National Income Accounting

National income accounts provide the formal structure for macroeconomic theory. It starts with the circular flow of income model, is based on national income accounting identity and helps us arrive at certain economic characteristics that affect business climate.
To begin with we provide you with some relevant topics that are important before we try to relate business and economy.

Some important concepts:

Stock vs. Flow Variables

• Stock Variables: those measuring how much of something exists at aparticular point in time.
• Flow Variables: those measuring changes in stock variables over time.

To start with we look at the first basic measure of national output i.e. GDP (Gross Domestic Product) - It is the value of all final goods and services produced in the economy/country within a given period (generally a year). The output of each of the goods produced is valued at market prices and added together to get GDP.
The value of total output in an economy identically equals the value of total income (based on the circular flow diagram).

National Income Accounting Identity
GDP (expenditure approach)= C+I+G+NX
C: Consumption expenditure
I: Investment expenditure
G: Government Spending
NX: Net exports (Exports - Imports)
If NX > 0, trade surplus
If NX < 0, trade deficit

Methods of Measuring GDP

• Expenditure Approach
  Based on the expenditure done by various sectors in the economy.
  C: Household spending on Goods & Services (G&S) including durables, nondurables, services.
  I: Spending by firms and HH on new capital.
  Namely plants, equipment, inventory and new housing.
  (DO NOT confuse with investment used in every day language.)
  1) Inventory Investment: change in the value of inventories businesses have on hand.
  2) Fixed Investment: Of a more permanent nature than inventory.
  a) Nonresidential: spending done by firms for new capital
  b) Residential: apartments, private homes.
  NOTE: I is gross investment: includes both replacement of worn out capital (K) as well as addition of new K. In other words, depreciation of K is not subtracted (if did subtract out then would have net I).
  G: Gov’t purchases of G&S. Includes imputed values of public goods (e.g. parks). Imputed values calculated as the cost of providing the good. Transfer payments too are not included.
  Also interest payments by G excluded (not considered payments
  for current services; rather considered a transfer).
  NX = EX-IM: Total demand for domestic G&S by ROW.
  EX: Exports: G&S sold to ROW
  IM: Imports: Purchases of G&S by US from ROW.
  Imports are subtracted because not produced in home.
• Value Added Approach
  Disaggregate GDP by which industry produced the value added associated with output. The value added is the value of the firm’s output minus the value of its purchases from other firms.
  For instance consider a single industry economy: Bread making
  Farmer grows wheat and sells it for Rs.10/gm to flour maker. Value added here is Rs 10. Flour maker sells the flour to baker for Rs 15. Value added is Rs.(15-10) = Rs. 5. The baker makes bread out of it and sells to the retailer for Rs. 22. Value added at this stage is Rs.(22-15) = Rs. 7. The retailer sells the bread to customers for Rs. 25. Value added here is Rs. (25-22) = Rs. 3. Thus, total value added in the economy is Rs.(10+5+7+3) = Rs. 25.
  Therfore, GDP = #Bread Loaves * Rs. 25
• Income Approach
  This approach is based on the income earned by the agents involved in economic activity(the suppliers of labour, capital etc.) According to the simple circular flow diagram that total expenditures (on G&S) equals total income. We will call total income National Income (NY). It includes:
  a) Compensation of employees (wages, social security and pension contributions)
  b) Proprietors income (unincorporated business income)
  c) Rental income (which includes imputed rent of homeowners since still providing services)
  d) Corporate profits (incorporated business income)
  e) Net interest (interest paid to HH by businesses and interest paid by ROW to HH and businesses.
  Note: interest payments by HH & G not included since not connected with provision of G&S)

NY does not exactly equal GDP. We must adjust NY by
· adding depreciation (capital consumption allowance)
· adding indirect taxes (sales, customs duties, license fees, etc.)
· subtracting subsidies
· adding net factor payment to the ROW
Therefore, GDP = NY + Depn + (Indirect Taxes - Subsidies) + Net Factor Payment to ROW

Other Measures: NNP, NY, PY, Yd
GDP is the most comprehensive measure of aggregate output for an economy but there are other measures which are also of interest.
GDP
- Net Factor Payment to ROW
=GNP
- Depn
=NNP
- (indirect taxes - subsidies)
- statistical error
=NY
- retained corporate earnings
- Social Security contributions
+ interest payments made by G and consumers
+ transfer payments (including social security)
=Personal Income = C + S + T
- personal income taxes
=Disposable Income = Yd = C + S = take home pay (its different from fat CTC inclusive packages :) )