TOWARDS A NATIONAL ACCOUNTING SYSTEM 

A real life modern economy is a very complex structure consisting of millions of units engaged in a variety of economic transactions. There are organizations which produce and distribute a variety of goods and services. There are households which consume goods and services, offer their labor services to productive organizations and make their savings available for investment. There are financial institutions which act as intermediaries between savers and investors. There are state and central governments who impose and collect taxes and provide a range of public services. Transactions take place among the units within an economy as well as with foreigners in the process of production and consumption of goods and services, creation and transfer of physical and financial assets, production of public goods and services, etc. National accounts attempt to provide a summary picture of the entire gamut of these economic transactions.

Obviously, to be useful at all, the national accounts cannot go down to the level of individual units. Substantial aggregation must be done over the units and detailed transactions so that national accounts can be cast in terms of a manageable number of macroeconomic aggregates. In the design and construction of these aggregates, the criterion is that the accounts must enable us to identify and estimate important economic relationships. A general principle is that economic activities subject to similar behavioral determinants should be aggregated together.

Corresponding to the corporate accounts, three types of accounts can be constructed for the national economy. The National Income Accounts deal with flows of goods and services during a year; the flow of funds accounts depict changes in financial assets and liabilities of the various sectors of the economy. (A sector is a collection of units engaged in similar economic activities.) Finally, the national balance sheet will reflect the nation's wealth at a point of time. A fourth type of accounts called Input-Output accounts depict the flows of goods and services between the various productive and household sectors of the economy.

In this note we will focus on National Income and Product Accounts often simply called 'National Accounts'. We will begin with a very simple hypothetical economy and add complications one at a time finally approaching an accounting system for a real-life economy.