Syllabus section – Phase 2- RBI Grade B- Economic and Social Issues (ESI)- Measurement of growth: National Income and per capita income – This will be released in a series of posts. (read first post and second post) The level of the material is kept at basic minimum so that aspirants from non-eco/commerce field can also understand.
Methods of Calculating National Income:
There are 3 methods to calculate national income. The details are as follows:
Circular flow of income: Money flows from producers to workers as wages and flows back to producers as payment for products. In short, an economy is an endless circular flow of money. These factors are the components of a nation’s national income. This is the reason why the model is also referred to as the circular flow of income model.
1. Output method: It is also known as Product method. In this method, national income is calculated as the sum of monetary value of all final goods and services produced in an economy during a particular time period.
To avoid double counting, we only use the value of final goods. Value of intermediate goods is not used.
GDP at market prices = Sum of market prices of all final goods and services produced.
Mind Teaser: A baker uses flour worth Rs. 10 to produce bread. The bread is sold for Rs. 20 to final consumer? What is the value added by the baker?
- The Value added by the baker = Value of final good – value of intermediate good
- Value added = 20 – 10
- Value added = 10
2. Expenditure Method: National Income is calculated as the sum total of all private consumption expenditure, government consumption expenditure, net exports (exports – imports), investment expenditure (also called gross capital formation).
3. Income Method: In this method, national income is calculated as the sum of all factor incomes. Land, labour, capital and entrepreneur are the various factors of production. Labour gets wages and salaries, capital gets interest, land gets rent and entrepreneurship gets profit as their remuneration.
There are some self-employed persons who employ their own labour and capital such as doctors. Their income is called mixed income. The sum-total of all these factor incomes is called NDP at factor costs.
NDP at factor cost = Compensation of employees + Operating surplus + Mixed income
Operating surplus = Interest + Rent + Profit
Per Capita Income:
It refers to the national income of an economy divided by the population. Per Capita Income = National income / Population. Per capita income gives us a better picture of income disparity among people of different nations as compared to total income of an economy.
Purchasing Power Parity (PPP):
Purchasing power parity (PPP) is an economic theory that allows the comparison of the purchasing power of various world currencies to one another. It is a theoretical exchange rate that allows us to buy the same amount of goods and services in every country.
Government agencies use PPP to compare the output of countries that use different exchange rates.
Calculating PPP: S = P2 / P1
- S= Exchange rate of currency 1 to currency 2
- P1= Cost of good X in currency 1
- P2= Cost of good X in currency 2
Understanding PPP more:
Let us suppose there is only one product being manufactured in both India and Japan – Shirts.
- Now to buy a shirt in Japan we need 1 Yen. In India, with the same one Yen which is equal to Rs.65, we can buy 5 shirts.
- This means in India one shirt can be purchased with Rs.13 and in Japan one shirt can be purchased with 1 Yen.
- So, PPP exchange rate is Rs.13 / Yen.
Adjusting GDP for exchange rate using PPP helps us to judge the actual purchasing power of different currencies. This facilitates comparison between two countries.