GDP and National Income: Concepts, Methods and Formulas

National income is the money value of all final goods and services produced by an economy in one year. Every question on growth, per capita income, recession or the share of agriculture and services rests on this one set of definitions, so the aggregates and the formulas that connect them are worth learning exactly. Read them once as a chain: from gross to net, from domestic to national, from market price to factor cost.

The four basic aggregates

Gross Domestic Product, or GDP, is the market value of all final goods and services produced within the domestic territory of a country in an accounting year, no matter whether the producer is a citizen or a foreigner. The word final matters: the value of intermediate goods is left out, because counting the wheat, the flour and the bread separately would count the same value three times. Gross National Product, or GNP, counts instead what the residents of a country produce, wherever they are, so it adds the income Indians earn abroad and subtracts the income foreigners earn in India. That difference is called net factor income from abroad.

Market price and factor cost

The same output can be valued in two ways. At market price it is valued at what the buyer pays, which includes indirect taxes and is reduced by subsidies. At factor cost it is valued at what the producers of the goods actually receive, that is the payments made to land, labour, capital and enterprise as rent, wages, interest and profit. The link between the two is short and often asked: factor cost equals market price minus indirect taxes plus subsidies. In India, since the national accounts series released in January 2015, gross value added at basic prices is published alongside GDP at market prices, and the headline growth rate that newspapers report is the growth of real GDP at market prices.

The three methods of measurement

All three methods must give the same answer, because one person's spending is another person's income.

• Product or value added method: add the value added by every producing unit, that is output minus intermediate consumption, across the primary, secondary and tertiary sectors. It avoids double counting.
• Income method: add the incomes earned by the factors of production, namely rent, wages and salaries, interest and profit, along with mixed income of the self-employed.
• Expenditure method: add all final spending in the economy. In symbols, GDP equals private consumption plus investment plus government spending plus exports minus imports.

Nominal GDP, real GDP and the deflator

Nominal GDP is measured at the prices of the year in question, so it rises when output rises and also when prices rise. Real GDP is measured at the prices of a fixed base year, so it changes only when the quantity of goods and services changes. This is why real GDP, and not nominal GDP, is used to measure growth. The ratio between the two, multiplied by a hundred, is the GDP deflator, a broad measure of inflation across the whole economy rather than over a fixed basket of consumer goods.

National income estimation in India

Dadabhai Naoroji made the first estimate of India's national income in the nineteenth century and used it in his work on the drain of wealth, famously putting the per capita income of India at twenty rupees a year. The first scientific estimate was made by V. K. R. V. Rao for the year 1931-32. After independence, the Government of India appointed the National Income Committee in 1949 with P. C. Mahalanobis as its chairman and D. R. Gadgil and V. K. R. V. Rao as members; its final report came in 1954. The work is now done by the National Statistical Office, formed by merging the Central Statistical Office and the National Sample Survey Office, under the Ministry of Statistics and Programme Implementation. The accounting year for these estimates is the Indian financial year, from 1 April to 31 March, and the base year of the series is revised from time to time.

What GDP does not tell you

A high GDP is not the same thing as a high standard of living. GDP leaves out unpaid work such as household labour, misses activity in the unorganised and black economy, says nothing about how the income is distributed between rich and poor, and does not subtract the cost of pollution or the exhaustion of natural resources, which is why measures such as green GDP and the Human Development Index are used alongside it. Growth means a rise in real national income; development means that growth together with better health, education and equality.