10 Main Disadvantages of the GNP Measure

GNP measures suffer from the following disadvantages:

1. Difficulty in accounting for quality changes in GNP:

A house in a congested locality offers lower welfare to the occupants yet commands a much higher price than what a high quality house in open surroundings offering much higher welfare to the occupants does.

GNP, thus, fails to incorporate quality changes with the result that it over-estimates economic welfare of the people.

2. Commodity Taxes Inflate the Value of GNP Without any Increase in the Volume of the Physical Output:

Indirect taxes raise the money value of GNP even when the physical volume of the output remains unchanged. As a result, the measure of welfare is much lower than what the GNP estimates reflect.

3. A Number of Services Remain Excluded from the GNP Estimate Despite their High Contribution to Development and Welfare:

In many economies, a number of services such as transport, teaching, laundries, and entertainment are not included in GNP (as has been a practice in Russia) even though their contribution to development and welfare of the people in the nation is of high significance. GNP thus fails to represent the true measure of welfare or development.

4. Inflation Enhances the Value of the GNP Even when Physical Volume of the Output Remains Unchanged:

The effect is the same as that of the commodity taxes. GNP if taken as an indicator of welfare, it would show it much higher than what people actually enjoy.

5. Problems of Unreported and Illegal Activities:

Illegal activities such as smuggling increase the welfare yet go unreported, and hence, excluded from the estimates of GNP. Welfare is in reality much higher than that reflected by GNP. Similarly, production of certain goods and services is not reported to government by their producers with a view to avoid taxation. GNP thus gets underestimated, reflecting much less welfare than that actually enjoyed by people.

6. Not All Activities have a Monetary Value:

Leisure or housewife’s services, though making a significant contribution to the people’s welfare, fail to be included in the GNP mainly due to the problem of assessing their values in monetary terms. Such activities therefore remain excluded from GNP. GNP estimates thus fail to reflect the true measure of economic welfare.

7. Production for Self-Consumption Increases Welfare but is Not Included in GNP:

The producers hold a part of the produce back for their self-consumption. This often does not get accounted for in the GNP. Production for self-consumption increases social welfare but fails to enter the GNP-estimates, which thus remain underestimated.

8. Increase in Industrial Output Increases Pollution, Which Decreases Welfare:

An increase in industrial production increases both GNP as well as pollution. An increase in pollution, however, reduces welfare.

9. A Change in the Composition of Output May Increase Welfare Without Changing the Volume of the Physical Output:

For example, expenditures incurred on production of destructive missiles and nuclear weapons, if made on promoting better health and education, may increase welfare significantly without any change in the money value of the physical output.

10. Inequalities in Income Distribution Reduce Welfare of the People:

Existence of inequalities of income distribution adversely affects welfare of the masses. The richer sections, on the contrary, enjoy surpluses.

Discussions above show that GNP per capita is an inadequate measure of economic development and social welfare. This has disenchanted economists about its efficacy as a true index of development and welfare.

Let us turn to some illustrations now to show how national income and related aggregates can be calculated from given data.

ILLUSTRATION 2.3:

From the data given below, calculate domestic income, domestic product and domestic expenditure. Are the three the same?

Salaries and Wages = 60,000

Rent = 12,000

Interest = 8,000

Dividend = 2,000

Undistributed Profits = 2,000

Employer’s Contribution to Workers’ Social Security = 1,000

Indirect Taxes = 3,000

Subsidies = 2,000

Mixed Incomes = 30,000

Consumption of Fixed Capital = 4,000

Government Final Consumption Expenditure = 25,000

Private Final Consumption Expenditure = 75,000

Exports = 3,000

Imports = 5,000

Net Factor Income from ROW = (-) 500

Transfer Payments = 2,000

Net Other Current Transfers from ROW = 500

Corporate Profit Tax = 10,000

Direct Personal Taxes = 8,000

Changes in Stocks = 2,000

Gross Domestic Fixed Capital Formation = 20,000

National Debt Interest = 5,000

Sales = 132,000

Intermediate Consumption = 14,000

Domestic Product to Govt = 25,000

(All the figures are in crore rupees)

Solution:

Domestic Income = Net domestic income at factor cost (NDIFC OR NDPFC)

= Compensation of employees + operating surplus + mixed incomes of the self employed

= (Salaries and Wages + Social Security Contribution) + (Rent + Interest + Dividend + Undistributed Profits) + (Mixed Incomes)

= (60,000 + 1,000) + (12,000 + 8,000 + 2,000 + 2,000) + (30,000) = 115,000

Domestic Expenditure = Net domestic expenditure at factor cost (NDEFC OR NDPFC)

= [Government Final Consumption Expenditure + Private Final Consumption Expenditure + Gross Domestic Capital Formation + Net Investment Abroad] less [Consumption of Fixed Capital + Net Indirect Taxes]

= [25,000 + 75,000 + (20,000 + 2,000) + (3,000 – 5,000)] Less [4,000 + (3,000 – 2,000)] =115,000

[Note that Net Indirect Tax = Indirect Tax – Subsidies, Net Investment Abroad = Exports – Imports, Gross Domestic Capital Formation

= Gross Domestic Fixed Capital Formation + Changes in Stock]

Domestic Product = Net domestic product at factor cost (NDPFC)

= Sales + Changes in Stock less Intermediate Consumption less Consumption of Fixed Capital Less Net Indirect Taxes

= 132,000 + 2,000 – 14,000 – 4,000 – 1,000 = 115,000

It is clear from the calculations that

Domestic Income (DI) = Domestic Expenditure (DE)

= Domestic Product (DP) = 115,000

Illustration 2.4:

From the data in illustration 2.3, determine the national income by

(i) Income Method

(ii) Expenditure Method

(iii)Value Added Method

Also determine all the national income aggregates.

Solution:

(i) National Income by income method is Net National Income at Factor Cost (NNIFC). It is same as the sum of the domestic income and the net factor income from ROW.

NNIFC = DI + Net Factor Income from ROW (NFIA).

= 115,000 (As calculated in illustration 2.3) + (-500) = 114,500

(Note that national income is less than the domestic income. It is so due to the negative balance of the net factor income from ROW).

(ii) National Income by expenditure method is the Net National Expenditure at factor cost (NNEFC). It is the same as the sum of domestic expenditure and the Net Factor Income from ROW (NFIA).

NNEFC = DE + Net Factor Income from ROW (NFIA)

= 115,000 (As calculated in illustration 2.3) + (-500) = 114,500

(iii) Following the pattern, national income by the value added method,

NNPFC = DP + Net Factor Income from ROW (NFIA) = 115,000 + (-500) = 114,500

Apart from NNPFC, there are seven other national income aggregates linked to it. They are – NNPMP, NDPFC, NDPMP, GDPFC, GDPMP, GNPFC, and GNPMP.

NNPMP = NNPPC + NIT

= 114,500 + 1000 = 115,500

NDPFC = NNPFC – NFIA

= 114,500 – (- 500) = 115,000

NDPMP = NDPFC + NIT

= 115,000 + 1,000 = 116,000

GDPFC = NDPFC + Depreciation (Dep.)

= 115,000 + 4,000 = 119,000

GDPMP = GDPFC + NIT

= 119,000 + 1,000 = 120,000

GNPFC = GDPFC + NFIA

119,000 + (-500) = 18,500

GNPMP = GNPFC + NIT

118,500 + 1,000 = 119,500

Illustration 2.5:

From the data in illustration 2.3, calculate:

(а) Private Income

(b) Personal Income

(c) Personal Disposable Income

(d) Personal Savings.

Solution:

(a) Private Income = NDPFC – Domestic product accruing to Govt + NFIA + Transfer Payments + National Debt Interest (NDI) + Net Other Current Transfers from Row (NOCT)

= 115,000 – 25,000 + (- 500) + 2,000 + 5,000 + 500 = 97,000

(b) Personal Income = Private Income – Corporate Tax – Undistributed Profits

= 97,000 – 10,000 – 2,000 = 85,000

(c) Personal Disposable Income = Personal Income – Personal taxes, fees, fines, etc.

= 85,000 – 8,000 = 77,000

(d) Personal Savings = Personal Disposable Income less Personal consumption expenditure

= 77,000 – 75,000 = 2,000

Illustration 2.6:

From the data given below, calculate GNP at market price through the Value Added Method:

Value of the output of the primary sector = 10,000

Intermediate consumption in the primary sector = 2,000

Value of the output in the secondary sector = 25,000

Intermediate consumption in the secondary sector = 5,000

Value of the output in the tertiary sector = 45,000

Intermediate consumption in the tertiary sector = 10,000

Net factor income from ROW = -1,000

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Illustration 2.7:

Industry A sells its product worth 2,000 to industry B, worth 3,000 to industry C, worth 5,000 to final demand and worth 2,000 to ROW. Industry B sells its product worth 500 to industry A, worth 3,000 to industry C, worth 12,000 to final demand and worth 3,000 to ROW.

Industry C sells its product worth 1,000 to industry A, worth 3,000 to industry B, worth 8,000 to final demand and worth 6,000 to ROW. Imports of the three industries from ROW are respectively 1,000, 5,000 and 8,000. Find the contribution of the three industries to the GDP at market price.

Solution:

Calculation of contribution of the three industries to the GDP at market price can be conveniently done as below:

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As is clear, inputs of the three industries constitute their intermediate consumption. In fact, inter-industry flows remain confined to the producers’ boundary and hence are treated as intermediate inputs. The total value added or the contribution to the GDPMP can also be found by adding up the sales of the industries to the final demand and to the ROW (expenditure method). The same is the result.

Sales to the final demand = 5,000 + 12,000 + 8,000 = 25,000

Sales to ROW (net investment abroad) = Exports – Imports

= (2,000 + 3,000 + 6,000) – (1,000 + 5,000 + 8,000) = 11,000 – 14,000 = (-) 3,000

Thus contribution to the GDPMP = Sales to final demand + Sales to ROW

= 25,000 + (-) 3,000 = 22,000

The expenditure method and the value added method, both, lead to the same estimate. Note that the estimate here is the domestic product, not the national product. We need net factor income from abroad to add to it to arrive at the national product. Note further that the estimate is at the market price, not at the factor cost. This is so due to the fact that the sales take place at the market price.

Submitted by : Professor Kamakshi, Category : Knowledge