Measurement of National

Income
October 11, 2021

1
 Economy’s income and expenditure
• Importance of income
– Standard of living
• The gross domestic product (GDP) is a measure of
– Total income of everyone in the economy
– Total expenditure on goods and services
• For an economy as a whole, its income must equal
expenditure
– Every transaction has a buyer and a seller
– Example
• GDP is believed to be a good measure of a society's economic
well-being
– The most important measure to assess overall performance of an
economy
– If we ask an economist, what happened to the economy during
the Great Depression or after the WW-II, the answer would
contain the changes in GDP
2
The circular flow diagram

3
 Defining GDP
• GDP is the market value of all final goods and services
produced within a country in a given period of time
– Market value
• Value: comparing apples and oranges
• Market price (price: willingness to pay; value)
– Of all final goods and services
• Goods (food, clothing), services (haircut, health), housing
• Final goods and services (double counting?)
– Produced within a country
• Only the goods and services currently produced are counted.
Selling a used car is not counted
• An IIT graduate working in the US
– In a specific period of time
• Usually annual frequency, quarterly GDP
4
 Three approaches to GDP Measurement
• Expenditure approach
– GDP = C + I + G + NX, NX = Exports – Imports
• Income approach
– the sum of income (factor rewards) for the factors of production
• Production (value added) approach
– Consider a farmer who produces wheat. It costs him Rs 0 to
produce wheat. The farmer sells the wheat to a flour factory for
Rs 5. The factory sells it to a bakery shop for Rs 10. Finally, a
consumer buys it for Rs 15
– GDP = sum of the value added in the three stages
– GDP = (5-0) + (10-5) + (15-10) = 15
• In practice, NAS are compiled from a mix of the three
approaches, using a wide array of data sources and
methods

5
Equivalence of the approaches (3 firms in the economy)

6
Treatment of investment and transfers
• Investment in macroeconomics
– Real vs financial investment
– Along with consumption goods and services, gross
investment is included in GDP
– Gross vs net investment
– Net investment is indicative of the increase in a nation’s
capital stock
• Government expenditure
– Government purchases and transfer payments
– Transfer payments are payments that are not made in
exchange of goods and services supplied
– Transfer payments are excluded but factor payments are
included

7
 The GDP family
• Gross National Product (GNP)
– Total income earned by the citizens
– GNP = GDP + Net factor income from abroad
• Gross and Net
– Net means net of depreciation, depreciation is wear
and tear of the capital stock in an economy
– Thus, Net = Gross – depreciation
– NDP and NNP
• GDP at factor cost and GDP at market price
– GDP at MP = GDP at FC + (Indirect taxes - subsidies)
8
 Factor cost and market price
• In the presence of government intervention
(indirect taxes or subsidies), market value
does not equal value added
• Cigarettes (taxes)
– If the market price is Rs 20, tax is Rs 2
– GDP at MP = Rs 20, GDP at FC = 18

9
From GDP to National Income
NI = GNP-Depreciation

10
14 October 2021

11
 India’s GDP
Quantity Value
• Any idea about India’s
GDP 20,351,213
GDP
NDP 18,187,414
– Rs 20,351,013 Crores in
2019-20 (NAS 2021) C 12,309,019
• Per capita GDP is the G 22,85,016
GDP per population I (GCF; public + private) 65,51,251
– Rs 151,760 in 2019-20 X 37,50,567
(NAS 2021) M 42,65,040
• NNP is generally NFIA -1,93,114
known as the national GNP or GNI 20,157,899
income and per capita 17,994,301
NNP or NI
NNP as per capita
GDP pc 151,760
income (PCI)
PCI 134,186
• Statistical discrepancy
Savings (Gross) 6,385,981
12
 Components of GDP
GDP = C + I + G + NX

Component USA (2009, billion USD) India (2009, Crore Rupees)

Amount Share (%) Amount Share (%)
GDP 14,259 6,457,352
C 10,093 71 3,708,136 57
I 1,623 11 2,363,670 36
G 2,933 21 774,272 12
NX -390 -3 -346,902 -5

13
 India’s GDP
Sectoral composition in 2019 (NAS 2021)

14
 Real and Nominal GDP
• If the GDP rises in the next year, it could be due to two
reasons
– Economy’s production has increased
– Prices of the goods and services being produced have increased
• Our interest lies in measuring the effect that is not due to
changes in prices. Hence, we use the real GDP
– Real GDP is the value of goods and services produced this year
and valued at the prices prevailing in the base year (last year, for
example)
– Nominal GDP, on the other hand, is the GDP valued at the
current year market prices
• GDP deflator
– Is the ratio (in %) of nominal to real GDP
– Is a measure of the price level

15
Real and Nominal GDP

16
Real and nominal GDP: which one is growing fast?

17
More numbers on India (NAS 2021)

18
 GDP and well being
• Is GDP a perfect measure?
– Transactions which take place at the market are easily
recorded whereas non-market transactions are not
• Barter and corporate transactions
• Vegetables bought from market and grown in kitchen garden
• A chef preparing meals for the restaurant and for home;
similarly, a man marrying his maid would reduce GDP
• Housewives' services and day care fee
– Environment
• What if there are no government regulations and producers
exploit the natural resources
• Externalities (cost to the society not counted)
– Distribution of income: inequality
– All the things that contribute to a good quality of life
not accounted for. Example, leisure
19
 GDP and the underground economy
• GDP includes all items produced in the economy and
sold legally in markets
– GDP excludes the items produced and sold illicitly; such
items do not enter the marketplace
– Examples: illegal drugs, criminal activities, gambling,
hunting, etc.
• In the US, the size of the underground economy is
estimated to be between 6 and 20 per cent
• Bolivia and Zimbabwe: nearly two-third of the output
• India: 17-25 per cent (Chaudhuri et al. 2005)
• It is generally agreed that the size of shadow economy
is larger in developing countries: their average was
about 40 % compared to 16 for the West
20
Price indices

21
 Defining a price index
• A price index (P) measures the average level of
prices
• Inflation (π) is a rise in the general price level. The
inflation rate is measured as follows
 Pt − Pt −1 
 t =   *100
 Pt −1 

• Generally, three price indices are used more

often
– GDP deflator
– Consumer Price Index (CPI)
– Producer Price Index (PPI)

22
 CPI
• CPI is a measure of the overall cost of the goods
and services bought by a typical consumer
• Computing CPI
– Fix the basket: Determine what items are most
important to the typical consumer
– Find the prices: Find the prices of each of the goods
and services in the basket for each point in time
– Compute the basket’s cost
– Choose a base year and compute the index by
dividing the price of the basket in one year by the
price in the base year and multiplying by 100

23
Computing CPI

24
 Computing CPI and inflation

CPI in Year 2 - CPI in Year 1

Inflation Rate in Year 2 =  100
CPI in Year 1

25
 The CPI basket (weighing diagram)
base: 2012

Item Rural Urban

Food and Beverages 54 36
Pan, tobacco, intoxicants 3 1
Clothing and footwear 7 5.5
Housing 21.5
Fuel and light 8 5.5
Miscell (edun, health, transport) 27 29.5

26
 CPI - measurement issues
• An objective of CPI is to measure the changes in
the cost of living
– How much incomes should rise to maintain a standard
of living
• CPI as a measure of cost of living
– Substitution bias
• Change in prices over time in not constant across all goods.
The consumers will substitute the costly goods with cheaper
alternatives, but the basket (weighing diagram) does not
change
– Introduction of new goods
• Means consumers have a larger basket to choose from and it
affects the cost of living

27
 PPI
• PPI measures the cost of a basket of goods and
services bought by firms (and not the consumers)
• In India, we had used Wholesale Price Index
(WPI) to measure inflation for a long period
– After the seventh base year revision, WPI (2011-12
series) is based on data on about 700 items/
commodities collected from different centers across
the country
– Weight attached to each item is “based on the value
of production adjusted for net imports”
– WPI basket does not cover services

28
Composition of WPI in India

Primary: food
15%

Manuf: rest Primary: rest

30% 7%

FPLL
14%
Manuf:
chemicals
Manuf:
12% Manuf: food
textiles 12%
10%

29
Price level in India (NAS 2021)

30
 Inflation targeting in India, recent
changes
• Since 2014, following the recommendations of the Expert
Committee to Revise and Strengthen the Monetary Policy
Framework (headed by Dr. Urjit Patel), the RBI has been
targeting CPI (combined)
• CPI (combined) is based on a combination of CPI for rural
and urban areas and is compiled by MoSPI
• The inflation target of 4 % (in terms of CPI) was kept for the
period 2016-21 and has been retained for the period of
next five years, 2021-26. The target is decided jointly by the
Government and RBI. There is an upper limit of 6 % and a
lower limit of 2 % to this target
• Earlier, the RBI used to target the WPI-based measure. The
information on WPI is compiled by the Office of Economic
Advisor, Ministry of Commerce and Industry
31
 Real and nominal interest rates
• Nominal interest rate (i)
– Is the interest rate usually reported without a
correction for inflation
– What is the interest rate we get on the money in
the savings bank account?
• Real interest rate (r)
– Is the interest rate adjusted for the effect of
inflation r = i − 

32
Most popular movies of all time in
the US
1. Avatar: USD 749 million
2. Titanic: USD 601 million
3. The Dark Knight: USD 533 million

These figures are inflation unadjusted

33
Most popular movies of all time in US
inflation adjusted

34
 Source:
https://www.visualcapitalis
t.com/most-valuable-
companies-all-time/ (2017)
35
 References
• Please see the relevant sections in
– Chapters 23 and 24, Mankiw
– Chapter 20, Samuelson and Nordhaus
• Those interested in studying more on India
may refer to
– National Account Statistics and CPI (available at
the website of Ministry of Statistics and
Programme Implementation)
– Ministry of Commerce and Industry (for WPI)

36