Concept of National Income and Measurement:

Meaning
National income is an uncertain term which is used interchangeably with national dividend,
national output and national outlay. On this basis, national income has been defined in a number
of ways. In common parlance, national income means the total value of goods and services
produced annually in a nation. In other words, the total amount of income accruing to a
nation from economic activities in a years time is known as national income. It includes
payments made to all resources in the form of wages, interest, rent and profits.

The important concepts of national income are:

1. Gross Domestic Product (GDP)

2. Gross National Product (GNP)

3. Net National Product (NNP) at Market Prices

4. Net National Product (NNP) at Factor Cost or National Income

5. Personal Income

6. Disposable Income

Let us explain these concepts of National Income in detail.

1. Gross Domestic Product (GDP): Gross Domestic Product (GDP) is the total market value of
all final goods and services currently produced within the domestic territory of a country in a
year.

Four things must be noted regarding this definition.

First, it measures the market value of annual output of goods and services currently produced.
This implies that GDP is a monetary measure.

Secondly, for calculating GDP accurately, all goods and services produced in any given year
must be counted only once so as to avoid double counting. So, GDP should include the value of
only final goods and services and ignores the transactions involving intermediate goods.

Thirdly, GDP includes only currently produced goods and services in a year. Market
transactions involving goods produced in the previous periods such as old houses, old cars,
factories built earlier are not included in GDP of the current year.

Lastly, GDP refers to the value of goods and services produced within the domestic territory of a
country by nationals or non-nationals.

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2. Gross National Product (GNP): Gross National Product is the total market value of all final
goods and services produced in a year. GNP includes net factor income from abroad whereas
GDP does not. Therefore,

GNP = GDP + Net factor income from abroad.

Net factor income from abroad = factor income received by Indian nationals from abroad
factor income paid to foreign nationals working in India.

3. Net National Product (NNP) at Market Price: NNP is the market value of all final goods
and services after providing for depreciation. That is, when charges for depreciation are deducted
from the GNP we get NNP at market price. Therefore

NNP = GNP Depreciation

Depreciation is the consumption of fixed capital or fall in the value of fixed capital due to wear
and tear.

4. Net National Product (NNP) at Factor Cost (National Income): NNP at factor cost or
National Income is the sum of wages, rent, interest and profits paid to factors for their
contribution to the production of goods and services in a year. It may be noted that:

NNP at Factor Cost = NNP at Market Price Indirect Taxes + Subsidies.

5. Personal Income: Personal income is the sum of all incomes actually received by all
individuals or households during a given year. In National Income there are some income, which
is earned but not actually received by households such as Social Security contributions, corporate
income taxes and undistributed profits. On the other hand there are income (transfer payment),
which is received but not currently earned such as old age pensions, unemployment doles, relief
payments, etc. Thus, in moving from national income to personal income we must subtract the
incomes earned but not received and add incomes received but not currently earned. Therefore,

Personal Income = National Income Social Security contributions corporate income taxes
undistributed corporate profits + transfer payments.

6. Disposable Income: From personal income if we deduct personal taxes like income taxes,
personal property taxes etc. what remains is called disposable income. Thus,

Disposable Income = Personal income personal taxes.

Disposable Income can either be consumed or saved. Therefore,
Disposable Income = consumption + saving.

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MEASUREMENT OF NATIONAL INCOME

Production generate incomes which are again spent on goods and services produced. Therefore,
national income can be measured by three methods:

1. Output or Production method

2. Income method, and

3. Expenditure method.

Let us discuss these methods in detail.

1. Output or Production Method: This method is also called the value-added method. This
method approaches national income from the output side. Under this method, the economy is
divided into different sectors such as agriculture, fishing, mining, construction, manufacturing,
trade and commerce, transport, communication and other services. Then, the gross product is
found out by adding up the net values of all the production that has taken place in these sectors
during a given year.

In order to arrive at the net value of production of a given industry, intermediate goods purchase
by the producers of this industry are deducted from the gross value of production of that
industry. The aggregate or net values of production of all the industry and sectors of the
economy plus the net factor income from abroad will give us the GNP. If we deduct depreciation
from the GNP we get NNP at market price. NNP at market price indirect taxes + subsidies will
give us NNP at factor cost or National Income.

The output method can be used where there exists a census of production for the year. The
advantage of this method is that it reveals the contributions and relative importance and of the
different sectors of the economy.

2. Income Method: This method approaches national income from the distribution side.
According to this method, national income is obtained by summing up of the incomes of all
individuals in the country. Thus, national income is calculated by adding up the rent of land,
wages and salaries of employees, interest on capital, profits of entrepreneurs and income of self-
employed people.

This method of estimating national income has the great advantage of indicating the distribution
of national income among different income groups such as landlords, capitalists, workers, etc.

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3. Expenditure Method: This method arrives at national income by adding up all the
expenditure made on goods and services during a year. Thus, the national income is found by
adding up the following types of expenditure by households, private business enterprises and the
government: -

(a) Expenditure on consumer goods and services by individuals and households denoted by C.
This is called personal consumption expenditure denoted by C.

(b) Expenditure by private business enterprises on capital goods and on making additions to
inventories or stocks in a year. This is called gross domestic private investment denoted by I.

(c) Governments expenditure on goods and services i.e. government purchases denoted by G.

(d) Expenditure made by foreigners on goods and services of the national economy over and
above what this economy spends on the output of the foreign countries i.e. exports imports
denoted by

(X M). Thus,

GDP = C + I + G + (X M).

Difficulties in the Measurement of National Income:

There are many difficulties in measuring national income of a country accurately. The
difficulties involved in national income accounting are both conceptual and statical in nature.
Some of these difficulties involved in the measurement of national income are discussed below:

Non-Monetary Transactions

The first problem in National Income accounting relates to the treatment of non-monetary
transactions such as the services of housewives to the members of the families. For example, if a
man employees a maid servant for household work, payment to her will appear as a positive item
in the national income. But, if the man were to marry to the maid servant, she would performing
the same job as before but without any extra payments. In this case, the national income will
decrease as her services performed remains the same as before.

Problem of Double Counting

Only final goods and services should be included in the national income accounting. But, it is
very difficult to distinguish between final goods and intermediate goods and services. An
intermediate goods and service used for final consumption. The difference between final goods
and services and intermediate goods and services depends on the use of those goods and services
so there are possibilities of double counting.

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The Underground Economy

The underground economy consists of illegal and uncleared transactions where the goods and
services are themselves illegal such as drugs, gambling, smuggling, and prostitution. Since, these
incomes are not included in the national income, the national income seems to be less than the
actual amount as they are not included in the accounting.

Petty Production

There are large numbers of petty producers and it is difficult to include their production in
national income because they do not maintain any account.

Public Services

Another problem is whether the public services like general administration, police, army
services, should be included in national income or not. It is very difficult to evaluate such
services.

Transfer Payments

Individual get pension, unemployment allowance and interest on public loans, but these
payments creates difficulty in the measurement of national income. These earnings are a part of
individual income and they are also a part of government expenditures.

Capital Gains or Loss

When the market prices of capital assets change the owners make capital gains or loss such gains
or losses are not included in national income.

Price Changes

National income is the money value of goods and services. Money value depends on market
price, which often changes. The problem of changing prices is one of the major problems of
national income accounting. Due to price rises the value of national income for particular year
appends to increase even when the production is decreasing.

Wages and Salaries paid in Kind

Additional payments made in kind may not be included in national income. But, the facilities
given in kind are calculated as the supplements of wages and salaries on the income side.

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Illiteracy and Ignorance

The main problem is whether to include the income generated within the country or even
generated abroad in national income and which method should be used in the measurement of
national income.

Besides these, the following points are also represents the difficulties in national income
accounting:

Second hand transactions;

Environment damages;

Calculation of depreciation;

Inadequate and unreliable statistics; etc.

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 Introduction to Inflation:
Inflation means a sustained increase in the aggregate or general price level in an economy.
Inflation means there is an increase in the cost of living.

Inflation means that your money wont buy as much today as you could yesterday.

Types of Inflation

The reasons for inflation depend on supply and demand. Depending on the type of inflation,
changes in either supply or demand can create an increase in the price level of goods and
services.

Demand-Pull Inflation

Demand-pull inflation is inflation that occurs when total demand for goods and services exceeds
the economy's capacity to produce those goods. Put another way, there is "too much money
chasing too few goods. " Typically, demand-pull inflation occurs when unemployment is low or
falling. The increases in employment raise aggregate demand, which leads to increased hiring to
expand the level of production. Eventually, production cannot keep pace with aggregate demand
because of capacity constraints, so prices rise

Cost-Push Inflation

Cost-push inflation occurs when there is an increase in the costs of production. Unlike demand-
pull inflation, cost-push inflation is not "too much money chasing too few goods," but rather, a
decrease in the supply of goods, which raises prices .

The reason for decreases in supply are usually related to increases in the prices of inputs. One
major reason for cost-push inflation are supply shocks. A supply shock is an event that suddenly
changes the price of a commodity or service. (Sudden supply decrease) will raise prices and shift
the aggregate supply curve to the left. One historical example of this is the oil crisis of the
1970's, when the price of oil in the U.S. surged. Because oil is integral to many industries, the
price increase led to large increases in the costs of production, which translated to higher price
levels.

Built-In Inflation

Built-in inflation is the result of adaptive expectations. If workers expect there to be inflation,
they will negotiate for wages increasing at or above the rate of inflation (so as to avoid losing
purchasing power). Their employers then pass the higher labor costs on to customers through
higher prices, which actually reflect inflation. Thus, there is a cycle of expectations and inflation
driving one another.

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Causes of inflation:
I. Demand side
Increase in aggregative effective demand is responsible for inflation. In this case, aggregate
demand exceeds aggregate supply of goods and services. Demand rises much faster than the
supply. We can enumerate the following reasons for increase in effective demand.

1. Increase in money supply: Supply of money in circulation increases on account of the

following reasons deficit financing by the government, expansion in public expenditure,
expansion in bank credit and repayment of past debt by the government to the people, increase in
legal tender money and public borrowing.

2. Increase in disposable income: Aggregate effective demand rises when disposable income of
the people increases. Disposable income rises on account of the following reasons reduction in
the rates of taxes, increase in national income while tax level remains constant and decline in the
level of savings.

3. Increase in private consumption expenditure and investment expenditure: An increase in

private expenditure both on consumption and on investment leads to emergence of excess
demand in an economy. When business is prosperous, business expectations are optimistic and
prices are rising, more investment is made by private entrepreneurs causing an increase in factor
prices. When the incomes of the factors rise, there is more expenditure on consumer goods.

4. Increase in Exports: An increase in the foreign demand for a countrys exports reduces the
stock of goods available for home consumption. This creates shortages in the country leading to
rise in price level.

5. Existence of Black Money: The existence of black money in a country due to corruption, tax
evasion, black-marketing etc, increases the aggregate demand. People spend such unaccounted
money extravagantly thereby creating un-necessary demand for goods and services causing
inflation.

6. Increase in Foreign Exchange Reserves: It may increase on account of the inflow of foreign
money in to the country. Foreign Direct Investment may increase and non-resident deposits may
also increase due to the policy of the government.

7. Increase in population growth creates increase in demand for everything in a country.

8. High rates of indirect taxes would lead to rise in prices.

9. Reduction in the rates of direct taxes would leave more cash in the hands of people inducing
them to buy more goods and services leading to an increase in prices.

10. Reduction in the level of savings creates more demand for goods and services.

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II. Supply side
Generally, the supply of goods and services do not keep pace with the ever-increasing demand
for goods and services. Thus, supply does not match with the demand. Supply falls short of
demand. Increase in supply of goods and services may be limited because of the following
reasons.

1. Shortage in the supply of factors of production

When there is shortage in the supply of factors of production like raw materials, labor, capital
equipments etc. there will be a rise in their prices. Thus, when supply falls short of demand, a
situation of excess demand emerges creating inflationary pressures in an economy.

2. Hoardings by Traders and speculators

During the period of shortage and rise in prices, hoarding of essential commodities by traders
and speculators with the object of earning extra profits in future creates artificial scarcity of
commodities. This creates a situation of excess demand paving the way for further inflation.

3. Hoarding by Consumers
Consumers may also hoard essential goods to avoid payment of higher prices in future. This
leads to increase in current demand, which in turn stimulate prices.

4. Role of Trade unions

Trade union activities leading to industrial unrest in the form of strikes and lockouts also reduce
production. This will lead to creation of excess demand that eventually brings a rise in the price
level.

5. Role of natural Calamities

Natural calamities such as earthquake, floods and drought conditions also affect adversely the
supplies of agricultural products and create shortage of food grains and raw materials, which in
turn creates inflationary conditions.

6. War: During the period of war, shortage of essential goods create rise in prices.

7. International factors also would cause either shortage of goods and services or rise in the
prices of factor inputs leading to inflation. E.g., High prices of imports.

8. Increase in prices of inputs with in the country.

III Role of Expectations

Expectations also play a significant role in accentuating inflation. The following points are worth
mentioning:
1. If people expect further rise in price, the current aggregate demand increases which in its turn
causes a raise in the prices.
2. Expectations about higher wages and salaries affect very much the prices of related goods.
3. Expectations of wage increase often induce some business houses to increase prices even
before upward wage revisions are actually made.

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Thus, many factors are responsible for escalation of prices.
In India the main reason for inflation in last quarter of 2009 was shortage of food grains due to
bad monsoons and hoarding by traders.

Measures to control Inflation

There are broadly two ways of controlling inflation in an economy:

1). Monetary measures and
2). Fiscal measures

I).Monetary Measures

The most important and commonly used method to control inflation is monetary policy of the
Central Bank. Most central banks use high interest rates as the traditional way to fight or prevent
inflation.
Monetary measures used to control inflation include:
(i) Bank rate policy
(ii) Cash reserve ratio and
(iii) Open market operations.

Bank rate policy is used as the main instrument of monetary control during the period of
inflation. When the central bank raises the bank rate, it is said to have adopted a dear money
policy. The increase in bank rate increases the cost of borrowing which reduces commercial
banks borrowing from the central bank. Consequently, the flow of money from the commercial
banks to the public gets reduced. Therefore, inflation is controlled to the extent it is caused by
the bank credit.

Cash Reserve Ratio (CRR): To control inflation, the central bank raises the CRR which
reduces the lending capacity of the commercial banks. Consequently, flow of money from
commercial banks to public decreases. In the process, it halts the rise in prices to the extent it is
caused by banks credits to the public.

Open Market Operations: Open market operations refer to sale and purchase of government
securities and bonds by the central bank. To control inflation, central bank sells the government
securities to the public through the banks. This results in transfer of a part of bank deposits to
central bank account and reduces credit creation capacity of the commercial banks.

II). Fiscal Measures

Fiscal measures to control inflation include taxation, government expenditure and public
borrowings. The government can also take some protectionist measures (such as banning the
export of essential items such as pulses, cereals and oils to support the domestic consumption,
encourage imports by lowering duties on import items etc.).

Since inflation in India is caused by many factors, a mix of aforesaid measures is necessary

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 Business Cycle

The term business cycle is referred to the recurrent ups and downs in the level of economic
activity that extend over a period of time. The business fluctuations occur in aggregate variable
such as national income, employment and price level.

Business cycle is also called as Trade Cycle

Four Phases of Business Cycle

Business Cycle (or Trade Cycle) is divided into the following four phases :-

Prosperity Phase: Expansion or Boom or Upswing of economy.

Recession Phase: from prosperity to recession (upper turning point).
Depression Phase: Contraction or Downswing of economy.
Recovery Phase: from depression to prosperity (lower turning Point).

Diagram of Four Phases of Business Cycle:

The four phases of business cycles are shown in the following diagram:-

The business cycle starts from a trough (lower point) and passes through a recovery phase
followed by a period of expansion (upper turning point) and prosperity. After the peak point is
reached there is a declining phase of recession followed by a depression. Again the business
cycle continues similarly with ups and downs.

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Explanation of Four Phases of Business Cycle

The four phases of a business cycle are briefly explained as follows :-

1. Prosperity Phase

When there is an expansion of output, income, employment, prices and profits, there is also a rise
in the standard of living. This period is termed as Prosperity phase.

The features of prosperity are:-

1. High level of output and trade.

2. High level of effective demand.
3. High level of income and employment.
4. Rising interest rates.
5. Inflation.
6. Large expansion of bank credit.
7. Overall business optimism.
8. A high level of MEC (Marginal efficiency of capital) and investment.

Due to full employment of resources, the level of production is Maximum and there is a rise in
GNP (Gross National Product). Due to a high level of economic activity, it causes a rise in prices
and profits. There is an upswing in the economic activity and economy reaches its Peak. This is
also called as a Boom Period.

2. Recession Phase

The turning point from prosperity to depression is termed as Recession Phase.

During a recession period, the economic activities slow down. When demand starts falling, the
overproduction and future investment plans are also given up. There is a steady decline in the
output, income, employment, prices and profits. The businessmen lose confidence and become
pessimistic (Negative). It reduces investment. The banks and the people try to get greater
liquidity, so credit also contracts. Expansion of business stops, stock market falls. Orders are
cancelled and people start losing their jobs. The increase in unemployment causes a sharp
decline in income and aggregate demand. Generally, recession lasts for a short period.

3. Depression Phase

When there is a continuous decrease of output, income, employment, prices and profits, there is a
fall in the standard of living and depression sets in.

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The features of depression are :-

1) Fall in volume of output and trade.

2) Fall in income and rise in unemployment.
3) Decline in consumption and demand.
4) Fall in interest rate.
5) Deflation.
6) Contraction of bank credit.
7) Overall business pessimism.
8) Fall in MEC (Marginal efficiency of capital) and investment.

In depression, there is under-utilization of resources and fall in GNP (Gross National Product).
The aggregate economic activity is at the lowest, causing a decline in prices and profits until the
economy reaches its Trough (low point).

4. Recovery Phase

The turning point from depression to expansion is termed as Recovery or Revival Phase.

During the period of revival or recovery, there are expansions and rise in economic activities.
When demand starts rising, production increases and this causes an increase in investment. There
is a steady rise in output, income, employment, prices and profits. The businessmen gain
confidence and become optimistic (Positive). This increases investments. The stimulation of
investment brings about the revival or recovery of the economy. The banks expand credit,
business expansion takes place and stock markets are activated. There is an increase in
employment, production, income and aggregate demand, prices and profits start rising, and
business expands. Revival slowly emerges into prosperity, and the business cycle is repeated.

Thus we see that, during the expansionary or prosperity phase, there is inflation and during the
contraction or depression phase, there is a deflation.

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