In the Insolvency and Bankruptcy Board of India’s exam for Registered Valuer for the Securities and Financial Asset class, National Income Accounting is part of Macro Economics chapter which carries 3 Marks weightage. For clearing this Registered Valuer exam of IBBI, one need not go into very minute detail about Macro Economics as the marks coverage is not very high so a bird-eye-view is sufficient to score 3 Marks in Macro Economics.

Spending in the economy takes many forms. GDP includes all of these various forms of spending on domestically produced goods and services. To understand how the economy is using its scarce resources, economists are often interested in studying the composition of GDP among various types of spending. To do this, GDP (which we denote as Y) is divided into four components (Components of GDP). Consumption (C), Investment (I), Government purchases (G), and Net exports (NX).

Y = C + I + G + NX.

This equation is an identity, An equation that must be true by the way the variables in the equation are defined.

In this case, because each dollar of expenditure included in GDP is placed into one of the four components of GDP, the total of the four components must be equal to GDP.

Let us now see what are the components of GDP. Economists and policymakers care not only about the economy’s total output of goods and services but also about the allocation of this output among alternative uses. The national income accounts divide GDP into four broad categories of spending: Consumption, Investment, Government purchases and Net Exports.

First is Consumption – It consists of the goods and services bought by households. It is divided into three subcategories: nondurable goods, durable goods, and services. Nondurable goods are goods that last only a short time, such as food and clothing. Durable goods are goods that last a long time, such as cars and TVs. Services include the work done for consumers by individuals and firms, such as haircuts and doctor visits. Consumption is spending by households on goods and services, such as the Smiths’ lunch at Burger King.

Next is Investment – It is the purchase of capital equipment, inventories, and structures, such as the General Motors factory. Investment also includes expenditure on new housing. (By convention, expenditure on new housing is the one form of household spending categorized as an investment rather than consumption.) The general rule is that the economy’s investment does not include purchases that merely reallocate existing assets among different individuals. Investment, as macroeconomists use the term, creates new capital.

Third is Government purchases – Government purchases include spending on goods and services by local, state, and federal governments, such as the Navy’s purchase of a submarine. The meaning of “government purchases” also requires a bit of clarification. When the government pays the salary of an Army general, that salary is part of government purchases. But what happens when the government pays a Social Security benefit to one of the elderly? Such government spending is called a transfer payment because it is not made in exchange for a currently produced good or service. From a macroeconomic standpoint, transfer payments are like a tax rebate. Like taxes, transfer payments alter household income, but they do not reflect the economy’s production. Because GDP is intended to measure income from (and expenditure on) the production of goods and services, transfer payments are not counted as part of government purchases.

Fourth and last for our discussion purpose is Net Exports – Net exports equal the purchases of domestically produced goods by foreigners (exports) minus the domestic purchases of foreign goods (imports). A domestic firm’s sale to a buyer in another country, such as the Boeing sale to British Airways, increases net exports. The “net” in “net exports” refers to the fact that imports are subtracted from exports. This subtraction is made because imports of goods and services are included in other components of GDP. In other words, net exports include goods and services produced abroad (with a minus sign) because these goods and services are included in consumption, investment, and government purchases (with a plus sign). Thus, when a domestic household, firm, or government buys a good or service from abroad, the purchase reduces net exports—but because it also raises consumption, investment, or government purchases, it does not affect GDP.

The GDP price deflator, also known as the GDP deflator or the implicit price deflator, measures the changes in prices for all of the goods and services produced in an economy. Gross domestic product (GDP) represents the total output of goods and services. However, as GDP rises and falls, the metric doesn’t factor the impact of inflation or rising prices into its results. The GDP price deflator addresses this by showing the effect of price changes on GDP, first by establishing a base year and, secondly, by comparing current prices to prices in the base year. Simply put, the GDP price deflator shows how much a change in GDP relies on changes in the price level. It expresses the extent of price level changes, or inflation, within the economy by tracking the prices paid by businesses, the government, and consumers. Typically GDP, expressed as nominal GDP, shows the total output of the country in whole dollar terms. Before we explore the GDP price deflator, we must first review how prices can impact the GDP figures from one year to another.

             GDP Price Deflator = (Nominal GDP ÷ Real GDP) ×100

The GDP price deflator helps identify how much prices have inflated over a specific time period. This is important because, as we saw in our previous example, comparing GDP from two different years can give a deceptive result if there’s a change in the price level between the two years. Without some way to account for the change in prices, an economy that’s experiencing price inflation would appear to be growing in dollar terms. However, that same economy might be exhibiting little-to-no growth, but with prices rising, the total output figures would appear higher than what was really being produced.