Session 2-3 National Income Accounting 1
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Transcript of Session 2-3 National Income Accounting 1
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National Income Accounting:
Important Identities
Dr. Leena Mary Eapen
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National Income Accounting: Measures the currenteconomic activity: Production, Income, andSpending of Nations
Accounting methodology is vital for identifyingeconomic problems and formulating plans forachieving goals.
Basic Measures:
Gross Domestic Product (GDP) is the value of all
final goods and services produced in the countrywithin a given period.
To assess the employment opportunity in a countryGDP is the best indicator.
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Gross National Product (GNP) = GDP + Net factorincome from abroad ((factor payments from abroad factor payments to abroad)
National income/product is that income/ productwhich accrues to the economic agents who are
resident of the country from both domestic sourcesand foreign sources (e.g. remittance from non-residents working abroad, income due to a foreignwork assignment to a resident).
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In your country,
which would you wantto be bigger, GDP or GNP?
Why?
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How to measure GDP?
The Product Approach: measures economic activity byadding the market values of goods and services produced.
The Expenditure Approach: measures activity by adding theamount spent by all ultimate users of output.
The Income Approach: measures economic activity byadding all income received by producers of output,including wages received by workers and profits receivedby owners of firms.
Fundamental identity of national income account: totalproduction = total income = total expenditure
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Q1
P1
QF2
WF2
Q2
P2WF1
QF1
D2D2
The interdependence of goods and factor markets
P
Q
P
Q
RsRs
RsRs
Factorservices
Goods
GoodsFactor
services
S S
D1 D1
(1)
Consumerdemand
(4)Factor
supply
(3)Factor
demand
(2)Producer
supply
OO
FIRMS(suppliers of goods and
services,demanders of factor
services)
HOUSEHOLDS
(demanders of goodsand services,
suppliers of factorservices)
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Factorpayments
Consumption ofdomestically
produced goodsand services (Cd)
Investment (I)
Government
expenditure (G)
Export (X)
BANKS, etc
Netsaving (S)
GOV.
Nettaxes (T)
ABROAD
Importexpenditure (M)
The circular flow of income
WITHDRAWALS
INJECTIONS
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Withdrawals [ T + S + M] = Injections [G + I + X]
can be broken down to three important balances in the
economy:
1. T - G: the Government's Budgetary Balance;
2. S - I: the Private Sector's Saving/Investment Balance;
3. M - X: (current account of Balance of Payments)
Exports = imports trade balance
All measurements in the circular flow model are rates of change (flows) and tell us
nothing about the total amounts (stocks) of goods, services, money or anything
else in the economy.
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Stock A stock is a quantity measured at a givenpoint in time e.g., items on a balance sheet (assets and
liabilities), the worlds oil reserves in the beginning
of a year.
Flow A flow is a quantity measured per unit of
time. e.g., items on an income statement (receipts and
expenses), the worlds current production of oil per
day.
Stocks vs. Flows
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Stocks vs. Flows
stock flow
a persons wealth a persons saving
# of people with # of new college
college degrees graduates
the govt. debt the govt. budget deficit
Flow Stock
More examples:
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The Product Approach
The production approach looks at GDP from thestandpoint of value added by each input in the
production process.
By final we mean exclusion of all intermediateproducts/inputs used up in the production.
Measure the Value Added summed across all firms
(value added = sale price - cost of raw materials).
This is to avoid double counting.
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Farmer sells to
Miller Sales price of raw wheat Rs. 100
Miller buys wheat
from farmer and
converts to wheat
flour and sells to
baker
Cost of raw material to miller
(Raw wheat)
Processing expenses (Say
cleaning and grinding)
Sales price of wheat flour
Rs. 100
Rs. 90
Rs. 190
Baker buys wheat
flour from miller
and converts tobread and sells to
the Consumer
Cost of raw material to baker
(Wheat Flour)
Processing expenses (baking,packing)
Sales price of packaged bread
(Final good)
Rs.190
Rs.80
Rs.270
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A question for you:
A farmer grows a bushel of wheatand sells it to a miller for Rs10.00.
The miller turns the wheat into flour
and sells it to a baker for Rs 30.00. The baker uses the flour to make a
loaf of bread and sells it to anengineer for Rs 60.00.
The engineer eats the bread.ComputeGDP
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Imagine that a bakery hires workers toproduce more bread, pays their wages,
and then fails to sell the additional bread.How does this transaction affect GDP?
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The answer depends on what happens tothe unsold bread:
bread spoils no change in GDP
bread is put into inventory to be soldlater increase in GDP
Baker consumed the bread- increase
in GDP
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Unsold output goes into inventory,
and is counted as inventoryinvestment
whether the inventory buildup was intentional
or not.
In effect, we are assuming that firms purchase
their unsold output.
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What happens to GDP later when the firmsells the bread out of inventory?
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This case is much like the sale of a used good.
There is spending by bread consumers, but there is
inventory disinvestment by the firm.
The negative spending by the firm offsets the positivespending by consumers, so the sale out of inventory
does not affect GDP.
However, the value of the services of the firm in thesale is part of GDP, because those services are
provided in the current period.
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Spending/Expenditure Approach
The spending approach divides GDP into four areas:
Spending by households (consumption) (C)
Spending by businesses (investment) (I)
Spending by government (G) and
Net Spending by foreign sector (net exports, NX =X-M).
Y = C + I + G + NX
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Consumption (C)
durable goodslast a long timeex: cars, homeappliances
non-durablegoodslast a short timeex: food, clothing
services
work done forconsumersex: dry cleaning,air travel.
def: the value of all goodsand services bought byhouseholds. Includes:
Consumption is the largest proportion of GDP.
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Gross Private Domestic Investment (I) orGross Capital Formation
def1: spending on [the factors of production] capital.
def2: spending on goods bought for future use.
Includes:
business fixed investment: spending on plant and equipmentthat firms will use to produce other goods & services
residential fixed investment: spending on housing units byconsumers and landlords
inventory investment: the change in the value of all firmsinventories (or) it is the difference between goods produced andgoods sold.
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Sales = production inventory investment
Very small proportion of GDP some times even
negative.
Investment in shares is the financial investment
which is not included.
Stock market transactions are not included because itrepresent only the exchange of certificates of
ownership (stocks) and not actual new production.
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Investment vs. Capital
Capital is one of the factors of production.At any given moment, the economy has a certain overallstock of capital.
Investment is spending on new capital.
Example (assumes no depreciation):
1/1/2010:economy has $500b worth of capital
during 2010:investment = $37b
1/1/2011:economy will have $537b worth of capital
G S di (G)
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Government Spending (G)
G includes all government spending on goods and
services.
G excludes transfer payments.
Transfer payments are transactions wherein one party
is not obliged to deliver a good or service in return for
the payment.
Examples: retirement benefits, unemployment benefits,
scholarships, donations etc.
Similarly, interest payments on the national debt are not
counted.
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Can exports exceed GDP?
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Yes. For example, a country that imports intermediate
goods for Rs 1000. Suppose it then transforms them
into final goods using only labor. Say that labor is
paid only Rs 200 and that there are no profits. The
value of these final goods is thus equal to Rs 1200.
Assume that these goods are exported. Then GDP =Rs 200 and the ratio of exports to GDP = 1200/200 =
6.
In 2010, the ratio of exports to GDP in Singapore was157%. India in the same year only 13%.
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The Income Approach
Income is what you earn from working plus what youreceive in interest and dividends.
The income approach divides GDP according to whoreceives the income from the spending flow.
In addition to aggregate income, national income andpersonal income are also used as measures of income.
Income Method: Labor Income (wages/salary) +Capital Income (rent, net interest, dividends, profits)+Government Income (taxes) + Depreciation.
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The Income Components Include:
Wages and salaries (largest component)
Corporate profits (Corporate income taxes + Dividends +Undistributed corporate profits)
Proprietors income (the profits of partnerships and solely ownedbusinesses, like a family restaurant)
Farm income
Rental income of persons
Net Interest (only the interest payments made by business firms are
included and the interest payments made by government areexcluded).
Taxes on production and imports
Depreciation (consumption of fixed capital )
The Income Approach
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Mario works at Pizza Hut and earns an annualwage plus tips of Rs 15,000. He sold 4,000pizzas at Rs 10 per pizza during the year. Hewas unemployed part of the year, so he
received unemployment compensation of Rs3,000. During the past year, Mario bought aused car for Rs10,000. Using theexpenditure approach, how much has Mariocontributed to GDP?
How Much Does Mario Add to GDP?
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Other Indicators Per capita GNP = GNP/Population.
It represents the average income of a country.
It indicates the level of economic development orliving standard of individuals in comparison to other
countries.
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Net Domestic Product (NDP) is GDP minusdepreciation. Depreciation is usually
11%.
NDP=89% of GDP
National Income (NI) or NDP at factor cost isNDP-Indirect taxes that Business pay +subsidy.
Indirect taxes that Business pay nearly 10%.
NI is nearly 90% of NDP
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Personal Income (PI) = NI - indirect taxes - corporate
profits - net interest - contributions for social insurance
+ income from assets + personal transfers.
Personal Disposable Income (DI) = PI personal tax
and non-tax payments (user charges, royalty fromminerals etc)
It is also equal to personal consumption expenditures
plus personal saving.
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National savings, S= Spvt+ Sgovt
Spvt = private corporate sector + householdsavings
Sgovt is also called as govt budget surplus.
IfSgovt is negative then it is known as govt
budget deficit.
Savings
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Household savings
Household savings: Financial and physical
savings.
Financial savings in the household sectorcomprise savings in the form of currency, net
deposits, shares and debentures, life insurancefunds, PFs, pension funds etc.
Savings in physical assets consist of net addition
to physical assets of the household, comprisinginvestment in land, houses, cattle, machineryand equipment, change in stocks etc.
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Period savings as share
to GDP
share of financial
savings to total
saving
1970-71 1.5 per cent 28.1 per cent
1980-81 4.9 per cent 39.4 per cent
1990-91 14.2 per cent 56.8 per cent
1998-99 18.5 per cent 59.1 per cent
2006-07 34.8per cent Less than 50
percent
I t ti l C i f GDP
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International Comparisons of GDP In any attempt to compare GDP between countries,
some account must be taken of differences in prices.
Purchasing power parity exchange rates attempt to
adjust exchange rates for differences in the prices of
goods across borders through the use of a ratio of priceindexes.
The exchange rate is adjusted to reflect this ratio.
Purchasing Power Parity Exchange Rate (PPPER)
= e Pf/Pd
Here e is $/`.
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How NI arrived at in India?
NI estimates are arrived by dividing the economy into
a few broad sectors and use estimates of value addedby them to arrive at a figure for NI.
The major sectors considered by the CentralStatistical Organisation of India include the
following.
http://mospi.nic.in/t1_income_at
_current_price_7april05.htm
http://mospi.nic.in/t1_income_at_current_price_7april05.htmhttp://mospi.nic.in/t1_income_at_current_price_7april05.htmhttp://mospi.nic.in/t1_income_at_current_price_7april05.htmhttp://mospi.nic.in/t1_income_at_current_price_7april05.htm -
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Sectoral Composition of GDP
Year Primary Secondary Tertiary
1950-51 59.2 13.3 28.0
1960-61 54.8 16.6 29.0
1970-71 48.1 19.9 32.2
1980-81 41.8 21.6 36.6
1990-91 34.9 24.5 40.6
2000-01 26.2 23.5 50.3
2003-04 23.9 23.4 52.7
March
2010 19.57 25.88 54.56
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Problems with NI Estimation in India
Weaknesses in respect of data used for estimatingNI. Gaps in data (e.g. no data are collected forunauthorized removal of forest produce and fellingof trees outside the regular forests).
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Unpaid activitiesMultiple jobs sector??
not marketed Oil spill wave Negative externality
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Quality excluded Services of durable goods excluded.
Unorganized sector- guess work Education input or output?
Is NI correct indicator of economic development?
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Due to following reasons, NI fails to serve as acomplete/adequate index of welfare.
(a) Income distribution is not reflected at all in NI. Even a veryhigh GDP may not contribute much to the well-being of anation if it is not distributed equally.
(b) Apart from income there are many other factors such asbetter education, health and drinking water facilities, thevalue of leisure, declining work week, nice week end etc.which determine human welfare. We cant ignore them.
(c)Environmental pollution in the process of production hasserious effects on the well-being/quality of life of thesociety/citizens.
Is NI correct indicator of economic development?
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P: 141 CP
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Nominal vs Real GDP
Nominal GDP is GDP measured in currentprices.
Real GDP is GDP measured at constantprices to compare economys performance
over time.
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Real GDP controls for inflation
Changes in nominal GDP can be due to: changes in prices
changes in quantities of output produced or
a combination of these two.
Changes in real GDP can only be due to
changes in quantities, because real GDP is
constructed using constant base-year prices.
It C t (2011) C t B (1993)
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Items Current year (2011)
production
Current year
prices
Base year (1993)
prices
Wheat 10 5 4
Car 6 9 8
Computer 15 6 5
Compute the nominal and real GDP in 2011 and
1993.
Price Indexes
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Price Indexes
The inflation rate is the percentage increase in the
overall level of prices.
An inflationary situation does not mean that all prices
are rising without exception.
Since many goods & services are produced in economy,
some prices may actually be falling and others may be
rising at any point of time.
But note that if the price of only one/very few goods
goes up, then it is not inflation. It is inflation, if the
prices of most goods go up.
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Price Indexes
A price index is a measure of the average level of
prices for some specified set of goods and services,relative to the prices in a specified base year.
Different prices indexes are:
1.GDP Deflator
2.Consumer price index
3.Wholesale price index
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GDP Deflator
GDP Deflator is a price index that measures theoverall level of prices of goods and services included
in GDP and is defined by the formula
Nominal GDPGDP deflator = 100
Real GDP
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Inflation Practice problem
Compute nominal GDP in each year
Compute real GDP in each year using 2001 asthe base year.
The base period has no particular significance.
2001 2002 2003 2004
P Q P Q P Q P Q
good A 30 900 31 1,000 36 1,050 34 1,050
good B 100 192 102 200 100 205 100 205
P ti bl
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Practice problem
Compute the GDP deflator in each year.
Use GDP deflator to compute the inflation rate from 2001 to2002, from 2002 to 2003 and from 2003 to 2004.
Nom.GDP
RealGDP
GDPDeflator
inflation
rate
2001 46,200 46,200 n.a.
2002 51,400 50,000
2003 58,300 52,000
2004 56,200 52,000
GDP L l V G th R t
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GDP: Level Versus Growth Rate
GDP growth equals:
1
1)(
t
tt
Y
YY
Periods of positive GDP growth are called expansions.
Periods of negative GDP growth are called recessions.
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Calculate the percentage growth of nominal and real
GDP in 2002.
Nom. GDP Real GDP
2001 46,200 46,200
2002 51,400 50,000
2003 58,300 52,000
2004 56,200 52,000
C P i I d (CPI)
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CPI is a measure of inflation based on what average
consumer pays.
It measures cost of buying a fixed basket of goods
and services by consumers.
The CPI is a weighted average of prices. The weight
on each price reflects that goods relative importance
in the CPIs basket. Note that the weights remainfixed over time.
Consumer Price Index (CPI):
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How CPI is constructed?
Household survey is conducted to find outconsumption of a typical household.
CPI is released on monthly basis.
Used to
track changes in the typical households cost of
living adjust many contracts for inflation
allow comparisons of currency from different years
C P i I di
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The four consumer price indices are:
CPI-IW for industrial workers; CPI-UNME for urban non-manual employees;
CPIAL for agricultural laborers; and,
CPI-RL for rural laborers.
CPI-IW used for wage indexation in Governmentand in the organized sectors (2001 as base year).
CPI UNME series is published by the CentralStatistical Organisation, the others are publishedby the Department of Labour.
Consumer Price Indices
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CPI vs. GDP DeflatorPrices of capital goods included in GDP deflator (if produced domestically)
excluded from CPI
Prices of imported consumer goods
included in CPI excluded from GDP deflator
Basket of goods
CPI: fixed GDP deflator: changes every year
h fl
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Reasons why CPI may overstate inflation
Substitution bias: The CPI uses fixed weights, so itcannot reflect consumers ability to substitute toward
goods whose relative prices have fallen.
Introduction of new goods: The introduction of newgoods makes consumers better off and, in effect,
increases the real value of the currency. But it does
not reduce the CPI, because the CPI uses fixed
weights.
Unmeasured changes in quality: Quality
improvements increase the value of the currency, but
are often not fully measured.
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Like CPI, WPI is a measure of cost of a given basket of goods.
WPI is an economy-wide index covering 676 commodities.
Weights of the commodities are derivedbased on the value of
quantities traded in the domestic market.
It is, therefore, the most comprehensive measure of economy-
wide inflation available with high frequency.
CPI measures prices at retail level, WPI is constructed atwholesale level. WPI measures average level of prices of goods
sold by producers.
Wholesale Price Index (WPI):
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WPI is useful because it gives us an idea of what will
happen to consumer prices in the near future it signals
changes in CPI/general price level.
How? If producers receive higher prices from sale to
wholesalers, then retailers will charge higher prices, which
will reflect in CPI.
WPI is released on weekly basis.
In India, we use WPI as our official measure of inflation.India constituted the last WPI series of commodities in
2004-05.
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WPI in India
Description
Weights
1981-82 1993-94 2004-05
I. Primary Articles 32.30 22.02 20.1
II. Fuel, Power, Light &
Lubricant 10.66 14.23 14.9
III. Manufactured Products 57.04 63.75 64.9
All Commodities 100 100 100
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Pros and Cons of WPI & CPI CPI takes time to get published (monthly). But, WPI is
released on weekly basis.
WPI data is more transparent compared to CPI data CPI
for all commodities taken together is not available! Non-
transparency has encouraged mistrust of CPI.
CPI measures increase in price that a consumer will
ultimately have to pay for. But WPI not.
Many commodities included in WPI have ceased to be
important from consumption point of view.
In WPI, fuel group gets a much higher weightage andservices not included.
In CPI, food gets maximum weightage.
Also, WPI differs from CPI in coverage - e.g. WPI
includes raw materials and semi-finished goods.
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Thank You