As you know Economy as a subject has always been a traditional bottleneck for Civil Services aspirants. This is because most of us did not study it during our school days.
So in this series of articles, we will be taking up the numerous economic jargon, one by one and try to simplify them for you.
We aim to do the above by explaining various economic terms in a simple and a lucid manner. This will be especially beneficial for the students who are going to give their first attempt.
In this article we will discuss the concepts related to National income aggregates. This is the first post in this series of Articles.
Table of Contents
- Concepts and aggregates related to National Income
- Few Concepts to know
- Methods of Measuring National Income
- Changes in the calculation of GDP Post 2015
- Drawbacks of measuring economic growth in GDP
- Other ways to measure growth
We will cover the above 6 topics in two posts. In this post we will be covering Topic 1 and Topic 2.
What is National Income Accounting?
National Income Accounting refers to a set of rules and techniques that are used to measure the output of a country. Various macroeconomic identities like GDP,GVA, NNP are used for calculation of national income. Now let’s understand each one of them clearly.
1. Concepts and aggregates related to National Income
1.1 Gross Domestic Product (GDP)
1.1.1 Measuring the size of Economy : Gross Domestic Product
What if somebody asks you – How big is Indian Economy? The question here is how do you measure the overall size of an economy of a nation
The size of a nation’s overall economy is typically measured by its Gross Domestic Product (GDP). It involves
- Counting of all the the production of goods and services (such as – smart phones, laptops, cars etc) within the nation’s boundary
- Finding their market value.
GDP is the market value of all the final goods and services produced within a country for a given time period.
1.1.3 Breaking Down the Definition
The following things must be kept in mind while calculating the GDP of a country
- The word “domestic” in Gross Domestic Product pertains to the fact that only the goods and services produced within a country are counted in the GDP.For example – an Indian company – Haldiram produces potato chips and USA company PespiCo also produces potato chips in India. Since both these companies produce Chips within India – their product will be considered for calculation of GDP of India. Similarly – Tata motors producing Car in Gujarat is counted in India’s GDP. But, Tata motors producing Car in UK is not counted in India’s GDP
- Only ‘final’ goods and services are included in the calculation of GDP. A final goods and services means goods and services meant for final consumption (for final user). It is unlike the intermediate goods and services which acts as component for final goods and services.
- Goods and Services produced during a certain period (usually an year) is counted. In India, GDP is computed quarterly and yearly.
1.2 Gross National Product (GNP)
GNP is another measure for National Income of the country.
Indian economy is not closed economy but an open economy. India has transactions with the rest of the world in the form of exports, imports loans etc. This give rise to the concept of national or domestic Income.
In case of GDP, we calculate the market value of all the final goods and services produced within the country.
However, It may be the case that resident of India work and earn in some other foreign countries. Similarly, Conversely, some production taking place within a country may be attributed to temporary and seasonal foreign labour.
This is measured by the Gross National product.
It is measured as the GDP plus the Net Factor income from Abroad
|GNP = GDP + ‘Net’ factor income from abroad|
Net Factor income from abroad = income earned by the domestic factors of production employed in the rest of the world – Factor income earned by the factors of production of the rest of the world employed in the domestic economy.
For example, in case of India
Net Factor Income from abroad will be = income earned by Indian resident in foreign countries – Income earned by foreign resident in India.
Let us understand this through an example.
Many Indians reside and work in Saudi Arabia. They earn their wages in the same country. The wages earned by Indians in Saudi Arabia will be counted in the Saudi Arabia’s GDP. It will not be counted in the India’s GDP
Similarly, Switzerland firm Nestle produces Maggi in in India. This will be counted in the Indian’s GDP.
Gross national Product provides a way to capture the trans boundary economic activity of nationals.
For example –
Profits earned by Chinese Company Xiaomi by selling smartphones in India will not be included in the GNP of India. Similarly, Profits earned by ONGC Videsh from its subsidiaries in different countries will be included in the GNP of India.
1.3 Net National Product (NNP)
Factors of production under go wear and tear. This wear and tear is called Depreciation. A part of capital is used for this wear and tear which is not used in production of goods and services.
If we deduct depreciation from the GNP, we get is NNP
|Net National Product (@Market Price) = Gross National Product – Depreciation|
|NNP (@Factor Cost) = NNP (@Market Price) – Taxes + Subsidies|
The Net National Product at factor cost is known as National Income (as mentioned in the class XI NCERT)
However, the Central Statistics Office (CSO) under the Ministry of Statistics and Program Implementation defines National Income of India as Net National Income at Market Price
1.4 Personal Income (PI)
Personal Income is the part of National Income which is received by the households.
The formula for calculating Personal Income (PI) is
|Personal income (PI) ≡ NI – Undistributed profits – Net interest|
payments made by households – Corporate tax + Transfer payments to
the households from the government and firms.
1.5 Personal Disposable Income
Personal Disposable Income refers to the income that is available to the households that they can spent as they wish.
All the Personal Income is not available to individuals to spend. They have to pay taxes (eg – Income tax) and non tax payment such as fines.
The formula for Personal Disposable Income is
|Personal Disposable Income (PDI ) ≡ PI – Personal tax payments – Non-tax payments (such as fines etc)|
Thus, Personal Disposable Income is the part of aggregate income which belong to the households. They may decide to consume a part of it, and save the rest.
1.6 National Disposable Income
National Disposable Income gives us an idea of what is the maximum amount of goods and services the domestic economy has at its disposal
The formula for National Disposable Income is
|National Disposable Income = Net National Product at market prices + Other current transfers from the rest of the world|
1.7 Private Income
The formula for Private Income is
|Private Income = Factor income from net domestic product accruing to the private sector + National debt interest + Net factor income from abroad + Current transfers from government + Other net transfers from the rest of the world|
2. Few important concepts to know
2.1 Gross vs Net value added
Production factors such as machines, equipment, tools, factory buildings, tractors etc depreciate over a period of time during the process of production. It may be the case that after certain time these capital goods needs replacement.
The capital used for the this wear and tear and is not part of any body’s income.
Thus we subtract depreciation from the GDP to get Net GDP
Net GDP = GDP – Depreciation
Similarly, Net National Product (NNP) = GNP – depreciation
2.2 Current vs Constant Prices
National income can be measured in terms of money in two ways –
- At Current Prices
- At Constant Prices
2.2.1 National Income at Current Prices [Nominal National Income]
It means that goods and services which are produced in an year are valued at prices prevailing that year.
Current prices refer to the prices prevailing in the year in which goods and services are produced.
For example – when goods and services produced during the year 2018-19 are valued at prices of the same year i.e. 2018-19, it will be called National Income at current prices for the year 2018-19
In Simple Terms
National Income at current prices = Final goods and services produced in an year * Prices of goods and services in that year
Thus we see that in determining national income at current prices, not only physical output produced during the year is important, but also the prices prevailing in that year are equally important.
The National Income at Current Prices is also called Nominal National Income
National Income at current prices is affected by two factors –
- Change in output (amounts of goods and services produced)
- Change in prices
It may sometime does not show true picture of economic growth of the country.
For example, if inflation is high, prices rise rapidly and thus any increase in nominal national income is largely due to rise in price level without any change in physical output.
Suppose in the Year 2017-18 – A country produces 10 oranges only and price of each orange is Rs 5. Thus GDP at current price for year 2017-18 = 10*5 = Rs. 50
Now in the year 2018-19 the country produces 7 oranges only. But the price of each orange rise to Rs. 10. Thus GDP at current price for year 2018-19 = 7*10 = Rs. 70
The GDP at current prices in year 2018-19 has increased in comparison to 2017-18. However, this increase in national income is attributed more to rice in prices (Production of oranges has decreased)
So, in order to eliminate the effect of price changes, national income is also estimated at a constant price.
2.2.2 National Income at Constant Prices [Real National Income]
It means that goods and services which are produced in an year are valued at fixed prices i.e. prices of base year.
Constant prices refer to the prices prevailing in the base year. In India base year for GDP is 2011-12.
For example – if goods and services produced during the year 2017-18 are valued at the prices of the base year [i.e., 2011-12), it will be called national income at constant prices for the year 2017-18.
National income at constant prices is affected by only one factor, i.e. change in physical output. It can rise only when there is an increase in the level of physical output because here prices are kept constant or fixed.
The need for estimating national income at constant price arises because national income at current price may give a misleading picture of economic performance if the prices are continuously rising or falling. With high rate of inflation in India, nominal national income may create a false sense of economic growth.
National income measured at constant prices truly reflects the real change in physical output of a country
2.3 Factor Price and Market Price
Factor Price is total cost of all factors of production (such as labour, capital, land etc) used in producing goods or services. It is the price of the commodity from the producers side.
When a commodity is produced, it is sold in the market
Market Price – It is the price at which a product is sold in the market. It includes the cost of production in the form of wages, rent, interest, input prices, profit etc. It also includes the taxes imposed by the government. It excludes Government subsidy.
Thus relationship between Factor price and Market price is
Market Price = Factor Price + Indirect Taxes – Subsidies
Phew, that’s all for this post folks. Do Comment down below and let us know what you thought about the post. See you in the next one.