National Income Accounting and determination

Gross domestic product (GDP): GDP is the market value of all final goods and services
produced within the economy in a given period of time. In other words, Gross domestic product
is the total value of everything produced in the country. It doesn’t matter if it’s produced by
citizens or foreigners. If they are located within the country’s boundaries, their production is
included in GDP. There are two types of GDP which are given below_

Nominal GDP: When GDP or the value of goods and services are measured at current prices,
classified as nominal GDP.

Real GDP: When GDP or the value of goods and services are measured using a constant set of
prices (prices of a given year), classified as real GDP.

For example: If a Japanese multinational produces cars in the UK, this production will be
counted towards UK GDP. However, if the Japanese firm sends £50m in profits back to
shareholders in Japan, then this outflow of profit is subtracted from GNP. UK nationals do not
benefit from this profit, which is sent back to Japan.

How to calculate nominal and real GDP:

Commodity Current Year Quantity Current Year Price Base Year price (TK. per
Produced (unit) (TK. per unit) (2013) unit) =2012
(2013)
X 10 12 10
Y 12 8 6

Equation for Nominal GDP =∑ Current Year Quantity∗Current Year price

=PX1X1+PY1Y1 =12*10+8*12 = 216
Where,
PX1= Current year price of Good X
X1= Current year quantity of Good X
PY1 = Current year price of Good Y
Y1= Current year quantity of Good Y
Equation for Real GDP = ∑ Current Year Quantity∗Base Year price
= PxoX1+PyoY1= 10*10+ 6*12 = 172
Where,
PX0= Base year price of Good X
X1= Current year quantity of Good X
PY0 = Base year price of Good Y
Y1= Current year quantity of Good Y
Gross National Product (GNP): Gross National Product or GNP is the total market value of
everything (i.e. goods and services) produced by the residents of the country during a particular
year.

GNP includes the income earned by the country’s nationals within and outside the country, but it
excludes the income earned by the foreign citizens and companies within the country. You can
understand the statement, through an example: There are many enterprises which are operating
outside the country. Many citizens of a country work in another country. The income earned by
all these persons is known as factor income earned from abroad.

To obtain GNP, we add receipts of factor income (wage, rent and profit) from the rest of the
world and subtract payments of factor income to the rest of the world.

GNP = GDP – factor payment to abroad + factor payments from abroad

Net National product (NNP): Net national product equals GNP less replacement investment
(Capital consumption allowances). Each year, some of the economy’s capital stock wears out.

NNP= GNP- Depreciation

National income (NI): National income sums the total amount earned by residents of a country
for their land, labor, capital, and entrepreneurial talent, whether within the country or abroad.
Hence, national income is sometimes referred to as factor income, because it equals the income
received by residents. i.e. National income = wages + interest + rent + profits or by subtracting
indirect business taxes from net national product.

NI= NNP- indirect taxes + subsidies

Methods of Calculating National Income
The national income of a country can be measured by three alternative methods: (1) Income
Method, (2) Expenditure Method and (3) Value added Method or Production Method. Let’s
briefly look at each method.

1. Income Method
The income method of calculating national income focuses on the production perspective. Now
production of goods and services involves the use of land, labor, capital, and so on. And if we
consider these factors of production, income is generated via rent, wages and salaries, profits,
and interest.

We can then calculate the national income by adding all these types of income. Another
important source of income is mixed income. Mixed income refers to the income generated by
self-employed professionals and sole proprietors. (Besides, there are some self-employed persons
who employ their own labour and capital such as doctors, advocates etc. Their income is called
mixed income).

According to the income method:

National Income = Rent + Wages + Interest + Profit + Mixed Income

The income method, however, does not consider transfer payments, prize money (lotteries),
illegal money and sale of second-hand goods.

Mixed Income or Income of Non-Corporate Sector: Mixed Income of the self-employed like
doctors, engineers, retailers is the total income of own account workers as well as profit
generated in the unincorporated enterprise. Income from employment and property as well as
entrepreneurship is included in mixed income. Those persons get mixed income that gives his
service in the form of households and as a producer uses his factor and services in the production
of goods and services. These all are self-employed persons and earn self-employed income, in
which wages, rent, interest, and profit are included. Those enterprises in which self-employed
person’s mixed income concept is used, thereby net value added at factor cost is equal to mixed
income of self-employed persons.

2. Expenditure Method

Expenditure method arrives at national income by adding up all expenditures made on goods and
services during a year. Income can be spent either on consumer goods or capital goods. Again,
expenditure can be made by private individuals and households or by government and business
enterprises. Further, people of foreign countries spend on the goods and services which a country
exports to them. Similarly, people of a country spend on imports of goods and services from
other countries. We add up the following types of expenditure by households, government and
by productive enterprise to obtain national income.

The expenditure method takes the following elements into consideration:

 Purchase of consumer goods and services by residents and households (C)

 Business enterprises’ expenditure on capital goods and stocks (I)
 Government expenditure on goods and services (G)
 Net exports (exports-imports) (NX)

Hence, according to the expenditure method:

GDPMP = C + I + G + (X-M)

= C+I+G+NX

On deducting consumption of fixed capital (i.e. depreciation) from gross domestic product at
market prices (GDPMP). We get net domestic product at market price (NDPMP).

i.e. NDPMP = GDPMP – consumption of fixed capital or Depreciation

In this method, we then subtract net indirect taxes (that is, indirect taxes – subsidies) to arrive at
net domestic product factor cost (NDPFC).

NDPFC = NDPMP – Net indirect taxes

Lastly we add net factor income from abroad to obtain net national product at factor cost
(NNPFC), which is called national income.

NI = GDPMP – Depreciation – Net indirect tax + Net factor income from abroad

Where,
Net indirect tax = Taxes – Subsidies
Net factor income from abroad = Factor income from abroad - Factor income to abroad

 Consumption: Consumption is normally the largest component in the economy, consists of

goods and services bought by households. It is divided into three subcategories: Non-durable
Goods: Goods that last only a short time such as food and clothing. Durable Goods: Goods
that last a long time, such as cars and TV’s. Service: Services include the work done for
consumers by individuals and firms, such as haircuts and doctor visits.
 Investment: Investment consists of the additions to the nation’s capital stock of building,
equipment, software, inventories during a year. In other words investment consists of goods
bought for future use. Investment is also divided into three sub categories: Business fixed
investment is the purchase of new plant and equipment by firms. Residential investment is
the purchase of new housing by households and landlords. Inventory investment is the
increase in firms’ inventories of goods (if inventories are falling, inventory investment is
negative).

 Government purchase: Government purchase is the goods and services bought by the
federal, state and local government. This category includes such item as military equipment,
highways, and service provided by government workers. It does not include the transfer
payments to individual such as social security and welfare. Because transfer payments
reallocate existing income and are not made in exchange for goods and services, they are not
part of GDP.

 Net exports: Net exports accounts for trade with other countries. Net exports are the value of
goods and services sold to other countries minus the value of goods and services that
foreigners sell to us.

3) Product method or Value-added Method:

In this method, national income is measured as a flow of goods and services. We calculate
money value of all final goods and services produced in an economy during a year. Final goods
here refer to those goods which are directly consumed and not used in further production
process.

Goods which are further used in production process are called intermediate goods. In the value of
final goods, value of intermediate goods is already included therefore we do not count value of
intermediate goods in national income otherwise there will be double counting of value of goods.

Suppose the quantity of goods and services produced in a year are X 1, X2, X3, X4, X5… Xn and
price of those goods and services are P1, P2, P3, P4, P5… Pn, respectively, then the national income
will be:

GDPMP=P1X1+ P2X2+ P3X3+ P4X4+ P5X5+… +PnXn

NDPMP = GDPMP – consumption of fixed capital or Depreciation

NDPFC = NDPMP – Net indirect taxes

 NI = GDPMP – Depreciation – Net indirect tax + Net factor income from abroad

This is the production method of national income accounting.

How to Avoid double Counting Problems/ Explanation of the method of Value-Added

Approach

It has been assumed in above table that at wheat producing time, there is no cost of intermediate
goods. Therefore, farmer value addition is equal to his value of product means Tk. 400. Flour
mill buys wheat in Tk. 400 and making it flour, sells in Tk. 600. Flour man (Tk. 600 – Tk. 400)
= Tk. 200 value addition. Bakery man buys flour in Tk. 600 and making it bread, sells it to
shopkeeper in Tk. 800. Bakery man value added (Tk. 800 – 600) = Tk. 200 and sell bread to
shopkeeper in Tk. 800. Shopkeeper sells bread to consumer in Tk. 900. Thus, value addition by
shopkeeper Tk. 900– Tk. 800 = Tk. 100. Therefore, total value addition is equal to Tk. 400 +
Tk. 200 + Tk. 200 +Tk. 100 = Tk. 900. If in each step of production market value is added then it
will be Tk. (400 + 600 + 800 + 900) = Tk. 2700. The value of wheat and flour will be double
counted. To escape from double counting value addition method is followed.

GDPMP is estimated by adding up Value Addition by all the producing units in the economy.
Thus GDPMP = ΣGVAMP. Generally, value addition has been done by primary, secondary and
tertiary sectors of economy, we estimate separately. Therefore, in the whole context of economy
these sectors' relative importance can be found out.

After the estimation of GDPMP following adjustment find out

NDPMP = GDPMP – consumption of fixed capital or Depreciation

NDPFC = NDPMP – Net indirect taxes

 NI = GDPMP – Depreciation – Net indirect tax + Net factor income from abroad

Difficulties in the measurement of national income

A number of difficulties arise in the measurement of national income. Following

are the main difficulties associated with the measurement of national income in
less developed countries.

1.                 Lack of statistical data:

In the less developed countries people keep no record of their income and
expenditure consequently there is lack of accurate statistical data and information,
which deprive national income from exact measurement.

2.                 The danger of double counting:

While computing the national income, there is always the harmful of double
counting. If care is not taken then the national income will be over-estimated.

3.                 Lack of trained staff:

In the less develop countries including Pakistan. There is lack of statistician and
mathematician. The information regarding different sectors of the economy is
usually collected by the untrained workers. So, a number of errors take place
during the collection of data and information, which deprives national income from
excel measurement.

4.                 Transfer earning:

Transfer earning should not be included in the estimation of national income,
because the payments made as relief allowance, pension etc. do not contribute
towards current in the production. But sometime they are added in the estimation
of national income due to lack of knowledge which again deprive national income
from exact measurement.

5.                 non-marketed services:

 In estimating the national income only these services are included for which the
payment is made. The without payment services are excluded from national
income, which create a problem in the estimation of national income.

6.                 Self-consumed production:

 In the developing countries a significant part of the output is not exchanged for
money in the market. It is either consumed directly by producers or bartered for
other goods. This unorganized or non-monetized sector makes calculation of
national income difficult.

7.            Different sectors of the economy are usually mixed with one another.
Similarly sometime people are engaging in different sectors of the economy at the
sometime e.g., farmers during off seasons engage themselves in other sectors like
industrial, transport and communication etc., and consequently exact information
regarding their income is not possible.

8. Environmental Damage:

No nation prepares account related to the depletion of natural resources in terms of

mining minerals, the erosion of soil, the pollution of air, water, and soil and so on.

Importance of national income

Today, national income statistics are collected by all the countries of the world for
a number of years. Raising national income is the important goal of all economic
activity. Economic welfare of a country depends upon what goods and services are
available for the consumption of its individuals. The changes in national income
statistics show how the economy is developing and enables the government to lay
down the appropriate economic policy necessary under the circumstances. With the
help of national income statistics, it is possible to chart cyclical movements, find
out the inflationary gap, measure economic growth and development, and evaluate
the country’s material standard of living in comparison with other countries. The
following are the main uses of national income.

 1. Since income is a flow of wealth changes in the national income give

some indication of economic welfare. 

 2. National income is used to compare standards of living in different

countries. 

 3. National income figures are used to measure the rate of growth of a

country. 
  4. The national income accounts make it possible for an analysis of the
behavior of the different sectors of the economy. 

 5. Inflationary and deflationary pressures can be estimated with the help of

national income statistics. 

 6 National income statistics can be used to forecast the level of business

activity at later date, and to find out trends in other annual data. 

 7. The national income figures are useful in providing a correct sense of

proportion about the structure of the economy. 

 8. In war time, the study of components of national income is of great

importance because they show the maximum possible production
possibilities of the country. 

 9. National income statistics can be used to determine how an international

financial burden should be an apportioned between different countries. The
quantum of national income measures the ability of a country to pay
contributions for international purposes, just as the income of a person
measures his ability to pay for the upkeep of his country. 

 10. Above all the national income statistics are used for planned economic
development of a country. In the absence of such data, planning will not be
possible. 

In the words of Prof. Samuelson, "By means of statistics of national income, we

can chart the movements of a country from depression to prosperity, its steady
long-term rate of growth and development, and finally, its material standard of
living in comparison with other nations".

Chapter overview

1. Define National Income.

2. Concepts of NI: GDP, GNP, NDP, NNP.
3. Distinguish between GDP & GNP; GNP & NNP
4. Discuss the methods of calculating national income
5. What is the importance of national income?
6. What are the problems of calculating NI in Bangladesh?
7. Math