National Income Accounts
National Income Accounts
National Income Accounts
(c) types of transactions, such as sales and purchases of goods and services, gifts,
taxes, and other current transfers.
(i) In the first account, incomes and outgoings relating a productive activity of
the transactor are brought together. The difference between the two shows the
profit or gain.
(ii) The second account seeks to show how this profit and any other income that
accrues to the transactor are allocated to different uses. The excess of income
over outlay is saving.
(iii) The third account shows how this saving and any other capital funds are used
to finance the capital expenditure or to give loans to other transactors.
Since in an economy, there are numerous transactors, therefore, they are grouped into
sectors. In a sector, accounts of a same type are consolidated. The ‘sector accounts’ form
the units in a system of national income accounting.
(a) Double entry book-keeping: Both national income accounting system and
individual income accounting system are based on the method of double-entry
book-keeping. For example, under individual income accounting, a cash sale is
recorded as a debit in Cash Account and as a credit in Sales Account. Whereas, in
national income accounting, the cash transactions are not separately presented.
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Cash balances are recorded in the capital transaction account. The difference is
that the national income accounting does not record the second entry in detail.
(c) Profit and loss account: Individual income accounts are usually presented in the
form of a Profit and Loss Account or Income Statement which shows the flow of
income and its allocation during a year. The Balance Sheet shows the stock of
assets and liabilities at the end of the year. The Profit and Loss Account of a
private businessman resembles in national income accounting to what is called the
Appropriation Account. The only difference is that in private accounting, the
profit often includes some elements of costs such as depreciation on plant and
machinery and fees paid to the directors of the company. On the other hand, in
national income accounting, these incomes are shown net. There is no
counterpart at all of a Balance Sheet in national income accounting since there is a
great difficulty in collecting such a huge bank of data accurately and completely
especially on uniform basis.
(a) Clear picture of the economy: The national income accounts or social accounts
give a clear picture of the economy regarding the GDP, national income, per
capita income, saving ratio, production, consumption, disposable income, capital
expenditure, etc. It gives a clear view of the health of the economy and the way
in which it functions. It also gives a view on the living standard of the people.
(b) Promotion of efficiency and stability of the economy: To foster the economic
growth, any government has to see what she has achieved in the past and what has
to be done in the future. For this purpose, the preparation of national income
accounts is quite inevitable for the promotion of economic efficiency and stability.
It helps the government to set the national priorities, such as education, inflation,
unemployment, defence, social development, and industrialisation, etc., in long-
term and medium-term planning. It also helps the planner to set the economic
objectives to be achieved in the near future. Thus it serves the purpose of
planning and controlling tool for public administrators.
(e) Monetary, fiscal and trade policies: The national income accounts are very
essential for the statesmen, governments, and politicians, because they help them
to efficiently formulate different economic policies, including monetary policy,
fiscal policy and trade policy. In the absence of national income accounts, the
economic planning would be disastrous.
(a) What is the output of the economy, its size its composition, and its uses? And
(b) What is the economic process by which this output is produced and distributed?
These questions are addressed below in relation to estimation of GDP/GNP and
final uses of the GNP.
The gross national product (GNP) is the market value of all final goods and services,
produced in the economy during a year. GNP is measured in Rupee terms rather than in
physical units of output. Gross domestic product (GDP) is a better idea to visualize
domestic production in the economy. GDP may be derived in three ways or in
combination of them.
(iii)Expenditure Approach: This approach looks at the final uses of the output for
private consumption, government consumption, capital formation and net of
imports & exports. According this approach, GDP is the sum of following four
major components:
The concepts of expenditure approach and cost approach have been illustrated in the
following diagram of circular flow of aFinal goods and services
simplified
(Bread, cars,two-sector
etc.) economy:
Households Business
Productive services
(Labour, land, etc.)
In the above diagram, the upper loop represents the ‘expenditure’ side of the economy.
Through this loop, all the products flow from business sector to household sector. Each
year the nation consumes a wide variety of final goods and services: goods such as bread,
apples, computers, automobiles, etc.; and services such as haircuts, health, taxis, airlines,
etc. But we include only the value of those products that are bought and consumed by the
consumers. In our ‘two-sector economy’ illustration, we have excluded the investment
expenditure, government expenditure and taxes from GDP calculation.
The lower loop represents the ‘cost or revenue’ side of the economy. Through this loop,
all the costs of doing business flow. These costs include wages paid to labour, rent paid
to land, profits paid to capital, and so forth. But these business costs are revenues that are
received by households in exchange of supplying factors of production to the business
sector.
(a) Reliable source of data: All the data for national accounts are collected from
different sources, including surveys, income tax returns, retail sales statistics, and
employment data. Inaccurate or incomplete data can severely damage the
integrity of the national accounts. The economists have to be very careful in
collection and selection of national income accounting data.
(i) Final product: A final product is one that is produced and sold for
consumption or investment.
(iii) Raw material: Raw materials are unfinished and unprocessed goods.
(a) Problem of Including All Inventory Change in GNP: Firms generally record
inventories at their original cost rather than at replacement costs. When prices
rise, there are gains in the book value of inventories but when prices fall, there are
losses. So, the book value of inventories overstates or understates the actual
inventories. Thus, for correct computation of GNP, inventory evaluation is
required. This is achieved when a negative valuation of inventory is made for
inventory gains and a positive valuation is made for losses.
(c) Exclusion of Capital Gain or Losses from GNP: Capital gain or losses accruing
to property owners by increase or decrease in the market value of their asset are
not included in GNP computation because such changes do not result from current
economic activities. Such exclusions underestimate or overestimate the GNP.
(d) Value added: ‘Value added’ is the difference between a firm’s sales and its
purchases of materials and services from other firms. In calculating GDP
earnings or value added to a firm, the statistician includes all costs that go to
factors other than businesses and excludes all payments made to other businesses.
Hence business costs in the form of wages, salaries, interest payments, and
dividends are included in value added, but purchases of wheat or steel or
electricity are excluded from value added. The following table illustrates the
concept of value addition in GDP:
Table
Bread Receipts, Costs, and Value Added
Rupees Per Loaf
(1) (2) (3)
Value
Stages of Cost of Added
Sales
Production Intermediate (wages,
Receipts
Materials profit, etc.)
(1 – 2)
Wheat 2.00 0 2.00
Flour 5.50 2.00 3.50
Baked dough 7.25 5.50 1.75
Delivered bread 10.00 7.25 2.75
Total 24.75 14.75 10.00
• All public transfer payments, which do not add to the current flow of
goods such as social security payments, relief payments, etc.
NNP equals the total final output produced within a nation during a year, where output
includes net investment or gross investment less depreciation. Therefore, NNP is equals
to:
It is the net market value of all the final goods and services produced in a country during
a year. It is obtained by subtracting the amount of depreciation of existing capital from
the market value of all the final goods and services. For a continuous flow of money
payments it is necessary that a certain amount of money should be set aside from the
GNP for meeting the necessary expenditure of wear and tear, deterioration and
obsolescence of the capital and ‘it should remain intact’.
In the above definition, the phrase ‘maintaining capital intact’ is meant to make good the
physical deterioration which has taken place in the capital equipment while creating
income during a given period. This can only be made by setting aside a certain amount
of money every year from the annual gross income so that when the income creating
equipment becomes obsolete, a new capital equipment may be created out. If the
depreciation allowance is not set aside every year, the flow of income would not remain
intact. It will decline gradually and the whole country will become poor.
Personal Income:
Personal Income is the total income which is actually received by all individuals or
households during a given year in a country. Personal income is always less than NI
because NI is the sum total of all incomes earned, whereas, the personal income is the
current income received by persons from all sources. It should be noted here that all the
income items which are included in NI are not paid to individuals or households as
income. For instance, the earnings of corporation include dividends, undistributed profits
and corporate taxes. The individuals only receive dividends. Corporate taxes are paid to
government, and the undistributed profits are retained by firms. There are certain income
items paid to individuals, but not included in the national income, commonly known as
‘transfer payments’. Transfer payments include old age benefits, pension, unemployment
allowance, interest on national debt, relief payments, etc. Personal income can be
measured as follows:
GNP GNP NNP NI PI DI
Personal Income
Expenditure = NI at Factor
Income/Cost National CostNational
– Contributions
Personal to Social Insurance –
Disposable
Approach Approach Product Incom e Incom e IncomPayments
e
Corporate Income Taxes – Retained Corporate Earnings + Transfer
Wages Wages
Disposable Income: Wages Wages
Disposable income is that Rent
Rent income which is left Rent
with theRent
individuals after paying taxes to
the government.
Personal The individuals
Interest
can spend this amount
Interest as they please. However, they
Interest
Cons. Interest
can spendExpenditure
in categorically two ways, i.e.,
Dividends either they can spend
Dividends
on consumption goods, or
Consumption
Dividends
they can save. Therefore, the disposable personal income is equal to:
Dividends
Income of Income of
Income of Unincorp. Income of
Unincorp. Unincorp.
Disposable Income Business
= Unincorp. Income
Personal Business– Personal Taxes
Business Business
Government
Purchases Corporate Savings
Corporate Income Corporate
Income Taxes or
Income
Subsidies
Taxes Taxes
Social Transfer
Gross Disposable
Social Income
Security = Consumption
Social Payments
+ Saving
Security Security Personal
Private Contribution
Contribution Taxes
Domestic Contribution
Investment Undistributed
Undistributed Corporate Undistributed
Corporate Profits Corporate
Profits Profits
Indirect
Indirect Business
Business Taxes Subsidies
Net
Taxes
Foreign
Investment
Depreciation
(a) GDP Deflator: The problem of changing prices is one of the problems
economists have to solve when they use money as their measuring rod.
Clearly, we want a measure of the nation’s output and income that uses an
invariant yardstick. This problem can be solved by using ‘price index’,
which is a measure of the average price of a bundle of goods. The price
index is used to remove inflation from GDP or to deflate the GDP, that is
why, it is also called ‘GDP deflator’. The function of GDP deflator is to
convert the ‘nominal GDP’ or the ‘GDP at current prices’ to ‘real GDP’.
The formula of real GDP is as follows:
or
Q = PQ
P
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Nominal GDP or PQ represents the total money value of final goods and
services produced in a given year, where the values in terms of the market
prices of each year. Real GDP or Q removes price changes from nominal
GDP and calculate GDP in constant prices. And the GDP deflator or P is
defined as the price of GDP.
Example:
A country produces 100,000 litres of coconut oil during the year 2005 at a price of Rs. 25
per litre. During the year 2006, she produces 110,000 litres of coconut oil at a price of
Rs. 27 per litre. Calculate nominal GDP, GDP deflator and real GDP (using 2005 as base
year).
Solution:
Nominal GDP:
Price × Quantity
Price Quantity
Year PQ
P Q
Nominal GDP
2005 25 100,000 2,500,000
2006 27 110,000 2,970,000
Hence, during 2006, the nominal GDP grew by 18.8%.
GDP Deflator:
Real GDP:
Real GDP
Nominal GDP GDP Deflator
Year (PQ/P)
PQ P
Q
2005 2,500,000 1 2,500,000
2006 2,970,000 1.08 2,750,000
Hence, during 2006, the real GDP grew by 10%.
(ii) Net investment: Gross investment does not adjust the deaths of capital
goods; it only takes care of the births of capital. However, the net
investment takes into account the births as well as deaths of capital
goods. In other words, net investment is adjusted for depreciation.
Therefore, the net investment plays a vital role in estimating national
income:
(b) Net Exports: ‘Net exports’ is the difference between exports and imports
of goods and services. Pakistan is facing negative net export situation
since her birth, except for few years. The biggest reason is that Pakistan is
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