National Income Notes of Indian Economy

 

National Income & Accounting Concepts

Like individual person's income, there is the income of a country also. The income of the country is also known as National Income. To measure the National Income, generally, there are many methods but 4 among them are more prominent. These are GDP, NDP, GNP, and NNP. Among these 4, GDP is supposed to be the most stable method. The reason for it, we will discuss further in this article. But before that we need to understand, what  GDP, NDP, GNP & NNP are all about.

GDP- Gross Domestic Product

NDP- Net Domestic Product

GNP- Gross National Product

NNP- Net National Product

You can observe that in all the above, there is a common term i.e product. Let's understand the product first. The catch-up sauce that we are using in our home is a product. Similarly, the flat we are residing in is a product. Because a company must have constructed this flat.

Similarly Sofa in our drawing room is a product because it must have been built by a company. All these are physical products. Apart from these, there some software products also are there.  For example, Finacle of Infosys is a software product. Similarly ERP System of  SAP is a software product. There are many products we use in our daily life. Now take an example of Tomato catch up and let's see how it is being made.

Tomatoes from Farmers Catch-up company Tomato catch-up

Here tomatoes are the raw materials for the catch-up company & raw material is converted to finished goods i.e tomato catch-up. That means all finished Goos are said to be products. Apart from this, services are said to be products also. For Example, Insurance Plans, Pension plans, unit linked plans, micro insurance plans, withdrawn plans, Health Plans, etc are products.  Now it is clear, that we can keep banking, insurance, shipping, and other services in the product category as well. Now from this understanding, we can say that Goods and Services are known as products. And each Good and Service has some monetary value. If you want to buy catch-up, you need to pay something or if you purchase any software, you need to pay something.

A lot of final goods and services are produced within the geographical boundary of India. If you calculate all the aggregate values of Good and Services produced inside the geographical boundary of a country and them. The result will be the GDP of that country.

I.e Aggregate Values of the Goods+ Aggregate values of the Services= GDP

GDP= Gross Domestic Product. Gross means Total. Domestic means it is produced within the Geographical boundary of the country.

That means GDP includes those Goods and services which are produced within the Geographical boundary of a country. So it is clear, that Indian companies producing Goods & services in India and Foreign companies producing Goods & services in India will contribute to the GDP of India.

Now let’s try to understand another concept of GDP.

Now take the example of a Masala Company i.e  MDH.

MDH Company100 packets.

 MDH Company is making 100 packets. Among these, 80 packets are sold in markets,12 packets still laying in Godown and 8 packets are used for self-consumption.

Here the 80 packets which were sold in the market will be considered in GDP. if one packet cost Rs 5 then 80*5=Rs 400 will be considered in GDP. The 12 packets that were laying in the Godown will not be considered in GDP. And the 8 packets used for self-consumption will not be used for GDP. Because no money transaction happened in these cases.

Now let’s Consider another concept of GDP. 

Consider a steel company named HEMUNDA Steel.

HEMUNDA Steel Steel

But there are some companies that use steel as raw material like Automotive companies and Tool Fabrication companies. Suppose A automotive company sold 10 CARS and a tool fabrication company sold 5 tools. Here the 10 cars and 5 tools will be considered in the GDP calculation. But the steel made by HEMUNDA Steel will not be considered as it is an intermediate product. This intermediate product has been used as a raw material for Automotive and tool fabrication companies.  The value of the intermediate product has been included in the final product. The final product is that product on which no further value addition is possible. The reason for not including The value of the Intermediate product in GDP Calculation is the issue of double accounting. The value of the intermediate product will be calculated twice as its value has been added to the final product.

Let’s understand another concept of GDP.

Suppose, you sold your old laptop to some other person through the OLX Platform. You purchased it for Rs 10k and sold it for Rs 5k. Will this have any impact on GDP? The answer is No. This transaction will not have any impact on GDP. There are no goods or services produced here. You just sold the already manufactured goods which had already been considered in GDP when it was produced.

Now tell me 

If a shopkeeper purchased a laptop for Rs 10k from a company and sold it to any customer for  Rs 15k. What will be the impact on GDP? 

If the laptop is produced in the present financial year, its value will be added to the GDP i.e Rs 10k. Now the Shopkeeper is producing service. He is paying rent, electricity bills, Paying his employees, etc. So he added extra Rs 5k. This will be added to the GDP. if we imagine that in the financial year only one laptop was produced and sold by one shopkeeper. Then the GDP of our country will be Rs 15k. But you can notice here we have not considered tax here. Now add a tax of 20% to each transaction. So 20% of 10k is 2000 so for the shopkeeper, the laptop was Rs 12k. And 20% of 5k is 1K. 

We should note that starting from manufacturer to end seller, all the indirect tax will be paid by the customer. So for the customer, the cost of the laptop was 18k instead of 15k. 

Here if you imagine, in a financial year, in our country, one laptop was produced and one service was produced. In this case what will be the GDP of our country? To answer this, we need to understand two things i.e GDP at factor cost and GDP at Market Price.

 

Now let’s understand, What is Factor cost?

Cost of producing this Good or Service

We know, for any good or service to produce, we need

• Entrepreneur

• Land

• labor

• Capital

Capital is needed for raw materials. Machines, marketing, transportation. Generally, Capital is taken from Bank on interest. 

An entrepreneur needs profit, Rent is paid for the land, wages, and salaries for the labor, and interest is paid for the capital. For example, 20k for rent, 20k for wages and salary, 20k for interest, and 40k for profit. So the total amount will be Rs 100k. Suppose the number of laptops produced is equal to 10. So the price of one laptop will be Rs 10k. This is called factor cost. Because all the factors needed for production have been considered to calculate this amount. So the factor cost of the laptop is Rs10k. Similarly, we can calculate the factor cost of the service provided by the shopkeepers considering his profit, electricity bill, the salary of his employee, etc. Here it is Rs 5k

Now in our example, the GDP at Factor Cost will be 10K+5K= Rs 15k

Now come to GDP at Market Price

GDP at Market Price= GDP at Factor Cost+ Indirect Taxes- Subsidies.

If we add all the indirect taxes and subtract the subsidies given by Govt if any, the amount we will get will be the GDP at Market Price.

Now understand this by taking more examples.

In the year 2020, suppose one laptop was produced in our economy, so our GDP at factor cost will be Rs 15k (According to our example). And for the years 2021 and 2022, one laptop was produced each year. Hence the GDP at factor cost for both the year is Rs 15k.

The GDP at Market Price for the year2020 is Rs 18k according to our example above. But now the Govt increased the indirect tax for the year 2021 so the GDP at Market Price will be Rs 20k suppose.  And further, the indirect tax for the year 2022 was increased, so the GDP at the market price will be Rs 25k suppose. Now you can observe that Goods and Services price has not changed over the three years but The GDP at Market Price has increased. The reason for it is the rise of indirect tax.

 From this understanding, if I ask you, which one is the better indicator from GDP at Factor Cost & GDP at Market Price to know if the production of Goods or services in an economy is increasing or decreasing? 

The Answer will be GDP at Factor Cost. Because GDP at Market Price can be increased by increasing the indirect tax without the increase in production.

In our country also GDP used to be calculated at Factor Cost. But in 2015, India switched to GDP at Market Price.

What is the reason for this shift?

 Change in the method of GDP calculation is done to make it in line with Global Practice. Because all the major economy of the world calculate their GDP at market price. So, by calculating GDP at Market Price- our growth can be compared with other developed nations more effectively. In fact, in 2008, the United Nations System of National Accounts also recommended that INDIA start calculating its GDP at Market Price.

Now we understood that GDP at Factor Cost is a better indicator to know if the production of goods and services in an economy is increasing or decreasing.  But this is not always true. This is because of Inflation. Let’s understand how inflation impacts GDP at Factor Cost.

Now understand this with an example. Suppose in the year 2020, one laptop was produced and its factor cost was Rs 10k. And one laptop was produced in each year 2021 and 2022. Suppose the inflation was 10%. It means the laptop will be costly by 10% in subsequent years. So it was Rs 11k in 2021 and  Rs 12.1k in 2022. Now we can see that in the year 2020, the GDP will be Rs 10k, in the year 2021, the GDP will be Rs 11k and in 2022 the GDP will be Rs 12.1k. From this example, we see even though, there is no increase in production and services in an economy, still the GDP kept on increasing year after year. Here the GDP value we saw in the years 2021 and 2022 are inflated GDP i.e Inflation has been added to GDP. This type of GDP is known as Nominal GDP. Nominal GDP is calculated by multiplying the current price by the number of products.  If we deduct inflation from the Nominal GDP, we will get the real GDP.

 But question is upto which year we need to deduct the inflation. The answer is upto the base year. Each country have set their own base year. For india the base year is financial year 2012.

So we need to deduct the inflation upto the base year 2012. The GDP at Factor Cost for the financial year 2012 is known as Real GDP. Accordingly we will get the real GDP for the year 2022. But how to remove inflation from base year till date. This can be done by GDP Defletor.

For example, GDP Deflator=10 

So Real GDP= Nominal GDP/10= 12.1K/10=Rs 1210. So the Real GDP is Rs 1210. Now knew that GDP is two types i.e Real GDP & Nominal GDP. Real GDP is also known as GDP at constant price since we deduct inflation from it. So we make the price constant. And Nominal GDP can be calculated at Factor cost and at Market Price. Real GDP can also be calculated at Factor Cost and Market price. That means GDP can be calculated by 4 way.

These are

1. Real GDP at factor cost

2. Real GDP at Market Price

3. Nominal GDP at factor cost

4. Nominal GDP at market price

Among these 4, In our country, we use Nominal GDP at market price. The reason for GDP at market price  we have discussed above in this article. Why Nominal GDP?

The answer is for Real GDP, Base year is required and for each country, the base year is different. For india it is FY 2012. It changes with time. Before it, this was financial year 2004. All other countries change their base year with respect to time. So we can not compare the GDP of countries with each other. But we can compare considering the Nominal GDP.

So, GDP is one of the method of calculating National Income.

National Income should be the value which i get by adding the incomes of all the people living in the Geographical boundary of India. 

Sum of Expenditure= Sum of Income=Sum of Products= National Income.

You must have thought, How?

Its True.

 Lets take the example of Laptop. Suppose a single laptop was produced in the entire financial year.  For the laptop to be produced, Entrepreneur, land, labour, capital are required. Suppose Entrepreneur makes a profit of Rs4k, Land rent is Rs 2k, Wages and salary of Labour is Rs2k, and interest of the Capital is Rs 2k. So the total cost is Rs 10k.  The laptop will be sold in the market for Rs 10k and the customer will purchase it for Rs 10k. So tne toal expenditure is Rs 10k, total production is Rs10k, and total income is Rs 10k and that is the total national income.

GNP- Gross National Product

GNP= GDP+ INCOME OF INDIAN ABROAD- INCOME OF FOREIGNERS IN INDIA

Income of Indians abroad- Income of Foreigners in India= Net Factor Income from Abroad 

( NFIAD)

NFIDA has 3 components

1. Private Remittances

2. Interest on External loans

3. External Grants

Private Remittances are something which indian staying abroad send to India and foreigners staying in India send to their own country. If it is coming to India, It is Positive and If it is going outside India, it is negative. In case of India, its mostly positive.  Similarly, it is negative in case of Inerest on external loans and external Grants.  Hence NFIAD is mostly negative. 

GNP=GDP-NFIDA

SO, WE can say GNP< GDP.

Now we completed both GDP and GNP. But through this we calculate the Gross Value

Now come to NDP and NNP. Through this, we calculate Net Value. Let’s understand the difference between the two.

GROSS Value means total value. But Net value is calculated by deducting all the deductions.

Let’s take an example, suppose we sow wheat seeds of Rs 10 and we get wheats of Rs 100. Here the Gross production is Rs 100 but the net production is 100-10= Rs 90.

In place of wheat, if we take the example of tomato  catch up, to make tomato catch up, machine is used and machine is a depreciating asset. Suppose we bought the machine in 2022 for 1 cr, it will be useless in the year 2042. This depreciation rates is fixed by the Govt. In India, the depreciation rates for all assets classes are announced by Ministry of commerce and Industry. Suppose the Govt. declared the depreciation rates as 30%. If we bought the machine for Rs 1 cr in 2022, its value will be Rs 70 lakh in 2023. Rs 30 lakh will be depreciated. This value of depreciation is calculated in Expenditure.  

Let the value of one catch up bottle be Rs 10. The company produced 10lakh such bottle. So the total value will be Rs 10* 10 lakh= Rs 1cr.

The Gross production is 1 Cr But the Net production is 1cr-30 lakh= Rs 70 lakh

So, Gross value-Depreciation= Net Value

GDP-Depreciation= NDP

GNP-Depreciation= NNP

But here, We should note that we can calculate the depreciation of only those things which are used by the businesses for production of Goods.

Now we underwood about the GDP, NDP, GNP, and NNP. Let’s try to understand which one is the best for the calculation of National Income.

GDP is the monetary value of all the goods and services produced in an economy within the geographical boundary of a country. That means it shows the internal strength of a country. It also indicates the Job creations.

GNP is the total value of all goods and services produced by the residents and businesses of a country & it is not restricted by the geographical boundary of a country. It shows how much the outside world is dependent on its product & how much it depends on the world for the same. So, it shows the internal and external strength of a country.

NDP is calculated by deducting depreciation from GDP. Depreciation can be minimised through R&D. It shows the achievements of the economy in the area of R&D because it considers the depreciation within the economy. So, it shows the efficiency of the Economy.

NNP is calculated by deducting depreciation from GNP. It is the total value of finished goods and services produced by a country’s citizens overseas and domestically, minus depreciation. This is the purest form of the Income of a nation. So NNP at factor cost is considered the National Income Of our Country. It is represented by NI.  When we calculate Percapita Income, We divide NNP at factor cost by Total population.

 Nominal Per capita income= NNP at factor cost/ total population.

If we deduct the inflation upto the base year, We will get the Real per capita Income. Real per capita income is considered the most appropriate measure of economic growth.

Now we will come to know which one is the best to compare the economic growth of different countries?

But here we can not take those measures which considers Depreciation in their calculation. Because, the rates of depreciation is set by the government of every country and it varies at lot. Now NNP & NDP are out. Among GDP and GNP, GDP is the most appropriate one. But the question is why GNP is not used to compare the economic growth of different countries.

 The  first reason is Dual Citizenship. Many countries have Dual citizenship provision. In this context, the income of a single citizen will be considered in the GNP of two countries. The problem of double counting happens in GNP.

The second reason is

GNP= GDP+Net factor income from Abroad(NFIAD). NFIAD depends on Foreign Exchange & foreign fluctuates so GNP will flactuate. So it will be difficult to compare the economic growth of two countries using GNP.

The third reason is

GDP is directly proportional to job creation. If GDP is decreasing, meaning unemployment is increasing but GNP can be increased in this context if NFIAD will increase abruptly. In this situation we can not say that economic growth is happening. So GNP is not helping in determining weather an economy is actually growing or sinking.

So, these are the reasons why GDP is preferred over GNP to compare economic growth of different countries.