Gross and Net Values
Definition
Depreciation (capital consumption): the fall in the value of an economy's capital stock as it wears out or becomes obsolete during a period of production.
Gross and net values: a gross value is measured before deducting depreciation; a net value is measured after deducting it, so net value = gross value − depreciation.
Gross Versus Net
- A gross value is measured before deducting depreciation.
- A net value is measured after deducting depreciation.
- The only difference between a gross and a net figure is the allowance for capital consumption.
Making the Adjustment
Reference formula
net value=gross value−depreciation \text{net value} = \text{gross value} - \text{depreciation} net value=gross value−depreciation- Producing output wears out machines, buildings and equipment.
- Some of the year's output must therefore be used just to replace this worn-out capital.
- So subtract depreciation from a gross value to obtain the matching net value.
- The net figure then shows the income available after keeping the capital stock intact.
Key Idea
- Net value = gross value − depreciation.
- Net measures are more accurate for sustainable income because they account for capital wearing out.
Example
- Gross National Income is £830 billion and depreciation is £50 billion.
- So Net National Income is £780 billion. The same rule applies to investment: gross investment is £120 billion and depreciation is £50 billion.
- Net investment is £70 billion: the capital stock is genuinely growing, since gross investment exceeds the capital used up.
Why It Matters
- Net measures show how much output is genuinely available once capital has been replaced.
- So a country with a high gross figure but heavy depreciation may have much less net income than it first appears.
- It depends on the estimate, though: depreciation is hard to measure accurately, so net figures carry more uncertainty than gross ones.
Exam technique
- Whenever you see gross and net together, the gap between them is depreciation.
- Apply the same rule to convert GNI to NNI or gross investment to net investment.
Common Mistake
- Do not confuse depreciation of capital with a depreciation of the exchange rate: they are unrelated ideas.
- Depreciation is subtracted, so a net value can never exceed the matching gross value.
Self review
- Define depreciation in the national income context.
- What is the only difference between a gross and a net measure?
- How do you convert GNI into NNI?
- Why are net measures useful?
