1 NATIONAL INCOME AND ITS ESTIMATES NATIONAL INCOME ACCOUNTING National income, in its simplest form, may be defined as the total value of a country s final output of all new goods and services produced in one year. According to National Income Committee (1949), A national income estimate measures the volume of commodities and services turned out during a given period counted without duplication. National income can be measured on the basis of two different approaches; (1) On the basis of place of production activities held. National income accounted on this approach is called domestic product. It is Gross Domestic Product (GDP) or Net Domestic Product (NDP) (2) On the basis of persons who are involved in production activities. Accounted on this basis, the national income is called national product. It is Gross National Product (GNP) or Net National Product (NNP) National income estimates in India are related with the financial year that begins on April 1 of every year and ends on March 31 of next year. National income accounting refers to the measure of value of production activity of a country within a given period. In this regards, two important points are worth attention; (1) Place of Production whether it is within the territory of a country only or production at a place beyond the territory can also be considered? (2) Persons involved in production whether the citizens of the country only or even the outsiders also? In actual, for national income accounting, geographical territory of a country is no limit. For national income accounting of India, it is not the geographical territory but the economic territory that matters. Similarly, the production activities carried on by the residents as well as citizens in the economic territory of a nation are taken into account for the purpose. In the above discussion, two important terms, economic territory and resident have been coined which needs to be clarified before going ahead in the discussion. ECONOMIC TERRITORY: It is the production within the economic territory of a nation that becomes the basis for GDP or NDP. It is irrespective of the category of persons involved in production activities. Economic territory of a country consists of geographical territory administered by the government within which people, goods and capital may circulate freely. Economic territory includes (a) Land, national airspace and territorial waters of a country, i.e. political frontiers (b) Natural deposits of oil and gas in international waters which are worked by the residential units of a country (c) Territorial enclaves abroad such as diplomatic representatives and military bases (d) Fishing vessels operated by the residents of a country in international waters or other areas over which the country enjoys exclusive rights or jurisdiction RESIDENT: It is the production activity carried on by the residents of a nation, irrespective of the territory, that forms the basis for GNP or NNP. In this context, resident and citizen are two different terms. A person is said to be a citizen if s/he fulfills the qualification prescribed in the law of a country to become its citizen. A person who is resident of a country may or may not be its citizen and similarly, a person who is citizen of a country may or may not be its resident. Resident can be an individual or an institution or a body corporate. For national income purpose, a resident is defined as a person whose centre of economic interest lies in the economic territory of a country where it lives. From the above discussion, now it becomes easier for one to differentiate between the two approaches of national income, i.e. domestic product and national product. Domestic Product refers to the total value of production by the production units within the economic territory of a nation irrespective of the fact they are residents or non-residents. There are two terms related with domestic product, i.e. Gross Domestic Product (GDP) and Net Domestic Product (NDP). Gross domestic product (GDP) is the market value of all officially recognized final goods and services produced within a country in a given period of time whereas Net Domestic Product (NDP) is GDP net of depreciation, i.e. NDP = GDP Depreciation National Product refers to the total value of production by the production activities of residents of a nation both within and outside the economic territory. Gross National Product (GNP) and Net National Product (NNP) are two terms related to the concept of national product.
2 Both GDP and GNP are the indicators of economic health of a nation. Practically, GDP being based on the production within the economic territory of a nation by tapping its national resources is preferred over GNP for measuring economic growth. There are two different approaches to measure Domestic Product and National Product of a nation. (1) Market Price approach (2) Factor Cost approach Factor Cost is arrived at by deducting indirect taxes from the Market Price and adding subsidies to it. Mathematically; Factor Cost = Market Price Indirect Taxes + Subsidies GDP at Market Price (GDPMP) is the value of final products in various sectors of economy at market price NDP at Market Price (NDPMP) is GDPMP minus depreciation. NDPMP = GDPMP Depreciation GDP at Factor Cost (GDPFC) is the GDPMP minus indirect taxes plus subsidies. GDPFC = GDPMP Indirect Taxes + Subsidies NDP at Factor Cost (NDPFC) is the GDPFC minus depreciation. NDPFC = GDPFC Depreciation. DEPRECIATION is the value of consumption of fixed assets during the production process. It can be because of time or wear & tear or accidents. NATIONAL INCOME of a country refers to the Net National Product at Factor Cost (NNPFC). NNPFC (National Income) = NDPFC + NFIA It is important to note that for every economy, there is (1) contribution to production by the residents who are residing abroad, i.e. outside the economic territory of the nation which is called FACTOR INCOME from abroad; and (2) contribution to production by non-residents within the economic territory which is called FACTOR INCOME paid to abroad The difference between (1) and (2) is called NET FACTOR INCOME from abroad (NFIA) The following equation shall depict better the relation between the domestic product and national product. National Product = Domestic Product + Contribution to production by residents of a nation outside its economic territory Contribution to production by non-residents within the economic territory of a nation Or National Product = Domestic Product + Net Factor Income from Abroad The domestic product of every economy consists of the total value of output by the production activities carried on any of the three sectors of the economy, i.e. Primary Sector, Secondary Sector and Tertiary Sector. Sector-wise estimates of production are very important for various economic decisions. Generally seen, in a less developed nations there is more contribution of primary sector in its GDP and this contribution of primary sector goes on decreasing as an economy progresses on the path of development. The more contribution of secondary sector into GDP is considered better for economic growth and high levels of employment. So, the analysis of sector-wise contribution in the GDP helps us in determining the nature of an economy. Moreover, it is statistically more convenient to estimate national income originating in a group of similar production units. In the case of India, the share of primary sector (particularly agriculture) in GDP has been on the decline continuously whereas the share of tertiary sector is on the rise. Manufacturing sector, i.e. the secondary sector has never remained dominating since independence. PRIMARY SECTOR: The primary sector of the economy extracts or harvests products from the natural resources. The primary sector includes the production of raw material and basic foods. Activities associated with the primary sector include agriculture (both subsistence and commercial), mining, forestry, farming, grazing, hunting and gathering, fishing, and quarrying. SECONDARY SECTOR: This sector depends on the primary sector for its raw-material. In this sector the raw-material provided by the primary sector is converted into the finished goods for final or intermediary consumption. All of manufacturing, processing, and construction lies within the secondary sector. An R.O. plant installed for supplying clean water to the residents of a locality is an example of secondary activity. Other examples are bakery, brewery, ship-building, brick kiln etc. TERTIARY SECTOR: The tertiary sector of the economy is the service industry. This sector supports both the primary sector and secondary sector. It even provides health, education and recreation to those individuals involved in production activities in various sectors of economy. Examples are marketing, banking, insurance, transportation, distribution, education, health, law, tourism etc. ESTIMATES OF NATIONAL INCOME Let us understand the relation between Production (P), Income (I) and Expenditure (E); Whatever production is made in an economy in a year is distributed among the various factor owners in the form of wages & salaries, rent & royalty, interest and profits which become their income and the factor owners either consume their income or invest it. So, P I E
3 Here, expenditure (E) equals the sum of consumption expenditure and investment. On the basis of above discussion, there are three methods of measuring national income of a nation. (1) Product Method (2) Income Method (3) Expenditure Method PRODUCT METHOD According to this method, the sum total of market value of production in each sector of the economy is counted.. It is, basically, the GDPMP. This method is also known as VALUE ADDED METHOD since in each sector at every stage of production some value is added to the material used. GVAMP in Primary Sector + GVAMP in Secondary Sector + GVAMP in Tertiary Sector = GDPMP GVAMP, here is Gross Value Added at Market Price. Further, GDPMP Depreciation = NDPMP NDPMP Indirect Taxes + Subsidies = NDPFC NDPFC + NFIA = NNPFC (National Income) The following points must be taken care of while estimating national income by Product Method; (1) Double counting should be avoided. Double counting shall lead to the over-estimation of the national income. To avoid double counting, only value added at each stage needs to be considered instead of final output. (2) Do not take into account the amount realized from the sale of second hand goods. (3) Any commission or brokerage paid to those facilitating the second hand goods shall be added in national income. (4) Value of self consumed output needs to be added in the estimates of national income. INCOME METHOD Here we take into account the sum of factor payments in each sector. Factor payments are equal to the value added net of depreciation and indirect taxes paid by the production units i.e. Net Value Added at Factor Cost (NVAFC). So, in a sense it is equal to the NDPFC which consists of (a) wages, salaries and other compensation (like PF etc.) to employees (b) rent paid including royalty payments to factor owners (c) interest paid to those who provide capital SOME IMPORTANT POINTS 1. GDP is an important indicator of economic growth of an economy. (d) profits to reward the entrepreneur for the risk it takes and efforts it puts in NDPFC = Wages + Rent + Interest + Profits NDPFC + NFIA = NNPFC (National Income) Like Product (Value Added) Method, Income Method also needs to be used carefully in national income estimates. The following points are worth mention here; (1) Transfer payments should not be included. The sums of money which one receives without rendering any service are called transfer payments. Examples are presents, gifts, donations etc. These are excluded on the logic that these are not paid in consideration of any service rendered in production activity. (2) Any capital gains from the sale of second hand financial assets should not be considered in national estimates. (3) Notional value equal to the consumption of self used assets/output or self-service provided by the owner to the production unit is included in estimates. EXPENDITURE METHOD Expenditure, here, refers to the sum of final expenditure on consumption and investment. National income, according to the expenditure method, is equal to Final consumption expenditure in private sectors (firms and individuals) - C Gross Domestic Capital Formation - I Final consumption expenditure in govt. sector G Net exports (Exports Imports) (X M) Gross Domestic Product at Market Price - GDPMP GDPMP = C + I + G + X M GDPMP Depreciation = NDPMP NDPMP Indirect Tax + Subsidies = NDPFC NDPFC + NFIA = NNPFC (National Income) 2. No serious attempts were made to estimate national income of India in the pre-independence era. Precautions to be taken while using the Expenditure Method; (1) Ignore intermediate expenditure. It will amount to double counting. So, only final expenditure is taken into account. (2) Notional value of products used for self consumption should be added to the national income estimates. (3) Any transfer expenditure needs to be ignored. (Transfer expenditure is a sum or value paid in cash or in kind without any economic obligation to pay). 3. Dadabhai Naoroji, in 1868, made his first attempt to measure national income of India. 4. In his book Poverty and Un-British Rule in India Dadabhai Naoroji estimated India s per capita annual income at Rs.20.
4 5. After that some other attempts were made by others in this respect. The following table depicts the names of the persons and the level of per capita annual income during the British rule in India. Name Findlay Shirras (1911) Wadia and Joshi (1913-14) Dr. V. K. R. V. Rao (1925-29) Per Capita Annual Income Rs.49 Rs.44.30 Rs.76 6. Soon after the independence, the government of India appointed the National Income Committee in 1949 under the chairmanship of Prof. P.C. Mahalanobis to compile authoritative estimates. 7. According to the first report the total national income of the country for 1948-49 was Rs.8710 crore and the per capita income was Rs.225. 8. According to the advanced estimates of 2012-13 by the Central Statistical Office, Ministry of Statistics and Program Implementation; GDPFC at constant (2004-05) prices in the year 2012-13 is likely to attain a level of Rs.5503476 crore. The growth in GDP during 2012-13 is estimated at 5.0 per cent as compared to the growth rate of 6.2 per cent in 2011-12. There may be slow growth in the sectors of agriculture, forestry and fishing (1.8%), manufacturing (1.9%) and electricity, gas & water supply (4.9%). The growth in the mining and quarrying sector is estimated to be (0.4%). The per capita income in real terms (at 2004-05 prices) during 2012-13 is likely to attain a level of Rs.39143. The growth rate in per capita income is estimated at 2.9 per cent during 2012-13, as against the previous year's estimate of 4.7 per cent. 9. The first person to adopt scientific procedure in estimating the national income was Dr. V.K.R.V. Rao in 1931. He divided the Indian economy into two parts Agriculture Sector and Corporate Sector. 10. National income may be calculated at current prices or at constant prices. Currently, the base year for measuring national income and per capita income at constant prices is 2004-05. 11. National income does not include income from illegal activities, income from work done without remuneration (like housewives work) and black money. GDP DEFLATOR GDP deflator is arrived at by comparing the Nominal GDP at current price with the Real GDP at base year prices. The mathematical formula for this is GDP Deflator = Nominal GDP at Current Prices Real GDP at Bse Year Prices OTHER CONCEPTS & CASES 100 Through GDP Deflator we come to know whether in a year there is inflationary trend in the economy or otherwise. If GDP Deflator is more than 100, then it means there is inflation. But if GDP Deflator equals 100, then the year is normal, i.e. there is no inflation. Generally, to measure inflation we consider WPI (Wholesale Price Index) and CPI (Consumer Price Index). Both WPI and CPI are calculated on the basis of prices of selected commodities. So, they do not present the real picture. But in the case of GDP deflator that limitation is overcome. Let s take an example to have a better understanding of the concept. Suppose the market price of 100 kg of sugar in 2008 was Rs.20 per kg. And in the year 2013 the market price of sugar becomes Rs.50 per kg. According to these prices the GDP in 2008 was Rs.2000, whereas in 2013 it becomes Rs. 5000 registering a growth of 150% over the period. But it is not the real situation. The real GDP is not Rs.5000 in 2013. It is only because of rise in the price of sugar whereas the production is the same. So, in this case GDP Deflator will be helpful where we compare the Nominal GDP at current prices with the Real GDP at base year prices. Presently, in our economy, the year 2004-05 is considered as the Base Year for such purpose. Suppose the price of sugar in 2004-05 was Rs.30 per kg. In that case our Real GDP at base year price was Rs.3000. So, GDP Deflator becomes GDP Deflator = 5000 100 = 166.67 3000 As GDP Deflator, here, is more than 100 so it is depicts that there is an inflationary trend in the market in the year 2013. Case 1: SUBSIDY Suppose the government gives subsidy on urea. The actual price is Rs.500 per bag, but its subsidized price is Rs.450, i.e. the government gives a subsidy of Rs.50 per bag. In this case, the GDP at market price is Rs.450 (the price actually paid by the farmer), whereas the GDP at factor cost is Rs.500 (the total amount the supplier of fertilizer receives on selling a bag of fertilizer). Case 2: INDIRECT TAX Suppose you join a tutorial. The tutorial fee is Rs.1000. Your tutor asks you to pay service tax (which is an indirect tax) @12.36% on the tutorial fee. Thus, the amount you finally pay is Rs.1123.60.
5 In this case, GDP at market price is Rs.1123.60 (the price you actually pay), whereas the GDP at factor cost is Rs.1000 (without including service tax as the amount that actually goes to the service provider is Rs.1000 not Rs.1123.60)
6 Important Questions 1. The present base year for the computation of National Income at constant prices is (a) 2004-05 (b) 2001 (c) 2010 (d) 1993-94 2. Over the time, the share of agriculture in GDP has (a) risen (b) fallen (c) remained stable (d) fluctuated 3. The National Income statistics are computed by (a) Planning Commission (b) CSO (c) NSSO (d) All of them 4. Of the following which is the most important source of saving (a) Households (b) Corporate Sector (c) Government (d) None of these 5. National Income is (a) Net National Product at market price (b) Net National Product at factor cost (c) Net Domestic Product at market price (d) Net Domestic Product at factor cost UPSC; CS (P) - 1997 6. Since 1980, the share of the tertiary sector in the total GDP of India has (a) shown an increasing trend (b) shown a decreasing trend (c) remained constant (d) been fluctuating UPSC; CS (P) - 1999 7. In an open economy, the National Income (Y) of the economy (C, I, G, X, M stand for Consumption, Investment, Govt. Expenditure, total exports and total imports respectively) (a) Y = C + I + G + X (b) Y = I + G X + M (c) Y = C + I + G + (X M) (d) Y = C + I G + X M UPSC; CS (P) - 2000 8. The per capita in India was Rs.20 in 1867-68 was ascertained for the first time by (a) M. G. Ranade (b) Sir W. Hunter (c) R. C. Dutta (d) Dadabhai Naoroji UPSC; CS (P) - 2000 9. The growth rate of per capita income at current prices is higher than that of per capita income at constant prices, because the latter takes into account the rate of (a) growth of population (b) increase in price level (c) growth of money supply (d) increase in the wage rate UPSC; CS (P) - 2000 10. The term National Income represents (a) gross national product at market prices minus depreciation (b) gross national product at market prices minus depreciation plus net factor income from abroad (c) gross national product at market prices minus depreciation and indirect taxes plus subsidies (d) gross national product at market prices minus net factor income from abroad UPSC; CS (P) - 2001 11. With reference to Indian economy, consider the following statements: (1) The Gross Domestic Product (GDP) has increased by four times in the last 10 years. (2) The percentage share of Public Sector in GDP has declined in the last 10 years. Which of the statements given above is/are correct? (a) 1 only (b) 2 only (c) Both 1 and 2 (d) Neither 1 nor 2 UPSC; CS (P) - 2010 12. Import liberalization for the domestic market as a strategy would tend to (a) raise the ratio of imports to GDP in the immediate future (b) lower the ratio of imports to GDP in the immediate future (c) hamper economic growth in the long run (d) depress commodity prices in the immediate future 13. In India, the value of output originating in the agriculture sector is measured with the help of which one of the following methods? (a) Net Income Method (b) Net Income and Expenditure Method (c) Net Output Method (d) Net Output and Expenditure Method 14. NNPMP has always been more than the NNPFC. This is the indicative of the fact that (a) India s imports are more than its exports (b) net depreciation in the Indian economy has been rising (c) the amount of the subsidies in the economy is falling (d) the net balance of indirect taxes minus subsidies in the economy has been positive PATIALA: Leela Bhawan, Opp. Gopal Sweets.