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National Accounting / National Income Accounts:
07-15-2006, 08:23 PM,
National Accounting / National Income Accounts:
National Income Accounts are designed to produce a meaningful summary of the working of the economic system of a country. They provide a framework within which the operations of the economy are recorded. As the formulation of business policy depends upon a full knowledge and analysis of costs, sales and financial conditions of the firm, the analysis of national income accounts is necessary for a comprehensive appraisal of the working of the economy. Because of their usefulness as an aid in formulating economic policies and numerous other applications in the field of economic decision-making national income and product estimate are now regularly prepared by most countries of the world. International organisations, including the UN and its regional economic commissions, have contributed considerably to the standardisation of national accounts.

Since national accounts provide a framework for studying the economic system as a whole and its various component parts, they bring out important inter-relationships of these parts with one another and with the economy as a whole. Thus, national accounting is of significant help in assessing and analysing the effects of policy measures on the structure of the economy and on major economic flows of income, expenditure and production. The shifts in the structural relationships of the economy as revealed by national accounts can be used to assess the success and consistency of policy measures.

The quantitative picture of the economy provided by these accounts answers certain basic questions about the structure of the economic system; for instance, what part of the national income is shared by different factors of production and who makes savings available to the economy; what part is played by external trade in providing goods and services and how is the national product broken down by the industrial origin. All this basic information is available in a comprehensive system of national accounts. The growth of the economy is generally measured with the help of trends in national and per capita income over a period of time.

One of the major uses of national accounts is in the field of economic planning. In order to ensure that an economic plan is internally consistent and optimal from the viewpoint of allocation and use of resources, it is necessary to examine its effect on the different aspects of economic activity. Such an appraisal is usually carried out with the help of data that become available through national accounts. The quantity of resources required to implement the plan, and the effects on employment, output and prices are best analysed within a national accounts framework.

The utility of national income estimates is by no means limited to the formulation of policies in the public sector. Income statistics are multi purpose tools and they can be equally useful in regard to the measurement of shifts in demand for the output of the private sector. Since national income estimates and other components which go into making up of the accounts provide comprehensive and understandable summary of the country’s economic life, the breakdown of these totals provides detailed information on various aspects of economic transactions which can be utilised in formulating short as well as long run production policies.

Some basic concepts

Domestic product, national income value-added and other similar concepts serve the purpose of measuring economic activity of a nation during a given period of time, usually a year. A clear definition of the concepts is important for comparison over time as well as for comprehension with other countries.

Gross domestic product

Gross Domestic Products (GDP) is derived from gross output of the economy, that is, the total flow of goods and services, which are produced during the period. These numerous and heterogeneous goods and services cannot be added together unless they are expressed in terms of common measure. The value that these products fetch in the market, the market price - can be used as a measuring rod. If we deduct from the total gross output measured at market prices all intermediate goods and services domestically produced as well as imported, which are used up in the production process during the period, we arrive at the gross domestic product at market prices.

Alternatively, the measuring rod can be the gross income received by the various factors of production. This measurement will yield the gross domestic product at factor cost. The difference between these two equals indirect taxes net of subsidies.

Thus gross domestic product at market prices = gross domestic product at factor cost + indirect taxes net of subsidies.

Some labour and capital belonging to the country may be engaged in production in other countries and vice versa. Factor payments may, therefore, take place both ways. If net factor payments from abroad, which can be positive or negative, are added to the gross domestic product, we get the gross national product (GNP). When measured at factor cost, the gross national product is the gross reward during the period of the factors participating in the production process. Gross national product at factor cost is therefore identical with gross factor income or gross national income.

Various methods for estimating national income

Product, income and expenditure mentioned above, form a circular flow and thus make it possible to measure national income, in three different ways, namely, as a sum of income derived from economic activities, as a sum of final expenditures on consumption and investment adjusted for exports or imports, or finally, as a sum of value-added by the various producing sectors in the country, adjusted for factor payments to and from abroad. One must be careful with regard to correction for depreciation of fixed capital so that the various elements in the aggregate are either gross or net. Since the measurement of national income through any of these approaches should yield identical results, they provide a check against each other. Each of these methods brings in the limelight different aspects of the basic operations of the economy viz; production, distribution and consumption.

The boundary of production

National income has been defined as the money value of goods and services produced by the economy during a given period of time, after deduction for certain inputs and other adjustments. This presupposes that each item entering into national income total can be traced back to goods and services expressed both in terms of a physical quantity and a value. Obviously this is not possible in every case. How for instance, can one measure and evaluate the services rendered by a mother to her child or services rendered to oneself. Any assumed value assigned to such services would be subjective and completely arbitrary. To avoid these difficulties of measurement, it is necessary to delimit the filed of production and draw a boundary between production that is included and that which is not.

As a broad rule, all goods and services exchanged for money are included in the concept of production. There are, however, a few exceptions to this general rule. In certain cases output is not necessarily exchanged for money and is wholly or partly consumed by the producer himself.

The farmers, for example, retain a part of their farm production for their own use and sell the remaining part in the market. To leave out this un-exchanged part would understate the farm production. It is assumed that the farmer is operating a business enterprise and sells a part of his production to himself as a consumer. Since a part of the production is already sold in the market, it is possible to apply a priced to the unsold part. Another important case where imputation is made is that of owner occupied houses.

Some other imputations usually made are remuneration in kind to employees, such as food and lodging for domestic servants and buildings owned and occupied by government. In order to maintain the identity of production, income and expenditure, whenever income is imputed, a corresponding expenditure is also recorded.

Depreciation of fixed capital

National income, product and expenditure can be measured either net or gross of deprecation of fixed capital assets. The gross national product is gross only in the sense that it contains an element of depreciation.

The net national product is defined as gross national product less depreciation.

The measurement of depreciation presents many problems. In a stationary economy where the quantity and quality of fixed assets do not change, the estimation of depreciation is relatively easy. In an economy witnessing both qualitative and quantitative changes in capital stock, the problem becomes complicated. In the absence of detailed information on the duration of assets, on their cost and on the methods of depreciating them, the estimates of depreciation are to be treated as approximations.

Market prices and factors costs

As mentioned earlier, goods and services can be valued either at market prices or factor cost. These two methods of valuation lead to different results. The national product at factor cost represents the sum of the incomes received by the factors of production. Since the market price is the price which the consumers pay it includes indirect taxes net of subsidies, if any. The two totals derived from these two methods of valuation will therefore be different, but can be easily reconciled.

Thus, if we deduct indirect taxes from the national product, and add subsidies, the resulting figure would be the national product at factor cost.

Real national income

In an open economy with a significant volume of international trade, it is advisable to distinguish between national income at constant prices and the "real" national income. In the former, exports of the country are measured with the help of export price, but in the latter exports are measured in terms of the real volume of imports that exports command at the current terms of trade.

An adjustment of the estimate of national product at constant prices in thus necessary to arrive at "real" national income in the event of a change in the country’s terms of trade since the base year. This adjustment can be done by deflating the current value of exports first by the import price index and then by the export price of index; the difference between the two would represent a correction for change in the terms of trade. This correction should be added to national product to arrive at "real" national income.

Personal income

Personal Income (PI) is the total money received by individuals in the community. It is the aggregate of earned and unearned incomes. Corporate income taxes and undistributed profits of corporations reduce the personal incomes of individuals to that extent. Social security contributions also diminish personal income. Transfer payments made by government as well as private business sector to individuals are, however, included in personal income.

Thus personal income = net national product - corporate income taxes - undistributed profits of corporation - social security contributions + transfer payments.

Disposable personal income

Disposable personal income (DPI), is arrived at by deducting direct personal taxes from personal income. It is also the sum of consumption and savings of individuals.

Thus DPI is simply PI - T, where T is direct personal taxes such as income tax, wealth tax etc.

Disposable personal income rather than net national product is the principal determinant of consumption because the consumption of a person largely depends on his take home pay.
07-16-2006, 07:21 AM,
a real nice note
refreshed quite a bit of economics
03-19-2007, 04:47 PM,
Jazak Allah

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