms of their social and economic requires an alternate measure, which
status but also between nations, would allow GNP to measure human
involving categorisation such as welfare. Some economists have suggested
developed, developing, less developed the concept of “green” GNP. Such a ‘green
and least developed countries. GNP’ would help attain a sustainable use
It is beyond the scope of this of the natural environment and equitable
chapter to probe into the development distribution of the benefits of
debates over the questions narrated development. It may be useful to debate
above. Suffice it to say that increase in these issues related to GNP.
SUMMARY
l Circular flow of income forms the basis for measurement of macroeconomic
activities.
l Product approach, Income approach and Expenditure approach are three
ways in which Gross National Product can be measured.
l In the product approach, only the final goods and services are included to
facilitate the aggregation of the value added by the producing units.
l Income approach is concerned with summation of factor incomes which in
turn must equal to total value added. Hence product is also income in
national accounts.
l Aggregate expenditure is obtained by adding all expenditures on
consumption, investment and government purchases of goods and services.
l Real GNP and Nominal GNP are outlined by taking the value of national
product at constant prices and current prices respectively.
l GNP deflator is used to measure the average level of the prices of all goods
and services.
l Purely financial transactions, government and private transfers, used goods,
illegal activities, non-market goods, etc. do not get included in the GNP.
7
J.R.Hicks, Value and Capital, Oxford University Press, 1975, Page 172.
NATIONAL INCOME ACCOUNTING : CONCEPTS AND MEASUREMENT 37
EXERCISES
Section I
1. Define:
(i) GNP at market prices
(ii) NNP at market prices
(iii) GNP at factor cost
(iv) NNP at factor cost.
2. Define the concept of value added.
3. Show how the sum of value added is equal to sum of factor incomes.
4. What is the difference between final good and intermediate good?
5. What is depreciation?
6. What are the components of aggregate expenditure?
7. What are factor incomes?
8. What is meant by double counting? Why should it be avoided?
9. What are transfer payments?
10. Explain the meaning of non-market activities.
11. What is called ‘Green GNP’?
12. Differentiate between national income at current price and constant
price.
13. Define: (a) Nominal GNP and (b) Real GNP
14. What is a GNP deflator?
15. Give reasons for not including leisure in GNP.
Section II
16. Explain product and income approaches to measure national income.
17. Explain the value-added method with the help of an example.
18. What are the items that are excluded from GNP? Give reasons.
19. Does GNP measure national welfare?
20. Explain the components of factor income.
21. Explain the following terms:
(a) Business fixed investment
(b) Inventory investment
(c) Residential construction investment
(d) Public investment.
Section III
22. Calculate the value added by Firm A and Firm B from the following
data:
(Rs. in lakhs)
(i) Purchase by Firm A from the Rest of the world 30
(ii) Sales by Firm B 90
(iii) Purchases by Firm A from Firm B 50
38 INTRODUCTORY MACROECONOMICS