National Income

Lecture Plan
Introduction to National Income
Concepts of National Income
Real and Nominal GDP
Methods for Measuring National Income
Uses of National Income Data
Difficulties in Measurement of National
Income

Learning objective
To understand various concepts of national
income, like GDP, GNP and NNP.
To understand the different methods of
measuring national income.
To understand the importance of national
income calculations.
To understand the difficulties involved in
the calculation of national income.

National income is defined as the money

value of all the final goods and services
produced in an economy during an
accounting period of time, generally one
year.
Accounting Year= 1st April-31st March

Concepts of National Income

Gross Domestic Product (GDP)

Gross National Product (GNP)
Net Domestic Product (NDP)
Net National Product (NNP)
Per Capita Income
Disposable Income

Gross Domestic Product

Gross Domestic Product (GDP): GDP is the sum
of money values of all final goods and services
produced within the domestic territories of a
country during an accounting year.
GDP= C+I+G+(X-M)
GDP at market price: includes the final value of
goods and services also includes indirect taxes and
excludes the subsidies given by the government.
GDP at factor cost is the money value of final
goods and services based on the cost involved in
the process of production.
Gross Domestic Product at factor cost
= GDP at Market Prices Indirect Taxes+ Subsidies

Gross National Product

Gross National Product (GNP): GNP is
the aggregate final output of citizens and
businesses of an economy in a year.
GNP may be defined as the sum of Gross
Domestic Product and Net Factor Income
from Abroad (NFIA).
GNP = GDP + NFIA
GNP = C+I+G+(X-M)+NFIA
Net Factor Income from Abroad:
difference between income received from
abroad for rendering factor services and
income paid towards services rendered by
foreign nationals in the domestic territory

Net Domestic Product and

Net National Product
Net Domestic Product
= GDP-Depreciation
Net National Product (NNP)
= GDPDepreciation +NFIA
Or =GNPDepreciation
Thus NNP is the actual addition to a years wealth and is the sum of
consumption expenditure, government expenditure, net foreign
expenditure, and investment, less depreciation, plus net income
earned from abroad.
= C+I+G+(XM)Depreciation + NFIA
NNP at Factor Cost is the sum total of income earned by all the
people of the nation, within the national boundaries or abroad
It is also called National Income.
NNP at Factor Cost = NNP at Market Prices Indirect Taxes+ Subsidies

?
Why should a manager monitor
GDP growth?

Per Capital Income and Personal

Income
Per capita income is the average income of the people of a country
in a particular year.
National Income
Per Capita Income =
Total Population

Personal income is the total income received by the

individuals of a country from all sources before direct
taxes in one year.
Personal Income = National Income Undistributed Corporate
Profits Corporate Taxes Social Security Contributions + Transfer
Payments + Interest on Public Debt

Personal Disposable Income is the income which can be

spent on consumption by individuals and families.
Personal Disposable Income = Personal Income Personal Taxes

Real GDP and Nominal GDP

Nominal GDP = National income estimated at the prevailing prices is
called nominal GDP.
Real GDP=National income measured on the basis of some fixed
price, say price prevailing at a particular point of time, or by taking a
base year, is known as national income at constant prices, or Real
GDP

GDP Deflator =

Nominal GDP
x100
Real GDP deflator

GDP deflator is the ratio of nominal GDP in a year to real GDP of

that year
GDP deflator measures the change in prices between the base
year and the current year.

?
How far national income of a
country a measure of welfare?

?
What is the Difference between
GDP and GNP?

Whether unemployment
allowance from the government
is to be included in the national
income. Why or Why not?
Will the transfer payment be a
part of personal income or not?

GDP and Economic

Well-Being

GDP is the best single measure of the

economic well-being of a society.
GDP per person tells us the income and
expenditure of the average person in
the economy.

GDP and Economic

Well-Being

Higher GDP per person indicates a

higher standard of living.
GDP is not a perfect measure of the
happiness or quality of life, however.

GDP and Economic

Well-Being
Some

things that contribute to well-being

are not included in GDP.
The value of leisure.
The value of a clean environment.
The value of almost all activity that takes
place outside of markets, such as the
value of the time parents spend with their
children and the value of volunteer work.

Methods of measuring national income

Product (or Output) Method
Income Method
Expenditure Method

Product (or Output) Method

The market value of all the goods and services produced
in the country by all the firms across all industries are
added up together.
Process

The economy is divided on basis of industries, such as

agriculture, fishing, mining and quarrying, large scale
manufacturing, small scale manufacturing, electricity, gas, etc.
The physical units of output are interpreted in money terms
The total values added up. (GDP at market price)
The indirect taxes are subtracted and the subsidies are added.
(GDP at factor cost)
Net value is calculated by subtracting depreciation from the total
value (NDP at factor cost).

Limitations of Product Method

Problem of Double Counting:
unclear distinction between a final and an intermediate
product.
Not Applicable to Tertiary Sector:
This method is useful only when output can be measured
in physical terms
Exclusion of Non Marketed Products
E.g. outcome of hobby or self consumption
Self Consumption of Output
Producer may consume a part of his production.

Income
Method

The net income received by all citizens of a country in a particular

year, i.e. total of net rents, net wages, net interest and net profits.
(GDP at factor cost).
It is the income earned by the factors of production of a country.
Add the money sent by the citizens of the nation from abroad and
deduct the payments made to foreign nationals (individuals and firms)
(GNP at factor cost) or Gross National Income (GNI).
Process:
Economy is divided on basis of income groups, such as
wage/salary earners, rent earners, profit earners etc.
Income of all the groups is added, including income from abroad
and undistributed profits.
The income earned by foreigners and transfer payments made in
the year are subtracted.
GNI = Rent + Wage + Interest +Profit + Net Income from AbroadTransfer payments

Limitations of Income Method

Exclusion of non monetary income: Ignores the nonmonetized section of economic activities.
Exclusion of Non Marketed Services: People
undertake a particular activity that are difficult to ascertain
in money value. E.g. mothers services to the family.

Expenditure method
One mans income is another mans
expenditure
Therefore national income can be
arrived at by adding the total
expenditure of individual and
business firms during a year
Expenditure or outlay on final
products takes place in three ways
24

Expenditure method
Expenditure or outlay on final products takes
place in three ways
Expenditure by consumers on goods and
services( Consumption Expenditure)
Expenditure by entrepreneurs on capital or
investment goods (Investment Expenditure)
Expenditure by government on consumption
and capital goods (Government Expenditure)
Net Exports
25

Expenditure method
The formula for this method is
Y = C + I + G +(X-M)

Here Y stands for total expenditure

C stands for consumption expenditure
I stands for investment expenditure
G stands for Government expenditure
(X-M) Difference between exports and imports
26

Limitations
Neglects Barter System
Ignores over consumption
Affected by Inflation

27

Difficulties in the computation

of National Income

In backward economies like India, particularly in the rural sector, the cu

28

Uses of National Income Data

National income is the most dependable indicator of a countrys econ

Summary

GDP is the sum of money values of all final goods and services produced
within the domestic territories of a country during an accounting year. It can be
measured at current or constant prices.
GNP is the aggregate final output of citizens and businesses of an economy in
one year. NNP is GNP less depreciation.
The average income of the people of a country in a particular year is per
capita income for that year.
National income can be measured by product method, income method and
expenditure method.
National income accounting data are of utmost importance for the economy of
any country; such data reveal the aggregate production of the economy and
also help to determine the total expenditure and total income of that country.
Difficulties in measuring national income include multiple counting, exclusion
of non market transacted services, self consumption of output, inflation or
deflation, confusion about informal sector, etc.
National income is considered as a measure of economic welfare. As national
income rises, the aggregate production of goods and services rises.
Therefore, there is a positive relation between increase in national income and
welfare.

??????????????

?
Consider an economy that produces
only three types of goods: A, B and
C. In the base year (a few year ago),
the production and price data were
as follows:
Fruit

Quantity

Price

3,ooo

$2

6,000

$3

8,000

$4

In the current year the production and

price data are given as follows
Fruit

Quantity

Price

4,000

$3

14,000

$2

32,000

$4

Find the nominal GDP and real GDP.

Find the GDP deflator for the current
year and the base year. By what
percentage does the price level
change from base year to current
year?

Circular Flow of Income

Learning Objectives
To explain the circular flow of economic activity and
income:
Two- Sector Model
Three- Sector Model
Four- Sector Model
Injections and Leakages in the circular flow of
economic activity.

Circular Flow of Economic Activities and Income

The simple model of the circular flow assumes two players
Firms
Produce and supply the goods and services.
Require various factors of production to produce these goods and services.
Households
Include a set of individuals living in the same house
Take joint decision about the consumption of goods and services.
Provide services in terms of factor inputs to the firms
Get paid for these services by firms which households spend on
consumption.
Money flows from firms to households as factor payments and from
households to firms as expenditure on goods and services.
It is a circular flow of money or income

Circular Flow of Income

(Two Sector Economy)
(Wages, Rent, Interest and Profits)

Factor Payments
(Y)
Factor Inputs

Households

Savings
(S)

Financial
Market

Investment
(I)

Firms

Goods and
Services (O)
Consumption
expenditure
(C)

In the equilibrium Y=C+S=C+I=E=O

Circular Flow of Economic Activities and Income

Value of output produced (Y) = value of output sold (O)

Value of output sold = Sum of consumption expenditure (C) and
investment expenditure (I).
Y=O=C+I=E(1)
Income is either consumed or saved (S).
Y=C+S.(2)
C+I=Y=C+S(3)
Therefore:
I = S(4)
Savings are withdrawal of money from the circular flow
Investment is injection of money into the circular flow
For equilibrium savings should be equal to investments
Hence Y=O=E

Circular Flow of Income

(Four Sector Economy)
The third sector is Government (G)

Government Spending

On provision of public utility goods and services.

Provides salaries to the households
Pays to firms for purchases of goods and services

Government Revenue

Households and firms pay various taxes and other payments and
provide factor inputs to the government.
Government borrows from the financial market to fill revenue gap.

The fourth sector is the external sector

Imports (M): Outflow of income occurs when the domestic firms buy
goods and services from foreign ones.
Exports (X): Inflow of income takes place when foreign firms buy
goods and services from domestic ones

Circular Flow of Income

(Four Sector Economy)
Governme
nt (G)
Taxe
s
Salarie
s
Savings
(S)

Househol
ds
Import
s
(M)

Factor
Payment
s
Factor
Inputs
Financial
Market

Taxe
s

Investme
nt
(I)

Good
s
(O) Consumpti
on
Expenditur
e
Foreign
Export
Export
Nations
s
s
(X-M)
(X)
(X)National Income=C+I+G+(X-M)

Remittance
s for
purchases

Firms
Import
s
(M)

Circular Flow of Income

(Four Sector Economy)
National income includes expenditures on consumption investment,
government and net of exports (X-M)
National Income=C+I+G+(X-M)
Since national income can either be consumed, or saved, or paid as tax to
the government:
C+I+G+(X-M)=C+S+T
I+G+(X-M) =S+T
Sum of private investment and expenditure on net exports is equal to the
sum of savings and tax revenue. Thus:
I+G+X =S+T+M
Therefore,
W=J
At equilibrium, total injections are equal to total withdrawals.

Objectives
To explore the realms of inflation and its
different frontiers.
To delve into concepts like wage price spiral,
hyperinflation and inflationary gap.
To understand various measures of inflation
and their role in decision making.
To analyze the reasons behind inflation, its
impact on the economy and the measures to
curb it.

Inflation

Coulborn: it is a state of too much money chasing too few

goods.
Two broad categories:
price inflation (generally called as inflation)
money inflation.
Money inflation is increase in the amount of currency in
circulation. Which may be due to:
Deficit financing : direct cause is printing of additional
currency on demand of the government to meet its
needs.
Additional money supply through foreign exchange
inflows in the form of capital, such as foreign direct
investment and foreign institutional investment,
tourism and other incomes from abroad.

Price inflation is a persistent increase in the general

price level or a persistent decline in the real
income of people, i.e. decline in value of money.

Concepts of Inflation

Headline Inflation: measure of the total inflation within an

economy
affected by the areas of the market which may experience
sudden inflationary spikes such as food or energy.
Hyperinflation: prices increase at such a speed that the
value of money erodes drastically
This is also known as galloping inflation or runaway
inflation.
Stagflation: a typical situation when stagnation and inflation
coexist.
Disinflation: a process of keeping a check on price rise by
deliberate attempts.
Deflation: a state when prices fall persistently; just opposite
to inflation
Inflationary Gap (Keynes): Excess of anticipated
expenditure over available output at base price
When money income exceeds the supply of goods and
services, a gap is created between demand and supply

Wage Price Spiral

Wages chase prices and prices chase wages, thus
create a wage price spiral.
When prices rise, workers
demand higher money (or
nominal) wages to protect
their real wages. This raises
the costs faced by their
employers.
To protect the real value of
profits producers pass the
higher
costs
onto
consumers in the form of
higher prices.
Workers (who are also
consumers
demand
for

Prices Rise
Cost of
production rises

Wages rise

Cost of
living rises

Causes of Inflation

Demand Pull Inflation: when aggregate demand increases due to any

reason, and supply of output is unable to match this increased demand;
i.e demand pulls prices up.

Increase in money supply/ Increase in disposable income

Increase in aggregate spending

Increase in population of the country

Cost Push Inflation: An increase in price of any of the inputs will
increase the cost of production; i.e. prices pushed up by cost.
Low Increase in Supply: if supply falls short of demand, prices will
increase.

Obsolete technology/Deficient machinery

Scarcity of resources

Natural calamities/ Industrial disputes/ external aggressions

Built in Inflation: Built in inflation is a type of inflation that has resulted
from past events and persists in the present.

It is also known as hangover inflation.

Inflation and Decision

Making

Impact on Consumers
increase in any price upsets the home budget.
Impact on Producers (or Suppliers)
Producers as sellers are benefited by inflation;
higher the prices, higher are their profits.
when as buyers of raw material, they are adversely affected by inflation.
Impact on Government:
Government has to take the economy to higher levels of growth by
encouraging production and investment,
At the other end, has to see that taxpayers money is not eroded by
hyperinflation.
Thus government has to act as the balancing force between consumers
and sellers.

Measuring Inflation

A price index is a numerical measure designed to compare

how the prices of some class of goods and/or services, taken
as a whole, differ between time periods or geographical
locations. (prices of the base year are assumed to be equal
to 100.)
Current Year' s Price
100
Price Index = Base Year' s Price

The most common term used to denote inflation is inflation

rate, which is annual rate of increase of prices.
Inflation Rate

Last year's Index - Current Year' s Index

100
Current Year' s Index

Measuring Inflation

Producer Price Index (PPI): measures average changes in prices

received by domestic producers for their output.
Wholesale Price Index (WPI): measures wholesale prices of a wide
variety of goods (including consumer and capital goods.

USA has replaced WPI with PPI

Consumer Price Index (CPI): measures the price of a selection of goods
purchased by a typical consumer.

CPI differs from PPI in that price subsidy, profits, and taxes may cause
the amount received by the producer to differ from what the consumer
paid.
Cost of Living Indices (COLI): used to adjust fixed incomes and
contractual incomes to maintain the real value of such incomes.

wage indexation is based on such indices.

Service Price Index (SPI): With the growing importance of service
sector across the world, many countries have started developing services
price indices (SPI).

Control of Inflation
Inflation erodes the value of money and
discourages savings
But zero inflation is undesirable
Need to control inflation

monetary policy measures (proposed by those

who believed money supply is the major
culprit)
fiscal policy measures (proposed by Keynes
and his followers).
Other measures

The government has to adopt an

appropriate combination of these
measures after thorough examination of
the causes of inflation

Monetary Policy
Measures
Increasing the discount rate: The central
bank rediscounts the eligible papers offered
by commercial banks. This is also called
bank rate.
Higher reserve ratios:
Cash Reserve Ratio (CRR)
Statutory Liquid Ratio (SLR)

Open market operations: directly sell

government securities to public and restrain
their disposable income
Selective credit control: discourages
consumption but not investment

Fiscal Policy Measures

The government may reduce public expenditure or
increase public revenue to keep a check on
inflation
Reducing public expenditure
When government spends on activities like
health, transport, communication, etc., income of
individuals increases; this in turn increases the
aggregate demand.
Therefore the reverse will also be true.

Increasing public revenue

Major source of government revenue is various types of
taxes
Increase in income tax leaves less of disposable income
in the hands of consumers

Learning Outcomes:
1. Meaning and Scope of monetary policy;
2. Instruments of monetary policy;
3. Role of Monetary Policy in achieving
macroeconomic goals;
4. Effectiveness
monetary policy.

and

limitations

of

Monetary policy refers to the

action

taken

authorities
regulate

the

by
to

the

monetary

control

demand

for

and
and

supply of money with a given

purpose.

Scope of Monetary Policy:

The

scope

depends,

of

by

monetary

and

large,

policy
on

two

factors:
i. The level of monetization of the
economy, and
ii. The level of development of the
financial market

INSTRUMENTS OF
MONETARY POLICY
General Credit
Control Measures
1. Bank Rate
2. CRR
3. Open Market
Operations
4. SLR
5. Repo Rate
(Repurchase

Selective Credit
Control Measures
1. Credit Rationing
2. Change in Lending
Margins
3. Moral Suasion
4. Direct Controls

General Measures:
1. Bank Rate Policy:
. The rate at which central bank lends
money to the commercial bank and
rediscounts the bills of exchange
presented by commercial banks is
termed as bank rate

 The central bank can change this

rate-

increase

or

decrease-

depending on whether it wants to

expand or reduce the flow of credit
from the commercial banks.
Current Bank rate (Dec, 2012):
9.00 %

Limitations of BR as a Weapon
of Credit Control
1. Nowadays, commercial banks are
not dependent

only on financial

support from central bank, which

makes change in rate ineffective.
2. With

the

growth

institutions

and

of

credit
financial

2. Cash Reserve Ratio:

Also termed as Statutory Reserve
Ratio (SRR)
It is the percentage of total deposits
which

commercial

banks

are

required to maintain in the form of

cash reserve with the central bank.
Objective

of

CRR

is

to

prevent

 By changing CRR, the central bank

can

change

the

money

supply

overnight
When contractionary monetary policy
is to be adopted , then the central
bank raises the CRR
When expansionary monetary policy
is to be adopted then central bank

3. Open Market Operations

Open Market Operations is the sale

and

purchase

of

government

securities and Treasury Bills by the

central bank of

the country.

WHAT ARE TREASURY BILLS?

 In India, Treasury Bills are short-term

promissory

notes

issued

by

the

Government of India through the

RBI.
There are two kinds of Treasury Bills:
a) 91-

Day Bill : are issued by the

RBI on behalf of the government at

fixed discount rate of 4.6 %. The

b) 182- Day Bill: introduced in 1986,

are sold by

auction to residents of

India for a minimum value

of Rs

1,00,000.
The auction bid is invited every
fortnight and the discount rate is
decided on the basis of auction rate.

 When central bank decides to pump

money into circulation, it buys back
the government securities, bills and
bonds
When it decides to reduce money in
circulation, it sells the government
bonds and securities.

How

the

bonds

sale

affects

of
the

government
supply

of

credit?
1. Purchase of govt. securities reduces
deposits with commercial banks and
their cash reserves which leads to
decreased credit creation capacity of
the banks.

 When commercial banks themselves

decide to buy the govt. bonds and
securities, their cash reserves go
down which further reduces credit
creation capacity of the commercial
banks.

How the sale of government

bonds affects the

demand of

credit?
1. Central banks sells the government
bonds them at a reduced price, i.e.,
at

price

less

than

their

denominated price.
2. Consequently, the actual rate of

3. The rise in the rate of interest

reduces the demand for credit.

Effectiveness of OMO
Under the following conditions, OMO
do not work properly:
1. When commercial banks possess
excess liquidity.
2. In UDCs where banking system is
not well developed and security
capital

markets

are

not

TIME FOR QUIZ

1. What is meant by monetary policy?

2. What monetary measures have
been used by the RBI to control
inflation in the country?
3. How does the working of OMO
affect the money supply in a
country like India?

4. Statutory Liquidity Ratio:

Under SLR, the commercial banks
are required to maintain a certain
percentage of their total daily
demand and time deposits in the
form of liquid assets.

 Liquid assets include:

a) Excess reserves
b) Unencumbered government
securities, e.g. bonds of IDBI,
NABARD, Development Banks,
debentures of ports, trusts etc.
c) Current account balance with other
banks

5. Repo rate: RBI buys securities

from banks and thereby provides
funds to the banks. The rate of
interest at which the RBI lends
money to the bank is the repo rate.
6. Reverse repo rate: is the rate at
which the banks can buy securities
or deposit money with the RBI

Quiz
1. What do you understand by SLR,
Repo Rate, and Reverse repo rate
2. Current rates?
3. How increase and decrease in repo
rate affects the credit creation?

2. Selective Credit Control

Measures:
1) Credit rationing
2) Change in Lending Margins
3) Moral Suasion
4) Direct Controls

Limitations and Effectiveness of

Monetary Policy:
1. The Time Lag
2. Problems in Forecasting
3. Growth of Non-Banking Financial
Intermediaries
4. Underdeveloped Money and Capital
Markets

?
1. Differentiate between general and
selective credit control measures?
2. What are the factors that determine
the effectiveness of monetary
policy?
3. What monetary measures have
been used by RBI in achieving the

FISCAL POLICY
Learning Objectives:
1. Meaning and scope of fiscal policy
2. Differentiate between financial
instruments and target variables
3. Kinds of fiscal policy
4. Fiscal policy and macroeconomic
goals

 The word fisc means state

treasury and fiscal policy refers to
policy concerning the use of state
treasury or government finances to
achieve certain macroeconomic
goals.

Fiscal Instruments
1. Budgetary policy deficit or surplus
budgeting
2. Government expenditure
3. Taxation
4. Public borrowings

Target Variables
Variables which are sought to be
changed through fiscal instruments
are:
1. Private disposable incomes,
2. Private consumption expenditure,
3. Private savings and investment,
4. Exports and imports, and

?
How Fiscal Instruments Affect
Target Variables?

Kinds of Fiscal Policy

1. Automatic Stabilization Fiscal Policy,
2. Compensatory Fiscal Policy, and
3. Discretionary Fiscal Policy

Fiscal Policy and Macroeconomic

Goals
1. Fiscal Policy for Economic Growth
2. Fiscal Policy for Employment
3. Fiscal Policy for stabilization
4. Fiscal Policy for Economic Equality

Crowding Out and Crowding-In

Controversy
Crowding-Out refers to the
adverse effect of high deficit
spending by the government on
private investment.
Crowding-in means rise in the
private investment due to deficit

?
1. What is fiscal policy?
2. Differentiate between fiscal
instruments and target variables?
3. Discuss the role of fiscal policy in
achieving economic growth?
4. Fiscal policy is the most powerful
tool of achieving macroeconomic