Macroeconomics

National Income: Methods & Measurements

Dr. G. Sathis Kumar

When National Income
Accounting arose..?
What Matters is What is Measured..?
 What is Growth?
Why the obsession
with it?
Who Calculates National Income?
 Economic Operators

1. Households 2-sectoral economy

• supply inputs, demand goods & sectors: households and firms
services
2. Firms _________________________
• supply goods & services, demand 3-sectoral (closed) economy
inputs
sectors: households, firms, state
3. State (the Government, CB)
• macroeconomic policy _________________________
4. Abroad 4-sectoral (open) economy
• export, import, capital flow sectors: households, firms, state, abroad
 National Income Accounting
• In the 1930s it was impossible for macroeconomics to exist in the
form we know it today because many aggregate concepts had not yet
been formulated, or were lacking rigour.

• In the mid-1930s, two Keynesians, Simon Kuznets and Richard Stone,

began to develop this terminology.

• They developed national income accounting – a set of rules and

definitions for measuring economic activity in the aggregate
economy – that is, in the economy as a whole.
 What is National Income?
• National income measures the total value of goods and services
produced within the economy over a period of time.
 Why is national income important?
• Measuring the level and rate of growth of
national income (Y) is important to
economists when they are considering:
• Economic growth and where a country is
in the business cycle,
• Changes to average living standards of
the population,
• Looking at the distribution of national
income (i.e. measuring income and
wealth inequalities).
The 3 Faces
of GDP
 Measuring Gross Domestic Product (GDP)

• The most common measure of the total output of

an economy is gross domestic product (GDP)

GDP is the total market value of all the final

goods and services produced within an
economy in a given year.
Measuring Gross Domestic Product
• “Total market value” refers to the quantity of
goods multiplied by their respective prices. Using
prices allows us to express the value of everything
in a common unit of measurement.

Quantity Price (Rs.) Value (Rs.)

2 cars 15,000 30,000

3 computers 3,000 9,000

Gross domestic product 39,000

Measuring Gross Domestic Product
• “Final goods and services” refers to the goods
and services that are sold to the ultimate, or final,
purchasers.
• In order to avoid double counting, we do not
count intermediate goods, or goods used in the
production process. The value of the final good
already reflects the price of the intermediate
goods contained in it.
• “In a given year” means that the sale of goods
produced in prior years, for example, used cars,
are not included in GDP this year.
 Measuring Gross Domestic Product
• Since we use the prices times the quantities of
goods to measure the value of GDP, GDP will
increase when prices increase, even if the physical
quantities of the goods produced remain the
same.
Year 1 Year 2
Quantity Price (Rs.) Value (Rs.) Quantity Price (Rs.) Value (Rs.)
2 cars 15,000 30,000 2 cars 30,000 $60,000
3 computers 3,000 9,000 3 computers 6,000 $18,000
GDP = 39,000 GDP = 78,000
 Measuring Gross Domestic Product

• A measure of total output that does not increase just

because prices increase is called real GDP.
• Real GDP takes into account price changes by using the
same prices for both years.
• Nominal GDP is the value of GDP in current rupees.
 Measuring Gross Domestic Product

Year 1 Year 2
Quantity Price (Rs.) Value (Rs.) Quantity Price (Rs.) Value (Rs.)
10 computers 1,000 10,000 12 computers 1,100 13,200
Nominal GDP 10,000 Nominal GDP 13,200
Growth in nominal GDP (13,200/10,000) = 1.32

• Using year 1 prices to compute GDP in year 2:

Quantity Price (Rs.) Value (Rs.) Quantity Price (Rs.) Value (Rs.)
10 computers 1,000 10,000 12 computers 1,000 12,000
Real GDP 10,000 Real GDP 12,000
Growth in real GDP (12,000/10,000) = 1.20
Expenditure Method
 Who Purchases GDP?
• Economists divide GDP into four broad expenditure categories:
1. Consumption expenditures: purchases by consumers
2. Private investment expenditures: purchases by firms
3. Government purchases: purchases by federal, state, and local
governments
4. Net exports: net purchases by the foreign sector, or domestic
exports minus domestic imports.

Y = C + I + G + (X-M)
Composition of India GDP
 Consumption Expenditures
• Consumption expenditures comprise purchases of currently produced,
domestic or foreign, goods and services.
• Consumption is broken down into:
• Durable goods.
• Nondurable goods.
• Services, the fastest growing component of consumption.
• Consumption comprises 70% of total purchases.
 Private Investment Expenditures
• Private investment expenditures include:
• Business Fixed Investment - Spending on new plants and
equipment.
• Residential Construction Investment - Newly produced housing.
• Inventory Investment - Increase in inventories during the current
year.
• Public Investment – spending by the state on the creation of fixed,
long-term assets. The classic examples are spending on physical
assets such as roads, buildings, bridges and tunnel

• Note: investment in everyday talk refers to the purchase of an existing financial

asset. Investment in GDP accounts refers to the purchase of new final goods
and services by firms. Don’t confuse the two.
 Private Investment Expenditures
• New investment expenditures are called gross investment. The true addition to
the stock of capital of the economy is net investment. Net investment equals gross
investment minus depreciation.
• Depreciation is the deterioration of plants, equipment, and housing in a given year.
 Government Purchases
• Includes any goods the government purchases plus the wages and benefits
of all government employees; but does not include all the government
spending.
❑ Transfer payments, or government payments to individuals
which are not associated with the production of any goods and
services, are not included in government purchases.
❑ This means that a large part of the federal government budget is
not part of GDP.
 Net Exports
• Net exports are total exports minus total imports. By including net exports
in GDP, we correctly measure the production—by adding exports and
subtracting imports.
• Purchases of foreign goods (imports) are subtracted from GDP
because these goods were not produced in the country.
• Any goods that are produced in the country and sold abroad
(exports) are included in GDP.
 Net Exports

• The balance of trade:

• Trade deficit: imports > exports
• Trade surplus: imports < exports
• Trade balance: imports = exports
Other Measures of Income
1. Gross national product (GNP) is the total income earned by a nation’s permanent residents
(called nationals).
[Link] national product (NNP) is the total income of a nation’s residents (GNP) minus losses
from depreciation.
• Depreciation is the wear and tear on the economy’s stock of equipment and structures, such
as lorries rusting and computers becoming obsolete.

[Link] income (NY) is the total income earned by a nation’s residents in the production of
goods and services.
[Link] income is the income that households and non-corporate businesses receive.
[Link] personal income is the income that households and non-corporate businesses
have left after satisfying all their obligations to the government.
 Methods of Measuring
National Income

For use with Mankiw and Taylor, Economics 4th edition

9781473725331 © Cengage EMEA 2017
Supply Side / Value Added Method

GDP at basic prices* = Value Added in (Agriculture +

Industry + Services)

* Includes production taxes and subsidies.

For use with Mankiw and Taylor, Economics 4th edition

9781473725331 © Cengage EMEA 2017
For use with Mankiw and Taylor, Economics 4th edition
9781473725331 © Cengage EMEA 2017
 GDP Calculation - Factor Income Approach

GDP factor cost = Rent + Wages + Interest + Profit

For use with Mankiw and Taylor, Economics 4th edition
9781473725331 © Cengage EMEA 2017
 Calculation of National Income Illustration
[Link]. Items Rs in Crores
1 Value of All Final Consumption and Capital Goods 2426210
2 Depreciation Allowances 352190
3 Value of Import 245199
4 Subsidies 30094
5 Value of Exports 209018
6 Commodity Taxation 116221
7 Net Income from Abroad 67146

GDP at Market Prices = (C + I + G) + (X-M) = = 2426210 + (209018-245199)

= 2426210 – 36181 = 2390029 Crores
• GNP at Market Prices = GDP at Market Prices + Net Income from abroad
(Receipts – Payments)
• NNP at Market Prices = GNP at Market Prices – Depreciation
• NNP at Factor Cost = NNP at Market Prices + Subsidies – Indirect Taxes)
Calculation of National Income Illustration
[Link]. Items Rs in Crores
1 Value of All Final Consumption and Capital Goods 2426210
2 Depreciation Allowances 352190
3 Value of Import 245199
4 Subsidies 30094
5 Value of Exports 209018
6 Commodity Taxation 116221
7 Net Income from Abroad 67146
Problems of GDP Measurement
• There are three major criticisms of the GDP measure:
1. Omits non-market goods and services
• Ex. Work of stay-at-home mothers and fathers not included in GDP
2. No accounting for “bads” such as crime and pollution
• Ex. Crime is a detriment to society, but there is no subtraction from GDP to account for it
3. No correction for quality improvements
• Ex. Technological improvements are beneficial to the economy, but nothing is added to GDP to
account for them

→ Despite these drawbacks, GDP is still considered one of the best

economic indicators for estimating growth in an economy

38
Remember
• GDP at Market Prices = (C + I + G) + (X-M)
• Nominal GDP values the production of goods and services at current prices.
• Real GDP values the production of goods and services at constant prices.

• GNP at Market Prices = GDP at Market Prices + Net Income from abroad
(Receipts – Payments)

• NNP at Market Prices = GNP at Market Prices – Depreciation

• NNP at Factor Cost = NNP at Market Prices + (Subsidies – Indirect Taxes)

Nominal GDP
GDP deflator =  100
Real GDP
 (in Crores)
• Interest Income Rs. 50
• Depreciation Rs.36
• Wages Rs. 67
Calculate the National Income.
• Gross Private Investment (I) Rs.124
• Business Profits Rs.200 1. Using Expenditure Method
• Indirect Business Taxes Rs.74 2. Using Income Method
• Rental Income Rs.75
• Net Exports (X-M) Rs.18
• Government Purchases (G) Rs. 156
• Household Consumption (C) Rs.304