National Income AccountingClass 12 Introductory Macroeconomics Case Study Questions

Let us suppose that there are only two kinds of producers in the economy: wheat producers (farmers) and bread makers (bakers). The farmers grow wheat and sell Rs 50 worth of it to the bakers. The farmers' total production is Rs 100, and they use no intermediate inputs. The bakers use the wheat they purchase to produce Rs 200 worth of bread. To calculate the net contribution of the bakers, we need to subtract the value of the wheat they bought from the farmers. If we do not do this, we shall commit the mistake of 'double counting', as the value of the wheat would be counted twice. The term used to denote the net contribution made by a firm is called its 'value added'. It is calculated as the value of production minus the value of intermediate goods used. Therefore, the aggregate value of goods produced is the sum of the value added by each producer.

In our modern economy, production arises from millions of enterprises. Each producer often intends to sell their output. An item that is meant for final use and will not pass through any more stages of production or transformations is called a final good. For example, a farmer producing cotton sells it to a spinning mill, where it is transformed into yarn. The yarn is sold to a textile mill and transformed into cloth. The cloth is then made into an article of clothing, which is sold to consumers for final use. Of the final goods, we can distinguish between consumption goods (like food and clothing) and capital goods (like tools and machines). Goods used by other producers as material inputs, like steel sheets for automobiles, are intermediate goods. Crucially, it is not the nature of the good but the economic nature of its use that makes a good final or intermediate. For instance, tea leaves bought by a consumer for home use are a final good, but the same tea leaves bought by a restaurant are an intermediate good.

In economics, it is important to introduce the concepts of stocks and flows. Statements about income or output are meaningless without a specified time period. These are called flows because they occur over a period of time. For example, income is expressed as monthly or annual. In contrast, some variables are defined at a particular point in time. These are called stocks. Capital goods, once produced, do not get consumed in a delineated time period and are therefore stocks. The buildings or machines in a factory are stocks. However, we can measure a change in stock over a specific period, and such changes are flows. For instance, the number of machines added this year is a flow, which is called investment. To understand the difference, suppose a tank is being filled with water. The amount of water flowing into the tank per minute is a flow. But the amount of water in the tank at a particular point of time is a stock.