Notes National Income Accounting

1.0 Meaning of Economics

1.1 Micro vs Macro Economics
1.2 Types of Economy
1.3 Sectors of Economy
2.0 Introduction to National Income
2.1 Meaning of National Income
2.2 Importance of Calculating National Income
2.3 Factors Affecting National Income
2.4 Limitations in Measurement of National Income
2.5 Precautions while calculating National Income
2.6 Glossary of terms related to National Income
2.7 History of National Income Calculation in India
3.0 Circular Flow of Income - Meaning and Significance
3.1 Injections and Leakages
4.0 Methods of Calculating National Income
4.1 Product Method or Value Added Method
4.2 Income Method
4.3 Final Expenditure Method
4.4 Reconciliation of the Three Methods of Measuring National Income
4.5 Reasons for Choosing NNP at Factor Cost as National Income
5.0 Other Variants of National Income
5.1 Private Income
5.2 Personal Income
5.3 Personal Disposable Income
5.4 National Disposable Income
5.4.1 Net National Disposable Income (NNDI)
5.4.2 Gross National Disposable Income (GNDI)
6.0 Real GDP vs Nominal GDP
6.1 Money Income vs Real Income
6.2 How to calculate Real GDP and Nominal GDP?
7.0 GDP Deflator
7.1 How to calculate Real GDP and Nominal GDP by using GDP Deflator?
8.0 Potential GDP
9.0 GDP and Welfare
9.1 Per Capita Real GDP
9.2 Limitations of Using Per Capita GDP as an Indicator of Economic Welfare
10.0 Different Estimations of National Income Released by NSO
10.1 NSO’s Method of National Income Accounting

Notes National Income Accounting 1

 11.0 New method of national income accounting
12.0 Green GDP
13.0 Social Accounting
14.0 Sectoral Classification as per MoSPI

1.0 Meaning of Economics

Economics is the study of how humans work together to convert the limited
resources into goods and services to satisfy their unlimited wants and how they
distribute the same among themselves.

The underlying assumption is that resources are limited but demands or needs are
unlimited. Therefore, the challenge lies in distributing the limited resources in a way
that maximizes satisfaction and needs of everyone.

1.1 Micro vs Macro Economics

Parameter Micro Economics Macro Economics

This branch of economics studies the This branch of economics studies the
Meaning behavior of an individual consumer, behavior of the whole economy at the
firm, family etc. national and international levels.

Topics covered under Micro Economics Topics covered under Macro

are demand, supply, product pricing, Economics are national income,
Scope
factor pricing, production, consumption general price level, distribution,
etc. employment, money etc.

It is helpful in determining prices of a It helps in maintaining stability in the

product along with the prices of factors general price level and focuses on the
Importance
of production (land, labor, capital, major macro problems of the economy
entrepreneur etc.) in an economy. such as inflation, unemployment etc.

1.2 Types of Economy

Based on the nature of demand and supply and underlying values, economies can
be divided into three major types - Market, Non-Market, and Mixed Economy.

🤑 Market Economy 🤑 Non-Market Economy 🤑 Mixed Economy

Market economy refers to an A non-market economy is an A mixed economic system
economic system in which economic system in which protects private property
production and prices are the government intervention and allows a level of
determined by the is important in allocating economic freedom in the
unrestricted competition goods and resources and use of capital, but also allows
between privately owned determining prices. for governments to interfere
businesses.

Notes National Income Accounting 2

 Example - United States in economic activities and
achieve social aims.

Example - India

1.3 Sectors of Economy

🚜 Primary Sector 🧑‍🏭 Secondary Sector 💻 Tertiary Sector
This sector makes direct use The secondary sector The tertiary sector provides
of natural resources. creates finished products services as the end
Examples: agriculture, for consumption by products. It is also known as

forestry and fishing, mining, manufacturing and/or the service sector.

extraction of oil and gas etc. processing.
It uses the raw material
produced by the primary
sector to produce finished
goods.

2.0 Introduction to National Income

2.1 Meaning of National Income
National Income is a measure of the sum of all the factor incomes earned by the
residents of a country for their land, labor, capital and entrepreneurial talent.

Factor income is the income that is derived from the factors of production,
which are the general inputs required to produce goods and services. The four
factors of production are Land, Capital, Labor, and Entrepreneur.

It is represented in the form of Net National Product (NNP) at factor cost.

It is a flow concept. Flow concept means a variable; the value of which can only be
derived over a period of time.

Notes National Income Accounting 3

 🧑‍🦰 Who is a Resident?
Citizen and Resident are two different terms.

1. Citizen - Citizenship is a legal concept. It is given to an individual at the

time of his/her birth.

2. Resident - Resident is an economic concept. A resident, whether a person

or an institution, is one whose center of economic interest lies in the
economic territory of the country in which he lives.

a. The ‘center of economic interest’ means one of the two things: (i) the
resident lives in the economic territory and/or (ii) the resident carries
out the basic economic activities of earnings, spending and
accumulation within the economic territory.

b. Economic territory is a region (administered by a government) where

the people, goods, and capital can move freely.

3. This does not mean that a citizen is not a resident, and a resident is not a
citizen. A person can be a citizen as well as a resident, but it is not
necessary that a citizen of a country is necessarily the resident of that
country.

Example - An NRI is a citizen of India but a resident of the country in

which he lives and carries out basic economic activities.

2.2 Importance of Calculating National Income

National Income represents the economic growth in quantifiable terms, which helps
in understanding whether the country is able to achieve its growth objectives or not.

It lets us understand the potential of the economy and accordingly helps to set
objectives.

The NI data helps to take steps in order to reduce inequalities in income distribution.

It also helps to forecast tax revenues.

It helps the corporate sector to plan their business activities and investments.

The NI figures give us an idea of inflationary or deflationary gaps.

The NI figures help us compare the standards of living of people in different

countries and of people living in the same country at different times.

2.3 Factors Affecting National Income

Several factors affect the national income of a country. Some of them have been listed
below:

Notes National Income Accounting 4

 Factors of production: land, labor, capital, and entrepreneurial skills are classified
as the factors of production. Income generated by deploying these factors is called
factor income. Normally, the more efficient and richer the resources, higher will be
the level of National Income.

Land: Resources like coal, iron and timber are essential for heavy industries so
that they must be available and accessible. In other words, the geographical
location of these natural resources affects the level of GNP.

Capital: capital is generally determined by investment. Investment in turn

depends on other factors like profitability, political stability etc.

Labor and Entrepreneur: The quality or productivity of human resources is more

important than quantity. Manpower planning and education affect the
productivity and production capacity of an economy.

Technology: This factor is more important for nations with fewer natural resources.
The development in technology is affected by the level of invention and innovation in
production.

Government: Government can help to provide a favorable business environment for

investment. It maintains law and order.

Political stability: A stable economy and political system helps in appropriate

allocation of resources. Wars, strikes and social unrests will discourage investment
and business activities.

2.4 Limitations in Measurement of National Income

Social Welfare: It measures economic performance only; it does not measure the
social welfare.

Non-market transactions: It does not capture the non-market transactions like the
service of the home makers, barter-based activities still done in some villages,
haats, etc.

Negative externalities: It does not take into account the negative externalities of
economic growth. When an economy grows, it often harms the environment
because more factories and industries produce pollution like waste and carbon
dioxide. But, National Income does not account for this problem.

Inclusion or exclusion of data - In National Income (NI) accounting, the inclusion or

exclusion of certain items in the calculations can impact the accuracy of the results.
Neglecting important factors or including irrelevant ones can result in inaccurate
figures.

Unavailability of data - During the data collection process for NI calculations,

challenges arise in obtaining precise information for every aspect of the economy.

Notes National Income Accounting 5

 Sometimes, educated guesses or estimates become necessary due to the
unavailability of exact figures.

These approximations introduce errors into the calculations, which can

diminish the precision and reliability of the final results. Thus, both the
inclusion/exclusion of items and the challenges in data collection can affect the
accuracy of National Income accounting.

2.5 Precautions while calculating National Income

1. Only newly produced goods and services must be
counted. Sale and purchase of second-hand goods
should not be treated as production.

2. Transactions in financial assets like shares and

debentures are not counted. However, any service
charge or brokerage paid as payment for the service
rendered and is included in production.

3. To calculate a country's total income, we must consider

items people produce for themselves, like grain for
personal use or self-built houses.

a. However, the condition is that we can only include

things if their value can be measured in money.
Household work, like cooking or cleaning, cannot be
measured in monetary terms, so it's not a part of the
national income.

b. But, building your own house is counted because it

contributes to the overall production of goods and
services in the economy.

2.6 Glossary of terms related to National Income

1. Consumption Goods - In economics, a ‘good’ (signifying both physical object and
services) is a product that commands price in the market. Consumption Goods,
purchased or own produced, are used for satisfying one’s wants. For ex. food,
clothes, vehicle, furniture etc. are consumption goods.

Notes National Income Accounting 6

 2. Capital Goods - These goods, when purchased or self-produced, are used for
producing other goods. These goods are used for generating income. These are
also known as Producer Goods. These are classified into durable and non-durable
capital goods.

a. Whether a good is a capital or a consumer good depends upon the use a good is
put to. For example: A car bought by a household is a consumer good. The same
car, when purchased by Zomato for delivery, would be a capital good.

3. Intermediate Goods - They refer to those goods and services which are purchased
during the year by one production unit from other production unit and are
completely used up, or resold, during the same year. It has two characteristics -

a. purchased by one unit from another production unit

Notes National Income Accounting 7

 b. used up or resold, during the same year, i.e., the year of purchase.

'Used up' means transformed into other products, or added to stocks.

4. Final Goods - Goods (including services), purchased or self-produced, for the

purpose of consumption and investment are final goods. Final goods are purchased
for the purpose of consumption for satisfying wants. Final goods can be capital or
consumer goods.

a. NO GOOD is ALWAYS FINAL or ALWAYS INTERMEDIATE - Stationery purchased

by a kid in a household is a final good whereas, in an Edtech company, it would
be an intermediate good.

5. Stock vs Flows - Stock variables can be measured at a given point of time whereas
flow variables are measured over a period of time. These two are accounting
classification of variables.

a. For example: You can measure the amount of cash that you have in your pocket
at a given point of time. So, cash is a stock concept. But, you cannot measure
your income at a given point of time because income is earned over a period of
time. Your income would not only comprise your salary. It will include the interest
on your savings, and return on your investments (which are calculated over a
period of time only).

6. Economic Territory - It refers to a geographic territory administered by a

government within which persons, goods, and capital move freely. It includes:

a. Territorial waters and airspace of India (or any country)

b. Embassies, consulates, military bases etc. of India which are located abroad.
Foreign embassies, consulates, military bases etc. of other countries in India
would not be a part of the Economic Territory of India.

c. Ships, aircrafts, etc. operated by residents between two or more countries. For
example: ONGC Videsh’s exploration ridges, offices, and all other assets in other
countries will be a part of India’s economic territory.

d. Fishing vessels, oil and natural gas rigs etc. operated by residents in the
international waters or other areas over which country enjoys exclusive rights or
jurisdiction.

Economic territory of a country is different from its political frontiers, i.e.,

geographic territory. It excludes some areas of political frontier of the country
and includes certain areas outside its own political frontier.

Notes National Income Accounting 8

 For example: the Embassy of Russia in New Delhi is not a part of the
Economic territory of India whereas the Embassy of India in Beijing is a part
of India’s Economic territory.

7. Resident vs Citizen -

a. Residents - The term “residents” refers to those individuals (and institutions)

whose economic interest lies in the country in which they live (or located). By
economic interest, we mean the basic economic activities of production,
consumption and investment.

b. Citizens - Citizenship is a legal concept based on the place of birth of the

person or some legal provisions allowing a person to become a citizen.

8. Transfer Payment - A transfer payment is a payment against which no production

takes place. National Income is the sum of factor income only. Therefore, if the
income is generated by putting inputs (land, labor, capital, and entrepreneurship),
only then, it will be counted in the National Income. Ex. charities, donations, gifts,
scholarships, etc. are transfer payments.

You cannot tell others that a gift received from parents is your income. Similarly,
if a country has received a gift from other country, that will also not be an
income.

Two Types of Transfers - Current vs Capital

CURRENT TRANSFER - A transfer made out of current income of the payer and
added to the current income of the recipient is called a current transfer.

Example - Domestic current transfers (tax, scholarships, donations,

unemployment allowance, old age pensions, lottery prizes etc.) and
International current transfers (donation in the wake of natural calamity,
remittances etc.)

CAPITAL TRANSFER - A transfer made out of wealth or capital of the payer and
gets added to the wealth or capital of the recipient is called a capital transfer. It
affects the wealth or capital of both the parties. But, these payments are not
made in exchange of some economic activities. Hence, they will not be a part of
national income.

Example - Domestic capital transfer (capital grants, lump sum payments to

households affected by natural calamities, accidents etc., payment of taxes
on capital and wealth etc.) and International capital transfer (grants, war
damages etc.)

Notes National Income Accounting 9

 9. Market Price vs Factor Cost -

a. Market Prices - It is the price that a consumer pays for the product while
purchasing it from the sellers. It is the price at which the units are sold in the
economy taking into effect the indirect taxes and subsidies.

b. Factor Cost - It refers to the cost of factors of production (land, labor, capital,
and entrepreneurial talent) for producing goods and services. Ex. payment of
rent, wages, interest on investment, and profits earned by entrepreneurs.
Factor Cost = Market Prices - Net Indirect Taxes

10. Depreciation - It refers to a decrease in the value of an asset over a period of time
due to use, wear and tear or obsolescence.

a. The depreciation is subtracted from the ‘Gross’ value to obtain the ‘Net’ value.

11. Net Factor Income from Abroad (NFIA) - Income earned by Indians in foreign
countries minus Income earned by foreigners in India. It is the factor income earned
by Indians abroad.

2.7 History of National Income Calculation in India

First attempt to calculate national income was made by Dadabhai Naoroji in 1868.
Annual Per Capita Income computed by him was Rs 20.

First scientific method to compute NI was used by Dr V.K.R.V. Rao in 1931-32. He

divided the Indian economy into two parts -

Primary sector

Secondary sector

He computed Rs 62 as the Per Capita Income of India

First official attempt to compute the National Income was made by PC Mahalanobis
as the head of the National Income Committee. He presented the report in 1951 for
the period of 1948-49. The National Income was Rs 8,710 crores. The Per Capita
Income was calculated as Rs 225.

Now, the calculation of National Income is done by the National Statistical Office
under the Ministry of Statistics and Program Implementation.

3.0 Circular Flow of Income - Meaning and

Significance

Notes National Income Accounting 10

 Meaning - The circular flow of income model explains how money, goods and
services flow among different stakeholders of an economy like households and
firms.

It shows how production, income and expenditure are interrelated with each other. It
also explains, why, in National Income accounting, Product or Income can be used
interchangeably. E.g., National Product is also referred to as National Income.

Before understanding the concept, we need to understand the role of following

sectors:

❓ Key Terms
Household sector: This sector includes all the individuals in the economy. The primary function of
this sector is to provide the factors of production. The factors of production include land, labor,
capital and enterprise. The household sectors are the consumers who consume the goods and
services produced by the firms and in return make payments for the same.

Production Sector/Firms: This sector includes all the business entities, corporations and
partnerships. The primary function of this sector is to produce goods and services for sale in the
market and make factor payments to the household sector.

The Government Sector: This sector includes the center, state, and local governments. The prime
function of this sector is to regulate the functioning of the economy. The government sector incurs
both revenue as well as capital expenditure. The government earns revenue from tax and non-tax
sources and incurs expenditure to provide essential public services to the people.

The Foreign Sector: This sector includes transactions with the rest of the world. Foreign trade
implies net exports (exports minus imports). Exports include goods and services produced
domestically and sold to the rest of the world and imports include goods and services produced
abroad and sold domestically.

The Financial Market: This market consists of financial institutions such as banks and non-bank
intermediaries who engage in borrowing (savings from households) and lending of money.

The Factor/Labor Market: The factors of production are traded through this market. For the
production of final goods and services, the firms obtain the factor services and make payments in
the form of rent, wages and profits for the services to the household sector.

The Goods/Commodity Market: In this market, the goods and services are exchanged. In the 4-
sector circular flow, the consumers are the household, government and the foreign sector while
the producers are the firms.

⬇️ Illustration 1 -

Assumption - There are only two sectors in an economy, which are households
and production units/factories. (You might be aware of this fact that assumptions are
taken in Economics to understand the concepts better and derive conclusions.)

The circular flow of income means that the income will flow from households to
production units and from production units to households in a circular manner.

Notes National Income Accounting 11

 As per the image mentioned above, the first flow illustrates the movement of factors
of production from households to firms.

The second flow shows money/income from production units to households in

return for their services (given in the form of land, labor, capital, and entrepreneurial
talent).

The third flow illustrates the spending of money/income by households and the
money moving back into the production units through the purchase of goods and
services by households. After all, the households earn money to buy products, they
need to satisfy their wants.

In this manner, the money will move from first sector to the second and from the
second sector back to the first sector.

⬇️ Illustration 2 -

Assumption - There are only 3 sectors in the economy - households, production

units, and government - with no external trade.

Notes National Income Accounting 12

 With the addition of government, new routes have been introduced into this circular
flow. The new routes are between Government-Households and Government-
Firms.

Government-Households -

1st flow (Factor Payments) - Government employs households for carrying

out its business. The households receive factor payments (money earned
against factors of production) in return for their services to government.

2nd flow (Transfer Payments) - Government has to take care of its people
(like parents), therefore, it also gives transfer payments (which is not earned
directly by deploying the factors of production) in the form of pension, social
security benefits, unemployment benefits etc.

3rd flow (Tax Payments) - For utilizing the free services offered by the
government or using the infrastructure created by the government,
households make payments to the government in the form of taxes.

👨‍🎓Understand this point that income flowing in a circular manner is the basic
assumption of Economics. Therefore, the flows are directed both ways.

Government-Firms -

1st flow (Payment for Goods and Services) - Government needs goods and
services to carry out its functions. It cannot produce everything in itself. It
has to purchase goods and services from the businesses. In return, for these
goods and services, government pays money to the businesses.

2nd flow (Subsidies) - Just like the government takes care of the
households, it also takes care of the firms. It provides subsides (which is
another flow of money) to the firms so that, they can produce goods and
services with ease and help in growing the economy of the nation.

Notes National Income Accounting 13

 3rd flow (Taxes to Government) - Firms also pay taxes to the government.
This completes the circular flow of money between the government and the
firms.

Take the interaction of government with households and firms separately. With
households, the government is completing an individual circular flow and with firms
also, the government is completing the individual flow. Don’t mix them up to avoid
confusion.

🛫 Taking it to the next level - These flows are actually interlinked. It is evident
that the money government receives from households and firms in the form of
taxes is used for purchasing goods and services from the firms, making wage
payments to the households etc. This money is, then, used by the households
for purchasing goods from firms. Firms use this money for making factor
payments, paying taxes, and producing goods. In this manner, the flow keeps
repeating.

Role of Financial Market in a 3-sector economy: The financial market helps in

mobilizing the savings of the households into the production units in the form of
borrowings/investments.

ATTENTION: Subsidies and Transfer Payments are not income. Hence, they are not
included in the calculation of GDP. GDP only includes the money earned by producing
goods and services. They just show the circular flow of money in an economy.
Therefore, they are shown in the above flow chart.

⬇️ Illustration 3 -

Assumption - It is an open economy with all the 4 sectors - households, production

units, government and external sector.

In order to understand the intricacies of the 3-sector flow, look at Illustration 2.

Notes National Income Accounting 14

 🧑‍🎓Let us understand each flow one by one:-
1st flow (Labor market) - Same as you have read above, the factors of
production go from households to firms and get factor payments. Now, look at
the first arrow in Labor market. It is moving from Business to Households, which
shows the income is moving from businesses to households.

2nd flow (Commodity market) - Here, the households buy goods and services
from the firms. The money flows back to the business in the form of revenue.

3rd flow (Financial Institutions) - Households do not spend 100% of their

incomes on consumption. They save as well! When you earn salary, do you
spend the entire amount on consumption? No, Right. You spend a percentage of
your total income on consumption and retain some portion as savings in your
bank accounts.

Now, the money in your bank account does not stay there. What does it
mean?

Notes National Income Accounting 15

 Bhoojo knows what happens to your money in the bank
accounts -

Banks lend this money to businesses for investment.

Thus, your savings takes the form of investment.

This is the function of financial sector, which includes

banks, NBFCs, securities markets etc.

They act as mediators and channelize the money from

households to the firms.

4th Flow (Government sector) - Government receives taxes from the households
and gives salaries to its employees (who come from households). Government
receives taxes from firms and buys goods from them. In both the flows, the
money is flowing in two directions. [see illustration 2 for better understanding]

5th flow (Foreign sector) - International market introduces new routes into the
circular flow of income.

Households-Foreign Sector - households and foreign sectors interact in two

ways.

Households import goods from international market. They make payments to

international market. That’s why, the arrow’s direction is from the households
to the foreign sector because the money is flowing in that direction.

Factors of production (like labor, entrepreneur, capital, and land) are given by
households to the international market. Then, the international market makes
factor payments. Households, who live abroad, send money back to their
families in the form of remittances. This is the transfer payment from
international market to households.

Notes National Income Accounting 16

 Business-Foreign Sector -

When businesses export goods, the international market pays them. So, the
money comes to the businesses. Hence, the movement of arrow is from
international market to businesses.

Businesses import goods and make payments to the international market for
the same. Thus, the circular flow is complete.

⬇️ Combined Infographic of All the Four Sectors

3.1 Injections and Leakages

INJECTIONS - An injection means an inflow of income into the circular flow. The
three main injections are investment, government expenditure, and exports.

LEAKAGES - A leakage is referred to an outflow of income from the circular flow

model. Leakages are that part of the income which the households withdraw from
the circular flow and is not used to purchase goods and services. This part of the
income does not go to the goods market. The three main leakages are savings,
taxes and imports.

In a circular flow, leakages = injections

4.0 Methods of Calculating National Income

Notes National Income Accounting 17

 ❓Key Terms
Gross Domestic Product - It is the value of total production by all production units located within
the economic territory of a country.

Net Domestic Product - It is the value of total production by all production units located within the
economic territory of a country. Depreciation is deducted from GDP to arrive at NET Domestic
Product.
➝ Depreciation in GDP inflates the value and does not give the actual amount of income.
Therefore, it is deducted.

Market Price - Market Price denotes that the value of GDP is inclusive of Indirect Taxes and
exclusive of Subsidies. It shows the price at which the goods are being sold in the market.

Factor Cost - Factor cost denotes the actual amount of income generated by a nation. To arrive at
the Factor Cost, indirect taxes are deducted and subsidies are added into the market prices. Let’s
understand this concept through examples.
Example 1- At the level of production, a pen was produced at the cost of Rs 10. Government levied
a tax of Rs 2 on the product. In the market, the product is of Rs 12. But, this is not the actual
production that had taken place. Therefore, the indirect taxes will be reduced to arrive at the actual
production level.
Example 2 - At the level of production, the same pen is produced at a cost of Rs 10. Suppose, the
government wants to promote education by reducing the cost of stationery. The government
decides to give a subsidy of Rs 2 on the pen. In the market, the pen is of Rs 8. Now, if we want to
calculate the actual amount of production, we need to add the amount of subsidy. Subsidy is
added to the market price to gauge the actual production potential of a country.

Net National Product at Factor Cost (National Income) - National Income is represented in the
form of NNP at FC because it is the actual amount of production that takes place in an economy. It
is exclusive of depreciation, indirect taxes and adds subsidies. In order to arrive at the National
level, Net Factor Income from Abroad is added.

Steps of calculating National Income -

Notes National Income Accounting 18

 4.1 Product Method or Value Added Method
Also known as ‘Output Method’

In this method, Gross Value Added is calculated at the first stage, which is
equivalent to the Gross Domestic Product. (GVA = GDP).

Value added is a method which only sums up the value addition at each stage. As
opposed to the GDP(which sums up the final market price of all goods and services
produced), GVA gives an idea of how much value each firm or each sector is adding
to the product/services.

Value Added= Value of Output-Intermediate Consumption

It measures the domestic income at the level of production.

📝 Let us understand through an example -

Step 1 - A farmer grows 1 kg wheat. He sells it to bread manufacturing unit for Rs 1000.
Step 2 - The bread manufacturing unit produced bread from the wheat and sells it to the
retailer at Rs 2000
Step 3 - The retailer, then, sells the bread to the final consumer at Rs 2200.

Now, what is the actual amount of GDP?

❌
Production Units Amount of Production

Farmer Rs 1000

Manufacturer Rs 2000

Retailer Rs 2200

Notes National Income Accounting 19

 Production Units Amount of Production

Total Amount of
Rs 5200
Production (GDP)

✅
Production Units Amount of Production Less: Intermediate Consumption

Farmer Rs 1000 Rs 1000

Manufacturer Rs 2000 Rs 1000 (2000-1000)

Retailer Rs 2200 Rs 200 (2200-2000)

Total Amount of Production (GDP) - Rs 2200

Table 1 is doubling the value addition at each stage. This overestimated the figures
of GDP.

In the table 2, we have deducted the intermediate consumption at each stage in

order to know the exact amount of value addition (production) done at each level.

👉 Intermediate Consumption - Intermediate consumption refers to the

consumption of goods (raw material) in the production of a final good. While
computing GVA, intermediate goods are subtracted to avoid double counting.

Formula to calculate GDP through Product Method:

📌 Gross Value Added at Market Price = Sales + Change in Stock - Intermediate

Consumption

Sales - Usually, businesses disclose their data of sales only. It is easier to calculate
as well. If the National Statistical Organization goes to each and every production
unit and asks for its raw materials, value addition, expenditure etc. to calculate the
National Income, then, it will become a herculean task. Therefore, the data of sales
is used to calculate GDP.

Change in Stock - The entire produce is not sold in a given year by the
manufacturer. Therefore, the producer keeps the unsold goods into the closing
stock. Now, the catch here is, that the closing stock does not solely comprise of the
unsold goods of the current year. They also contain the unsold goods of the
previous year (Opening Stock). Then, how to calculate the total production of the
current year?

Notes National Income Accounting 20

 Change in Stock = Closing Stock - Opening Stock

Intermediate Consumption - To avoid double counting, we subtract it.

ATTENTION: Sales is inclusive of domestic sales and exports. Intermediate

Consumption is also inclusive of domestic intermediate consumption and imports
used for further production.

☠️Precautions in Product Method

Avoid Double Counting of Output - In order to avoid double counting, one must
deduct intermediate consumption from the total output.

Include Value of Goods Produced for Self-Consumption - To know the actual

production that has taken place in an economy, it is important to calculate the total
production, even if it is not sold in the market. If a farmer is producing rice for own
consumption, then also it will be counted. If we leave out such goods, then, it will not
show us the true potential of our economy.

Do not include the sale of second-hand goods - Output of only the goods produced
in the current year should be counted. If used and old goods are resold, they will not
be counted.

4.2 Income Method

Also known as the ‘Income Distribution Method’.

It counts the income earned by the Factor Owners. Every type of production takes
place through factors of production (land, labor, capital, and entrepreneurs) only.

As you have studied in the circular flow of income above that the income flows in a
circular manner, therefore, the income earned by the factors is only the outcome of
income generated by the production units.

Hence, it does not matter which method we are using to calculate the income -
product or income - the GDP is going to be the same.

Formula to calculate NDP through Income Method

📌 Net Domestic Product at Factor Cost = Compensation of

Employees+Operating Surplus+Mixed Income of Self Employed

Notes National Income Accounting 21

 Components in detail -

Royalty - It is given on subsoil assets like minerals.

Compensation of Employees - It includes wages in cash, wages in kind

(accommodation, conveyance etc.), and social security benefits (like provident
fund, insurance etc.)

Profits - We include dividend, corporate tax, and retained earnings as part of

profit of an entrepreneur.

Mixed income of self-employed - Understand it through an example. ⬇️

Suppose, Sukriti is a doctor who is running her clinic in her own house. She
buys medical equipment for her clinic. She is treating the patients herself.
Now, in this case, it is very difficult to segregate the factor payments into the
above-mentioned categories. Hence, it is classified as Mixed Income in
National Income Accounting.

Notes National Income Accounting 22

 ATTENTION: We are calculating all the incomes at the factory level. Therefore, there
is no question of indirect taxes and/or subsidies getting added into the domestic
income at this stage. Next, the output is net of depreciation because ‘Profit’ is
calculated only after subtracting depreciation from it.

☠️Precautions in Income Method

Do not include transfer incomes - Gifts, donations, taxes, remittances, lottery
prizes, etc. are not included because they are not generated through factors of
production. No production (of goods and services) means no income.

Do not include capital gains arising out of sale of second-hand goods

Do not include income arising from the sale of financial assets - Buying and selling
of financial assets is not a production activity. It is just the transfer of money and
ownership of assets against which nothing has been produced.

4.3 Final Expenditure Method

Whatever goods and services are produced in the economy are ultimately
purchased by the four sectors of the economy i.e., household sector, government
sector, private sector (for investment) and external sector.

So, if we add the expenditures done by these four sectors on the purchase of final
goods and services, produced by the firms within the domestic territory, then it shall
be equal to the GDP of the country.

This method counts the expenditures which are incurred for the purpose of
consumption and investment only.

This method is the other side of the coin of the value added method. In the value
added method, we estimate the national income from the ‘sales’ side. In the
expenditure method, we estimate the national income from the ‘purchase’ side.

Formula to calculate National Income through Expenditure Method

📌 Gross Domestic Product at Market Price = Private Final Consumption

Expenditure (PFCE) + Government Final Consumption Expenditure (GFCE) +
Gross Domestic Capital Formation (GDCF) + Net Exports (Exports - Imports)

Or
GDP at MP = C + G + I + X-M

Private Final Consumption Expenditure (’C’) - It is the total of final consumption

expenditure of households and private non-profit institutions serving households.

Notes National Income Accounting 23

 Government Final Consumption Expenditure (’G’) - It is the imputed value of
services produced and provided by government to the people at free of cost. Ex.
expenses incurred for providing free water, military expenditures etc.

Gross Domestic Capital Formation (’I’) - This equals the expenditure incurred on
acquiring goods for investment by production units located within the domestic
territory. There are two components of GDCF.

1st - Investment in capital goods. This is also known as Gross Domestic FIXED
Capital Formation.

2nd - Net addition to stocks of raw materials, semi-finished goods, and finished
goods. This is called ‘Net Change in Stocks’.

GDCF = GDFCF + Net Change in Stocks

Net Exports (X-M) - Exports are included because it is the expenditure on our
products, even though by non-residents.

Imports are deducted because it is expenditure on foreign products. Hence, it is

other country’s income and not ours.

☠️Precautions in Final Expenditure Method

Properly identify expenditure on intermediate goods and services

Include expenditure of goods used for self-consumption

Do not include expenditure on transfer payment

Do not include expenditure on financial assets

Do not include expenditure on second-hand goods

4.4 Reconciliation of the Three Methods of Measuring

National Income
🏭Product Method 💵Income Method 🍉Expenditure Method
GDP at MP = Sales + Change NDP at FC = Rent + Royalty + GDP at MP = C + G + I + X-M
in Stock - Intermediate Compensation of Employees
Consumption + Interest + Profit + Mixed
Income
NDP at MP = GDP -
NDP at MP = GDP - Depreciation
Depreciation

NDP at FC = NDP at MP -
NDP at FC = NDP - Indirect Indirect Taxes + Subsidies
Taxes + Subsidies

Notes National Income Accounting 24

 NNP at FC = NDP at FC +
NFIA NNP at FC = NDP at FC + National Income (NNP at FC)
NNP at FC is the National NFIA = NDP at FC + NFIA
Income

4.5 Reasons for Choosing NNP at Factor Cost as National

Income
NNP Shows the income earned by all citizens of country. This makes sense, since
the earnings of Indian residents abroad should be included in India’s national
income. Thus, NNP is preferred over Net Domestic Product (NDP).

Factor cost is used because Net Indirect Taxes like sales taxes, excise taxes are not
the payments for factors of production. They are transfer payments only.

There is a lack of uniformity in taxes among the countries. Therefore, NNP at FC is

used for gauging the actual potential of the economy.

5.0 Other Variants of National Income

5.1 Private Income
Meaning - It is the total income accrued to the private sector (households and
private companies) for their consumption and savings. It includes both factor
income (from India and abroad) and transfer payments (such as National Debt
Interest, current transfers from the government and the rest of the world).

Formula for calculating the Private Income

📌 Private Income =
Domestic Income Accruing to the Private Sector (NDP at FC- Government
Income ) ⬇️
+
National Debt Interest
+
Current Transfers from the Government
+
Current Transfers from the Rest of the World
+
Net Factor Income from Abroad

Notes National Income Accounting 25

 What is Domestic Income Accruing to the Private Sector? Is it the same as GDP?

Domestic Income Accruing to the Private Sector - It is the sum of total income
minus income accruing to the government sector, which accrues to the private
sector.

Formula: NDP (at FC)- Income from Entrepreneurship accruing to the

Government Administrative Departments - Savings of Government’s Non-
Departmental Enterprises

It is different from GDP because the latter includes government’s income as well.

🤔Difference between Private Income and Domestic Income Accruing to the Private
Sector

Domestic Income Accruing to

Basis of Distinction Private Income
the Private Sector

It includes factor income as It only includes the factor

Components
well as transfer income. income.

It does not include NFIA

NFIA It includes NFIA
because it is domestic income.

What is National Debt Interest and why is it added?

National Debt Interest - Government of any country borrows money from its
general public by issuing securities, bonds, etc. to meet its rising consumption
expenditure. The interest paid on such debts is a source of income for the
private sector. Hence, it is included in the Private Income.

But, this interest is paid on borrowings taken for meeting the current
expenditure requirements and not the capital requirements, therefore, the
interest earned here is treated as a transfer payment and not a factor
payment.

Why is transfer payment added to Private Income when it is subtracted in the

National Income?

Private Income measures the income accrued to the Private Sector (Households
+ Private Companies) for their expenditure. Private Sector uses the amount of
Transfer Payments for their expenditure only. Therefore, it is added.

Example: You get Rs 10,000 as gift from your parents. You also earn a monthly
salary of Rs 50,000. Now, how much money do you have for your expenditure?
Is it Rs 50,000, Rs 10,000, or Rs 60,000? It is Rs 60,000.

In Private Income, we not only see the earned income but we also account for
the unearned income in order to gauge the actual amount available for
expenditure with the Private Sector.

Notes National Income Accounting 26

 Current transfers from the government include scholarships, unemployment
benefits, social security allowances etc.

Net current transfers from the Rest of World (ROW) - They include gifts and
remittances received from abroad minus gifts and remittances paid to abroad.

Why is Net Factor Income from Abroad added to calculate Private Income?

It must be noted that Net Factor Income from Abroad (NFIA) accrues to both
Private and Government sectors. However, due to lack of data available for the
government sector, it is assumed that NFIA is attributed to the Private Sector
only.

If we have the data of domestic income, we add NFIA and if we have the data of
national income, we do not add NFIA again.

5.2 Personal Income

Basis of Distinction Personal Income Private Income

It is the actual income It refers to the income which

Meaning received by the households accrues to private sector from
from all sources. all sources.

It is a broader concept and it

Scope It is a narrower concept. includes Personal Income as
well.

Private Income includes

Retained Earnings and
Corporate Tax. These two
Personal Income = Private components accrue to the
📌Formula Income - Corporate Tax - Private Sector but they are not
Retained Earnings received as income by the
Private Sector. Hence, they are
deducted for calculating
Personal Income.

5.3 Personal Disposable Income

Personal Disposable Income refers to that part of personal income which is actually
available at the disposal of households.

Personal Income shows the total income received by households from all sources.
However, the Personal Disposable Income is that part of the personal income which
the households can spend the way they like, i.e., it shows the purchasing power of
the households.

Therefore, Personal Disposable Income removes that part of the personal income
that is paid to the government, such as Direct Tax (income tax, house tax etc.) and

Notes National Income Accounting 27

 Miscellaneous Taxes Paid to the Government (fines, penalties etc.).

Formula to Calculate Personal Disposable Income

📌 Personal Disposable Income = Personal Income - Direct Taxes - Miscellaneous

taxes paid to the government

5.4 National Disposable Income

It refers to the income which is available to the whole country for disposal. It
includes both factor income and transfer income. It has two variants -

5.4.1 Net National Disposable Income (NNDI)

It includes ‘Net Indirect Taxes’ as it is the transfer income of the government and
the government is free to use it, the way it likes.

It also includes ‘Net Current Transfers from Rest of the World’ as the government
has the full right to use this money for its expenditure purposes.

Formula to calculate the Net National Disposable Income (NNDI)

📌 NNDI = NNP at FC + Net Indirect Taxes + Net Current Transfers from Rest of
the World

5.4.2 Gross National Disposable Income (GNDI)

We have to add Depreciation to the NNDI to get GNDI.

6.0 Real GDP vs Nominal GDP

Notes National Income Accounting 28

 Nominal GDP (or GDP at Current
Basis Real GDP (or GDP at Constant Prices)
Prices)

When GDP of a given year is estimated When GDP of a given year is

Definition on the basis of price of the base year, calculated on the basis of price of the
it is called Real GDP. same year, it is called Nominal GDP.

Real GDP reflects the change in

production over a period of time. It Nominal GDP reflects the GDP at
Benefits does not take into account the frequent current price. It is not used for
changes in prices. Thus, it is able to comparison and/or policy making.
show the real change in output.

Real GDP is affected by change in Nominal GDP is affected by both-

Fluctuation
physical output only. changes in price and physical output.

6.1 Money Income vs Real Income

Basis of Distinction Money Income Real Income

Real income deducts inflation

It is basically the income in
first in order to gauge the
Meaning terms of money. How many
actual purchasing power of the
Rupees you bring to home?
earners.

Current Income, Nominal

Other Names GDP at Constant Prices
Income, GDP at current prices

Example:

Notes National Income Accounting 29

 💁‍♂️Imagine you have a weekly allowance of $50 and the price of a pizza is $10. With
your $50 allowance, you can buy 5 pizzas ($50 ÷ $10 = 5). Here, your money
income is $50, and your real income in terms of pizzas is 5.

🍕Now, let's say the price of a pizza increases to $12, but your allowance remains
the same at $50. With the increased price, your purchasing power decreases, and
now you can only buy 4 pizzas ($50 ÷ $12 = 4.16, rounded down to 4). Here, your
money income is still $50, but your real income in terms of pizzas has decreased to
4.

💵So, despite having the same amount of money ($50), the increase in the price of
pizzas has reduced your ability to purchase, resulting in a decrease in your real
income in terms of the number of pizzas you can buy.

6.2 How to calculate Real GDP and Nominal GDP?

7.0 GDP Deflator

The change in prices is calculated by an index of prices called the GDP deflator,
which is nothing but the ratio of the nominal GDP to the real GDP multiplied by 100.

It is also called “Price Index”. It measures the average level of prices of all the
goods and services that make up GDP.

Formula to calculate GDP Deflator

📌 GDP Deflator (or Price Index) = Nominal GDP / Real GDP X 100

Notes National Income Accounting 30

 Example:

As per the example given in the above 6.1 heading, the GDP Deflator is -

GDP Deflator (for 2013) = 3300 / 2200 X 100

GDP Deflator for 2013 is 150%.

7.1 How to calculate Real GDP and Nominal GDP by using

GDP Deflator?
Real GDP = Nominal GDP / GDP Deflator X 100

Nominal GDP = Real GDP X GDP Deflator / 100

8.0 Potential GDP

Potential GDP refers to the maximum level of output an economy can sustainably
produce when all resources, such as labor, capital, technology, and resources, are
fully employed at their normal utilization rates.

It represents an idealized level of economic activity that an economy can achieve

without generating inflationary pressures or causing other imbalances.

9.0 GDP and Welfare

Welfare means the well-being of people. Welfare can be affected by a wide range of
factors - quantitative (consumption level, income level etc.) and qualitative (law and
order, justice etc.).

The Welfare which is affected by only economic factors (like income, investment,
savings) is called “Economic Welfare”.

The Welfare which is affected by the non-economic factors is called “Non-

Economic Welfare”.

Combination of both is called “Social Welfare”.

9.1 Per Capita Real GDP

Definition - It is calculated by dividing the total GDP of a country with its total
population.

Benefit - It gives a better understanding about the availability of goods and services
to an individual in a society, which indicates an average standard of living.

Limitation - Although, it provides the information on the income earned by an

individual, it does not account for the inequality in income distribution.

Notes National Income Accounting 31

 9.2 Limitations of Using Per Capita GDP as an Indicator of
Economic Welfare
Many welfare services contributing to economic welfare are not included in GDP -
Due to unavailability of data, many services which contribute to economic welfare
are not included in the GDP. Hence, depending on only GDP numbers to measure
Economic Welfare is not sufficient.

Example: Services of a housewife, self-consumption goods, and services

rendered by family members to each other.

Externalities are not taken into account in GDP, but affect welfare - The impact of
economic activity on others with no payment received for the benefit and no
payment given for the harm done, such benefits and harms are called externalities.
They are of two types - positive and negative.

Positive Externality increases the GDP. While Negative Externality decreases the
GDP.

GDP does not calculate these externalities. Hence, it cannot be considered a

measure of Economic Welfare.

Example: Establishing a manufacturing plant will be counted in GDP but the

pollution it spreads is not counted. Therefore, the GDP (equivalent to the plant’s
value) cannot be a measure for economic welfare.

Change in the distribution of income (GDP) may affect welfare - All people do not
earn the same amount of income. Some earn more and some earn less. Per Capita
GDP does not take this inequality into account. Hence, using GDP for measuring
welfare is not enough.

All products may not contribute equally to economic welfare - Products like food
items, clothes, house contribute more to the welfare and standard of living of the
people whereas products like military services, police services etc. do not affect the
standard of living of the people directly.

Therefore, how much is the economic welfare would depend more on the types
of goods and services produced, and not simply how much is produced.

It means that if GDP rises, the increase in welfare may not be in the same
proportion.

Contribution of some products may be negative - GDP includes the production of

both milk and liquor. While the former contributes to the welfare, the latter harms
people.

10.0 Different Estimations of National Income

Released by NSO

Notes National Income Accounting 32

 10.1 NSO’s Method of National Income Accounting
NSO uses 2011-12 as the base year to calculate Real GDP.

It was changed from 2004-05 to 2011-12.

Government of India is planning to change the base year to 2022-23.

Note: A 26-member Advisory Committee on National Accounts Statistics (ACNAS),

chaired by Biswanath Goldar, has been constituted to recommend the roadmap for this
change in base year to 2022-23. This committee includes representatives from the
Central and State Governments, Reserve Bank of India, academia, and researchers.

Reasons for changing the base year -

To take into account structural changes, which have been taking place in the
economy

To examine the performance of the economy in real terms

💡 In 2019, the National Sample Survey Office (NSSO) and Central Statistical
Office (CSO) were merged and National Statistics Office (NSO) was created.

11.0 New method of national income

accounting
The Central Statistics Office (CSO) has introduced the new series of national accounts
statistics in 2015, with base year 2011-12, in place of the previous series with base year
2004-05. The new series on National Accounts Statistics has been introduced after a
comprehensive review of both the database and the methodology employed in the
estimation of various aggregates.

Notes National Income Accounting 33

 The reason for changing the base year of the national accounts periodically is to
take into account structural changes, which have been taking place in the economy
and to depict a true picture of the economy through macro aggregates like Gross
Domestic Product (GDP), National Income, consumption expenditure of Government
and individuals, capital formation etc.

To examine the performance of the economy in real terms, estimates of these

macro-economic aggregates are prepared at the prices of selected year known as
base year. While output level of current year is used, prices of base year are used to
eliminate “inflation” from GDP estimates.

The estimates at the prevailing prices of the current year are termed as “at current
prices”, while those prepared at base year prices are termed as “at constant prices”.
The comparison of the estimates at constant prices, which means “in real terms”,
over the years gives the measure of real growth.

After revision in method of GDP calculation, growth rate will now be measured by
“GDP at constant market prices”, which means market prices of base year.
Previously, the method used was “GDP at constant factor cost”.

The method to calculate sector wise estimates of Gross value added has also been
changed. Previously, it was GVA at factor cost, but now it has been changed to GVA
at basic prices.

GVA at basic prices

To understand relation between market price, basic prices and factor cost, it is
important to understand product taxes and subsidies as well as production taxes and
subsidies.

Notes National Income Accounting 34

 💡 Production taxes and subsidies:

Production taxes and subsidies are those that are levied or received with
relation to production. They are independent of volume/ quantity of
production.

For example, stamp duty and professional tax are charged irrespective of
volume of activity. subsidies to farmers, small industries, railway subsidies
etc.

Product taxes and subsidies:

Product subsidies and taxes are those that are levied or received on per
unit of product.

For example, food subsidy, petroleum subsidy, interest subsidy etc. GVA at
basic prices takes into consideration “production taxes and subsidies”.

GVA at basic prices = (employee compensation + mixed income of self exployed +

operating surplus) + (production taxes – production subsidies)

Efforts have been made to implement recommendations of the System of National

Accounts (SNA) 2008 to bring GDP calculation in line with global practices. This will
make the estimates more comparable over space and time.

There are many unincorporated enterprises, which tend to behave in the same way
as corporations. These enterprises are called as “quasi corporations” as per SNA
2008. The new method has expanded the list of enterprises to be included under
“quasi corporations”. As India has a large base of unincorporated, household run
enterprises, expansion of the list would give a clearer picture of GDP.

Under the older method, private corporate sector series was covered on the basis of
financial results of around 2500 companies. In the new series, a comprehensive
coverage of corporate sector has been ensured by analyzing 5 lakh companies.

Earlier, estimates for local bodies and autonomous institutions were prepared on the
basis of information received for seven autonomous institutions and local bodies of
four states. In the new series, there has been an improved coverage of local bodies
and autonomous institutions, covering around 60% of the grants/transfers provided
to these institutions.

The GDP data revision will also incorporate the new CPI (CPI- Combined) instead of
the previous practice of using CPI for various groups such as agricultural laborers
and industrial workers.

Reasons for change in GDP estimates as per new method:

Notes National Income Accounting 35

 Composition of various activities between the two Series- The weighting pattern of
various activities in the GVA in the old and new series for the year 2011-12 also
influences to some extent the overall growth rate in GVA.

Marked changes have been observed in the shares of two major industries, namely,
‘manufacturing’ and ‘trade’. In the case of manufacturing, with the availability of the
MCA21 database (5 lakh enterprises), coverage of the activities other than
manufacturing in the companies has improved significantly.

Estimates of ‘trade and repair services’ has become lower than in the old series
because Trade carried out by manufacturing companies, which has now become
part of ‘manufacturing’, was earlier covered in ‘trade’.

Weights of various sectors at current prices in the new and old series:

Industry 2004-05 series 2011-12 series

Agriculture, forestry and fishing 17.9 18.4

Manufacturing 14.7 18.1

Trade, repair, hotels and restaurants 17.4 10.8

Transport, storage, communication &

7.3 6.5
services related broadcasting

Mining and quarrying 2.7 3.2

Electricity, gas, water supply & other utility

1.6 2.4
services

Construction 8.2 9.4

12.0 Green GDP

Definition: Green GDP reflects a country's economic growth while considering its
environmental impact, adjusting conventional GDP figures to include the
environmental costs of economic activities.

This helps see if a country is moving towards a sustainable economy or not.

Calculation of Green GDP:

First, in estimating the national income, the costs of pollution of air and water by
the firms in the production process of goods must be subtracted to arrive at the
Green GDP.

Second, in order to arrive at the Green GDP, depletion of natural resources for
generating income should also be accounted in the calculation of the National
Income.

Notes National Income Accounting 36

 13.0 Social Accounting
Origin - Term coined by JR Hicks in 1942

Social accounting is that branch of accounting which is concerned with the

functioning of the economic system as a whole. It may be considered to be
‘nothing else but the accounting for the whole community or nation, just as private
accounting is the accounting of the individual firm’.

In the current times, social accounting is a branch of accounting that involves

communicating the social and environmental effects of an organization's
economic actions to society.

14.0 Sectoral Classification as per MoSPI

Primary Sector: Agriculture, Livestock, Forestry & Fishing and Mining & Quarrying.
Secondary Sector: Manufacturing, Electricity, Gas, Water supply & Other Utility Services
and Construction.
Tertiary Sector: Trade, Hotels, Transport, Communication and Services related to
Broadcasting, Financial, Real Estate & Professional Services and Public Administration,
Defence & Other Services.

Notes National Income Accounting 37