Chapter 2 — National Income Accounting

The four factors are: human labour (remunerated by wage), capital (remunerated by interest), entrepreneurship (remunerated by profit), and fixed natural resources called 'land' (remunerated by rent).

Final goods are meant for final use and will not pass through any more stages of production. Intermediate goods are used as raw material or inputs for producing other commodities. The value of final goods already includes the value of intermediate goods, so counting intermediate goods separately causes double counting.

Stocks are defined at a particular point of time (e.g., capital stock, inventory). Flows occur over a period of time (e.g., income, investment, value added). Capital is a stock; net investment is a flow. Similarly, water in a tank at a moment is a stock; water flowing in per minute is a flow.

Depreciation is the annual allowance for wear and tear of a capital good — essentially the cost of the good divided by its useful life in years. Net Investment = Gross Investment − Depreciation. It measures the actual addition to the capital stock.

GDP = sum of gross value added (GVA) of all firms. GVA of a firm = value of output − value of intermediate goods used. If there is depreciation, Gross Value Added − Depreciation = Net Value Added. Summing GVA across all N firms gives GDP.

GDP ≡ C + I + G + X − M, where C is aggregate final consumption expenditure, I is investment expenditure, G is government expenditure on final goods and services, X is exports, and M is imports.

GDP = W + P + In + R, where W is the sum of wages and salaries, P is gross profits, In is interest payments, and R is rents received by all households. The revenues earned by firms are distributed among the four factors of production in these forms.

GDP measures the aggregate production of final goods and services within the domestic economy. GNP = GDP + Net Factor Income from Abroad (factor income earned by domestic factors employed abroad minus factor income earned by foreign-owned factors within the domestic economy). For example, profits of a Korean-owned car factory in India are part of India's GDP but are subtracted when computing India's GNP.

Nominal GDP is the value of GDP at current prevailing prices. Real GDP is calculated by evaluating goods and services at a constant set of base-year prices so that changes in real GDP reflect changes in the volume of production, not price changes.

GDP Deflator = Nominal GDP / Real GDP (expressed as a percentage by multiplying by 100). It measures how prices have moved from the base year to the current year. For example, if nominal GDP is Rs 1,650 crore and real GDP is Rs 1,100 crore, the deflator is 1.50 (150%), meaning prices rose 1.5 times.

CPI measures the cost of a fixed basket of goods bought by a representative consumer and includes imported goods. GDP Deflator covers all goods and services produced domestically but excludes imports. Additionally, CPI uses constant weights, while GDP Deflator weights vary with the production level of each good.

Personal Disposable Income (PDI) = Personal Income (PI) − Personal Tax Payments − Non-tax Payments. PI itself = NI − Undistributed Profits − Net interest payments by households − Corporate Tax + Transfer payments from government and firms. PDI is the portion of aggregate income that households can choose to consume or save.

Three reasons from the chapter: (1) Distribution — rising GDP may be concentrated among a few, leaving the majority worse off; (2) Non-monetary exchanges — domestic services and barter exchanges are not counted in GDP, causing underestimation; (3) Externalities — negative externalities like industrial pollution reduce welfare but are not deducted from GDP, so GDP overestimates welfare in such cases.

Factor cost includes only payments to factors of production with no taxes. Basic prices add net production taxes (production taxes minus production subsidies) to factor cost. Market prices further add net product taxes (product taxes minus product subsidies) to basic prices. India's CSO now reports GVA at basic prices; adding net product taxes gives GDP at market prices.

Inventories are the stock of unsold finished goods, semi-finished goods, or raw materials a firm carries from one year to the next. They are treated as capital, so change in inventories is treated as investment. Change in inventories ≡ production of the firm − sale of the firm. Inventory changes can be planned or unplanned depending on whether sales match expectations.

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