National Income Accounting

The four factors of production are labour, capital, entrepreneurship and land. Their remunerations are called wages for labour, interest for capital, profit for entrepreneurship and rent for land.

In a simple economy, households supply factor services to firms and receive factor payments such as wages, rent, interest and profit. They then spend this income on the final goods and services produced by firms. So the money firms pay out as factor incomes comes back to firms as aggregate expenditure on their output.

Hence, in the circular flow of income, aggregate final expenditure = aggregate factor payments. Since the same flow of money is viewed from two sides, the value of final expenditure and the value of factor incomes must be equal. Therefore, aggregate income, aggregate expenditure and aggregate value of output are the same in equilibrium.

Flows are variables measured over a period of time. Stocks are variables measured at a particular point of time.

- Capital is a stock because the amount of capital a firm or economy has is measured at a point in time.
- Net investment is a flow because it is measured over a period, such as a year.

Comparison with water in a tank:
- The amount of water in the tank at a particular moment is a stock.
- The flow of water into the tank per minute is a flow.

Similarly, capital is like the water in the tank, while net investment is like the rate at which water enters the tank. Net investment adds to the stock of capital over time.

Inventories are the stock of unsold finished goods, semi-finished goods or raw materials carried from one year to the next.

- Planned inventory accumulation occurs when a firm deliberately decides to increase its inventories.
- Unplanned inventory accumulation occurs when sales turn out to be lower than expected, so unsold goods remain with the firm unexpectedly.
- Unplanned decumulation happens when sales are higher than expected and inventories fall unexpectedly.

The relation between change in inventories and value added is:

$$\text{Change in inventories} = \text{Production} - \text{Sales}$$

and since

$$\text{Production} = \text{Value added} + \text{Intermediate goods used}$$

we get

$$\text{Change in inventories} = \text{Value added} + \text{Intermediate goods used} - \text{Sales}.$$

The three identities for GDP are:

1. Product method
$$GDP \equiv \sum_{i=1}^N GVA_i$$

2. Expenditure method
$$GDP \equiv C + I + G + X - M$$

3. Income method
$$GDP \equiv W + P + In + R$$

These give the same GDP because they are just three ways of looking at the same circular flow of income in the economy:
- In the product method, we add the value added by all firms.
- In the expenditure method, we add all final expenditures on domestic output.
- In the income method, we add all factor incomes paid for producing that output.

Since the value of output produced, the spending on it, and the income generated from it are the same flow seen from different sides, all three methods must give the same GDP.

Budget deficit means the excess of government expenditure over its revenue.

Trade deficit means the excess of imports over exports, i.e. $M - X$.

From the national income identity:

$$S - I = (G - T) + (X - M)$$

where $S-I$ is the excess of private saving over private investment. The question gives excess of private investment over saving = Rs 2,000 crores, so

$$I - S = 2000 \Rightarrow S - I = -2000$$

Budget deficit is given as $( - )$ Rs 1,500 crores, so

$$G - T = -1500$$

Now,

$$S - I = (G - T) + (X - M)$$

Substitute:

$$-2000 = -1500 + (X - M)$$

$$X - M = -500$$

So,

$$M - X = 500$$

Thus the trade deficit is Rs 500 crores.