MACROECONOMICS NATIONAL INCOME ACCOUNTING

National Income Accounting

Basic Concepts of Macroeconomics

Concept and Types of Goods

Goods produced in an economy are generally classified as final goods and intermediate goods.

Final Goods
Goods which have crossed the boundary line of production and are readily available for use by their final
users are termed as final goods. Consumers and producers are the two types of final goods.

Intermediate Goods
Goods which are within the boundary line of production, the value is yet to be added to these goods and
are not available for use by their final users are called intermediate goods. These goods are consumed by
another firm and used as intermediate goods in the production process or for further sale. For example,
papers purchased by newspaper agency for printing news are intermediate goods.

Expenditure on intermediate goods by the producers during an accounting year is called intermediate
consumption.
Value of output– Intermediate consumption = Gross Value Addition or Gross Product of the Users

Differences between Intermediate Goods and Final Goods

Intermediate Goods Final Goods

These goods are mostly used as raw material for These goods are not used as raw material for the
the production of other goods during an production of other goods during an accounting
accounting year year
These goods may be used for further sale to earn These goods are not used for further sale to earn
profit during an accounting year profit during an accounting year
These goods are within the boundary line of These goods are outside the boundary line of
production process production process
These goods are still in the process of value A value addition is not required to these goods and
addition and are not available for use by their final is available for use by their final users
users
These goods are not included in the estimation of These goods are included in the estimation of
national income national income

Consumer Goods or Consumption Goods

Final consumer goods are purchased by the consumer for the satisfaction of their wants. They are the
final users of food stuffs, dress material and other accessories. Final users of consumption goods are
consumer households, general government or government welfare agency and non-governmental
organisations.

www.topperlearning.com 2
MACROECONOMICS NATIONAL INCOME ACCOUNTING

Classification of Consumption Goods

 Durable consumer goods are those goods which can be used for several years and are of relatively
high value. Examples are television, washing machine and air conditioner.
 Semi-durable consumer goods are those goods which can be used for a period of one year or slightly
more. Examples are clothes, furniture and crockery.
 Non-durable or single use consumer goods are those goods which are used in a single act of
consumption. Examples are bread, ink, petrol and milk.
 Services are those non-material goods which directly satisfy human wants. Examples are doctor,
lawyer and domestic servant.

Producer Goods or Capital Goods

Final producer goods are purchased by the producers in the production process for several years and are
of high value. These goods are fixed assets of the producers such as land, building and machineries.

All capital goods are producer goods but all producer goods are not capital goods
Producer goods includes goods used as raw material such as papers for print media to print newspapers,
journal, books and magazines and also goods used as fixed assets such as land, building and machinery.
Capital goods include only the fixed assets of producers. These goods are used as durable use producer
goods, whereas the goods used as raw material are single use producer goods. These goods cannot be
used again in the production process. Therefore, all capital goods are producer goods but all producer
goods are not capital goods.

Expenditure incurred on final consumer goods by the households is called consumption expenditure,
whereas expenditure on final goods by the producers is called investment expenditure.

Concept and Types of Investments

Investment is a process of capital formation or a process of increase in the stock of capital.

I = ∆K
Where, I = Investment, K Capital stock, ∆K = Change in capital stock during the year.

Change in the stock of capital is also called capital formation. The two components of investment are fixed
investment and inventory investment.
www.topperlearning.com 3
MACROECONOMICS NATIONAL INCOME ACCOUNTING

Fixed Investment and Inventory Investment

 Fixed investment means an increase or addition in the stock of fixed assets of the producers during an
accounting year.

Fixed Investment = Stock of fixed assets with the producers at the end of the accounting year – Stock of
fixed assets with the producers at the beginning of the year = Increase in the stock of fixed assets with the
producers during an accounting year.

 Inventory investment means the stock of finished goods, semi-finished goods and the raw material. It
keeps varying over a period.

Inventory Investment = Inventory stock at the end of the accounting year – inventory stock at the
beginning of the accounting year = Change in inventory stock during an accounting year.

Net Investment, Gross Investment and Depreciation

Expenditure on the purchase of fixed assets or on inventory stock during the year is called gross
investment. It also includes expenditure on the purchase of new assets in place of worn-out assets.
Replacement of fixed assets owing to their depreciation is a part of gross investment. This will not cause
any net increase in the existing stock of capital. If expenditure on the replacement of worn out fixed assets
are excluded from gross investment, we get net investment. Net investment implies net addition to the
stock of capital.

Net investment = Gross investment – Depreciation

Gross investment = Net investment + depreciation

Depreciation is the loss of value of fixed assets in use because of normal wear and tear, normal rate of
accidental damages and expected or foreseen obsolescence. It is also called as consumption of fixed
capital. Because of depreciation, fixed assets are to be replaced after a certain period. A provision of fund
is required to meet the replacement cost of fixed assets. This is called depreciation reserve fund.

www.topperlearning.com 4
MACROECONOMICS NATIONAL INCOME ACCOUNTING

Stocks, Flows and Circular Flow of Income and Methods

Stocks and Flows

A stock is a quantity measured at a particular period of time. For example, amount of money in a bank
account at particular period of time.
A flow is a quantity measured over a specified period of time. For example, amount of interest received
against the bank deposits.

Difference between Stock and Flow

Stock Flow
Stock is measured at a point of time. For example, Flow is measured over a period of time. For
savings as on June, 2015 are Rs.1000 example, monthly expenses of Rs. 500.
Stock is not time dimensional Flow is time dimensional such as per month and
per year
Stock influences the flow. More the stock of capital, Flow influences the stock. For example, monthly
more is the flow of goods and services. increase in the supply of money increases the
quantity of money.
Some concepts in Economics do not have their Imports and exports are used as flow concepts
stock aspect such as imports and exports

www.topperlearning.com 5
MACROECONOMICS NATIONAL INCOME ACCOUNTING

Circular Flow of Income

Circular flow of income refers to the unending flow of activities such as production, income generation and
expenditure involved in all the sectors of the economy.

Three Phases of Circular Flow

The production of goods and services causes

Production
generation of income. Income causes expenditure. of Goods
When demand increases, expenditure causes and
Services
production again. This leads to generation and
disposition of income again. The flows of
production, income and expenditure form
circularity with no end and beginning. Thus, it is
called circular flow. Different Phases
 Production aspect states the flow of goods and of Circular Flow
of Income
services in the economy or the process of
value adding. Generation Expenditure
 Income or distribution aspect states the or
Disposition
or
Disposition
distribution of income in terms of wage, rent, of Income of Income

interest and profit.

 Expenditure or disposition aspect states the
disposal of income in terms of consumption
expenditure or investment expenditure.

Circular Flow Model in a Two-Sector Economy

In a simple economy, there are firms and household sectors’ economic activity. People from households
render factor services to firms and firms hire factor services from households. Households spend their
earned income completely on consumption. Products which are produced by firms are sold to consumers.
Assume that there is no external trade and government in an economy, then:

 Total production of goods and services by firms are equal to the consumption of goods and services
by firms

www.topperlearning.com 6
MACROECONOMICS NATIONAL INCOME ACCOUNTING

 Factor payments by firms are equal to the factor incomes of the household sector
 Consumption expenditure of household sector is equal to income of the household sector
 Money flows are opposite to real flows because factor services flows from households to firms are real
flows and the factor payments made by firms to households are money flows

Leakages and Injections in a Circular Flow

Injections are those flow variables which cause an expansion in the process of production or the income
generation in the economy. Investments, exports and consumption expenditure on goods and services by
the household or the government are the expenditure variables on goods and services produced in the
economy. It affects the economy as it increases the volume of production and generation of demand for
production of goods and services.

Leakages are those flow variables which have a negative impact on the process of production in the
economy. Savings, imports and tax by the government are the variables which reduce the flow of income
in the economy.

National Income and its Methods of Calculation

The three phases of the circular flow of income are the different methods of explaining the concept of
national income or national product. Phase I is the value addition or production of final goods and services
which is converted into factor incomes in Phase II and factor incomes are converted into expenditure on
final goods and services in Phase III. Hence, these three phases of circular flow of income is measured
through three methods - product or value added method, expenditure method and income method.

Basic Concepts

 Gross and Net Income

Gross income is inclusive of depreciation and/or consumption of fixed capital. Net national income does
not include depreciation.
Gross national income – Depreciation = Net national income
Gross domestic income – Depreciation = Net domestic income

 Market Price and Factor Cost

National income may be explained in terms of market price or factor cost such as national income at
market price or national income at factor cost.
Market price includes the impact of subsidies which tend to lower it and indirect taxes which tend to raise
it. Factor cost is free from the impact of subsidies and indirect taxes.
National income at market price – Indirect taxes + Subsidies = National income at factor cost. (Or)
National income at market price – Net indirect taxes = National income at factor cost.

 Factor income/payment and transfer income/payment

Factor incomes are incomes received by the owners of factors of production i.e. households for rendering
their factor services to the producers. Because of this real factor services, there is a money flow from
producers to the households in the form of rent, interest, profit and wages. Hence, there is production of
goods and services in an economy.
www.topperlearning.com 7
MACROECONOMICS NATIONAL INCOME ACCOUNTING

Transfer payments are charity or grant from one sector to the other sector which do not cause the
production of goods and services in the economy. It only transfers income from one sector to the other
sector without any return.

Concepts of National Income

 National income in terms of production of goods and services

National income is the market value of final goods and services produced in an economy during the
period of an accounting year.

 National income in terms of factor incomes

National income is the sum total of factor incomes earned by normal residents of a country during an
accounting year as rewards for rendering their factor services.

 National income in terms of expenditure of income

National income is the sum total of the final consumption expenditure and investment expenditure in an
economy during an accounting year.

 Gross Domestic Product at market price

GDPMP is the market value of the final goods and services produced within the domestic territory of a
country.

 Gross National Product at market price

GNPMP is the market value of the final goods and services produced by normal residents of a country
during an accounting year.
Net factor income from abroad = Factor income earned by our residents from abroad – Factor income
earned by non-residents within our country.
Components of net factor income from abroad are net compensation of employees, net income from
property and entrepreneurship and net retained earnings of resident companies abroad.
Gross Domestic Product at market price + Net factor income from abroad = Gross National Product at
market price

 Net National Product at market price

NNPMP is the market value of the final goods and services produced by normal residents of a country
during an accounting year, exclusive of depreciation.
NNPMP = GNPMP – Depreciation

 Net Domestic Product at factor cost

NDPFC is the sum total of factor incomes, profit, wages, interest and rent generated within the domestic
territory of a country during a year.
NDPFC = NDPMP – Indirect taxes + Subsidies (Or) NDPFC = NDPMP – Net indirect taxes

 Gross Domestic Product at factor cost

GDPFC is the sum total of factor incomes, profit, wages, interest and rent generated within the domestic
territory of a country, along with the consumption of fixed capital during a year.
NDPFC + Depreciation = GDPFC
GDPFC - Depreciation = NDPFC

www.topperlearning.com 8
MACROECONOMICS NATIONAL INCOME ACCOUNTING

 Net National Product at factor cost

NNPFC is the sum total of factor incomes earned by normal residents of a country during the period of an
accounting year.
NNPFC = NDPFC + Net factor income from abroad

 Gross National Product at factor cost

GNPFC is the sum total of factor incomes earned by normal residents of a country, including the
depreciation during an accounting year.
GNPFC = NNPFC + Depreciation

 National Disposal Income

National disposal income is the income from all sources which is the earned income as well as transfer
payments from abroad available to residents of a country for consumption expenditure or for saving during
a year.
National disposal income = National income + Net indirect taxes + Net current transfers from rest of the
world.

 Factor income from net domestic product accruing to private sector

Factor income from net domestic product accruing to private sector includes that part of net domestic
product which accrues to private sector. It excludes property and entrepreneurial income of the
government departmental services and saving of the non-departmental enterprises.

 Private income
Private income is the total of factor income from all sources and current transfers from the government
and rest of the world accruing to private sector.
Private income from net domestic product accruing to private sector + Net factor income from abroad +
Interest on national debt + Current transfers from government + Current transfers from rest of the world.

 Personal income
Personal income is the income actually received by the individuals and households from all sources in the
form of factor income and current transfers.
Personal income = Private income – Undistributed profits (Corporate saving) – Corporation tax

 Personal disposable income

Personal disposable income is the income remaining with individuals and households after deduction of
all taxes levied against their income and their property by the government which they use for consumption
expenditure or savings.
Personal disposable income = Personal income – Direct personal tax – Miscellaneous receipts of the
government administrative department or fees and fines paid by the households.

Methods of Measuring National Income

Based on the circular flow of income and the aggregate value of goods and services produced in an
economy national income can be calculated by the following 3 methods:
 Product or value added method
 Expenditure method
 Income method
www.topperlearning.com 9
MACROECONOMICS NATIONAL INCOME ACCOUNTING

Measurement of National Income using Product or Value Added Method

Product method is a method which measures domestic income by estimating the contribution of each
producing enterprise to production in the domestic territory of the country during an accounting year.

Value added means the difference between the value of output of an enterprise and the value of its
intermediate consumption.

Intermediate consumption refers to value of non-factor inputs which includes value of raw material used in
the process of production.

Gross value added by all the producing enterprises within the domestic territory of a country during an
accounting year is called Gross Domestic Product at market price (GDPMP).

Gross Domestic Product at market price (GDPMP) = Gross value added by all producing enterprises within
the domestic territory of a country during an accounting year

Net Domestic Product at market price (NDPMP) = Gross value added by all producing enterprises within
the domestic territory of a country during an accounting year – Depreciation

Net Domestic Product at factor cost (NDPFC) = NDPMP – Indirect taxes

Net National Product (NNPFC) or National income = NDPFC + Net factor income from abroad

Measurement of National Income using Expenditure Method

Expenditure method is a method which measures national income in terms of expenditure on the
purchase of final goods and services produced in the country during an accounting year.

Final expenditure during an accounting year is equal to GDPMP. It is broadly classified into four categories:
 Private final consumption expenditure (c) refers to expenditure on final goods and services by the
individuals, households and non-profit private institutions serving society.
 Government final consumption expenditure (G) refers to expenditure on final goods and services by
the government.
 Investment expenditure (I) refers to expenditure on final goods by the producers. Further, these goods
are used in the production process. Investment is classified into fixed investment and inventory
investment. Fixed investment refers to expenditure on the purchase of fixed assets and inventory
investment refers to change in stock during the year.
 Net exports (X – M) refer to the difference between exports and imports during an accounting year.

Sum total of expenditure on the domestically produced goods and services during an accounting year is
called GDPMP.

GDPMP = Final consumption expenditure + Gross domestic capital formation + Net export.
Where,
Private final consumption expenditure + Government final consumption expenditure is the Final
consumption expenditure,

www.topperlearning.com 10
MACROECONOMICS NATIONAL INCOME ACCOUNTING

Gross domestic fixed capital formation + Change in stock is the government is the Gross domestic capital
formation and exports – imports is the net exports.

NDPMP = GDPMP – Depreciation

NDPFC = NDPMP – Indirect taxes

NNPFC = NDPFC + Net factor income from abroad

Measurement of National Income using Income Method

Income method is a method to measure national income in terms of factor payments to the owners of
factors of production during an accounting year.
Domestic income is estimated as the sum total of factor incomes generated within the domestic territory of
a country during an accounting year. A factor income refers to income earned as a reward for rendering
his or her factor services. Factor incomes are classified as compensation of employees, operating surplus
and mixed income.
Compensation of employees includes wages, salaries in cash or in kind, employer’s contribution to social
security schemes and pension on retirement.
Operating surplus refer to income from property and entrepreneurship. It includes rent, interest and profit.
Further, profit is classified into dividends, corporate profit tax and undistributed profit.
Mixed income is the income of the self-employed persons using their own land, labour capital and
entrepreneurship to produce goods and services. These incomes are a mixture of wages, rent, interest
and profit.

NDPFC is the sum total of factor incomes generated within the domestic territory of a country during an
accounting year. It is also known as domestic income.
NDPFC = Compensation of employees + Operating surplus + Mixed income

NNPFC = NDPFC + Net factor income from abroad.

Nominal GDP and Real GDP

 Nominal GDP refers to market value of final goods and services produced within the domestic territory
of a country during an accounting year as estimated with the current year’s prices. Hence, it is called
GDP at current price of monetary GDP.

 Real GDP refers to market value of final goods and services produced within the domestic territory of
a country during an accounting year as estimated with the base year’s prices. Hence, it is called GDP
at constant price.
Real GDP = Nominal GDP / Current Price index * 100

 Consumer Price Index measures changes in the price level of a market basket of consumer goods and
services purchased by households.

 Wholesale Price Index is the representative basket of wholesale goods. It is also known as producer
price index.
 GNP deflator measures the average level of the prices of all goods and services produced in a country
during an accounting year.
GNP deflator = Nominal GNP / Real GNP * 100

www.topperlearning.com 11