National Income Accounting: GDP, GNP, NNP, NDP & Key Concepts

In an economy, income and expenditure are the fundamental elements of all transactions. Measuring income has long been a method to gauge the prosperity and well-being of individuals and the economy as a whole. While income alone doesn’t provide a complete picture of prosperity, it serves as a crucial indicator. Today, we use broader measures like the Human Development Index (HDI) to assess the overall development of an economy, which includes income as a key component.

Income can be calculated on an individual scale in microeconomics or at larger scales in macroeconomics—such as district, state, national, or global levels. As we move from individual to higher levels, accounting becomes more complex due to generalizations and potential errors. National Income Accounting is a macroeconomic concept that helps measure the economic activity of a nation.

Fundamental Concepts

Understanding national income accounting requires familiarity with several key economic concepts:

Gross vs. Net

Gross = Net + Depreciation
Net = Gross – Depreciation

• Gross Value: The total value of goods and services produced without deducting depreciation.
• Net Value: The value remaining after deducting depreciation from the gross value.
• Depreciation: Also known as Capital Consumption Allowance, it represents the wear and tear or obsolescence of physical assets over time.

Real vs. Nominal (Constant Price vs. Current Price)

Real = Nominal – Inflation Adjustment
Nominal = Real + Inflation Adjustment

• Nominal Value: The monetary value of goods and services measured at current Market Cost, without adjusting for inflation.
• Real Value: The value of goods and services measured at constant prices, adjusting for inflation, to reflect true purchasing power.
• Example: If the nominal GDP of a country is ₹150 lakh crore and the inflation rate is 5%, the real GDP would be adjusted to reflect the purchasing power relative to a base year.

National vs. Domestic

National = Domestic + (Inflow from Abroad – Outflow to Abroad)
Domestic = National – (Inflow from Abroad – Outflow to Abroad)

• Domestic Income: Income generated within the geographical boundaries of a country, regardless of the nationality of the producers.
• National Income: Income earned by the residents (nationals) of a country, including income from abroad.
• Net Factor Income from Abroad (NFIA): The difference between income earned by nationals abroad and income earned by foreigners domestically.
• Example:
  • Inflow: Indian software engineers working in the USA send remittances back home.
  • Outflow: Foreign companies operating in India repatriate profits to their home countries.
  • NFIA = Inflow – Outflow

Cost and Price of National Income

Factor Cost vs. Market Price

Factor Cost (FC):

• Definition: The cost of production from the producers’ perspective, including payments to all factors of production (wages, rent, interest, and profits).
• Excludes indirect taxes and includes subsidies.
• Reflects the income received by factors of production.

Market Cost (MC):

• Definition: The cost at which goods and services are sold in the market, including indirect taxes and excluding subsidies.
• Reflects the actual amount paid by consumers.
• Includes indirect taxes (e.g., sales tax, excise duty) and subtracts subsidies.

Relationship between Factor Cost and Market Price:
Market Cost = Factor Cost + Indirect Taxes – Subsidies
Factor Cost = Market Cost – Indirect Taxes + Subsidies

Current Price vs. Constant (Fixed) Price

Current Price (Nominal Price):

• Definition: The price of goods and services measured at the prices prevailing in the current year.
• Includes the effects of inflation.
• Useful for assessing the monetary value of output in present terms.

Constant Price (Real Price):

• Definition: The price of goods and services adjusted for inflation, measured at the prices of a base year.
• Removes the effects of inflation to reflect the real volume of production.
• Useful for comparing economic output over different years.

Constant Price = Current Price + Inflation Adjustment

National Income

National income is a comprehensive measure of a nation’s overall economic activity. It encompasses various indicators like GDP, NDP, GNP, and NNP, each reflecting a different dimension of the economy. First let’s get an overview of how they all relate, then we will dive into individual analysis.

Overview of National Income Indicators

• Gross Domestic Product (GDP): Measures the total value of all final goods and services produced within a country’s borders in a given period. It focuses on domestic production.
• Net Domestic Product (NDP): Obtained by subtracting depreciation from GDP. It represents the net value of goods and services after accounting for the wear and tear of capital assets.
  NDP = GDP – Depreciation
• Gross National Product (GNP): Measures the total value of all final goods and services produced by the residents of a country, including net factor income from abroad (NFIA). It emphasizes national ownership of production.
  GNP = GDP + NFIA
• Net National Product (NNP): Calculated by subtracting depreciation from GNP. It reflects the net national production after accounting for capital consumption.
  NNP = GNP – Depreciation

Relationship Between Indicators:
GDP → Subtract Depreciation → NDP
NDP → Add NFIA → NNP
NNP → Adjust for Taxes/Subsidies → National Income at Factor Cost (NI)

Significance

• GDP focuses on where the production takes place (domestic territory), regardless of who produces it.
• GNP considers who produces the goods and services (national residents), regardless of where they are produced.
• NDP and NNP account for depreciation, providing a clearer picture of the economy’s sustainable production.
• National Income at Factor Cost (NNP_fc) represents the income earned by the factors of production and is considered the official national income.

Gross Domestic Product (GDP)

Definition

Gross Domestic Product (GDP) is the total monetary value of all final goods and services produced within a country’s borders in a specific period, usually a year. GDP is a quantitative measure, focusing on the total output without considering the quality or sustainability of growth.

Importance

• Economic Indicator: GDP is a primary indicator used to gauge the health of a country’s economy.
• Comparison Tool: Allows comparison between different economies and tracking economic performance over time.

Components of GDP

• Final Goods and Services: Only final products are counted to avoid double-counting. Intermediate goods are excluded.
• Within Borders: Includes all production within the country’s territory, regardless of who produces it.

Limitations of GDP

• Income Inequality: Does not reflect how income is distributed among the population.
• Non-Market Activities: Excludes unpaid work like household chores and volunteer services.
• Quality of Life: Does not account for happiness, leisure time, or environmental quality.
• Negative Externalities: Ignores environmental degradation and depletion of natural resources.

Important Concepts

Nominal GDP

• Definition: GDP measured at current Market Cost, without adjusting for inflation.
• Nature: A quantitative measure that can be misleading due to price level changes.
• Limitation: Inflation can distort the true growth rate.

Real GDP

• Definition: GDP adjusted for inflation, measured at constant prices from a base year.
• Nature: A more qualitative measure as it reflects the real purchasing power and actual growth.
• Importance: Provides a more accurate reflection of an economy’s size and how it’s growing over time.
• Base Year: Real GDP is calculated based on a comparison year called the base year.

GDP Deflator = (Nominal GDP / Real GDP) × 100%

Gross Value Added (GVA)

• Definition: Gross Value Added (GVA) measures the contribution to the economy of each individual producer, industry, or sector.
• Importance: Helps understand which sectors are driving economic growth and assists in policy decisions.
• Relationship with GDP: At the macro level, the sum of GVA across all sectors, adjusted for taxes and subsidies, equals GDP.

Net Domestic Product (NDP)

Definition: Net Domestic Product (NDP) is the GDP after subtracting depreciation. It is considered a qualitative measure because it accounts for the depreciation of capital assets, reflecting the economy’s efficiency and sustainability.

• Internal Progress Indicator: NDP reflects the internal economic progress by showing the net production value.
• Technological Progress and Efficiency: Improvement in NDP indicates advancements or increased efficiency in production processes.
• Non-Comparability: Unlike GDP, NDP is generally not used for international comparisons due to differences in depreciation methods across countries.

Depreciation in Economics:

• Depreciation of a currency in the forex market
• Depreciation of capital goods: as in the context of NDP
• A tool of control for the government

Gross National Product (GNP)

Definition

Gross National Product (GNP) is the total value of all final goods and services produced by the residents of a country in a given period, including Net Factor Income from Abroad (NFIA). It reflects both the quantity of production and the quality aspects by including net income from abroad.

Components of NFIA

• Income from Abroad (Inflow): Earnings of residents from overseas investments or work.
• Income Paid Abroad (Outflow): Earnings of non-residents from domestic investments or work.

Utility of GNP

• Reflects Both Quantitative and Qualitative Aspects: Unlike GDP, which presents only the quantitative aspect, and NDP, which focuses on the qualitative aspect, GNP reflects both.
• International Comparisons: The IMF considers GNP for creating indexes based on Purchasing Power Parity (PPP).
• India’s Global Position: India is the third-largest economy in terms of PPP, following China and the USA, and ahead of Japan.
• Integration with Global Economy: GNP signifies the integration and place of the Indian economy vis-à-vis the global economy.

Net National Product (NNP)

Definition: Net National Product (NNP) is the GNP after subtracting depreciation, considered the purest measure of national income.

• Reflects net production: by a country’s residents after accounting for capital consumption.
• Official National Income (NNP_fc): Used in the calculation of per capita income in India and widely in policy formation.

National Income (NI) = NNP_fc

Comparison of National Income Indicators

Methods of GDP Calculation

Circular Flow of Income

The circular flow of income is a foundational concept in macroeconomics that illustrates how money moves through an economy between producers and consumers. It provides a simplified representation of the interactions between different sectors, helping to explain how economic activity is sustained over time. While the model is instrumental in understanding basic economic functions, it has limitations that can affect its applicability to real-world scenarios.

The Concept of Circular Flow of Income

• Households: Owners of the factors of production—labor, land, capital, and entrepreneurship. They supply these factors to firms.
• Firms: Producers of goods and services. They hire factors of production from households to create products.

Real Flow vs. Money Flow

• Real Flow: The flow of factors of production from households to firms and the flow of goods and services from firms to households.
• Money Flow: The flow of income (wages, rent, interest, profits) from firms to households and the flow of consumer spending from households to firms.

Assumptions: No government intervention, closed economy, and no savings (households spend all their income).

Outcome: The total income of households equals the total expenditure on goods and services, creating a continuous, circular flow.

Limitations of the Circular Flow of Income

• Oversimplification: Ignores complexities of modern economies and the informal sector.
• Assumption of Equilibrium: Static analysis that doesn’t account for economic fluctuations.
• No Time Dimension: Doesn’t consider delays or changes over time.
• Exclusion of Price Changes: Often assumes constant prices, ignoring inflation/deflation.
• Full Employment Assumption: Overlooks unemployment/underemployment.
• Technological Progress Ignored: Assumes static production methods.
• No Role for Financial Markets: Underrepresents complexity of financial instruments.
• Environmental and Social Factors: No consideration for resource depletion or externalities.
• International Trade Complexities: Simplifies or omits foreign trade and capital flows.

There are three primary methods to calculate GDP:

Income Method

Calculates GDP based on the income earned by all factors of production in an economy. It is a quantitative approach focusing on total income generated.

• Factors of Production and Corresponding Incomes:
  • Land: Rent
  • Labor: Wages
  • Capital: Interest
  • Entrepreneurship: Profit

GDP_fc = Rent + Wages + Interest + Profit
GDP_mp = GDP_fc + Indirect Taxes – Subsidies

Expenditure Method

Calculates GDP based on total spending on goods and services in an economy, a quantitative approach measuring total expenditure.

• C: Private Consumption Expenditure
• I: Investment Expenditure
• G: Government Expenditure
• X: Exports
• M: Imports
• (X – M): Net Exports

GDP = C + I + G + (X – M)

Production Method (GVA Method)

Calculates GDP based on the Gross Value Added (GVA) at each stage of production, incorporating both qualitative and quantitative elements.

GVA_fc = Value of Output – Intermediate Consumption
GDP_mp = GVA_fc + (Product Taxes – Product Subsidies) + (Production Taxes – Production Subsidies)

GDP Calculation in India

Statistical Organizations

National Statistical Office (NSO)

• Formation: Established in 2019 by merging the Central Statistics Office (CSO) and the National Sample Survey Office (NSSO).
• Function: Operates under the Ministry of Statistics and Programme Implementation (MoSPI).
• Responsibilities: Conducting surveys, collecting data, compiling statistical information including GDP figures.

Historical Background

• Before 2019:
  • CSO: Coordinated statistical activities and maintained standards.
  • NSSO: Conducted large-scale surveys, collecting socio-economic data.
• After 2019: NSO was formed to enhance efficiency in data collection and dissemination.
• NSO Structure:
  • Statistics Wing: Manages statistical data.
  • Programme Implementation Wing: Monitors government programs.

GDP Calculation Methodology

Pre-2015 Methodology

Before 2015, India’s GDP was calculated at Factor Cost, primarily reflecting input costs incurred during production (e.g., wages, rent, profits). Methods used included the Income Method and the Gross Value Added (GVA) Method.

2015 Reforms and Adoption of SNA 2008

• Base Year Change: From 2004–05 to 2011–12.
• Switch to GDP at Market Prices: Incorporates indirect taxes and subsidies.
• Increased Use of Data: MCA21 database expanded coverage of corporate sector contributions.

Why GDP at Market Prices?
GDP at Factor Cost excludes taxes and subsidies, while GDP at Market Prices reflects the value of goods and services based on market prices and accounts for indirect taxes and subsidies.

Steps in GDP Calculation (Post-2015)

1. Calculate GVA at Factor Cost (GVA_fc):
   GVA_fc = Compensation of Employees (C) + Consumption of Fixed Capital (F) + Mixed Income/Operating Surplus (MO)
   • Compensation of Employees (C): Wages, salaries, benefits.
   • Consumption of Fixed Capital (F): Depreciation of fixed assets.
   • Mixed Income/Operating Surplus (MO): Profits of unincorporated enterprises.
2. Adjust for Production Taxes & Subsidies → GVA_bp:
   GVA_bp = GVA_fc + Production Taxes – Production Subsidies
   • Production Taxes: Taxes not dependent on per-unit production (e.g., property tax).
   • Production Subsidies: Subsidies on the production process.
3. Adjust for Product Taxes & Subsidies → GDP_mp:
   GDP_mp = GVA_bp + Product Taxes – Product Subsidies
   • Product Taxes: Payable per unit of a good/service (e.g., excise, sales tax, GST).
   • Product Subsidies: Subsidies per unit of a good/service.
4. Convert to Constant Prices: Use price indices to get GDP at constant (real) prices. This is the official GDP measure of India at market cost.

Advantages of the New Methodology

• International Standards: Aligns with global norms, making India’s GDP data more comparable.
• Broader Data Sources: MCA21 database plus large-scale surveys enhance coverage.
• Improved Coverage: Better representation of financial services, stock exchanges, mutual funds, etc.

Criticisms of the New Methodology

• Base Year Selection: 2011–12 might be contentious due to economic volatility.
• Data Quality: Potential “shell companies” in MCA21 may inflate figures.
• Informal Sector Representation: Large informal workforce still underrepresented.