National Income

Rich / Developed nations

World

Developing Nations

Poor / Least Developed Nations

How do we measure the performance of an economy?

A countrys economic performance is measured by indicators of National Income ( GDP or GNP). Performance of an economy is the level of production (of goods and services) or total economic activity. It estimates the total value of production in an economy.

Definition of National Income

National income is a measure of the total market value of the
goods and services (output) produced by an economy over a period of time (normally a year). 1) It is a Monetary Measure

2) Goods and Services to be counted only once ( Final goods and not intermediate goods)

Need for the Study of National Income

A national income measure serves various purposes regarding economy, production, trade, consumption, policy formulation, etc.

1. To measure the size of the economy and level of countrys economic performance.
2. To trace the trend or speed of the economic growth in relation to previous year(s) as well as to other countries. 3. To know the structure and composition of the national income in terms of various sectors and the periodical variations in them. 4. To make projection about the future development trend of the economy.

5. To help government formulate suitable development plans and policies to increase growth rates. 6. To fix various development targets for different sectors of the economy on the basis of the earlier performance. 7. To help business firms in forecasting future demand for their products.

8. To make international comparison of peoples living standards.

However it has its own Limitations.

3 Interpretation of National Income

National Income = National Product = National Expenditure

The sum of values of all goods and services produced ( Production).

The sum of all incomes, in cash and kind, accruing to factors of productions in a year (Distribution).
The sum of consumers, investment and government expenditure (Expenditure).

Circular Flow of Income

Modern Economy is a monetary economy Money act a medium of Exchange A circular flow of money or income exist Each money flow is in opposite direction to real flow Flow of money income will not always remain constant

Economy
Household Sector

Firms or Business Sector

Government Sector

Foreign Sector

Two Sector Model of Income Distribution

Factor Payments
Rent, Wages, Interest, profits

Economic Resources
Land, Labour, Capital, Enterprise

Business Firms Goods and Services

Households

Consumption Expenditure

Assumptions

No savings from household or business firms Government has no role in the national economy Its a closed economy

Three Sector Model of Income Distribution

What if household save?

The expenditure on goods and services decline Savings reduces the flow of money expenditure to the business firms Firms hire fewer workers / reduce factor payments Causes a fall in Economy's Total Income.

Hence savings a leakage from the money expenditure flow Savings = Investments

Investment is injection of money in circular flow of income

Three Sector Model of Income Distribution

Factor Payments Business Firms Consumption Expenditure Households

Financial Market

What if Investment Savings?

Investment < Savings

Stocks of goods will Increase Demand reduces Production falls Investment in capital goods will fall

Income , output and employment Falls Flow of money contracts

Which leads to Rate of interest falls Leads to increase in investment

Hence Savings = Investments

What if Investment Savings?

Investment > Savings

Stocks of goods will falls Demand rises Production rises Investment in capital goods will rise Income , output and employment increases Flow of money expand Which leads to Rate of interest rise Leads to increase in savings

Hence Savings = Investments

Why are poor countries poor?

Economic Wealth : Man-made resources (road, factories, machines, communication system) Human Resources ( Hard and education) Technological Resources ( High tech machinery)
Poor countries should grow rich by investing money in physical resources and developing human and technological resources. Poor countries should grow faster as new investments have the biggest rewards. Rich countries dont gain much from further investments: law of diminishing returns

Why are poor countries poor?

So what should they do? They should improve there education, technology and infrastructure. Since the Returns for investors are high, there should be no shortage of Investment. Countries should take loan from banks for reconstruction and development. Countries can take foreign aids from rich countries.

This didnt happen? WHY? Except for countries like Taiwan, South Korea, China, India, Singapore

Money Flows with Government Sector

Government absorbs a good part of the incomes earned by Households. Government purchases goods and services from firms Government spends on capital goods, infrastructure, defence, education and health etc. Household and firms pay taxes to Government. Government also finance their expenditure by borrowing from the financial market Hence the Government Intervenes and take preventive and corrective action to stabilise an Economy

Three Sector Model of Income Distribution

Factor Payments

Business Firms
Consumption Expenditure

Households

Financial Market

Borrowing

Government

Total Expenditure (E) = C + I + G Consumption Expenditure (C) Investment Expenditure (I) Government Expenditure (G) Total Income (Y) = C + S + T Consumption ( C) Savings (S) Taxes ( T ) E=Y C+I+G= C+S+T I+G=S+T G T= S I G> T (Budget deficit) Government borrows from the financial market

Four Sector Model of Income Distribution

Foreign Sector
Factor Payments

Business Firms
Consumption Expenditure

Households

Financial Market

Borrowing

Government

Four Sector Model of Income Distribution

Balance of Trade Export (X) = Import (M) National Income = C + I+ G+ Xn ( X-M) C + I + G + Xn = C + S+ T

India GDP growth rate

05-06 06-07
07-08

: 9.2% : 9.4%
: 9%

Economic Development Phase 1 : Pre-1991

Policy tended towards protectionism, with a strong emphasis on import substitution, industrialisation, state intervention in labour and financial markets, a large public sector, business regulation, and central planning. Faced crises like Wars China (61) & Pakistan (65, 71) Oil crisis (73, 79) Severe Draughts (65-67)

Economic Development Phase 2 : Post-1991

Late 80s Policy changes Eased restrictions on capacity expansion for incumbents, Removed price controls and Reduced corporate taxes.

This increased the rate of growth, But led to high fiscal deficits and a worsening current account. Balance-of-payment crisis The collapse of the Soviet Union, which was India's major trading partner. Gulf War, which caused a spike in oil prices.

Concepts of National Income

The basic concepts

GNP vs GDP Market Price Vs Factor costs Gross Vs Net Nominal Vs Real PI ( Personnel Income)

Disposable Income Per capita

GDP vs GNP

Gross Domestic Product (GDP)

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

sum total of values of goods & services produced in the country, in a given year

GDP vs GNP

Gross National Product (GNP)

GNP = GDP + net factor income from abroad

sum total of values of goods & services produced by the nationals of a country, in a given year

Net factor income from abroad: Is the difference between

income received from abroad by the normal residents of India for rendering services in other countries and the income paid to the foreign residents for the services rendered by them in India.

GDP vs GNP

Gross National Product (GNP)

GNPMP = GDPMP + net factor income from abroad

GNP = C + I +G + (X-M) + (R-P)

R = P = Income receipts from abroad Income paid abroad

Requirements for Calculating GNP

It measures the market value of annual output Its a Monetary measure GNP accounts for goods that are traded through official market i.e free of cost are not included All good and services must be counted once Income earned through illegal activities are not included

GDP Vs GNP

GDP

Used when the purpose is to measure the product generated in a country.

i.e. whatever is produced in India, will go to constitute GDP, no matter even if foreigners have contributed towards it

GNP

Used when the purpose is to measure the product that accrues to the citizens of a country.

i.e. whatever is produced by Indian nationals whether inside or outside the country will form GNP of India

Market Prices Vs Factor Costs

The GNP / GDP can be estimated at

Market Prices Factor Cost

The Market Prices is a resultant of

Indirect Taxes; and Subsidies

Factor Cost =

Market Price Indirect Taxes + Subsidies

Hence Factor Cost estimates are more real.

Gross Vs Net

In the process of creating national product there is erosion of total productive assets

Net estimates account for this erosion (called Depreciation)

Net

Gross - Depreciation

Nominal Vs Real

The price trend does not remain constant, it can rise or fall. Hence the estimates in terms of money value will increase as price of commodities have risen even if their physical output hasnt. Economic Growth implies increase in real or physical output than the rise in money value of output. Adjustment of the National Income figures for the change in prices needs to be done. Deflating the NI Real estimates account for this increase in prices

Nominal Vs Real

Increase in Price Price Index

Is denoted by Price Index

Selection of Base year

: (Current base year 1999-2000)

Price Index for Base year is taken to be 100

Price Index for the current year

Current Year Prices / Base Year Prices X 100

So if Price index is 145 then prices as compared to Base year have increased by 45%

Nominal Vs Real

Real estimates

Nominal Estimates ---------------------------- X 100 Price Index

Hence

Nominal Real

= =

Estimates at current prices Estimates at fixed prices

The Estimates
Estimate GDP GNP GDPFC Definition C + I + G + (X-M) GDP + NFIA GDPMP Indirect Taxes + Subsidies

NDP Real GDP

GNI NNP NI

GDP - Depreciation Nominal GDP/ Price Index * 100

GNP GNP - Depreciation NNPFC

National income (NI) or National Income at Factor Cost (NNPFC)

It refers to the sum of all incomes earned by factor owners for their contribution of factor services namely land, labour, capital and enterprises in the form of rent, wages, interest and profit.

NI = NNPFC = NNP MP - Indirect Taxes + Subsidies

Personal Income (PI)

It is the sum of all incomes received by all individual or households during a given year. PI = National Income + Transfer payments (Social security + Corporate Income tax + Undistributed Profits) Transfer Payments = Incomes which are not earned but received ( Old- age pensions, unemployment compensation, relief payments)

Disposable Income (DI)

DI= Personal Income Personal Taxes

Or Disposable income can either be consumed or saved DI= Consumption ( C) + Savings (S) DI includes Transfer payments It is the total income earned and unearned of individuals minus direct taxes.

Per Capita Income (PCI)

Per capita income (or) output per person is an indicator to show the living standards of people in a country. If real PCI increases, it is considered to be an improvement in the overall living standard of people. National Income PCI = --------------------------Population

The Estimates
Estimate GDP GNP Definition C + I + G + (X-M) GDP + FIFA

GDPFC
NDP Real GDP GNI NNP NI PI DI PCI

GDPMP Indirect Taxes + Subsidies

GDP - Depreciation Nominal GDP/ Price Index * 100 GNP GNP - Depreciation NNPFC NI + Transfer Payments (Social Security + Corporate Income Tax + Undistributed profits) C + S or PI Personal Taxes NI/ Population

Examples
GNP Capital Consumption Allowance Net National Product (NNP) Indirect Taxes Subsidies National Income ( NI ) Corporate Profits Dividends Government Transfer payments Personal Income Personal Indirect Taxes Disposable Personal Income (DPI) Personal Consumption expenditure Personal Savings 500 ( Rs Cr) - 50 450 - 60 10 400 - 70 15 25 370 - 70 300 - 275 25

Exercise
Q1. Find the Personal Disposable Income (PDI) Rs. Trillion National Income Undistributed Profits Corporate Taxes Personal Taxes Ans.

= = = =

20 1.00 2.00 1.50

Exercise
Q2. Find the NIFA Rs. crores GDPFC NNPFC Depreciation Subsidies Indirect Taxes Ans.

= = = = =

7,00,000 8,00,000 7,000 1,000 1,00,000

Exercise
Q3. Find the GNPMP and NNPMP Rs. crores GDPFC NFIA Indirect Taxes Subsidies Depreciation Ans.

= = = = =

10,000 500 1,000 500 1,000

Exercise
Q4. Find the GNPMP , NNPFC and PDI Rs. Lakh crore GNPFC Indirect Taxes Subsidies Depreciation Undistributed Profits Corporate Taxes Personal Taxes Ans.

= = = = = = =

15.00 2.00 1.00 1.2 0.5 3.00 1.50

Exercise
Q5. Find the GNPMP , GDPMP, NNIMP, NDPMP and PDI Rs. crore GDPFC = 30,000 Indirect Taxes = 4,000 Subsidies = 2,000 Depreciation = 2,000 Undistributed Profits = 1,250 Corporate Taxes = 6,000 Personal Taxes = 4,000 Factor Income received from abroad = 7,500 Factor income paid abroad = 9,000 Ans.

Q6. A) Find the real national income or national income at constant price. B) Find the real annual growth in NI for various years

Year

NI AT Current Prices (Rs 000 crores)

Wholesale Price Index Number (Base 1993-94=100) 112.6 121.6 127.2 132.8

1994-95 854.1 1995-96 941.8 1996-97 1093.9 1997-98 1376.8

1998-99 1583.1
1999-00 1740.2 2000-01 1878.4

140.7
145.3 155.7

2001-02 2060.6

161.3

Methods of Estimating National Income

A quick recap

NI

NNPFC

NNPFC =
NDPFC =

NDPFC

NFIFA

GDPMP D + S T

We will now estimate NDPFC by the 3 methods

3 Interpretation of NI
National Income = National Product = National Expenditure

Y= O=E

The sum of values of all goods and services produced ( Production).

The sum of all incomes, in cash and kind, accruing to factors of productions in a year (Distribution). The sum of consumers, investment and government expenditure (Expenditure).

Sectors used for Estimates

3 Methods of estimating NI
Value Added Method Income Method

1.

2.

3.

Expenditure Method

1. Value Added Method

Called as Output or Production method Value added is the difference between a firms sales and its purchase of raw materials and services from other firms. The economy is divided into different industrial sectors:

Agriculture, fishing, mining, manufacturing, construction, trade, transport, communication ..............

Contribution of each enterprise to the generation of flow is measured

1. Value Added Method

Objective Estimate Total Output/ Production

Method of Estimation

Value Add

Value Add

Output Price

Input Cost

Source of Data

Enterprises

The Process
Classification into industrial sectors Calculate Net Output for each enterprise Subtract Input cost Subtract Depreciation & Indirect Tax Total units produced X MRP O - I = P (production) PD+ST

= Value Add of each enterprise

Collate for all enterprises in a sector Collate for all sectors Sector contribution NDPFC

Precautions
To be Included in NI Not to be included in NI 1. 2. 3. Sale and purchase of second hand goods Value of intermediate goods Value of services of Housewives

1. Rent of self- occupied

houses 2. Value of production for self consumption

2. Income Method

It approaches NI from distribution side To produce goods and services we require the factors of production The owners of these factors participate in the production for which they receive INCOME Wages, rent, interest and profit.

It identifies the productive enterprises and classify them into various sectors
Its the sum of incomes of all individuals of a country

2. Income Method
Objective Estimate Total Income Wages, Rents, Interests, Profits. land vs capital labour vs entrepreneurial function Labour Capital Mixed Enterprises

Income Difficulties in differentiating earnings Income Classification Source of Data

The Process
Classification into industrial sectors Classify factor payments Measure Labour Payments Labour, Capital, Fixed Wages & Salaries

Why have we not accounted for

Measure Capital Payouts 1. Depreciation

& 2. Rent/ Interest income received by Individuals Measure Mixed Income Self-employed (Salaries cum Profits)3. Exports/ Imports

Dividends, Undistributed Profits IndirectInterest, TaxesRoyalties, Rent

Collate for all enterprises in a sector Collate for all sectors

Sector contribution NDPFC

Precautions

To be Included in NI

Not to be included in NI 1. 2. 3. 4. 5. Transfer Payments Illegal Money Windfall gains- prizes, lotteries Corporate profit Tax Sale of second- hand goods

1.Imputed rent of self- occupied

houses 2. Value of production for self consumption

3. Expenditure Method
Objective Estimate Total Expenditure Individuals or Households

Nature of Expenditure

Government

Enterprises

Expenditure by foreigners on Exports Expenditure on buying Imports

The Process
Final private consumption expenditure Governments final consumption expenditure Gross domestic capital formation (Fixed capital + Addition to stocks) Net Exports Summation = Total Expenditure Subtract : Depreciation Subtract : Indirect taxes C (individuals/ households) G

I (enterprises) X-M C + G + I + (X-M) = GDPMP

GDPMP D = NDPMP
NDPMP (S-T) = NDPFC

Precautions
Not to be included in NI 1.
2.

Sale and purchase of second hand goods Expenditure on intermediate goods Expenditure on Transfer Payments Purchase of shares and Bonds as they do not add to NI.

3.

4.

In Sum

Value Added

NI = (P-D) + (S-T) + (X-M) + (R-P)

Income

NI = (w + r + i + n) + (X-M) + (R-P)

Expenditure

NI = (C + I + G) + (X-M) + (R-P)

Choice of Method

Choice of Method depends upon

i) The purpose of national income analysis ii) Availability of necessary data

The task of estimating NI in India is with CSO ( Central statistical organization) CSO uses output and Income method Output Method Agriculture and Manufacturing Income Method - Services

Difficulties in calculating NI
1.

Non- Monetized Transactions Black Money

2.

3.

Double Counting
Transfer Incomes Growing Service Sector Household Services Social Services Environmental Cost Government Incomes Capital Gains

4.

5.

6.

7.

8.

9.

10.

Difficulties in India
1.

Reliable data is not available Large regional diversity Illiteracy Lack of differentiation of economic functions Presence of unorganized sectors Presence of large non- monetized transactions

2.

3.

4.

5.

6.