Chapter 3 Basics of National Income Accounting. Gross Domestic Product Money value of all final goods and services produced within the domestic territory.

Chapter 3

Basics of National Income Accounting

Gross Domestic Product

Money value of all final goods and services produced

within the domestic territory and valued at market prices in

a given time period Time period : typically one year

: India – 1 April to 31 March

Product : output of goods and services

Money value : converting output into a common denominator of

money

Need for ‘Money Value’

Common Unit

Money (Rs)

(Measured in Kgs)

(Measured in litres)

(Measured in metres)

(Measured in tonnes)

Different commodities measured in different units Addition becomes difficult

Nominal GDP

GDP (output) is valued at current prices Current prices are the prices prevailing in the year in which

production takes place Reflects the change in output due to:

Price changing and / or Quantity of commodities produced changing

Commodity Output Price Value of Output Price Value of(Yr1) (Yr1) output (Yr2) (Yr2) output

Wheat (kg) 20 3 60 20 5 100Cloth (mt) 15 5 75 15 6 90GDP 135 190

Nominal GDP

Nominal GDP

Table shows GDP has increased Output has remained constant in both years Rise in GDP due to rise in price Inflationary trend needs to be discounted to get actual

change in availability of goods and services Use of ‘Real GDP’

Real GDP

GDP measures at constant prices Value current year’s output using base year prices Rise in GDP reflects rise in output

Commodity Output Price Value of Output Price Value of(Yr1) (Yr1) output (Yr2) (Yr1) output

Wheat (kg) 20 3 60 20 3 60Cloth (mt) 15 5 75 15 5 75GDP 135 135

Real GDP

Value of output has remained constant over the years

GDP Deflator

Measures the average price level of all goods and services

that constitute GDP in the economy

Output is kept constant

GDP Deflator = X 100

For year 2 –

GDP Deflator = X 100 = 140.74

On an average prices have risen by 41%

Nominal GDP

Real GDP

190

135

Terms to Understand

Domestic product vs National product Gross product vs Net product Final product vs Intermediate products Market price vs Factor Cost

Domestic Product vs National Product

Domestic Product is the output produced within the economic or domestic territory of a country

Domestic territory Includes :i. Political boundaries

ii. High commissions, embassies military bases located overseas

iii. Ships, fishing vessels, air crafts owned by residents

Domestic territory excludes : i. Embassies, aid agencies of

foreign governments situated in India

ii. Offices of international organisations such as World Bank, IMF etc

Indian HighCommission Islamabad

UK High Commission

World BankOffice

Indian Airline flying from

Kathmandu to Colombo

Normal Resident of a country

Normal Resident is defined as a person who Ordinarily resides in a country Economic interest lies within the economic territory

Resident ≠ Citizen Citizenship based on nationality Resident based on economic interest

Household Production unit

Resident

Normal Residents of a country

All households in an economy ≠ resident households Households = Resident + Non-resident households Non-resident households in a domestic territory include :

Foreign visitors on conferences, vacations, tours Seasonal workers within the domestic territory Diplomats of other countries living within the domestic territory Foreign employees in international organisations Foreign consultants, technicians, engineers who come on projects

Resident households outside the domestic territory include: Citizens of a country employed in their own embassies, consulates, military

bases Medical patients and students (as long as they continue to be a part of a

household of their home country) Citizens working in the local offices of international organisations

Domestic Product vs National product

National income is the income earned by residents of an economy Domestic income = income of residents in the domestic

territory

+ income of non-residents in the domestic territory National income = income of residents in the domestic

territory

+ income of residents from abroad National income = Domestic income

+ net factor income from abroad

Net factor income from abroad (NFIFA)

NFIFA = Factor income earned by residents abroad

- Factor income earned by non-residents in the domestic territory

Factor income earned by non-residents within the domestic territory

Factor income earned by residents abroad

minus

UK High Comm. Delhi (abroad)

Indian Security Guard

Factor Income

Factor

Services

British Security Guard

Factor Income

Indian High Comm., London

(domestic territory)Factor

Services

Domestic Product vs National Product

Domestic Product = National Product – NFIFA National Product = Domestic Product + NFIFA When NFIFA < 0; Domestic Product > National Product When NFIFA > 0; Domestic Product < National Product

Gross Product vs Net Product

Gross product includes depreciation Depreciation

Wear and tear of plant and machinery with use Foreseen obsolescence

Also called Replacement cost Consumption of capital

Gross product = net product + depreciation Net product = gross product - depreciation

If Gross product is Rs 200 and

Depreciation is Rs 50, then

Net product is Rs 150

New clothes

Faded clothes

wear and tear

Final vs Intermediate Goods

Intermediate Products Goods and services used for

furthering production

Final Products Goods and services used for

directly satisfying the wants of consumers

No good is either intermediate or final Distinction is based on the USE of the good

Household

Vegetables Food

Tasty Food Restaurant

Vegetables Food

Problem of Double Counting

Occurs when the value of a commodity is counted more than once in valuing the output of an economy

Output available is valued at Rs. 100 and not Rs. 150 (50 + 100) Rs. 50 (value of inputs) is already included in Rs. 100 (value of

output)

MILK

Cocoa Chocolate

YummyChocolate FactoryInput = Rs. 50

Sugar

Rs. 15 + Rs. 25 + Rs. 10Output = Rs. 100

Rs. 100

Problem of Double Counting

Leads to overestimation of output Can be avoided by :

taking only final goods and services taking value added at each production process

Farmer WheatRs. 20

MillerFlour

Rs. 30

BakerBreadRs. 40

CustomerBreadRs. 40

Value Added 20 – 0 = 20 30 – 20 = 10 40 – 30 = 10

Total value added = 20 + 10 + 10 = Rs. 40 Value of final product = Rs. 40

Indirect TaxFactor Cost: Rs. 100Sales Tax: 10%Market Price: Rs. 100 + Rs. 10

= Rs. 110

Product at Market Price vs Product at Factor Cost

Factor Cost + Net Indirect Taxes = Market Prices

IndirectTax

Subsidy___

Rs. 100

Factory

Rs. 10

Government

Results in : price

SubsidyFactor Cost: Rs. 100Subsidy: 10%Market Price: Rs. 100 - Rs. 10

= Rs. 90

GovernmentRs. 10 Rs. 100

Results in : price

Factory

Paid to factors of production

Paid by households

Factor Income vs Transfer Receipts

Factor Income Arise due to the result of

productive activity Paid to factors of

production Included in national

income estimates e.g. : rent, wages,

interest, profits

Transfer Receipts Do not arise due to any

productive activity Not paid to factors of

production Excluded from national

income estimates e.g. : scholarships to

students, old age pension, lotteries, remittances received from abroad