Macroeconomic Identities


Gross Domestic Product measures the aggregate production of final goods and services taking place within the domestic economy during a year. But the whole of it may not accrue to the citizens of the country. For example, a citizen of India working in Saudi Arabia may be earning her wage and it will be included in the Saudi Arabian GDP. But legally speaking, she is an Indian. Is there a way to take into account the earnings made by Indians abroad or by the factors of production owned by Indians? When we try to do this, in order to maintain symmetry, we must deduct the earnings of the foreigners who are working within our domestic economy, or the payments to the factors of production owned by the foreigners. For example, the profits earned by the Korean-owned Hyundai car factory will have to be subtracted from the GDP of India.

The macroeconomic variable which takes into account such addition and subtraction is known as Gross National Product (GNP). It is, therefore, defined as follows

GNP ≡ GDP + Factor income earned by the domestic factors of production employed in the rest of the world Factor income earned by the factors of production of the rest of the world employed in the domestic economy

Hence, GNP ≡ GDP + Net factor income from abroad
(Net factor income from abroad = Factor income earned by the domestic factors of production employed in the rest of the world Factor income earned by the factors of production of the rest of the world employed in the domestic economy).

A part of the capital gets consumed during the year due to wear and tear. This wear and tear is called depreciation. Naturally, depreciation does not become part of anybody’s income. If we deduct depreciation from GNP the measure of aggregate income that we obtain is called Net National Product (NNP).

Thus, NNP ≡ GNP – Depreciation.

Note : All these variables are evaluated at market prices.

  • Through the expression given above, we get the value of NNP evaluated at market prices. But market price includes indirect taxes. When indirect taxes are imposed on goods and services, their prices go up. Indirect taxes accrue to the government. We have to deduct them from NNP evaluated at market prices in order to calculate that part of NNP which actually accrues to the factors of production.
  • Similarly, there may be subsidies granted by the government on the prices of some commodities (in India petrol is heavily taxed by the government, whereas cooking gas is subsidised). So we need to add subsidies to the NNP evaluated at market prices.
  • The measure that we obtain by doing so (deduct indirect taxed & add subsidies) is called Net National Product at factor cost or National Income.

Thus, NNP at factor cost
≡ National Income (NI)
≡ NNP at market prices ( Indirect taxes Subsidies )
≡ NNP at market prices Net indirect taxes

Net indirect taxes ≡ Indirect taxes – Subsidies

.

The part of NI which is received by households is called Personal Income (PI).

  • First, let us note that out of NI, which is earned by the firms and government enterprises, a part of profit is not distributed among the factors of production. This is called Undistributed Profits (UP). We have to deduct UP from NI to arrive at PI, since UP does not accrue to the households.
  • Similarly, Corporate Tax, which is imposed on the earnings made by the firms, will also have to be deducted from the NI, since it does not accrue to the households.
  • On the other hand, the households do receive interest payments from private firms or the government on past loans advanced by them. And households may have to pay interests to the firms and the government as well, in case they had borrowed money from either. So we have to deduct the net interests paid by the households to the firms and government.
  • The households receive transfer payments from government and firms (pensions, scholarship, prizes, for example) which have to be added to calculate the Personal Income of the households.

Thus, Personal income (PI) ≡ National Income (NI)
Undistributed profits
Net interest payments made by households
Corporate tax
+ Transfer payments to the households from the government and firms.

However, even PI is not the income over which the households have complete say. They have to pay taxes from PI. If we deduct the Personal Tax Payments (income tax, for example) and Non-tax Payments (such as fines) from PI, we obtain what is known as the Personal Disposable Income (PDI).

Thus Personal Disposable Income (PDI) ≡ PI – Personal tax payments – Non-tax payments.

Personal Disposable Income is the part of the aggregate income which belongs to the households. They may decide to consume a part of it, and save the rest.

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National Disposable Income and Private Income

Apart from these categories of aggregate macroeconomic variables, in India, a few other aggregate income categories are also used in National Income accounting

National Disposable Income = Net National Product at market prices
+ Other current transfers from the rest of the world

The idea behind National Disposable Income is that it gives an idea of what is the maximum amount of goods and services the domestic economy has at its disposal. Current transfers from the rest of the world include items such as gifts, aids, etc.

Private Income = Factor income from net domestic product accruing to the private sector
+ National debt interest
+ Net factor income from abroad
+ Current transfers from government
+ Other net transfers from the rest of the world

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Bibliography : NCERT – Introductory Macroeconomics

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