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C O The objective of this chapter is to discuss the concepts applied to and methods of measuring national income–the most important macroeconomic variable. The discussion includes the following aspects: Concepts applied in national income accounting Various measures/parameter...

C O The objective of this chapter is to discuss the concepts applied to and methods of measuring national income–the most important macroeconomic variable. The discussion includes the following aspects: Concepts applied in national income accounting Various measures/parameters of national income The concepts of nominal and real national income Methods of measuring national income Methods applied in India to measure national income National income data of India INTRODUCTION Measurement of national income is a part of the process of estimating the national income. It is also known as national income accounting. Understanding national income accounting is important because macroeconomics is the study of economy as a whole and national income is the single-most important macro variable that represents ‘the economy as a whole’. The level of national income determines the level of all other macroeconomic variables – aggregate consumption, saving, investment, employment, and also the price level. Also, most macroeconomic theories are based on national income and its components. Therefore, a clear understanding of concepts and methods of measurement of national income is necessary for the study of macroeconomics. The objective of this chapter is to discuss briefly the concepts used in and the methods of measuring national income with examples of methods used in India. Looking back historically, the available records show that the attempts to estimate national income, especially by Gregory King, had started in the 17th century. Gregory King had adopted a simple method of estimating the national income, i.e., by taking it as the sum of individual incomes and the government income reconciling with their expenditures. Not much progress was made in the method of estimating national income until the 1930s. The first estimate of national income was made in the US in 1934. The modern concepts of national income and the method of ‘national income accounting’, known also as ‘social accounting’, was developed and adopted by Simon Kuznets1 of Harvard University in 1941. In fact, the need and necessity of a reasonable estimate of national income had arisen after the publication of Keynes’s The General Theory of Employment, Interest and Money in 1936. The analytical framework adopted by Keynes in his The General Theory for macroeconomic analysis required detailed accounting of various components of the national income, including aggregate demand and aggregate supply, aggregate consumption expenditure (private and public), aggregate savings and investment, total exports and imports, net balance of foreign transactions, etc. National income accounting is, in fact, a detailed accounting of total national product resulting from different kinds of economic activities, classified under different sectors and industries, and also the intersectoral flows of goods and services. It also takes into account the net effect of foreign trade, i.e., inflows and outflows of goods and services to and from the foreign countries. The importance of national income accounting lies in the fact that the performance and behaviour of an economy are studied on the basis of the performance of its macroeconomic variables including national income (estimated as Gross National Product or Gross Domestic Product), aggregate consumption, aggregate savings and investment, total labour employment, general price level, total supply of money and total demand for money, and balance of payments (BOP). Incidentally, of these aggregates, national income is the ‘most macro’ of all macroeconomic variables. All other macro variables are either the components of or are the result of national income (GDP/GNP). For instance, the level of employment depends on the level of GDP, aggregate consumption expenditure and aggregate savings and investment are the components of GDP, and their level depends on the level of GDP. Given the money supply, the general level of price depends on the GDP, and so on. National income is the most important variable from both the theoretical and the practical points of view. At the theoretical level, a major part of macroeconomic theories seeks to explain the determination of the equilibrium level of the national income, the interrelationship and interaction between its various components, and the growth of and fluctuation in the national income. From the practical point of view, a country’s national income data is used for (i) measuring the standard of living and economic welfare of the people, (ii) formulation of economic policies for the management of the economy, and (iii) making international comparisons about the status of the economy. The objective of this chapter is to present a brief discussion on the concepts used in national income estimation and on the methods of national income estimation with examples of methods used in India. 3.1 SOME CONCEPTS RELATED TO NATIONAL INCOME In general sense of the term, ‘national income’ refers to the aggregate money value of all final goods and services resulting from the economic activities of the people of a country over a period of one year. Given this definition of national income, it appears that measuring national income is an easy task. However, making a reliable measure of national income is an extremely complex and difficult task. Measuring national income is a complex task because it involves many conceptual problems. The conceptual problems arise because the term ‘national income’ is used in a variety of senses depending on (i) what is a productive and what is a non- productive activity? (ii) within the productive activities, what is economic and what is non-economic production? (iii) what is to be included in, and what should be excluded from, the national income concept? and (iv) what method, or methods, are to be used to measure national income? Therefore, prior to discussing the methods of measuring national income, it is essential to have a clear understanding of the various concepts used in its measurement. 3.1.1 Economic and Non-Economic Production All productive activities of human beings create goods and/or services, but all goods and services produced by human activities are not included in national income accounting. For the purpose of national income accounting, goods and services produced by human beings are classified under two categories: 1. Economic production 2. Non-economic production Let us look at the differences between the two kinds of production. Economic Production In economic-sense, economic production refers to the goods and services which are produced for sale and have a market value, and the goods and services which are produced and provided to the people jointly by the government and public organisations. Thus, economic production includes both marketable and non-marketable production. Goods and services produced by farmers, firms, factories, shops, hoteliers, tailors, lawyers, medical practitioners, etc., fall in the category of marketable production. And, the goods and services produced and supplied by the government, public institutions, social organisations, NGOs, social service clubs, charitable societies, etc., fall in the category of non-marketable production. The government provides administrative services, law and order, judiciary services, national defence, educational and medical services, etc. These services (except medical and educational services) cannot be provided individually, and they do not have a market and market price. But, all these services use national resources—land and labour—which have an economic cost, and they add to the production capacity, and to the welfare of the society. Production of all such goods and services falls in the category of Economic Production. It must, however, be noted that all marketable production is economic production but all economic production is not marketable, e.g., public goods. But all the goods and services of this category are included in national income accounting. Non-Economic Production Non-economic production includes the production of goods and services that are not meant to be sold, nor is there any market for them, nor do they have a market price, even though they add to human welfare. To this category, belong mainly the following services: 1. Services rendered to self, e.g., exercising, acquiring knowledge, shaving, washing one’s own clothes, self entertainments, hobbies, cooking for self, etc. 2. Services provided by the family members to the family members, e.g., housewives cooking for the family and looking after the household, parents teaching their own children, mothers rearing the children, providing nursery help, doctors treating their own family members, gardening in one’s own house campus, etc. 3. Services provided by the neighbours to each other, e.g., helping each other on festivals and marriage occasions, social works, etc. Although these non-economic products contribute to human welfare like any economic good and can be valued at an imputable rate, these products are not included in the measurement of the national income as these services cannot be valued at market rate. 3.1.2 Intermediate and Final Products In estimating national income, a problem of double counting arises, i.e., the value of the same product is counted more than once. Double counting of products results in overestimation of national income. Therefore, with the purpose of encountering the problem of double counting in national income accounting, the goods and services produced in a country are classified as intermediate and final products. National income includes the value of only final products—be it a good or a service. Let us understand the distinction between intermediate and final goods and its importances in national income accounting. Intermediate and Final Goods In the process of production, certain goods, called material inputs, pass from one stage to another, with their form changing, until the product reaches its final stage. Such products are called intermediate products. Thus, the goods that flow from one stage to another in the process of production of a good, with their form changing, are called intermediate products. The goods that reach the final stage of production and flow to their ultimate consumers/users are called final products. Practically, a product sold by one firm to another for resale, or for further processing or value addition, in the process of production is also called intermediate product, and a product that is sold finally to the consumer or to the investor is final product. Final goods are classified under two categories: (i) final consumer goods, and (ii) final producer goods or capital goods. Final consumer goods are those that flow to the ultimate consumers. Final capital goods (machinery, plant and equipment) are those that are finally used by the firms in the process of production. Final capital goods are also called ‘Investment goods’. Example The distinction between intermediate and final products, in case of consumer goods, can be clarified further with an example. Let us consider the production of sandwiches. Initially, the sandwich was in the form of wheat. In the process of sandwich production, wheat flows from the farmers to flour mills, from flours mills to bakeries, and from bakeries to restaurants, where bread is converted into sandwiches – the final product – which are sold finally to the consumers. Note that in the process of sandwich production, wheat flows from one stage to another but its form keeps on changing – from wheat to wheat-flour, from wheat-flour to bread, from bread to sandwich, the final product. In this case, wheat, wheat flour and bread are intermediate products and sandwich is the final product.  As noted above, the need for distinction between the intermediate and final products arises because of the problem of double counting, i.e., the value of the same product counted more than once in national income accounting. In our example of sandwich production, wheat is converted into flour, wheat-flour is converted into bread, and bread into sandwich. At each stage of production, the products—wheat, flour, bread and sandwich—are priced differently. Wheat price is included in the price of flour, in the price of bread, and in the price of sandwiches. Therefore, if the total value of all these products—wheat, wheat-flour, bread and sandwich—is taken into account in national income counting, wheat price would be counted four times, wheat flour price three times and bread price twice. In economic terminology, this is called double counting, even though it is counted multiple times. Double counting leads to overestimation of the national income. Intermediate and Final Services The double counting problem arises also in case of services provided by the firms and the government. Whether the service provided by the private firms and by the government is an intermediate product or a final product is a rather ticklish issue. The classification of services under the intermediate and final product categories depends on the purpose of their use. For example, services provided by the government, like transport, postal, water, communication, etc., at a cost are used for both production and consumption purposes. When used for production purpose, these services are treated as intermediate products and when used for private consumption, they are treated as final products. For example, the part of railway services used for transporting production materials are treated as intermediate service product, and railway service used by the travellers for travelling from one place to another for personal purposes is treated as final service product. Similarly, postal services provided to business firms are intermediate products and those provided to households are treated as final products. Bus services are regarded as final products as they are used for commuting from one point to another. However, there is a difference of opinion among the economists on the issue of treatment of services as intermediate and final products. It all depends on the practice adopted by the authority assigned the task of estimating national income. 3.1.3 Transfer Payments Transfer payments are the payments made by the people to the people, and by the people to the government without corresponding transfer of goods and services. In other words, transfer payment refers to the flow of money without a reverse flow of goods or services. For example, when a person gifts some money to a relative or friend, or donates an amount to a poor person or to a charitable organisation, without receiving anything in return, it is a transfer payment. Similarly payment of taxes by the people to the government and payment of old-age pension by the government to the retired employees are treated as transfer payments in national income accounting. It is important to note here that transfer payments are not taken into account while counting the national income because such payments do not make any addition to the total production nor do they add any additional value to the society. However, the concept of transfer payment at times becomes disputable. To use Beckerman’s example2, when a father pays some money to his son as pocket money, it is transfer payment. But, if the son cleans his father’s car in return to pocket money, the question arises ‘should father’s payment to the son be treated as a transfer payment or as a payment in return for son’s service. In such cases, an arbitrary approach is adopted or a value judgment is used. Therefore, practice varies from country to country. According to him, “ … the dividing line between what is and what is not productive activity is arbitrary in any system of national accounts, including the system adopted by nearly all Western countries.”3 3.1.4 Consumer and Producer Goods All final products, as discussed above, can be classified under two categories: (i) consumer goods, and (ii) producer goods or capital goods. The goods and services that are consumed by the people to directly satisfy their needs and yield utility to the consumer are consumer goods. For example, food, clothes, house, personal cars, household goods, petrol, books, etc., consumed or used by the people of a country are all consumer goods. Also, the total annual expenditure by the government on staff salary, education, health care, and law and order represent government consumption expenditure. Thus, the services created by the government are consumer goods. As regards the producer goods, the category of final products which are not used as consumer goods but are used for enhancing the production capacity of the national economy with the purpose of increasing the flow of income in the future are treated as producer goods. Such goods are also called capital goods. Capital goods are the man-made means of production, including machinery, tools and equipment; corporate, educational, hospital and factory buildings; roads, railways, airports and aeroplanes, etc. All such final products are producer goods. 3.2 DIFFERENT KINDS OF MEASURES OF NATIONAL INCOME Having discussed the conceptual problems, we discuss now the different kinds of measures of national income used in national income analysis and in economic policy formulations. Also, different concepts of national income are used in economic analysis depending on (i) what is and what is not included in the national income estimates, and (ii) what method is used for estimating the national income. In this section, we describe briefly the main concepts and measures of national income. 3.2.1 Gross Domestic Product (GDP) The Gross Domestic Product (GDP) can be defined as the sum of market value of all the final goods and services produced in a country during a specific period of time, generally one year. It is important to note here that in estimating GDP of an open economy, the income earned by the foreigners in the country are included and the income earned by the residents abroad and remitted to the home country are excluded. In simple words, GDP includes income earned by the foreigners in the country and excludes income earned abroad by the residents. The market value of domestic product is obtained at both constant and current prices. Accordingly, GDP is known as ‘GDP at constant prices’ and ‘GDP at current prices’, respectively. Measuring GDP at ‘the market value of all final goods and services’ is beset with the following problems: 1. Determining what is ‘final’ and what is not, to avoid the problem of double counting 2. Evaluation of non-marketed goods and services, e.g., farm products produced and consumed by farmers themselves and rental value of owner-occupied houses, etc. 3. Accounting of incomes from illegal activities and professions, e.g., smuggling, production and sale of prohibited goods, like narcotics and arms, etc. 4. Accounting of unsold stocks and inventories 5. Distortion of prices due to indirect taxes In practice, these problems are resolved by the national income estimating agency. For instance, in India, the Central Statistical Organisation (CSO) finds ways and means to account for these problems. Alternatively, the GDP can also be defined and measured as the sum of all factor payments (wages, interest, rent, profit and depreciation). It is then called ‘GDP at factor cost.’ 3.2.2 Gross National Product (GNP) The Gross National Product (GNP) is another measure of national income which often figures in macroeconomic analysis and policy formulations. The concept of GNP is similar to that of GDP with a significant difference, of course. The concept of GNP includes the income of the resident nationals which they receive abroad, and excludes the incomes generated locally but accruing to the non-nationals. In case of GDP, however, it is just the otherway round. The GDP includes the incomes locally earned by the non- nationals and excludes the incomes received by the resident nationals from abroad. A comparative definition of GNP and GDP is given below: GNP = Market value of domestically produced goods and services plus the incomes earned by the residents of the country in foreign countries minus the incomes earned by the foreigners in the country GDP = Market value of goods and services produced by the residents in the country plus the incomes earned in the country by the foreigners minus the incomes received by residents of a country from abroad 3.2.3 Net National Product (NNP) The concept of Net National Product (NNP) is closely related to the concept of GNP. The concept of GNP includes the output of both final consumer goods and capital goods. However, a part of capital goods is used up or consumed in the process of production of these goods. This is called depreciation or capital consumption. While GNP is gross of depreciation, NNP is net of depreciation. NNP is obtained by subtracting depreciation from GNP. That is, NNP = GNP – Depreciation or capital consumption The NNP is the measure of national income which is available for consumption and net investment to the society. The NNP is, in fact, the actual measure of national income. The NNP divided by the population of the country gives the per capita income. 3.2.4 Personal Incomes (PI) Personal income (PI) can be defined as the sum of all kinds of incomes received by a person from all sources of incomes. Personal income includes wages and salaries, fees and commission, bonus, fringe benefits, dividends, interest earnings and earnings from self-employment. It also includes transfer incomes like pensions, family allowances, unemployment allowances, sickness allowances, old age benefits and social security benefits. Personal income also includes the incomes earned through illegal means, e.g., bribe, smuggling, cheating, theft, prostitution, at least for the taxation purpose. Personal Income and NNP It is important to note here that the sum of personal incomes is not exactly the same as NNP. The reason is that NNP excludes certain items included in personal incomes and it includes some other items not included in personal incomes. NNP does not include many items of personal income, for example, transfer payments like social security benefits, pensions, old age allowances, and such other benefits. And, it includes undistributed profits of private companies, surpluses of public undertakings, and rentals of the public properties. However, NNP can be measured by making some additions to the personal income (PI). The estimate of NNP can be expressed as follows: NNP = PI + UDP + SPU + RPP where, PI = personal income excluding items not included in NNP; UDP = undistributed company profits; SPU = surplus of public undertakings; RPP = rentals of public properties. 3.2.5 Some Other Income Concepts There are some other income concepts used in the analysis of national income and in economic reports. Two of such important income concepts are briefly discussed below. Disposable Income In wider sense of the term, disposable income refers to personal income of the income earners against which they do not have any legally enforceable payment obligations. Legally enforceable payment obligations include such payment obligations as income tax, payment due against government loans, and fines and penalties imposed by legal authorities. In specific terms, however, disposable income can be defined as follows: Disposable income = Personal income – (personal income tax + fees + fines) Private Income Broadly speaking, all personal incomes are private incomes. However, the term private income is used in contrast to public income. For the purpose of national income accounting, NNP is generally divided into two parts: (i) private income, and (ii) public income. Public income is that part of NNP which accrues to the public sector, including the government administrative units and the government commercial undertakings. Thus, income accruing to the public sector is called public income. In contrast, incomes accruing to the individuals, including private sector earnings, transfer payments and undistributed profits of private companies are called personal income. By definition, Total Private Income = Net Domestic Product – Public Income National Income Concepts: Summary 1. GNP = Market value of final goods and services (including both consumer and capital) plus the incomes earned by the national residents in foreign countries minus the incomes earned locally but accruing to foreigners 2. GDP = Market value of goods and services produced by the residents in the country plus the incomes earned locally by foreigners minus the incomes received by the nationals from abroad. 3. NNP = GNP – Depreciation (or Capital Consumption) 4. PI = NNP – (Undistributed Company Profits + Surplus of Public Undertakings + Rentals of Public Property) 5. Disposable income (Yd) = PI – Personal Taxes Some Accounting Relationships 1. GNP at factor cost plus net indirect taxes less depreciation = GNP at market price 2. GNP (at market price) less depreciation = NNP at market price  3. NNP at market price less indirect taxes add subsidies = NNP at factor cost 4. NNP at factor cost minus domestic income accruing to non-residents = NDP at factor cost 5. NDP at factor cost – [surplus of public undertakings + profits of statutory corporations + profit tax + income accruing to non-residents] + [interest on national debts + transfer payments] = Personal income 6. Personal income less direct taxes, fees, fines, etc. = Disposable income 3.3 NOMINAL AND REAL GNP4 The GNP and GDP are estimated at both current and constant prices. The GNP estimated at current prices is known as nominal GNP and GNP estimated at constant prices in a chosen year (called ‘base year’) is known as real income. Similarly, GDP estimated at current prices and constant prices is called nominal GDP and real GDP, respectively. The need for estimating GNP (or GDP) at constant prices arises because GNP at the current prices produces a misleading picture of economic performance of the country when prices are continuously rising or decreasing. In a country having a high rate of inflation, the nominal GNP produces an inflated estimate of the national income and creates false sense of richness or economic growth. This kind of misleading picture of an economy that GNP estimated at the current prices creates can be seen, for example, in Table 3.1. This table presents India’s GNP and its annual growth rates estimated at both current and constant prices during the period from 2000–01 to 2013–14. The GNP data given in Table 3.1 shows the difference between the nominal and real GNP of India. More obvious is the discrepancy between the annual growth rate of the nominal and real GNP. The table shows clearly that nominal GNP presents an inflated measure of India’s GNP.  Table 3.1 Nominal and Real GNP of India at Factor Cost : 2001–02 to 2013–14 (Real GNP and GDP at 2004–05 Prices) Note: Nominal GNP and GDP are estimated at current price; Real GNP and GDP estimated at constant price of 2004–05; (1R) = First Revision; (2R) = Second Revision; (PE) = Provision Estimate. Source: Economic Survey – 2013–14: Statistical Appendix, Table 1.1, Table 1.3A and Table 1.4. In order to avoid this kind of misleading estimates of national income, GNP is also estimated at constant prices for a chosen base year. The GNP estimated at constant prices of the base year is called real GNP: it gives national income estimates free from distortion caused by inflation or deflation. However, estimating GNP at the prices of the base year is not an easy task. The economists use a simple adjustment factor called GNP Deflator or National Income Deflator to eliminate the effect of rising prices on the GNP and to work out real GNP at the base year prices. Let us now see how ‘GNP deflator’ is worked out and applied to estimate the real GNP. 3.3.1 GNP Deflator and its Application The GNP deflator is essentially an adjustment factor used to convert nominal GNP into real GNP. The GNP deflator is the ratio of price index number (PIN) of a chosen year to the price index number (PIN) of the base year5. The PIN of the base year = 100. The chosen year is the year whose real GNP is to be estimated. The method of working out GNP deflator is given below. The formula for converting nominal GNP of a year into real GNP may be written as follows: where, PINcy is the price index number of the chosen year For application of GNP deflator concept, let us consider an example. Suppose nominal GNP of a country, i.e., GNP estimated at current prices, in year 2012 is given at 500 billion and Price Index Number (PIN) is given as base year 2012 = 100. Now let the nominal GNP increase to 600 billion in year 2017 and PIN rises to 110. Given this data, GNP deflator for the country can be obtained as shown below. GNP Deflator = = 1.10 Given the GNP Deflator at 1.10, the Real GNP for the year 2017 can be worked out as follows: Real GNP (2017) = = 545.45 billion Note that nominal GNP increases from 500 billion to 600 billion, i.e., by 20 per cent over a period of five years or at an annual average rate of 4 per cent. Since PIN increases from 100 to 110, i.e., by 10 per cent over a period of five years, real GNP increases at a lower rate, i.e., at 9.1 per cent [= (545.45 – 500) 100/500] or at an annual average rate of 1.8 per cent. 3.3.2 GNP Implicit Deflator Another variant of GNP deflator is GNP implicit deflator, also called implicit price deflator. It is the ratio of nominal GNP to real GNP, i.e., GNP Implicit Deflator = The GNP implicit deflator can be used for the following purposes. 1. To construct price index number 2. To measure the rate of change in prices, i.e., to measure the rate of inflation or deflation For instance, in our example, the nominal GNP in year 2012 is 500 billion and the real GNP is 545.45 billion. In that case, GNP Implicit Deflator = = 1.10 3.3.3 GNP Implicit Deflator and Price Index Number The GNP Implicit Deflator multiplied by 100 give the Price Index Number (PIN) for the year 2012. That is, Thus, 110 is the price index number for the year 2012. The same procedure can be adopted to calculate PIN for other years. Once PINs for different years are calculated, the same can be used to calculate the rate of change in price, i.e., the rate of inflation or deflation. For example, the rate of inflation between the year 2012 and 2017 can be worked out as follows: This means that inflation over a period of five years was 10 per cent or at an annual average rate of 2 per cent. 3.4 METHODS OF MEASURING NATIONAL INCOME Given the important uses of national income estimates, estimating national income is an indispensable task of the government. However, estimating national income is an extremely complicated and gigantic task. The reason is that the process of income generation in a modern economy is extremely complex and, therefore, collecting necessary data on the different sources and levels of income is beset with conceptual and data availability problems. The economists have, however, devised different methods of estimating national income. The basic approach in measuring national income is to measure the two kinds of flows generated by the economic activities of the residents of the country. As we know from the circular flows of income, the income generating process creates two kinds of flows: 1. Product flows 2. Money flows The money flows can be looked upon from two angles. 1. Money flows as factor payments 2. Money flows as payments for goods and services Given the product flows and two ways of money flows, the economists have devised three methods of measuring national income. 1. Net Product Method or the Value Added Method 2. Factor Income Method 3. Expenditure Method Any of the three methods can be adopted to measure Gross Domestic Product (GDP) of a country provided required data is fully available. In case a single method cannot be adopted due to nonavailability of the required data, or due to conceptual problems as to what should be and what should not be included in national income accounting, a combination of the three methods is used to measure GDP. All these methods are, in fact, used to measure the gross domestic product (GDP). The estimated GDP is then adjusted for net income from abroad to estimate GNP. The three methods of measuring GDP based on three approaches are briefly described here. The treatment of net income from abroad is discussed in the following section. The three methods of estimating GDP are described here briefly. 3.4.1 Net Product Method—The Value Added Method The net product method, also called the value added method, consists of three stages: “(i) estimating the gross value of domestic output in the various branches of production; (ii) determining the cost of material and services used and also the depreciation of physical assets; and (iii) deducting these costs and depreciation from gross value to obtain the net value of domestic output...”6 The formula for measuring value of net product may be expressed as follows: Net product value = Gross value of Domestic Product less cost of Production less Depreciation The methods of estimating gross value and its cost of production and also the method of measuring net product are described here briefly. Measuring Gross Value For measuring the gross value of domestic products, the output of different industries are classified under various categories. The classification of products varies from country to country depending on (i) the nature of domestic industries, (ii) their significance in aggregate economic activities, and (iii) the availability of requisite data. For example, in the US, seventy- one divisions and sub-divisions were sometime ago used to classify the national output; in Netherlands the classification ranges from a dozen to a score; and only half-a-dozen classifications were used in Russia. According to the Central Statistical Organisation (CSO) publications, twenty-one sub- categories of products are currently used in India. After classifying the output in appropriate categories, the gross value of output of each category is computed by any of the following two alternative methods: Method 1 By multiplying the output of each category or sector by their respective market prices and adding them together Method 2 By collecting the data on gross sales and inventories from the records of the companies and adding them up If there are gaps in the data, necessary adjustments in estimates are made. Estimating Cost of Production The next step in estimating the net national product is to estimate the intermediate cost of production including depreciation. Estimating the cost of production is often a complicated task because of non-availability of necessary cost data. Much more difficult is the task of estimating depreciation as it involves both conceptual and statistical problems. For this reason, many countries adopt factor income method for estimating their national income. However, countries adopting net product method find some ways and means to compute the deductible costs. The costs are computed either in absolute terms (where input data are adequately available) or as an overall input-output ratio. For estimating depreciation, the general practice is to adopt the practice followed by the business firms in general. Conventionally, however, depreciation is estimated at some percentage of original cost of capital, permissible under the taxation laws. In some countries, it is estimated at some percentage of total output rather than as percentage of cost of capital. Measuring Net Product Once intermediate cost and depreciation are estimated by a suitable method, these costs are deducted from the estimated sectoral gross output to arrive at net sectoral product, i.e., sectoral NNP. The NNP of different sectors of the economy are then added together to arrive at the aggregate NNP. Value Added Method The product method, described above, can be understood better through the value added method of estimating national income. In the net product method, a serious problem is often confronted, i.e., the problem of double counting of the same product. Value added method is used to avoid double counting, i.e., counting the value of a commodity more than once. To understand the problem of double counting, recall the definition of national income (GDP). National income is defined as the money value of all final goods and services produced in a given period of time. The problem of double counting arises because of the conceptual and practical problem in determining whether a product is final or intermediate. This problem arises because in the process of production, some material products pass from one stage to another. But, at each stage of production, it is transformed into a final product. However, the same final product is used as material input at the next stage in the production process of another commodity. Therefore, the value of the same product is likely to be counted twice, or more than twice, in estimating national income. For example, wheat is the final product for the farmer, Kisanchand. But wheat is an input (raw material) for a flour mill, say, Shaktibhog Atta. Wheat flour is the final product for Shaktibhog Atta company. But wheat flour is used by the bread manufacturer, Britannia Bread Company, as raw material. For Britannia, bread is the final product. But bread is an input for sandwich-maker, the Tastyfood Restaurant. Now, if all these products—wheat, wheat flour, bread and sandwich—are treated as final products, then the value of wheat is counted at four stages—wheat production, flour production, bread production and sandwich production. This is called double counting in national accounting jargon. Double counting results in overestimation of national income. Therefore, in order to avoid the problem of double counting, a method called value added method is used to estimate the national income. The method of calculating value added to a product (wheat flour) can be illustrated as shown in Table 3.2. Suppose Shaktibhog Flour Mill buys one quintal wheat for 1000 and sells the flour to bread manufacturing company, Britannia, at 1500. This means that Shaktibhog has added a value of 500 to the wheat. Let us suppose that value addition includes the cost components as given below. Table 3.2 Value Addition by Flour Mill (per quintal)  For the purpose of estimating national income, the valuation process related to the final product, sandwich, is illustrated in Table 3.3. Table 3.3 Method of Measuring Value Added As the table shows, the gross value added in case of sandwich production is estimated at 2500 per quintal. This per quintal value multiplied by total production of sandwiches gives the total value of the final product, the sandwiches. This method avoids counting value of wheat, a material input, more than once. The same method of value added is followed for each enterprise producing goods and services within the territory of a country. For the purpose of estimating value added, the following steps are generally followed: 1. Identifying the production units and classifying them under different industrial activities  2. Estimating net value added by each production unit in each industrial sector 3. Adding up the total value added of each final product to arrive at GDP 3.4.2 Factor Income Method The factor income method is also known as factor share method. In this method, the national income is treated to be equal to all the “incomes accruing to the basic factors of production used in producing the national products.” The factors of production are traditionally categorised as land, labour, capital and entrepreneurship. Accordingly, the national income is treated as the sum of factor payments, viz., rent, wages, interest, and profits, respectively, plus depreciation. Thus, National Income (GDP) = Rent + Wages + Interest + Profit + Depreciation In a modern economy, however, it is conceptually very difficult to distinguish between earnings from land and capital and between the earnings of ordinary labour and entrepreneurial efforts. For the purpose of estimating national income, therefore, factors of production are broadly grouped as labour and capital. Accordingly, the national income is supposed to originate from two primary factors—labour and capital. In some productive activities, however, labour and capital are jointly supplied by the same person and it is very difficult to separate the labour and capital income contents from the total earning of the supplier. Such incomes are, therefore, termed as mixed incomes. Thus, the national income is considered to be comprised of three components : (i) labour incomes, (ii) capital incomes, and (iii) mixed incomes. These factor incomes have some specific connotation as discussed below. Labour Incomes Labour incomes include: (i) wages and salaries (including commission, bonus and social security payments) paid to the residents of the country; (ii) supplementary labour incomes including employer’s contribution to social security and employee’s welfare funds and direct pension payments to retired employees7; and (iii) supplementary labour incomes paid in kind, for example, free-of-cost provision for health care, education, food, clothing, accommodation, and servant facility, called perks. Transfer payments like old age pensions, service grants, compensation to war-affected people, etc., are not included in labour incomes and labour incomes from incidental jobs, gratuities, tips, and so forth are ignored for lack of the data. Capital Incomes According to Studenski8, capital incomes include: (i) dividends excluding inter-corporate dividends, (ii) undistributed before-tax profits of corporations, (iii) interest on bonds, mortgages and saving deposits (but not on war bonds and consumer credits), (iv) interest earned by insurance companies and credited to the insurance policy reserves, (v) net interest paid out by commercial banks, (vi) net rents from land and building, including imputed net rents on the owner occupied dwellings, (vii) royalties, and (viii) profit of the government enterprises. The data for the first two items are obtained mostly from the books of accounts submitted by the corporations to the tax authorities for tax assessment purpose. Incidentally, the definition of profit used for national accounting purposes differs from one used by the tax authorities. Some adjustment in data, that is, some additions and some deductions, are made in the assessment of profits in regard to (i) the excessive allowance of depreciation, if any, made by the tax authorities, (ii) elimination of capital gains and losses because these items do not reflect the change in the current output; and (iii) elimination of under- or overvaluation of inventories on book values. Mixed Incomes Mixed incomes include earnings from: (i) farming enterprises, (ii) sole proprietorship (not included under profit and capital incomes), (iii) other professions, including legal and medical practices, consultancy services, trading and transportation, and (iv) mixed incomes of those who earn their living from various sources, including wages, rent on own property, interest on own capital and so forth. All the three kinds of incomes, viz., labour incomes, capital incomes, and mixed incomes, are added together to obtain the estimate of the national income by factor-income method. 3.4.3 Expenditure Method The expenditure method, also known as the final product method, measures national income at the final expenditure stage. In order to estimate the aggregate expenditure, any of the following two methods may be followed: Income Disposal Method Under this method, all the money expenditures at market prices are added up together to obtain the total final expenditure. Under the income disposal method, the items of expenditure that are taken into account are: Private consumption expenditure Direct tax payments Payments made to the non-profit institutions and charitable institutions like schools, hospitals, orphanage, etc. Private savings (or investments) Product Disposal Method Under this method, the value of the products finally disposed of are computed and added together. This gives a measure of the total final expenditure and, hence, a measure of the national income by expenditure method. Under the product disposal method, the following items of expenditure are included: Private consumer goods and services Private investment goods Public goods and services Net investment abroad  The product disposal methods is far more extensively used compared to the first method because the data required by the second method can be collected with greater ease and accuracy. 3.4.4 Treatment of Net Income from Abroad As mentioned above, the three methods of estimating national income give the measure of GDP of a closed economy. In reality, however, most modern economies are, ‘open economies’ in the sense that they have trade relations and other kinds of economic transactions with the rest of the world. In the process, some countries make net gains and some net losses. The net gains are, in fact, additions to the national income and net losses cause deduction from the national income. Therefore, in estimating the national income, net incomes from abroad are added to GDP and net losses are subtracted from GDP to arrive at the national income figure of an open economy. It is important to note here that GDP adjusted for net income from abroad is called Gross National Income (GNI). In practice, all the exports of merchandise and services like shipping, insurance, banking, tourism and gifts are added to the national income. All the imports of goods and services like shipping, insurance, banking, tourism and gifts are subtracted from the national income. The final outcome of these adjustment is a measure of the national income (GNP). 3.4.5 Double Entry System of Accounting Another method which is often used in national income accounting is double entry of book keeping system. National income accounting is a systematic recording of all economic transactions carried out by different sections of the society and the resulting output. Economic transactions involve at least two ‘transactors’: one who pays and the one who receives. Note that in the process of earning and spending, each person works as a payer as well as a receiver. A person receives money when he or she sells a product or service and he or she pays the money when he or she buys a product or service. So each person can be allocated an account containing two sides – credit and debit. What money a person receives, he or she is recorded on the ‘credit’ side and what he or she pays money is recorded on the ‘debit’ side of the account. Thus, a double entry accounting system is one in which both receipts and payments are recorded—receipts on credit side and payments on debit side of the account. Another aspect of the double entry accounting system is that the account of a person need not to be in balance. A person may spend less than what he or she receives. Then he or she has a saving. The savings are recorded on the debit side to balance the account. Under double accounting system, account of each person is always in balance, as it is done in double entry book-keeping system of business accounting. Similarly, if a person spends more than what he or she receives, he or she has a debit balance. His or her debit is recorded on the credit side as borrowings and his or her account is balanced. In overall accounting, the sum of savings is equal to the sum of borrowings. In double entry accounting system, many types of accounts can be imagined and operated. Accounts may be based on individual transactors or on the basis of sectoral transactions—consumption and investment. In national income accounting system, the main types of transactions and their accounting include the following: 1. Private consumption 2. Government consumption 3. Investment (savings converted into capital) 4. Government taxes and spending 5. Inventories 6. Net of foreign transactions (exports and imports) These sectoral transactions can be shown as the circular flows of incomes and can be converted into equations. For instance, refer to the circular flows of income in two-sector model in Ch. 2. From the two-sector model of circular flows of incomes, the following equations can be derived: Y=C+I=C+S where, Y = national income; C = consumption expenditure by households; I = capital spending by firms; and S = savings by households In the three-sector model, the national income equation is given as follows:  Y=C+I+G=C+S+T where, G = Government spending, and T = tax revenue of the government. In four-sector model of circular flows, the equation takes the following form: Y = C + I + G + (X – M) = C + S + T where, X = exports and M = imports We have described above the method of estimating national income used in India. Let us now look at India’s national income estimates and trends. 3.5 MEASUREMENT OF NATIONAL INCOME IN INDIA Before we discuss the method of measuring national income in India, let us have a glance at the history of measurement of national income in the country. 3.5.1 History of National Income Measurement in India The history of measurement of national income in India can be divided under two phases: (i) pre-Independence phase, and (ii) post-Independence phase. In the pre-independence phase, the first attempt ever to measure national income of India was made by Dadabhai Naoroji9 in 1867–68. Subsequently, several attempts were made by the economists and government officials to estimate India’s national income10. Most of these estimates had their own methodological and data limitations and, therefore, had doubtful reliability. The first systematic attempt to estimate India’s national income was made by Prof. V.K.R.V. Rao for the year 1925–29 and again for the year 1931–32. The estimate of national income made by Prof. Rao is considered to be superior in many respects. By 1949, some other agencies had also estimated India’s national income. But all these estimates had serious limitations.  In the post-Independence phase, the first official estimate of India’s national income was made in 1949 by the Ministry of Commerce, Government of India. For the purpose of devising a comprehensive method of data generation and measuring national income, a National Income Commission (NIC) was set up in 1949 with P.C. Mahalnobis as the Chairman, and D. R. Gadgil and V.K.R.V. Rao as its members. The NIC made the first official estimate of the national income for the year 1948–49, and then again for the year 1951–52. The methodology developed by the NIC was followed until 1967. Since 1967, however, the task of estimating national income has been assigned to the Central Statistical Organisation (CSO). The CSO had adopted NIC’s methodology until 1967. Thereafter, CSO devised an improved methodology and procedure for estimating national income as there was a greater availability of comprehensive data. The methodology developed and used by the CSO, which is still followed, is described below. 3.5.2 Methodology For systematic and reliable accounting of the national income, it is essential to classify different types of economic activities and sources of income as they provide conceptual clarity and comprehensiveness in national income estimation. Therefore, the sources and types of national income are classified under different categories. The purpose of classifying different sources and types of economic activities under different sectors is to make national income accounting systematic and analysis of national income data easy and comprehensive. The different sources of income are generally called ‘sectors’ of the economy. This method is called sectoral accounting of national income. For sectoral classification of economic activities, the activity performers of different sectors are classified on the basis of (i) the nature of the economic activity, also called functional classification, and (ii) the use of the national income. The basis of classification is chosen in accordance with the purpose and method chosen for estimating national income. In mixed economies, an economy is often classified as (i) private sector, and (ii) public sector. Sectoral Classification of Economy For the purpose of estimating national income, the CSO uses the following sectoral classification of the economy: 1. Primary sector, including agriculture and allied activities, forestry, fishing, mining and quarrying 2. Secondary sector, including manufacturing industries 3. Tertiary sector or service sector, including banking, insurance, transport and communication, trade and commerce Depending on the purpose and data availability, these broad sectors of the economy are sub-classified under their sub-categories. For the purpose of estimating national income, the broad sectors are further divided under sub- sectors as given below. 1. Primary sector (a) Agriculture (b) Forestry and logging (c) Fishing (d) Mining and quarrying 2. Secondary sector (a) Manufacturing (b) Registered manufacturing (c) Unregistered manufacturing (d) Construction (e) Electricity, water and gas supply 3. Tertiary sector (a) Transport, Trade and Communication Transport, storage and communication Railways Other means of transport Communication Trade, hotels and restaurants  (b) Finance and Real Estate Banking and insurance Real estate for residential and business purposes (c) Community and Personal Services Public administration and defence Other services Methods of Measuring National Income It may be noted at the outset that, given the nature of the Indian economy and the paucity of reliable data, it is not possible to use any single method, or to estimate the national income by using each method separately. For example, income method cannot be used for the agricultural sector because of unavailability of reliable data, and income of household enterprises cannot be estimated by the expenditure method. Therefore, a combination of different methods, especially of value added method and income method, is used for estimating national income in India. Given the sectoral and sub-sectoral classification of the economy, let us now look at the methods adopted by the CSO for estimating income of the different sectors. Production method, which is also called net output method or value added method, is used to estimate income or domestic product of the following production sectors: 1. Agricultural and allied services 2. Forestry and logging 3. Fishing 4. Mining and Quarrying 5. Registered manufacturing Income method is used for estimating domestic income of the following sectors: 1. Unregistered manufacturing 2. Gas, electricity and water supply 3. Banking and insurance  4. Transportation, communication and storage 5. Real estate, ownership of dwellings and business services 6. Trade, hotels and restaurants 7. Public administration and defence 8. Other services For the sake of comparison of estimates and to check their reliability, CSO estimates national income also on the basis expenditure method. Under the expenditure method of estimating national income, sectoral division of the economy is based on the use pattern of the national income. In India, the sectoral accounting of GDP, based on the expenditure method, follows the following classification of the national income: 1. Private final consumption expenditure including expenditure on (i) durable goods, (ii) semi-durable goods, (iii) non-durable goods, and (iv) services 2. Government final consumption expenditure 3. Gross fixed capital formation including construction, machinery and equipment 4. Change in stocks 5. Net export of goods and services What kind of sectoral division of economic activities is made depends on the uses of income and the method chosen for the purpose of estimating the national income. Often all the three methods are chosen for the sake of completeness and comparison. Incidentally, a combination of expenditure method and commodity-flow approach is adopted for estimating income generated in the construction sector. Methods of Measuring National Income Aggregates Estimating national income – more appropriately gross national product (GNP) – is not the end of the story. Once GNP of the country is estimated, it provides the basis of measuring other national income aggregates. The process of generating macroeconomic aggregates other than GNP is shown below in Table 3.4.  Table 3.4 National Products and Related Aggregates 3.5.3 Estimates of India’s National Income Having described the method of measuring national income used in India, we present in this section the actual estimates of some major aspects of India’s national income and its growth rate. The national income estimates are presented here in terms of absolute numbers and growth rates. Let us first look at the estimates of national income in absolute numbers. Table 3.5 presents estimates of India’s GNP, NNP and per capita income, all at factor cost at current and constant prices of 2004–05. National figures are shown first for Plan-end years until 2000 and in annual years in later period. As Table 3.5 shows, GNP, NNP and per capita income in India have been increasing almost continuously over 66 years from 1950–51 to 2016– 17, as estimated at current and constant prices of 2004–05. In fact, national income of India increased at a higher rate, and almost continuously, after economic liberalisation in 1990–91. However, the income growth accelerated over the past decade. National income data given in Table 3.5 gives a long-term view of trends in India’s GNP, NNP and per capital income. 3.5.4 Growth Rates A better view of the performance of the economy can be had by looking at the plan-wise annual average growth rate of GNP, NNP and per capita NNP. The plan-wise annual average growth rate of GNP, NNP and per capita NNP are given in Table 3.6 at both current and constant prices. Certain important conclusions can be drawn from the data given in Table 3.6. First, as the table shows, India’s GNP, NNP and per capita NNP have registered positive growth rates – low and high – throughout the Plan period, except in 1979–80 when GNP registered a negative growth rate of 5.0 per cent, NNP a negative growth rate of 6.0 per cent and per capita NNP a negative growth of 8.2 per cent. Table 3.5 Estimates of India’s GNP, NNP and Per Capita Income at Factor Cost Source: Economic Survey - 2013–14: Statistical Appendix (GOI, MOF), Table 1.1 * Economic survey – 2016–17: Statistical Appendix, Table 1.1. (P) Provisional Second, the growth rate of India’s national income was the lowest (2.8 per cent) during the Third Plan period (1961–66) and growth rate was the highest in the Eleventh Plan period (2007–12). During the period of the Eleventh Plan, per capita income at constant prices of 2004–05 prices had increased at 6.3 per cent during the plan period.  Table 3.6 Plan-wise Average Percentage Growth Rate of GNP, NNP and Per Capita NNP (All at factor cost) Source: Economic Survey – 2013–14: Statistical Appendix, GOI, MOF, Table 1.2. Third, a comparison of the income growth rates at current and constant prices shows that GNP, NNP and per capita NNP at current prices have grown at a much higher rate than at constant prices. It means that the Indian economy has been constantly under the pressure of inflation—sometimes low and sometimes high. 3.5.5 Recent Growth in India’s National Income It is useful to have a look at the growth in India’s national income in the recent past. This gives an idea of the future growth in Indian economy. The growth rates of India’s GNP, NNP and per capita NNP are given in Table 3.7. As can be seen in Table 3.7, the growth rate of India’s real GNP has almost continuously increased over the last eight years from 3.8 per cent per annum in 2000–01 to 8.4 per cent in 2010–11 (based on quick estimates). A similar trend can be observed in case of NNP growth rate. More significantly, per capita real income too has increased almost continuously the though the rates have been varying. However, over the period from 2003–04 to 2010–11, the growth rate of real per capita income has registered an unprecedented increase at about 7 percent. Table 3.7 Annual Growth Rate of India’s GNP, NNP and Per Capita NNP at Factor Cost: 2000–01 to 2010–11 Source: Economic Survey – 2016–17: Statistical Appendix, GOI, MOF, Table 1.2. (PE) - Provision Estimate *Data at 2011–12 prices 3.6 TRENDS IN SOME OTHER MACRO VARIABLES IN INDIA In the preceding section, we have presented the estimates of GNP, NNP and per capita NNP over a period of six decades just to show the trends in India’s national income. In this section, we show the estimates and trends in some other macroeconomic variables in India. The main macro variables discussed here are: 1. Aggregate consumption expenditure 2. Gross domestic savings 3. Gross domestic capital formation, i.e., investment 4. Price index number 3.6.1 Aggregate Consumption Expenditure The aggregate consumption refers to the aggregate expenditure made by the citizens of a country on consumer goods and services during a period of time. In national income accounting, the national income is accounted in terms of its various aggregate components. The components of national income (GDP), looked at from demand side, are specified as Consumption Investment Savings Government expenditure Exports Imports Of these components, aggregate consumption accounts for the largest proportion of the national income. As shown in Table 3.8, in India, the aggregate consumption11 is accounted for 76.3 per cent of GDP in 2000– 01, though it has declined in the subsequent years. The gross domestic consumption accounted for 66.3 per cent in 2010–11. Though, according to 2011–12 series of data, it had increased to 67.3 per cent in 2015–16. This implies that aggregate consumption accounts for two-thirds of the GDP in India. So is the case in most developed countries, e.g., about two-thirds of GDP is currently consumed in the United States12. The last column of Table 3.8 shows the percentage of gross household consumption to GDP. As the estimated figures of gross domestic consumption show, the aggregate consumption has been increasing continuously over time. However, the percentage of gross domestic consumption to GDP has been almost continuously declined over time. This is a general trend in a growing economy. Table 3.8 GDP, Aggregate Savings and Consumption in India: 2000–01 to 2016–17 (At Current Prices) * Estimated as Gross Domestic Consumption = Gross Domestic Product – Gross Domestic Savings; @ % of estimated GDC to GDP. Source: Economic Survey—2013–14, GOI, Statistical App., Table 1.5 and Economic Survey - 2016– 17, Table 1.9. 3.6.2 Gross Domestic Savings Gross domestic savings (GDS) refer to the aggregate of savings made by all the citizens of the country during a period of time. In national income accounting, gross domestic saving (GDS) is estimated as national income (GDP) less aggregate consumption (C) less all the taxes (T). In India, however, it is other way round. The gross domestic savings constitute the second most important component of the national income (GDP). In fact, the level of aggregate savings in a country depends on the level of its GDP – the higher the level of GDP, the higher the level of savings. Also, the level of aggregate savings determines the level of investment in the country and, thereby, the growth rate of the economy. The estimates of gross domestic savings in India over the past one and a half decade are given in Table 3.8. Let us look at the trends in the rate of gross domestic savings in India and its components. The gross domestic saving is estimated in India by adding together the savings made by three sectors: (i) the household sector, (ii) the private corporate sector, and (iii) the public sector. Table 3.9 presents annual trend in the gross domestic savings during the period from 2000–01 to 2015–16. Table 3.9 Percentage of Gross Domestic Savings to GDP in India 2000–01 to 2016–17 (Percentage to GDP at current prices) Source: Economic Survey—2013–14, GOI, MOF, Statistical Appendix, Table 1.6, and Economic Survey 2016–17, Statistical Appendix, Table 1.9. Gross domestic saving (GDS) has increased almost continuously over the past 60 years from 8.6 per cent in 1950–51 to about 33 per cent in 2015–16. Table 3.9 presents the annual percentage of saving to GDP for the period from 2000–01 to 2015–16. As the Table 3.9 shows, the major part of GDS has come from the household sector. For example, about 20 per cent out of about 33 per cent of GDS had come from the domestic sector, and the private corporate sector accounted for about 12 per cent. 3.6.3 Gross Domestic Capital Formation We have discussed above the meaning of gross domestic consumption and gross domestic savings in their trend in recent times in India. In this section, we describe the meaning of gross domestic capital formation and the trend in capital formation in India in the recent years. The gross domestic capital formation refers the part of national income spent on capital formation, i.e., creating the productive stock of capital in the country. Conceptually, gross domestic capital formation is the capital formation gross of depreciation, i.e., gross capital formation includes the depreciation of capital.  The rate of capital formation is the most important determinant of the rate of economic growth. It is an empirical fact that the higher the rate of capital formation, the higher the rate of economic growth, except under abnormal economic and political conditions of a country. For instance, in spite of a high rate of domestic capital formation, the growth rate of the erstwhile Soviet economy declined sharply and the country suffered severe recession in same years in the late 1980s due to domestic turmoil leading to disintegration of the country in 1990. During 2008–12, the US economy faced a recession mainly due to ‘sub-prime crisis’ – a problem of financial nature in the banking sector, though the rate of capital formation remained fairly high – over 20 per cent of GDP. We describe below in detail the rate of gross domestic capital formation in India. India, being a mixed economy, gross capital formation is the sum of capital formation made by (i) the private sector, and (ii) the public sector. Table 3.10 presents the data on gross capital formation in India in both the private and the public sectors, in terms of percentage to GDP – for the period from 2000–01 to 2015–16. As Table 3.10 shows, the gross capital formation in India has been increasing almost constantly since 1980–81. Although the Table 3.10 presents figures only since 2000–01, the capital formation has been increasing since Independence of the country. It may be noted here that, as shown in the table, the growth rate of gross domestic capital formation had declined in 2000–01 and 2001–02. The lower rate of growth in gross capital formation was mainly due to slowdown in the GDP growth rate. The rate of capital formation as percentage of GDP has decreased during the past three years. Table 3.10 Percentage of Gross Domestic Capital Formation to GDP  * Adjusted total figures do not match because of adjustment for errors and omissions. Source: Economic Survey: 2013–14, Statistical Appendix, Table 1.6, pp. 11–12, and Economic survey – 2016–17, Statistical Appendix, Table 1.9. 3.6.4 General Price Level The general price level of a country is a very important macroeconomic variable. A stable general price level or even a moderate increase in the general price level is treated to be a very healthy sign for the economy as a whole. It promotes economic activities, employment and economic welfare of the society. This becomes a main factor in maintaining a peaceful, social and political environment of the country. Therefore, maintaining a stable general price level with a moderate rise is considered to be a highly desirable policy objective. Therefore, a high fluctuation in the general price is highly undesirable for the economy. In fact, a high rate of persistent inflation or deflation proves destructive for the economy. Therefore, it becomes the responsibility of the government to find ways and means to maintain the general price level at socially and economically acceptable level. Otherwise, it would create social, economic and also political problems for the government. For example, in May–June 2008 the general level of price in India had increased by 8.25 per cent, which was the highest rate of inflation in eight years. This had become a big problem for the Government of India, the Ministry of Finance and the RBI. These kinds of problems keep arising in different countries at different times. Therefore, it becomes the responsibility of the government to keep an eye on the behaviour of the general price level so that necessary action can be taken whenever necessary. However, knowing the general price level by one indicator is a highly complex problem. The complexity in finding an indicator of the general price level arises out of the complexity of the price system. People of a country buy and sell thousands of goods and services. Each commodity has a price. Prices differ from commodity to commodity. The difference between commodity-prices is in some cases very small, but very large in some cases, e.g., a pin has a price of five paise and a plane has a price more than 50 crore. Besides, the price variations differ from one commodity to another. While prices of some goods decrease, the prices of some goods increase and that of some others remain constant. Not only that. The rate of increase and decrease also varies from commodity to commodity. While prices of some goods increase at a low rate, prices of some other goods increase at a high rate and that of some goods at a very high rate. Similar is the case with decrease in prices. In order to resolve the complexity in understanding the behaviour of the price level, the statisticians have devised a technique called price indexing technique. Through this technique, an indicator of the general price level is generated, which is known as Price Index Number (PIN). There are two kinds of prices in the market: (i) price paid by the wholesalers, and (ii) price paid by the final consumers or users of the product. The price paid by the wholesalers is called the ‘wholesale price’ and the price paid by the final users is called the ‘retail price’ or the ‘consumer price’. Accordingly, two kinds of price index numbers are constructed in most countries with, of course, two different purposes, viz., (i) Wholesale Price Index Number (WPI) (ii) Consumer Price Number (CPI). For the sake of example, we discuss here only the meaning and the purpose of the Wholesale Price Index Number (WPI). Wholesale Price Index (WPI) The wholesale price index is constructed on the basis of the wholesale prices. The wholesale prices are the prices paid by the wholesale dealers to the producers of a product. The wholesale dealers are those who buy a product in bulk from the producers to sell it forward to the retailers. The wholesale price forms the basis of pricing the product for the consumers of the product. The task of collecting data on prices and construction of price index is performed by the Central Statistical Organisations (CSO) in India. For the purpose of constructing the wholesale price index (WPI), also the consumer price index (CPI), first a base year is chosen. The criteria for choosing the base year are (i) it should be a ‘normal production year’, (ii) prices in the year should neither be abnormally high nor low, and (iii) the year should not precede or succeed by a high-price or low-price year. Once the base year is chosen, the weighted average of all the wholesale prices is treated to be 100. Similarly, the wholesale price of the succeeding years are calculated and indexed accordingly. The basic purpose of constructing the wholesale price index (WPI) is to know the trend in the general price level. A rising trend in WPI shows inflationary trend and the declining WPI shows a deflationary trend in the general prices. The rate of inflation or deflation is calculated by the change in the WPI in the current and the succeeding year. The trend in the WPI (Base Year 1993–94 =100) over the period from 1994–95 to 2003–04 is shown in Table 3.11. As can be seen from this table, the WPI has been rising continuously since 1993–94. The table shows also the annual rate of inflation in India. Table 3.11 Wholesale Price Index: 1993–94 to 2006–07 (1993–94 = 100: Average of Weeks)  Source: Economic Survey: 2003–04, 2006–07 and 2007–08 Since base year of PIN is changed after every 5–6 years, the rate of inflation goes on changing. That is why inflation data for long period is not produced here. According to the Economic Survey 2013–14, the annual rate of inflation was 8.94 per cent in 2011–12, 7.35 per cent in 2012–13 and 5.98 per cent in 2013–14. Abraham, W. I., National Income and Economic Accounting (NJ, Prentice-Hall, 1969) Beckerman, W., An Introduction to National Income Analysis (London, English Language Book Society, 1968), Ch 2 Eady, H.C., Peacock, A. T. and Ronald, A. C., National Income and Social Accounting (London, Hutchinson University Library, 1967) Ruggles, R. and Ruggles, N., National Income Accounts and Income Analysis (NY, McGraw-Hill, 1956), Chs. 1, 2 and 12 Studensky, P., The Income of Nations, Part II, Theory and Methodology (Delhi, Khosla & Co.), Chs. 11 and 17–20 1. Distinguish between economic and non-economic production in national income accounting. Why is non-economic production  excluded from national income estimates? 2. Distinguish between: (a) GNP and GDP (b) NNP and NDP (c) Nominal GNP and Real GNP 3. Explain the difference between the final products and intermediates. How does the inclusion of intermediate products affect the measure of national income? 4. What are the methods of measuring national income? What conceptual problems are confronted in estimating national income? 5. What is meant by double counting? How does it affect the measure of GNP? What is the method used to avoid double counting? 6. Explain the concept of value added and the value added method of measuring GNP. 7. Suppose wheat costs ` 10 per kg, wheat-flour costs ` 12 per kg, and the price of bread is ` 8 per 500 grams. Find the value added at different stages of bread production. 8. Suppose A sells a product to B at ` 100 and B sells it to C at ` 150. Finally, C sells the product to D, the final consumer. What is the total value added? 9. How does the GNP estimate of a closed economy differ from that of an open economy? How is net income from abroad treated in GNP and GDP? 10. Distinguish between net product and factor-income methods of measuring national income. Why do the two methods yield the same measure? 11. State in case of each of the following items whether they are included in GNP, NNP or personal income. (a) Depreciation (b) Old age pensions (c) Unemployment allowance (d) Social security payments (e) Excise revenue (f) State sales tax revenue (g) Salary of the government officials (h) Unsold stock of the finished goods (i) Capital gains 12. What is meant by GNP deflator? What purpose does it serve in national income analysis? 13. From the following data, compute (a) real GNP, (b) GNP deflator, and (c) implicit GNP deflator, and (d) rate of inflation.  14. Explain factor income method of estimating national income. How is this method different from expenditure method? 15. What are the methods of estimating national income in India? Name the sectors which are used in estimating national income in India? 16. What is double accounting system of accounting? What are the accounts used in national income accounting? 17. Write a note on the sectoral and sub-sectoral division of economy for estimation of national income in India. 18. From the data given below, calculate (a) GDP at market price, (b) GDP at factor cost, and GNP. ---------------- 1. In his book National Income and Its Composition (New York: National Bureau of Economic Research, 1941), for which he was awarded Nobel Prize. This book is treated to be a path-breaking work on measurement of national income. 2. Wilfred Beckerman, An Introduction to National Income Analysis (Universal Book Stall, New Delhi, 1993), pp. 7-8. 3. Wilfred Beckerman, op. cit., p. 8. 4. It is the GNP, not the GDP, which is available to the people of a country for consumption and investment. Therefore, our discussion on ‘nominal’ and ‘real’ income concepts is based on GNP. However, the analyses carried out in this section apply to GDP also. 5. Alternatively, the GNP deflator can be expressed as the ratio of PIN (Base year) to PIN of the chosen year. The GNP deflator so obtained  multiplied by GNP of the current year gives the real GNP. That is, 6. Paul Studenski, The Income of Nations–Part Two: Theory and Methods (New York: New York University Press, 1958). 7. Conventionally, pension to the retired employees is considered to be a ‘transfer payment’ and is excluded from labour income and the national income accounting. In the US, however, this item is included in national income. For details, see Studenski, op. cit., pp. 11 and 118–20. 8. Paul Studenski, op. cit., pp. 118–20. 9. In his book Poverty and Un-British Rule in India published in 1867–68. 10. Some widely referred names include Atkinson (1875 and 1895), Major Baring (1881), Digby, W. (1898–99), C. N. Vakil and S.K. Majumdar (1891–94 and 1911–14), Curzon (1901), Home, E. A. (1911), K. T. Shah and K.J. Khambata (1900–1914 and 1921–22), Findlay Shirras (1911 and 1921), V. K. R.V. Rao (1925–29) and Commerce Journal (1938–39, 1942–43 and 1947–48). 11. The data on aggregate consumption in India is not readily available. Table 3.8 presents data on gross household consumption estimated by deducting gross domestic savings from GDP. 12. N. Gregory Mankiw, Macroeconomics (NY, Worth Publishers, 2004), p. 54.