Lecture Notes: C6 Economics of Public Policy-II
Week: 2: Measurement of macroeconomic variables
1. National income accounting why?
 Formal structure of the economy for building macro models;
 Helps in assessing the magnitude of different economic transactions and the
economy at large.
2. Gross Domestic Product: It is the gross money value of all final goods and services
produced in an economy (economic territory by residents and non-residents) in a given
period (usually a year we also have quarterly GDP estimates, important: it is produce of
residents in a country and current not past produce).
Gross National Product is the gross money value of all final goods and services produced
by the residents of an economy in a given time period.
GDP Factor Cost + Net indirect taxes = GDP Market Prices
Net Indirect Taxes = Indirect taxes paid – subsidies received
GNP = GDP + net factor income from abroad
GDP real and nominal and GDP deflator
GDP – Depreciation = Net Domestic Product (NDP); Depreciation is the value of capital
used up in the production in that year.
Net National Product NNP = NDP + net factor incomes from abroad
(Net factor income from abroad= factor income received from abroad- factor income paid
abroad)
Net Domestic Product FC = Domestic Income
Net National Product FC = National Income (NY)
3. Disposable Income: Is the money in the hands of people, what they earn and what they
get as transfers, money that they can spend as they like.
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Domestic product accruing to the private sector = NDPFC – property and
entrepreneurial income of govt. enterprises - savings of non-departmental enterprises
of the government.
Private Income: It is the total income that accrues to the private sector i.e. private
enterprises and households.
Private Income = Domestic product accruing to the private sector + net factor income
from abroad + interest on national debt + net current transfers from the government
+ net current transfers from the rest of the world.
Personal Income: Is the total income (factor and transfers) that accrues to the households.
Personal Income = Private Income - corporate taxes- retained earnings or savings of
the private corporate sector.
Personal Disposable income = personal Income- direct taxes paid by the households
– miscellaneous receipts of the government from households (contribution to
provident fund)
Personal Disposable Income = Consumption + Savings
Net National Disposable Income = NY / NNPFC + net indirect taxes + net current
transfers from the rest of the world.
4. Goods:
 Final and Intermediate: Final goods are purchased by consumers and firms for
their own use Final goods do not undergo any further change in the production
process. Intermediate goods are those that are used in furthering the production of
final goods and services. They are non-durable goods and services used in the
production of other goods. Distinction between final goods and intermediate goods
is purely on the basis of how the good is used.
 Consumption and capital goods (fixed capital, change in stock and buildings)
 Durable and non-durable;
 Services: single-use and multiple use
5. Examples on National Income Accounting
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(i)
If for a country GNPFC = Rs. 1000 million.
Indirect taxes = Rs. 200 million.
Net factor incomes from abroad = Rs 50 million
Subsidies = Rs 100 million
Consumption of fixed capital (depreciation) = Rs 100 million;
Calculate GNPMP, NNPFC, and NDPMP
(ii)
On the basis of following data, calculate Personal Income and Personal Disposable
Income: (figures in Rs million)
NNPFC = 54,500
Corporate tax = 1520
Undistributed profits of companies = 3500
Income from domestic product accruing to government sector =1680
National debt interest = 700
Current transfers from government = 1,200
Current transfers from the rest of the world = 300
Personal income tax = 250
Net factor incomes from abroad = 50
6. Income = Private Consumption + Government Consumption + Investment + Net
Exports
Y = C + G + I + (X-M) or NX
G = Transfer Payments + Purchase of goods and services
I= Public and Private
= Addition to physical stock of capital
= Machines and buildings
(Capital can also be broadly defined to include both physical and human or social capital)
= Inventory + change in stock of capital ( here only the inventory of firms is included as
investment. Inventory maintained by households is treated as consumption.
Share of Y between C, G and I and X-M is important to see the trends in the economy.
USA: C is 70 per cent, I is about 17 per cent, G is 19 per cent and NX is negative.
India: C is about 50 to 55 per cent, G is about 10 to 12 per cent, I is about 30 per cent has
gone up to 40 per cent.
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7. Three methods for estimating national income:
 Production or value added;
 Income Method
 Expenditure method
Circular flow of income:
Production
(generation of income within production units)
Expenditure
(disposal of income by households)
Income
(distribution of income to factors of production)
8. Product Method or value added method: National income is the net value added at factor
cost by each production unit in an economy.
Value of output = Sales (Q* MP) + Change in stocks
Value of output- value of Inputs = Value added by a firm It is the Gross value added at
market prices.
GVAMP- Net Indirect Taxes = GVAFC - Depreciation = NVAFC
 NVAFC =NDP FC
 GVAMP =GDP MP
Precautions/issues: Double counting; imputed value of own account production or
imputed rent of owner-occupied houses to be included; sale of second hand goods not to
be included, production of illegal activities not included, services rendered by housewife
is not included.
9. Income method: Factor incomes paid to the different factors of production by various
production units.
NVAFC = Wages (compensation to Employee) +Interest income + Rent/Royalty + Profits
Operating surplus= Interest income + Rent+Royalty + Profits
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Wages = Cash + kind + Employer’s contribution to social security
Mixed Income of self employed (MISE)viz. doctor practicing from home will earn salary,
rent and profits.
Precaution/issues: Transfer earnings should not be included (pensions, scholarships etc.),
income from sale of second hand assets not to included as only a transfer of ownership
takes place- the capital gains is not treated as income but commission or brokerage is
included as income in that year.; income from sale of bonds/shares is also not included as
only a transfer of ownership takes place; windfall gains not included as income because no
productive service is involved; Imputed value of own services or production to be included
(rental).
10. Expenditure method: Total expenditure on final goods and services:
C+I +G+ X-M
I= Gross Fixed Investment + Change in stocks
Precautions/issues: expenditure only on final goods and services, exp on second hand
goods excluded, imputed values of owner account consumption or production to be
included and expenditure on financial assets not to be included.
Reconciliation of Methods:
Product Method
GVAMP for all sectors
-NIT
-Deprecation
NDPFC
+ NFIFA
National Income
Income Method
Compensation to Employees
+Operating surplus
+MISE
NDPFC
+ NFIFA
National Income
Expenditure Method
Pvt. C+G+I+Net Exports
GDP MP
-NIT
Depreciation
NDPFC
+ NFIFA
National Income
11. GDP is not a good measure of economic activity or of economic wellbeing and is a poor
measure of human wellbeing (welfare) in general.
12. Problems of GDP Measurement
 Some outputs are poorly measured as they are not traded
 Some activities add to GDP but are ‘bads’, including pollution and environmental
degradation.
 Reflecting the improvement in the quality of goods
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