CHAPTER 3
NATIONAL INCOME ACCOUNTING:
CONCEPTS AND MEASUREMENT
The structure of the macro economy has
been portrayed in the circular flow of
output and income as dealt with in the
previous chapter. This circular flow
depiction of macroeconomic activities
provides logical foundation for the
concepts and measurement of national
income aggregates. A strikingly unique
feature of national income concepts is
that they are quantifiable and are not
abstract ones. Hence, they render as
much precision as feasible in the
national income statistics, given the
limitations in the estimation of national
income aggregates and in the
construction of national income
accounts. There have been many
attempts in the past to evolve methods
of national income accounting and these
efforts have contributed to the system
that we have at present. In this chapter,
we shall present principal methods to
measure national income aggregates. It
is pertinent at this juncture to remind
ourselves of an important observation
made in respect of the circular flow of
macroeconomic activities. We have, in
that context, stated that the value of
aggregate output equals the value of
aggregate income, which in turn must
equal to the aggregate expenditure.
Based on this, national income
measurement can be categorised into
three approaches : output or product
approach, income approach and
expenditure approach. All these must,
in principle, yield the same result.
Measuring Gross Domestic Product
Let us first take up the measurement
of the value of all that is produced in
the economy. This is expressed as Gross
Domestic Product. Here, the
measurement procedure is actually
three-fold. We use the product method,
the income method and the expenditure
method to compute the Gross Domestic
Product. As this aggregate is held to be
very important for macroeconomic
assessment, greater attention is called
for in the computation of this measure.
Gross Domestic Product : The Output
Approach
Gross Domestic Product (GDP) is a
summary statistic, which is widely used
by economists and policy analysts to
18 INTRODUCTORY MACROECONOMICS

assess the rate of growth of an economy
during a year. GDP is generally
recognised to be the primary measure.
GDP is defined as the market value
of all final goods and services produced
by the factors of production located in
the country during a period of one year.
A key phrase in this definition is ‘final
goods and services’ which require some
elaboration.
Final goods are those that are meant
for final use by consumers or firms. These
goods are not required to enter into
further stages of production or resale to
change their form and content. They are
finished goods meant only for final
consumption and investment.
Measurement of GDP includes only
the aggregate value of final goods. Also,
from a development perspective, the
strength of an economy is seen in its
capability of producing final goods and
services.
It may be useful at this stage to draw
a distinction between final goods and
intermediate goods. The latter are not
Clip 3.1
PIONEERS IN NATIONAL INCOME ANALYSIS
taken into account in the measurement
of GDP.
Inter mediate goods are those
goods that are used to produce other
goods and therefore they always move
from one stage of production to another
in the manufacture of a final product.
Let us now show the difference
between final and intermediate goods with
the example of producing an automobile.
The industrial process to
manufacture an automobile involves
materials such as steel, paint, rubber,
foam, plastic, glass, cables, battery, etc.
and a variety of component parts. All
these items are produced by the
respective firms only to be used in the
production of another product; in our
example it is the automobile. But once
the process of producing an automobile
starts, all these are converted into
integral parts of an automobile. So,
these goods are not important in their
own right; they are just a means to an
end. Such goods are called intermediate
goods. The automobile that is produced

In the contemporary world now, national income concepts and accounting methods
are widely recognised and applied to measure the economic performance of countries.
However, these concepts and methods became popular only a few decades ago.
A seminal contribution to the field of National Income and
Product Accounts (NIPA) made by Simon Kuznets (1901–1985)
set the trend of using national income aggregates to measure
the direction of growth of economies. He was a great pioneer in
this field and due to his research efforts, the first national
income figures for the US economy was published in 1934 as
an official document of the US Senate. This helped immensely
to understand the severe impact of the Great Depression in
1929. His monumental book of two exhaustive volumes, National
Simon Kuznets Income and its Composition, 1919-1938 (New York; NBER, 1941)
NATIONAL INCOME ACCOUNTING : CONCEPTS AND MEASUREMENT 19

earned him the worldwide recognition. This was followed by two of his landmark
contributions, namely, National Product since 1869 (New York; NBER, 1947) and
Economic Growth of Nations : Total Output and Production Structure (Cambridge Mt,
Harvard University Press, 1971). For his contributions, Kuznets was honoured
with the Nobel Prize in 1971 in recognition of his empirical interpretation of
economic growth.
Another important contribution in this field is that of
Richard Stone (1913-1991). Stone worked with John
Maynard Keynes as a research assistant. Stone during the
early 1940s prepared a statistical profile of the British
economy. After the World War II, Stone headed a United
Nations project to develop standard national income
accounting model.
In India, prior to 1947, the estimation of national income
was attempted by individual economists and scholars for
Richard Stone specific years.

V.K.R.V. Rao P.C. Mahalanobis D.R. Gadgil

Among these, the most systematic work was that of V.K.R.V. Rao in his book
National Income in British India 1931-32 (London; MacMillan 1940), which formed
the basis of national income estimation in the post-independence period. In
1949, the Government of India formed the National Income Committee under
the Chairmanship of P.C. Mahalanobis, with V.K.R.V. Rao and D.R. Gadgil as
members. From then onwards the national income estimation has been steadily
strengthened. Now, the Central Statistical Organization (CSO) is entrusted with
the task of publishing National Accounts Statistics (NAS).

in the final stage of the assembly line is
the final good.
Hence, the rationale for not taking
into account the value of intermediate
goods in the measure of GDP is to avoid
the problem of double counting. That
is, no product should be counted two
or more times. Double counting will
only exaggerate or over-estimate the
value of GDP.
The procedure by which we eliminate
the values of intermediate goods from GDP
20 INTRODUCTORY MACROECONOMICS

is through the method of value added. a good’s value increases at each stage
This is discussed in the following section. until its final value is obtained in the
last stage. It follows therefore that the
Concept and Measurement of Value value of final good will have to be equal
Added to the sum of the value-added at each
The concept of value added is very basic stage of production. This is shown with
to the measure of GDP. Value-added is a numerical illustration in Table 3.1.
defined as the difference between total Consider the production and sale
value of output of a firm and value of of a cake to the Household sector for
inputs bought from other firms. It thus final consumption. The process of
measures the value, which the firm production starts with a farmer raising
concerned has added by its process wheat crop and harvesting it. Since we
of production. are starting with the stage of wheat
Most goods go through multiple cultivation, let us not go into the
stages of production. This means that backward production linkages of the
Table 3.1 : Numerical Illustration of GNP Measurement
using Value Added Method
Stage I Stage II Stage III Stage IV
(Wheat) (Flour) (Cake at Bakery) (Cake at Retailer)
Farmer
Black’s Purchases Miller White’s Baker Brown’s Retailer Green’s
from other firms
None
Value Added Rs. 1.00 Purchases Rs. 1.00 Purchases Rs. 1.50 Purchases Rs. 2.00
from Farmer from Miller from Baker

Value Rs. 0.50

Added
Value Rs. 0.50
Added
Value Rs. 0.50
Added

Break-up of Value of Final

value added good = Rs.2.50

Profit = 0.20 + 0.25 – 0.40 + 0.28 = 0.33

Wages = 0.60 + 0.10 + 0.70 + 0.05 = 1.45
Rent = 0.05 + None + None + None = 0.05
Interest = 0.05 + 0.10 + 0.01 + 0.02 = 0.18
Depreciation = 0.02 + 0.02 + 0.09 + 0.07 = 0.20
Property and = 0.08 + 0.03 + 0.10 + 0.08 = 0.29
sales taxes Sum of value
added
Total (in Rs.) 1.00 + 0.50 + 0.50 + 0.50 2.50
NATIONAL INCOME ACCOUNTING : CONCEPTS AND
farmer. Therefore, the farmer’s value-
added in the cultivation stage will be
just the value of his output as such (that
is one rupee). In the second stage, the
miller buys the wheat from the farmer
and grinds it into flour, and sells it to
the baker for Rs.1.50. By this, he adds
a value of 50 Paise. The baker makes
the cake and sells it to the retailer for
Rs. 2.00, thereby adding a value of 50
paise. The retailer who buys the cake
from the baker sells it to the final
consumer for Rs. 2.50, thereby adding
a value of 50 paise. This means that the
value of the final good, namely, the cake
is Rs. 2.50 at the retail store. This final
value of the cake is the sum of the value
added from the stage of cultivation to
that of retail sale at the shop, that is,
total value added equals Rs.1.00 + 50
Paise + 50 Paise + 50 Paise = Rs. 2.50.
On the other hand, if we had
included the value of all the
intermediate stages, preceding the retail
sale, cake’s value would have increased
manifold, due to the problem of double
- counting. That is, wheat would have
been counted four times, floor three
times and baked items twice. This is the
reason why we take the final value of
the output as a sum of all values added
in producing a good.
This procedure of value added
method demonstrated for an individual
product is applied at the aggregate level
for the measurement of GDP.
Concepts of Value Added
(i) Value of output by a Firm = Sales +
Change in Stock
(ii) Value Added = Value of output –
Intermediate goods cost
MEASUREMENT 21
(iii) Net-value added at Market Price =
Gross value added at Market price
– Consumption of fixed capital
(Depreciation)
(iv) Net-value added at Factor Cost =
Net value added at Market Prices –
Net indirect taxes (Net Indirect Taxes
= Indirect Taxes – subsidies)
(v) Net value added at factor cost = Total
Factor Income
Now, let us look into the
computation of value added as shown
in the illustration below:
Example 1: From the following data
calculate the value added by Firm A and
Firm B.
(Rs. in Lakhs)
(i) Closing stock of Firm A 20
(ii) Closing stock of Firm B 15
(iii) Opening stock of Firm A 5
(iv) Opening stock of Firm B 10
(v) Sales by Firm A 300
(vi) Purchases by Firm A from 100
Firm B
(vii) Purchases by Firm B from 80
Firm A
(viii) Sales by Firm B 250
(ix) Import of raw material 50
by Firm A
(x) Exports by Firm B 30
As first step calculate the value of
output for each Firm. Then find the
value added.
Step 1. Value of output of Firm A
= Sales + Change in stock
(Closing stock – Opening stock)
= 300 + (20 – 5)
= Rs. 315 lakhs
Step 2. Value added by Firm A
= Value of output – purchases
22
from Firm B – imports by
Firm A
= 315 – 100 – 50
= Rs. 165 lakhs
Repeat the same procedure for Firm B
Step 3. Value of output of Firm B
= Sales + Change in stock
(Closing stock – Opening stock)
+ Exports by Firm B
= 250 + (15 – 10) + 30
= Rs. 285 lakhs
Step 4. Value added by Firm B
= Value of output – purchases
from Firm A
= 285 – 80
= Rs. 205 lakhs
Gross Domestic Product : As Sum of
Expenditure
GDP can be measured by taking into
account all final expenditures in the
economy. There are three distinct types
of expenditure as they are committed
by Households, Firms and Government
respectively. These expenditures are
classified into following types :
(i) Private Consumption (C)
Expenditure
(ii) Investment Expenditure (I)
(iii) Government Purchases of (G)
Goods and Services
(iv) Net Exports (X – M)
Let us discuss these items of final
expenditures with respect to the sectors
concerned.
(i) Private Consumption expenditure
The private consumption component of
GDP measures the money value of
INTRODUCTORY MACROECONOMICS
goods and services that are purchased
by households and non-profit
institutions for current use during a
time period. Considering the fact that
consumption expenditure is a
significant part of GDP, it requires
special attention by economists and
government. Private consumption is the
demand for consumer goods and
services. While goods are tangibles,
(that is, you can see a car) the services
are intangibles (that is, you cannot see
a service such as car insurance).
Further in the case of goods,
consumption or use of a good can be
separated from the place of its
production and can be separated in
time, that you can consume or use a
good at your convenient place or time.
But services should necessarily be used
at the time and place in which they are
produced. For instance, banking service
will take place at the place and time
specified by the banker and customers
utilise their banking facilities accordingly.
Consumption can be divided into
three sub-categories such as,
consumer services, consumer non-
durable goods and consumer durable
goods. Non-durable goods are used up
immediately or within a short span of
time. Durable goods in contrast could
be used for a longer period of time.
Food items are non-durable
consumption goods whereas furniture,
stereo equipment, washing machines
are durable consumption goods. But
usually this distinction is based only
on the given length of time within which
consumer goods are used. Durability
does not imply a state of permanence.
NATIONAL INCOME ACCOUNTING : CONCEPTS
Durable goods also have their limited
period of use value, after which they are
given up. Private final consumption will
include expenditure on all these three
categories mentioned here.
(ii) Investment
Investment is an addition to the stock of
capital during a period. The Gross
Private Domestic Investment shows the
aggregate value in this regard. Unlike
the intermediate goods which are used
up entirely in the process of making
other goods, capital is only partially
depleted in making other goods. That
is, a steel mill may have a useful life of
say, 50 years. In providing steel in any
one year, only a small portion (1/50th)
of the mill is used. This using up of
capital is called depreciation.
Depreciation is the value of the existing
capital stock that has been consumed
or used up in the process of producing
output. Usually an asset is depreciated
at a predetermined rate and monetary
value is assigned to the rate of
depreciation of a physical asset in
one year. This is also described as
capital consumption allowance1. When
investment is expressed as Gross
Investment or Net Investment it means
whether investment has or has not been
adjusted against depreciation. Gross
term includes depreciation while Net
term is obtained after deducting the
depreciation amount.
Investment component could be
classified under four categories : they are
(a) Business fixed investment
1
The usage of fixed assets lead to their wear and tear; so, we must provide for consumption of
fixed capital as a prerequisite in accounting the product.
AND MEASUREMENT 23
(b) Inventory investment
(c) Residential construction investment
(d) Public investment
(a) Business Fixed Investment (BFI) is
the amount spent by business units on
purchase of newly produced plant and
equipment. The two measures of BFI are
Gross Business Fixed Investment (GBFI)
and Net Business Fixed Investment
(NBFI). Gross Business Fixed investment
is the gross amount spent on newly
provided plant and equipment, that is,
capital goods. If depreciation is
deducted from it, then we obtain Net
Business Fixed Investment.
The inclusion of capital goods in the
final product along with the goods and
services produced by them would
involve double counting. For this reason
it is important to make provision for
depreciation. If in every year we deduct
from investment (and therefore from
domestic product) the amount by which
capital stock has been used up over the
year, then over the whole lifespan of the
capital good, we will have deducted
from the domestic product the whole
value of the capital good. In this way
we will have avoided counting in the
domestic product both the asset and
the goods produced by it and so shall
have avoided double counting. BFI is
usually the result of a conscious
decision by firms to augment their
productive capacity.
(b) Inventory Investment is the net
change in inventories of final goods
24
awaiting sale, semi-finished goods, or
of materials used in the production
process (inputs). These must be
included since they represent currently
produced output not included in the
current sales of final output.
Changes in inventory are usually
the result of unintentional short run
deviations between supply and
demand. Stock changes play a crucial
role in income determination. For
example, if there is a sudden doubling
of the demand for television sets, it is
unlikely that the production of them will
also double overnight. So, the first effect
of the increase in demand relative to
supply will be a fall in the inventory of
television sets normally held in the
economy (inventory that is held by the
producer, wholesaler or retailer), in the
attempt to satisfy the sudden increase
in demand. This process will continue
until production is augmented to
match the increased demand.
Conversely, a sudden fall in demand will
lead to a rise in inventories of television
sets until production adjusts itself to
the lower level of demand.
(c) Residential Construction Investment
is the account spent on the building of
housing units. This is also expressed
in terms of either gross or net depending
on whether depreciation has been
subtracted or not.
(d) Public Investment includes all
capital formation carried out by the
government such as building of roads,
hospitals, schools etc. This is also given
in gross or net value depending on
whether depreciation has been
subtracted or not.
INTRODUCTORY MACROECONOMICS
Now the investment component as
a whole can be thought of in the
following two ways :
Gross Investment = Gross Business
Fixed Investment + Gross Residential
Construction Investment + Gross Public
Investment + Inventory Investment
Net Investment = Net Business Fixed
Investment + Net Residential
Construction Investment + Net Public
Investment + Inventory Investment
As pointed out earlier, the difference
between gross investment and net
investment is depreciation.
(iii) Gover nment Purchases of
Goods and Services
This component summarises the
government spending on goods and
services. Remember that government
purchases is a proxy measure for
government output.
As a matter of fact, government
purchases from private producers
would be intermediate goods and
government wages and salaries would
be part of the income side of the
national accounts. Instead of doing this
we take the government purchases as
part of the final product.
In the above we have understood
government as a producer of goods and
services. This is an important function
of the government. At the same time we
should also be aware of another function
of government – that is, making
payments to certain categories of people
or firms to compensate them as a matter
of its social obligation. This is called
Government Transfers, which refer to the
NATIONAL INCOME ACCOUNTING : CONCEPTS AND
total value of payments made by
government sector towards households
and firms as income supplements and
subsidies respectively. This is also known
as Transfer Payments, and they are not
counted in the GDP because there is no
production of goods due to them.
Transfer Payments are basically welfare-
oriented expenditures of the
Government.
(iv) Net Exports
This is the difference between Exports (X)
and Imports (M) of a country, that is
(X – M).
Based on the expenditure flows
in the economy, Gross Domestic
Product is the total value of the sum
of consumption and investment
expenditure along with government
purchases and net exports.
In other words
GDP = C + I + G + (X – M)
Where,
C = Consumption expenditure by
households
I = Investment expenditure by firms
G = Government purchases of goods
and services.
X-M = Net Exports.
Gross Domestic Product : A Measure
of Income
The third approach to the measurement
of GDP is to compute it by addition of all
factor incomes generated in the
production of goods and services.
Because each rupee of goods and
services produced is matched by a rupee
of income, we can arrive at the same
figure for GDP on the income side as we
MEASUREMENT 25
did on the product side. While measuring
GDP we must include only those income
flows that originate with the production
of the goods and services within the
particular time period.
The components of factor income are:
1. Employee compensation
2. Profits
3. Rent
4. Interest
5. Mixed income
Now let us look into the details of
each one of these.
1. Employee Compensation
Compensation to employees in the form
of wages, salaries and benefits makes
up the largest single component of
income generated with production of
GDP. Wages and salaries are payable
in cash, kind or both.
2. Profits
Profits are the reward the owners of
firms receive for being in business.
Firms’ desire to earn profits is the main
motivating force behind production in
a market economy.
3. Rent
Rental income is, for example, income
earned by owners of rental housing. The
meaning of rent in the national income
accounts is that it is a charge for the
temporary use of some capital asset.
4. Interest
Households both receive and pay
interest. We include in GDP only the net
interest, that is the difference between
interest amount paid and the interest
income received by households.
26
5. Mixed Income
Mixed income will include the income of
own account workers and profits and
dividends of unincorporated enterprises.
In other words, it may be called as mixed
income of the self employed.
All the above mentioned components
of income measure of the GDP have an
important implication for the economy
as such. Their relative share in GDP
shows the manner in which each of
these income flows changes overtime.
It is possible to show by way of an
illustration as to how the sum of value
added is equal to the total of the above
types of income earned during the
process of production. This is shown
in Table 3.1
GDP as measured by the
aggregation of factor incomes is also
called as Gross Domestic Income (GDI).
Gross National Product
After getting GDP we can add Net Factor
Income from abroad to estimate the
value of Gross National Product (GNP).
How is Net Factor Income from Abroad
defined? What are included in it?
Net Factor Income from Abroad is
the difference between the factor income
received from the rest of the world, i.e.
abroad for rendering factor services, and
the income paid for factor services
rendered by non-residents inside the
domestic territory of the country. As we
know that factor incomes include
compensation to employees and income
from property and entrepreneurship,
then Net Factor Income from abroad is
the difference with respect to these items
received by residents abroad and given
INTRODUCTORY MACROECONOMICS
to non-residents working in the
domestic territory during a given
accounting year. Hence, the components
of Net Factor Income from abroad are :
(i) Net compensation to employees
(ii) Net income from property and
entrepreneurship, which includes
rent, interest, dividends, etc.
(iii) Net retained earnings of resident
companies abroad
Hence,
Gross Domestic Product + Net Factor
Income from abroad = Gross National
Product
Now we may distinguish between
Gross National Product and Gross
Domestic Product. The difference
between the two arises from Net Factor
Income from Abroad. Note that the
(X – M) component of GDP represents
only goods and services other than
factor incomes.
Real and Nominal GNP
Having presented the measurement of
GNP it remains to be seen as how the
changes in the GNP value are expressed
in relation to price level changes as price
changes affect the value of the national
income aggregates. For this we must
explain the two ways of computing
national income data at current market
prices and constant prices.
Current Market Prices
If the GNP (or any other related
aggregates) is measured in terms of
current market prices, then it is referred
to as Nominal GNP. Since the nominal
GNP measures the value of currently
produced goods and services at market
NATIONAL INCOME ACCOUNTING : CONCEPTS AND
prices, GNP will change when either the
overall price level changes or when the
actual volume of production changes
or when both change simultaneously.
Constant Prices
However, for certain purposes we may
want to have a measure of output that
changes only when the quantity of goods
produced changes. This measure of only
quantity change, not prices, is the method
of using constant prices. Accordingly,
GNP that is computed at constant prices
will be called the Real GNP. Usually,
under this method GNP value is
expressed in terms of prices prevailing in
a year chosen to be the base year.
Real GNP has the following
advantages:
(a) It is useful in finding out the effect of
increased production of goods and
services on the real development
capacity of the economy in general.
But the nominal GNP cannot show
this as we cannot segregate the
change in output alone, since, the
current market prices in terms of
which it is measured prevent such
an exercise;
(b) Real GNP also enables one to make
a year-to-year comparison of the
changes in the growth of output of
goods and services. An expansion
phase of the economy is a period of
rising real GNP. On the contrary a
recession is a period in which real
GNP falls consecutively; and
2
An index number is a representative number to decode the changes in price level. The consumer
price index number is used to represent the average change over time in the prices paid by the
final consumer of a specified group of goods or services.
MEASUREMENT 27
(c) Real GNP is also often used in
making international comparisons
of economic performance across the
countries.
Having explained the concepts of
Nominal and Real GNP, let us proceed
to know the method by which we obtain
the value of Real GNP through the
constant prices.
The purpose of using constant
prices is to eliminate the effect of price
changes. For this, we are supposed to
express the value of current year’s GNP
(Nominal GNP) in terms of prices
prevailing during a reference year in the
past, which is called the Base year. That
is, the account for the value of current
year’s GNP as if the price level is same
as that of the base year. As you may be
aware that the price level is usually
measured by the Wholesale Price Index
or the Consumer Price Index Number.2
If the GNP in the current year is
valued at current market prices, it will
not be possible for us to find out how
much of the increase in GNP is due to
increase in prices (inflation) and how
much of the increase is due to an
increase in the production of goods and
services. To know whether GNP
increase actually means an increase in
the output of goods and services, we
must eliminate the effect of price
increases.
We shall explain, through the
following illustration, the calculation of
28 INTRODUCTORY MACROECONOMICS

nominal GNP and real GNP as well as
GNP deflator (Table 3.2).
Let us assume that our imaginary
economy has only three final goods :
Oranges - Consumption good
Computers - Capital good
and Government purchases of cloth.
Let us take up the calculation
of nominal GNP through the
expenditure approach. Let us therefore
find out the expenditure on each good
and obtain the total expenditure at
current prices.
Consumption expenditure (oranges)
is Rs. 4452, investment (computers) is

Table 3.2: Nominal GNP, Real GNP and the GNP Deflator
Current Period Base Period

Item Quantity Price Expenditure Price Expenditure

(Rs) (Rs) (Rs) (Rs)
Oranges 4,240 Kgs. 1.05 per kg. 4,452 1 per Kg 4,240
Computers 5 2100 each 10,500 2000 each 10,000
Government 1,060 1 per 1,060 1 per meter 1,060
Purchases meters meter
of Cloth
Nominal GNP 16,012 Real GNP 15,300

Deflators for the current period

Nominal GNP × 100 Rs.16012

GNP Deflator = = × 100 = 104.7
Real GNP Rs.15300

Consumption Expenditure Deflator

Current period consumption

expenditure Rs. 4452
= × 100 = × 100 = 105.0
Base period consumption Rs.4240
expenditure

Current period investment Rs. 10500

Investment Deflator = × 100 = × 100 = 105.0
Base period investment Rs.10000

Current period Government

purchases Rs. 1060
Government Purchases = × 100 = × 100 = 100.0
Base period Government Rs.1060
purchases
NATIONAL INCOME ACCOUNTING : CONCEPTS AND MEASUREMENT 29

Rs. 10,500, and government expenditure measures the average level of the prices of
is Rs. 1,060, so the nominal GNP is Rs. all the goods and services that make up
16012. GNP. It is calculated as the ratio of nominal
Now, let us calculate real GNP. This GNP to real GNP, multiplied by 100.
is, as mentioned before, calculated by In the above example, we divide
valuing the current period quantities at nominal GNP (Rs.16,012) by real GNP
the base period prices. Accordingly, the (Rs. 15,300) and multiply the results by
consumption expenditure is Rs. 4240, 100. We obtain GNP deflator as 104.7.
investment is Rs.10,000 and government It is also possible to calculate
expenditure is Rs.1,060. So the real deflator for specific expenditures as we
GNP is Rs.15,300. would like to know the real value of
Finally, the concept of GNP deflator these expenditures. This is also shown
requires explanation. The GNP deflator in Table 3.2.
GNP
MP
(-)net income from

(–
(-

)n
)d

et
pr e

abroad

in
ec

di
at i

re
io

ct
n

ta
xe
s

NNPMP
GDPMP GNP
FC
(–
) (–
(–)net income

(–)net income
from abroad

from abroad

ne )
ti ne
nd ti
ire nd
ire
(–

-d

ct
)

ct
d

ep

ta
e

xe ta
pr

re

s xe
c
ec

ia

s
i

tio
at
io

n
n

NDPMP NNPFC GDP

FC
(–)
(-)
(–)net income

ne
from abroad

ti
ep

nd
re

ir e
cia

ct
tio

ta
n

xe
s

NDPFC

Fig 3.1: Relationships between Different aggregates of National Income3

3
Wilfred Beckerman, An Introduction to National Income Analysis, 3rd Edition, Universal Book
Stall, New Delhi, 1999.
 30 INTRODUCTORY MACROECONOMICS

Important National Accounts 5. GNP at Factor Cost (GNPFC) = GDPMP

Aggregates
Gross National Product is the core
concept of national income accounting.
From this several other measures are
derived, each having its specific purpose
to interpret the performance of a given
economy. All these concepts and
measures are interrelated which is
shown in Figure 3.1. From this, we may
observe eight major national accounts
concepts as given below and they may
be derived following the direction given
in the diagram.
1. GNP at Market Prices (GNPMP)4 =
Value of all the final goods and
services produced in the economy
+ Net Factor Income from Abroad
2. NNP at Market Prices (NNPMP) =
GNPMP –Depreciation
3. GDP at Market Prices (GDPMP) =
GNPMP – Net Factor Income from
Abroad
4. NDP at Market Prices (NDPMP ) =
GDPMP – Depreciation
+ Net Factor Income from Abroad –
Net Indirect taxes
6. NNP at Factor Cost (NNP FC ) =
GNPFC – Depreciation
7. GDP at Factor Cost (GDPFC) = GDPMP
– Net Indirect taxes
8. NDP at Factor Cost (NDPFC)= GDPFC
– Depreciation
National 5 Disposable Income
In addition to the above, we may also
include the concept of National
Disposable Income. National Disposable
Income is the income from all sources to
the residents of a nation for spending on
consumption as well as saving during a
year. It is given by the following :
National Disposable Income
= NNPMP + Other Current Transfers
from the rest of the world6
This is the maximum available income
for a country. National Disposable
Income for a country is what the
Personal Disposable Income (Personal
Income – Personal Taxes) is for an
individual.

4
A particular value may be expressed at Market Prices or at Factor Cost. If a quantity is expressed
in terms of its current prices it is referred to as market price. Suppose the total value added is
computed on the basis of current prices of inputs then we may call this as value added at Market
Prices. On the other hand, if the value added is arrived at by adding the payments to factors
(land, labour, capital and entrepreneurship) such as rent, wages, interest and profit, (as was
done in Table 3.1) then it is described as value added at Factor Cost. In the same manner, all the
concepts of national income may be shown either at market prices or at factor costs.
5
It may be necessary to give the meaning of ‘Domestic’ and ‘National’ used in National Income
aggregates. Domestic here simply means ‘domestic territory’. So, domestic product would imply
the value of all goods and services produced by the normal residents of a country. ‘National’
refers to the addition of the net factor income from abroad to the domestic product.
6
Current transfers from the rest of the world may include gifts, cash, consumer goods and even
military equipment.
NATIONAL INCOME ACCOUNTING : CONCEPTS
The above definitions may be
understood as general principles of how
these measures are conceptualised. In
practice each country follows its own
method of compilation and hence
definition of specific items, which
constitute an aggregate measure, will
be different from others. In India, the
national accounts are prepared in
accordance with System of National
Accounts (SNA) since 1975.
Subsequently, there has been a
significant improvement in the
statistical statements in terms of
database and coverage. Presently the
SNA 1993 is being used.
Concepts of National Product and
National Income: A Summary
GNPMP = Value of all final goods and
services produced in the
economy+Net factor income
from abroad
NNPMp = GNPMp – Depreciation
GDPMp = GNPMp – Net factor income
from abroad
NDPMp = GDPMp – Depreciation
GNPFc = GNPMp – Net indirect taxes
NNPFc = GNPFc – Depreciation =
National income
GDPFc = GDPMp – Net indirect taxes
NDPFc = GDPFc – Depreciation
Three Methods of Measurement of
National Product
(i) Expenditure Method
GNP Mp = Personal consumption
expenditure + Gross Investment
(Gross business fixed investment +
Inventory investment + Gross
residential construction investment
+ Gross public investment) +
AND MEASUREMENT 31
Government purchases of goods and
services + Net exports (Exports – imports)
+ Net factor income from abroad.
(ii) Income Method
GNPMp = Employee compensation
(wages and salaries + employers’
contribution towards social
security schemes) + profits + rent +
interest + mixed income +
depreciation + net indirect taxes
(Indirect taxes – Subsidies) + Net
factor income from abroad.
(iii) Value Added Method
GNPMp = (Value of output in primary
sector – intermediate consumption
of primary sector) + (value of output
in secondary sector – intermediate
consumption of secondary sector)
+ (value of output in tertiary sector
– intermediate consumption of
tertiary sector) + Net factor income
from aboard.
The following numerical examples will
help us to understand various national
income aggregates.
Example 1: From the following data
calculate the Gross National Product at
Market Price through the Expenditure
Method
(Rs. in crores)
i. Inventory Investment 10
ii. Exports 20
iii. Net factor income from abroad (–5)
iv. Personal consumption 350
expenditure
v. Gross residential 30
construction investment
vi. Government purchases of
goods and services 100
vii. Gross public investment 20
viii. Gross business fixed 30
investment
ix. Imports 10
32 INTRODUCTORY MACROECONOMICS

Solution: + Mixed Income = 400

GNPMp = + Depreciation = 50
Personal consumption = 350 + Net Indirect taxes which = 200
expenditure include
+ Gross Investment = 90 Indirect taxes = 300
which include: Subsidies = 100
Gross Business Fixed = 30 + Net Factor Income from Abroad = –10
Investment GNPMp =1930.
Gross Residential = 30 So the GNPMp is Rs.1930 crores
Construction Investment
Gross public Investment = 20 Example 3: From the following data
Inventory Investment = 10 calculate the Gross National Product at
+ Government purchases of = 100 Market Price via the Value Added method
goods and services
+ Net exports = 10 (Rs. in croroes)
which include: i. Value of output in primary 1,000
Exports = 20 sector
Imports = 10 ii. Net factor income from abroad –20
+Net Factor Income From Abroad = –5 iii. Value of output in tertiary sector 700
GNPMp = 545
iv. Intermediate consumption 400
So, GNPMp is Rs. 545 crores.
in secondary sector
Example 2: From the following data
v. Value of output in secondary 900
calculate the Gross National Product at
Market Price via the Income method sector
(Rs. in crores) vi. Intermediate consumption in 500
i. Wages and Salaries 700 primary sector
ii. Rent 100 vii. Intermediate consumption in 300
iii. Depreciation 50 tertiary sector
iv. Net factor income from abroad –10
v. Mixed income 400 Solution:
vi. Subsidies 100 Value of output in primary sector = 1,000
vii. Profits 400 – Intermediate consumption of
viii. Indirect taxes 300 primary sector = 500
ix. Employers contribution 50 + Value of output in secondary = 900
to social security schemes sector
x. Interest 40 – Intermediate consumption in = 400
Solution: secondary sector
Employee Compensation which + Value of output in tertiary = 700
include = 750 sector
Wages & Salaries = 700
– Intermediate consumption = 300
Employers’ contribution to = 50
of tertiary sector
social security schemes
+ Profits = 400 + Net factor income from abroad = –20
+ Rent = 100 GNPMP = 1380
+ Interest = 40 So, GNPMp is Rs. 1380 crores.
NATIONAL INCOME ACCOUNTING : CONCEPTS AND MEASUREMENT 33

Example 4: From the following data So, GDPFC = Rs. 545 crores
calculate the GNP, GDP, NNP, NDP at both h) NDPFC = GDPFC – Depreciation
factor cost and market prices. = 545 – 15 = 530
(Rs. in crores) So, NDPFC = Rs. 530 crores
i. Gross Investment 90
ii. Net exports 10 Items that are Excluded from GNP
iii. Net indirect taxes 5 Measurement
iv. Depreciation 15 It may be recalled that GNP is the
v. Net factor income from abroad –5 measure of the value of the final goods
vi. Personal consumption 350 and services produced in one year. But
expenditure in reality many transactions occur in
vii. Government purchases of 100
the economy that have either nothing
goods and services
to do with the final goods and services
Solution: produced or that they are non-market
a) GNPMP = activities or illegal activities whose
Personal consumption expenditure = 350 measurement has its own limitations,
+ Gross investment = 90 both conceptual and empirical. We shall
+ Government purchases of = 100 now enumerate a few of these
goods and services transactions that are excluded in the
+ Net exports = 10 estimation of GNP.
+ Net factor income from abroad = –5 1. Purely Financial Transactions
GNPMP = 545 There are three generate types of purely
So, GNPMP is Rs. 545 crores financial transactions. They are
b) NNPMP = GNPMP – Depreciation (a) Buying and Selling of securities
= 545 – 15 = 530 (b) Government Transfer Payments
So, NNPMP = Rs. 530 crores (c) Private Transfer Payments
c) GDPMP = GNPMP – Net Factor Now, let us examine these
Income from Abroad transactions in detail.
= 545 – (–5) = 545 + 5
= 550 (a) Buying and selling of securities
So, GDPMP = Rs. 550 crores
d) NDPMP = GDPMP – Depreciation In the financial markets as shown
= 550 – 15 = 535 earlier in circular flow model, potential
So, NDPMP = Rs. 535 crores savers and investors buy and sell
e) GNPFC = GNPMp – Net indirect financial assets such as shares and
taxes bonds. While someone buys a share
= 545 – 5 = 540 there is only a transfer of ownership
So, GNPFC = Rs. 540 crores right. It is a claim to ownership of assets.
f) NNPFC = GNPFC – Depreciation
In the case of bonds, it is
= 540 – 15 = 525
So, NNPFC = Rs. 525 crores acknowledging a debt transaction.
g) GDPFC = GDPMp – Net indirect There is no production activity but only
taxes exchange of funds for financial claims.
= 550 – 5 = 545 Trading in financial instruments does
34
not imply production of final goods and
services. As such these are not included
in the GNP.
(b) Government Transfer Payments
As defined earlier, transfer payments
are payments for which no goods or
services are provided in exchange.
Pension payments, Employees’ social
security measures, adhoc assistance
due to certain exigencies like floods,
drought, etc. and subsidies are
examples for government transfer
payments. As there is no production of
final goods and services in response to
transfer payments, the transfer
payments are not included in the GNP.
(c) Private Transfer Payments
Items such as pocket money given by
parents to their children, elders gifting
money to the young ones are private
transfer payments. This is merely a
transfer of money from one individual
to another. Hence this is also not
included in the GNP.
2. Transfer of Used Goods
GNP refers to the value of the final goods
and services produced in a given year.
Hence, goods produced in the previous
time period cannot be included in the
GNP. For instance, when a person buys
a used car, it cannot be recognized in
GNP measurement as the car was
produced in an earlier year. Spending
on a used car simply reflects a change in
the ownership of a pre-existing output.
3. Non-market Goods and Services
Many final goods and services are not
acquired through regular market
INTRODUCTORY MACROECONOMICS
transaction – vegetables can be grown
in the backyard instead of bought in
the super market, or an electrical fault
can be repaired by the house owner
himself or herself instead of hiring an
electrician. These are examples of non-
marketed goods and services that have
been consumed without using
organised markets. But GNP includes
only those transactions that occur
through market activities. Barter
transactions and production for self-
consumption by household are not
included in the GNP. It is in this context,
there is a debate as to whether
housewives services should be included
or not. If so, how do we value their
services at current market prices?
4. Illegal Activities
GNP does not include trade in illegal
goods and services even though they
are final products and are purchased
in market transactions. Activities such
as smuggling, gambling, crime for hire,
drug trafficking, illegal arms sale are
some cases in point.
These illegal activities create an
‘underground economy’ wherein
‘production’ is unreported or
unaccounted either because it is
unlawful or those involved want to
evade the government tax-net. As a
result these illegal and concealed
transactions create a huge volume of
unaccounted money that is popularly
called the black money. Black money
is the main driving force of
underground economy or “parallel
economy”. As in the case of non-market
goods, it is difficult to fix exact market
NATIONAL INCOME ACCOUNTING : CONCEPTS AND
value for transactions in the
underground economy. Technically, as
per the law of the land, these activities
are classified under economic offenses.
Hence their exclusion from GNP.
5. The Value of Leisure
Leisure is regarded as an economic
good. It may be that, other things being
equal, more leisure is better than less
leisure. When the levels of income
increase, the resultant state of affluence
would induce people to prefer more
leisure than less of it. This means that
with higher economic security the richer
segment of our society would cut down
their work effort, which in turn means
producing less GNP. But that would not
imply or suggest that people become
worse off than before. In fact, choice of
more leisure is simply an increase in
utility. However, it would be very
difficult to measure the intangible item
like leisure and include it in the GNP.
Nevertheless, in a modern economy,
there is wide range of business
opportunities to provide for leisure time
activities. So, though leisure as such
cannot be measured, the services
provided by the business sector to
capture the demand for leisure-time
activities could be brought under final
services for inclusion in the GNP.
Leisure-time activities are in great
demand from the middle and richer
classes of society.
However, leisure per se cannot be
brought within the treatment of national
accounts mainly because there is no
valuation possible and imputing value
is both difficult and not useful for any
analysis.
MEASUREMENT 35
Does GNP Measure Economic
Welfare?
For a very long period of time
economists have used GNP quite
uncritically as the principal measure of
economic growth and development.
Maximisation of national income was
taken synonymous with maximisation
of growth; hence rising GNP is good and
declining GNP is bad for the economy.
But a whole range of questions
concerning it are being raised these
days. They are such as, what is or ought
to be growth? What happens to
distribution of income and wealth with
an increase of GNP? What does an
increasing GNP do to the use of non-
renewable natural resources? Is there
a necessary association between
increase in national income and
national welfare? Can the increase in
national income accomplish good
quality of life and human development?
All these and other questions have been
researched into in the recent past and
at present GNP measure is under close
scrutiny by economists and policy
makers. In recent times more and more
economists have shown keen interest to
critically look at GNP as the indicator of
growth and development of a nation.
Measurement of GNP is subject to
the rules of national income accounting.
These rules may rigidly classify
production activities to be included in
or excluded from GNP. Hence GNP as a
statistic can be misleading as the basis
of overall development of an economy.
Therefore, the main question that needs
to be discussed is : Does the GNP
measure economic welfare?
 36 INTRODUCTORY MACROECONOMICS

J.R. Hicks once wrote that, “The GNP as the sole objective of development
purpose of income calculation... is to will be counter productive. It is
give people an indication of the important to test whether growth in
amount they can consume without GNP results in equitable distribution of
impoverishing themselves”7. income, sustainable development and
In the contemporary economies, good quality of life for people. The
particularly in the developing process of development must create
countries, we are confronted with the sustainable societies without
serious issue of inequality in the endangering the natural resources and
income distribution, environmental
ecological systems.
degradation, and deterioration in the
Therefore, attempts to enhance GNP
quality of life. All these and related
problems have not only introduced at any cost may create economic ‘bads’
gaps between different classes of people such as poverty and pollution. This
in terms of their social and economic requires an alternate measure, which
status but also between nations, would allow GNP to measure human
involving categorisation such as welfare. Some economists have suggested
developed, developing, less developed the concept of “green” GNP. Such a ‘green
and least developed countries. GNP’ would help attain a sustainable use
It is beyond the scope of this of the natural environment and equitable
chapter to probe into the development distribution of the benefits of
debates over the questions narrated development. It may be useful to debate
above. Suffice it to say that increase in these issues related to GNP.
SUMMARY
l Circular flow of income forms the basis for measurement of macroeconomic
activities.
l Product approach, Income approach and Expenditure approach are three
ways in which Gross National Product can be measured.
l In the product approach, only the final goods and services are included to
facilitate the aggregation of the value added by the producing units.
l Income approach is concerned with summation of factor incomes which in
turn must equal to total value added. Hence product is also income in
national accounts.
l Aggregate expenditure is obtained by adding all expenditures on
consumption, investment and government purchases of goods and services.
l Real GNP and Nominal GNP are outlined by taking the value of national
product at constant prices and current prices respectively.
l GNP deflator is used to measure the average level of the prices of all goods
and services.
l Purely financial transactions, government and private transfers, used goods,
illegal activities, non-market goods, etc. do not get included in the GNP.

7
J.R.Hicks, Value and Capital, Oxford University Press, 1975, Page 172.
NATIONAL INCOME ACCOUNTING : CONCEPTS AND MEASUREMENT 37

EXERCISES

Section I
1. Define:
(i) GNP at market prices
(ii) NNP at market prices
(iii) GNP at factor cost
(iv) NNP at factor cost.
2. Define the concept of value added.
3. Show how the sum of value added is equal to sum of factor incomes.
4. What is the difference between final good and intermediate good?
5. What is depreciation?
6. What are the components of aggregate expenditure?
7. What are factor incomes?
8. What is meant by double counting? Why should it be avoided?
9. What are transfer payments?
10. Explain the meaning of non-market activities.
11. What is called ‘Green GNP’?
12. Differentiate between national income at current price and constant
price.
13. Define: (a) Nominal GNP and (b) Real GNP
14. What is a GNP deflator?
15. Give reasons for not including leisure in GNP.

Section II
16. Explain product and income approaches to measure national income.
17. Explain the value-added method with the help of an example.
18. What are the items that are excluded from GNP? Give reasons.
19. Does GNP measure national welfare?
20. Explain the components of factor income.
21. Explain the following terms:
(a) Business fixed investment
(b) Inventory investment
(c) Residential construction investment
(d) Public investment.

Section III
22. Calculate the value added by Firm A and Firm B from the following
data:
(Rs. in lakhs)
(i) Purchase by Firm A from the Rest of the world 30
(ii) Sales by Firm B 90
(iii) Purchases by Firm A from Firm B 50
38 INTRODUCTORY MACROECONOMICS

(iv) Sales by Firm A 110

(v) Exports by Firm A 30
(vi) Opening stock of Firm A 35
(vii) Closing stock of Firm A 20
(viii) Opening stock of Firm B 30
(ix) Closing stock of Firm B 20
(x) Purchases by Firm B from Firm A 50
23. Calculate value added by Firm X and Firm Y from the following data:
(Rs. in lakhs)
(i) Sales by Firm X 100
(ii) Sales by Firm Y 500
(iii) Purchases by households from Firm Y 300
(iv) Exports by Firm Y 50
(v) Change in stock of Firm X 20
(vi) Change in stock of Firm Y 10
(vii) Imports by Firm X 70
(viii) Sales by Firm X to Firm Y 250
(ix) Purchases by Firm Y from X 200
24. From the following data calculate the Net National Product at Market
Prices by (a) Expenditure Method (b) Income Method:
(Rs. in Crores)
(i) Personal consumption expenditure 700
(ii) Wages and salaries 700
(iii) Employers contribution to social security schemes 100
(iv) Gross Business fixed investment 60
(v) Gross Residential construction investment 60
(vi) Gross public investment 40
(vii) Inventory investment 20
(viii) Profits 100
(ix) Government purchases of goods and services 200
(x) Rent 50
(xi) Exports 40
(xii) Imports 20
(xiii) Interest 20
(xiv) Mixed income 100
(xv) Net factor income from abroad –10
(xvi) Depreciation 20
(xvii) Subsidies 10
(xviii) Indirect taxes 20
25. From the following data calculate the Gross Domestic Product at Factor
Cost by (a) Expenditure Method (b) Income Method:
(Rs. in Crores)
(i) Personal consumption expenditure 700
(ii) Wages and salaries 700
NATIONAL INCOME ACCOUNTING : CONCEPTS AND MEASUREMENT 39

(iii) Employers’ contribution to social security schemes 100

(iv) Gross business fixed investment 60
(v) Profits 100
(vi) Gross residential construction investment 60
(vii) Government purchases of goods and services 200
(viii) Gross public investment 40
(ix) Rent 50
(x) Inventory investment 20
(xi) Exports 40
(xii) Interest 20
(xiii) Imports 20
(xiv) Net factor income from abroad – 10
(xv) Mixed income 100
(xvi) Depreciation 20
(xvii) Subsidies 10
(xviii) Indirect taxes 20
26. From the following data calculate the Gross Domestic Product at Market
Prices:
(Rs. in crores)
(i) Value of output in primary sector 2,000
(ii) Intermediate consumption of secondary sector 800
(iii) Intermediate consumption of primary sector 1000
(iv) Net factor income from abroad – 30
(v) Net indirect taxes 300
(vi) Value of output of tertiary sector 1,400
(vii) Value of output of secondary sector 1,800
(viii) Intermediate consumption of tertiary sector 600