Quick revision of Chapter 2: National Income Accounting (Introductory Macroeconomics). For full explanations and solved examples, read the complete notes.
1 Basic concepts
Key definitions
Final goodAn item for final use that will not pass through further production; decided by the economic nature of its use
Consumption goodsGoods and services consumed when bought by their ultimate consumers (food, clothing, recreation)
Consumer durablesLong-lasting consumption goods: television sets, automobiles, home computers
Capital goodsDurable final goods used over many production cycles: tools, implements, machines
Intermediate goodsInputs for other production: steel sheets, copper; counting them separately is double counting
StockMeasured at a point of time: capital, inventory
FlowMeasured over a period of time: income, output, investment, depreciation
DepreciationAnnual allowance for wear and tear = cost ÷ years of useful life; consumption of fixed capital; an accounting concept
Net investmentGross investment − depreciation = new capital formation
InventoryUnsold finished or semi-finished goods and raw materials carried to the next year (a stock)
Value addedValue of production − intermediate goods used
Macroeconomic modelA simplified story of an imaginary economy that highlights its essential features
2 Circular flow of income (two-sector)
- Assumptions: only households and firms; no saving, government or external trade; no leakage
- Real flows: factor services (households → firms), goods and services (firms → households)
- Money flows: factor payments (firms → households), consumption expenditure (households → firms)
- A = expenditure method, B = product method, C = income method; all three equal
- Four factors: land → rent, labour → wage, capital → interest, entrepreneurship → profit
3 The three methods
| Method | Identity | Gives | Main precaution |
|---|---|---|---|
| Value added (product) | GDP ≡ ∑GVAi; GVAi ≡ sales + change in inventories − intermediate goods | GDPMP | No double counting; no second-hand goods; include own consumption |
| Expenditure | GDP ≡ C + I + G + X − M | GDPMP | No intermediate spending, second-hand goods, shares or transfers |
| Income | GDP ≡ W + P + In + R; in practice: compensation of employees + rent + interest + profit + mixed income | NDPFC | No transfers or capital gains; do not add dividends to profit again |
- Farmer and baker: 100 + (200 − 50) = ₹250; adding outputs directly (₹300) is double counting
- Firms A and B: value added 50 + 150 = 200; expenditure 200; income (80 wages + 120 profits) = 200
- The most unstable expenditure component: investment (I); I includes planned and unplanned investment
- Three categories of investment: inventory investment, fixed business investment, residential investment
- Inventories: unplanned accumulation (sales unexpectedly fall), unplanned decumulation (sales unexpectedly rise); planned changes are the firm’s own decision
4 The ladder of aggregates
Three conversion rules
Gross − Depreciation = Net
Domestic + NFIA = National
Market price − (Indirect taxes − Subsidies) = Factor cost
| Aggregate | Formula |
|---|---|
| GNPMP | GDPMP + NFIA |
| NDPMP | GDPMP − Depreciation |
| GDPFC | GDPMP − Net indirect taxes |
| NNPMP | GNPMP − Depreciation = NDPMP + NFIA |
| NDPFC (domestic income) | NDPMP − Net indirect taxes |
| NNPFC = National income | NNPMP − Net indirect taxes = NDPFC + NFIA |
- NFIA = income of the country’s factors abroad − income of foreign factors in the country (an Indian’s wage in Saudi Arabia; profits of the Korean-owned Hyundai factory in India)
- GDP: production within the domestic territory; GNP: production by normal residents, at home or abroad
- Petrol heavily taxed, cooking gas subsidised (the book’s example)
- CSO, January 2015: GVA at basic prices replaced GDP at factor cost; GDP at market prices is the main measure
- India 2024-25 (constant prices): GVA at basic prices ₹1,71,87,446 crore + ₹16,09,509 crore (labelled “net production taxes” in the table; by the formula, net product taxes) = GDP ₹1,87,96,955 crore
5 Included or not included
✓ Included in national income
- Brokerage on a second-hand sale
- A farmer’s own consumption
- Imputed rent of an owner-occupied house
- A new machine bought by a firm (final investment)
✗ Not included
- Sale of second-hand goods
- Purchase or sale of shares and bonds; capital gains
- Old-age pension, scholarships, gifts, donations (transfers)
- Domestic services of a homemaker
- Purchase of raw materials (intermediate)
6 Personal income (Not in CBSE 2026-27 syllabus)
- PI = NI − Undistributed profits − Net interest payments by households − Corporate tax + Transfer payments
- PDI = PI − Personal taxes − Non-tax payments (fines)
- National disposable income = NNPMP + Other current transfers from the rest of the world
7 Nominal GDP, real GDP, deflator
- Nominal GDP: at current prices; real GDP: at constant base-year prices, showing only volume changes
- GDP deflator = Nominal GDP ÷ Real GDP (× 100)
- Bread: 2000, 100 × ₹10 = ₹1,000; 2001, 110 × ₹15 = ₹1,650 (nominal) and 110 × ₹10 = ₹1,100 (real); deflator 1.5 = 150%
- “GDP adjusted for inflation” = real GDP
- CPI (not in CBSE): basket of the representative consumer; example 1,950 ÷ 1,400 × 100 = 139.29; WPI (PPI in the USA)
- CPI vs deflator: CPI covers only consumer goods, includes imports, constant weights; the deflator covers all goods produced, excludes imports, weights change
8 GDP and welfare
| Limitation | Key point | Effect |
|---|---|---|
| Distribution | GDP ₹1,000 to ₹1,010, but 90% of people’s income fell from ₹10 to ₹9 | GDP up, most people worse off |
| Non-monetary exchanges | Domestic services and barter not counted | Underestimation |
| Externalities | Oil refinery pollutes the river; no payment or penalty | Negative: overestimation; positive: underestimation |
Remember
- National income = NNPFC, not GDP
- If NFIA is negative, national income is less than domestic income
- The income method gives NDPFC directly
- The change in stock sits inside GDCF in the expenditure method, and inside the value of output in the value added method
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