National Income and Circular Flow

National Income

• National income encompasses all income within a nation, essential for economic understanding
• Understanding national income is vital to gauge an economy's health and activity
• This unit explores national income principles, methods, and importance
• Macroeconomics focuses on aggregate demand and supply, not individual components

Circular Flow of Income

• Circular flow describes the continuous movement of income and expenditure in an economy
• Four sectors exist within an economy, those are household, firms, government, and foreign sector

Sectors of the Economy

• Households: Consumers of goods and services
• Firms: Producers of goods and services, relying on factors of production
• Government: Manages resources, provides services, and ensures fair pricing
• Foreign Sector: Engages with the domestic economy through trade and financial flows, also known as the "Rest of the World"
• Simplified economies are modeled with two sectors
• Two-sector economies include only households and firms for simplicity

Flow Between Households and Firms

• Firms need factors of production that are land, labor, capital, and entrepreneurship
• Households provide factor services to firms like land, labor, capital, and entrepreneurship
• Factor services lead to income generation, as firms pay for these services
• Firms provide factor payments to households such as rent, wages, interest, and profit
• Payments create income for households, enabling consumption expenditure
• Households spend their income to purchase goods and services from firms, initiating consumption expenditure
• Consumption spending leads to the creation of Goods and Services, which generates income for the firms, that fulfills household needs and starts the cycle all over again
• In the entire circle, Money is exchanged, first going from households to firms, and the turning back from the firms to household
• There is a constant circular flow of money and goods and services

Flow Types

• Money Flow: Circulation of money among sectors for payments and expenditures
• Real Flow: Exchange of goods and services between households and firms
• There are money flow and a real flow in circular flow of income

Three Phases of Circular Flow

• Generation Phase: Firms produce goods and services using factor services, leading to the generation of income
• Income Phase: Households receive income through factor payments
• Expenditure Phase: Households spend their income on goods and services
• The Generation, Income, and Expenditure phases may also be called Generation, Distribution, and Disposition, or Production

Real Flow vs Money Flow

• Real Flow: Flow of goods and services between households and firms
  • Factor services from households to firms
  • Goods and Services from firms to households
  • The exchange of goods and services
  • Also known as "Physical Flow"
• Money Flow: Flow of money between households and firms
  • Factor Payments from firms to households for factor services
  • Corresponding Consumption Expenditure from households to firms
  • The exchange of money
  • Also known as "Nominal Flow"

Sectors in an Economy

• Four major sectors: household, firms, government, and rest of the world

Two-Sector Economy

• Focuses on interactions between households and firms
• Illustrates how they exchange goods and services and money

Stock and Flow

• Differentiating between stock and flow variables is essential for understanding economic dynamics
• Stock: Quantity measured at a specific point in time (e.g., bank balance)
• Flow: Quantity measured over a period of time (e.g., production)
• Time dimension determines whether something is Stock or Flow
• Time dimension does not exist for a particular point in time

Real world Stock and Flow examples

• Water flowing down a Tap and filling a container shows a flow
• Still water in a container shows a stock

Stock Variable vs Flow Variable

• Stock Variable: Measured at a particular point in time
  • Example: Population, Wealth, Capital
  • Static concept
  • No time dimension
• Flow Variable: Measured over a period of time
  • Example: Production, Profit, Loss
  • Dynamic Concept
  • Time dimension does exist

What is a Domestic Territory?

Domestic Territory

• The area administered by a government
• People, goods, and capital circulate freely
• Governed by government

Additions to Domestic Territory Definition

• Embassy: A country's embassy in another country is part of its domestic territory
• Consulate: Government official office is part of that territory
• Military Establishment: A country's military base or camp abroad is part of its territory
• Ships and Aircrafts: Ships and aircrafts owned or operated by the country and located in international waters or airspace
• Fishing Vessels: A country's fishing in the water is part of its territory
• Oil and Natural Gas Rigs: A country's oil and natural gas rigs contained in the water is part of its territory

What is excluded from Domestic Territory definition?

• Military of other countries contained in a country's territory
• Any International Organization, Like the UN or WHO

Normal Resident

• A person who lives in a country for more than one year
• Their economic interests (earning, spending) are in that country

Citizenship

• A legal determination that gives the person legal rights
• Citizenship is obtained by birth or government approval
• Residency can exist in multiple territories but not Citizenship

Residency

• Economic Concept which is based on basic economic activities
• Normal Resident of a Country ordinarly resides in the Country for more than a year

What is Factor Income?

• Income people earn from production (rent, wages, interest, profit)
• Labor should be of effort to earn income, earning is the term to classify as a factor income

Factor Payment vs Transfer Income

• Factor income is always earned and cannot be transfer
• Transfer refers to things freely given
• Transfer Income is without productive services like scholarships, old age pensions, and unemployment allowances

Intermediates and Final Goods

• Intermediate Goods: Resold or used in further production within the same year
• Final Goods: Purchased for consumption or investment, not for resale
• Goods held for over a year become final, regardless of original intent

Final Goods

• Consumer Goods: Purchased by households for personal satisfaction
• Capital Goods: Used by firms for further production e.g., machinery
• Distinguishing Capital Goods and consumer goods happens by user/purpose not by the good itself
• Examples: Sugar purchased by a tea stall (intermediate) vs. by a consumer (final)

Stock of Sugar vs Production for use

• Stock of sugar left at a the end of the year of production, and was not resold or to be use in other production means that the business now holds that good for more than a year
• Car Purchased by a car dealer will be an intermediate good
• The same with clothes purchase depends on the end user

Consumption Good divisions

• Non Durable
• Semi-durable
• Durable
• Services

Production Boundary

• Separates intermediate and final goods
• Intermediate goods are used within the boundary, final goods are outside

Investment vs Capital

• Investment increases the capital stock through new hospitals, school, colleges etc

Gross Investment vs Net Investment

• Gross and Net investment are calculated respectively before and after accounting for capital consumption, also known as depreciation

Calculation of National Income

National Income Calculation

• It requires measuring economic activity in money value (rupees). Production is measured in units
• Aggregates are the sum of all goods and services in money terms

The Structure of Aggregate

• Four major components
• Total of 8 Aggregates
  • Gross vs Net
  • Domestic vs National product
  • Product
  • Factor cost vs market price

What is Gross?

• The value of the product before taking depreciation into account

What is Net?

• The value of something after depreciation has been taken from its original value

Domestic and National

Domestic income

• All money earned within a domestic territory

National income

• All money earned, both outside and inside domestic territory
• Total income, including income from factor of production from abroad
• Domestic to National income is acquired through adding net factor income from aboard Nifa
• Nifa= Fifa-Fita

The different terms used to describe Deprecation

• "Consumption Of Fixed Capital"
• "Replacements Cost of Fixed Factors"
• "Current Replacement Cost"

Factor cost vs Market Price

• Factor cost it's the value + normal Profit
• Market Price Is the overall price + indirect taxes
• MP is always above FC
• Adding NIT to factors makes them Market, to switch back subtract NIT

Components that make up Net indirect tax

• "Indirect Tax" - subsidies = NIT
• Some taxes are sales, service tax, vats which are all now GST

The eight Types of Aggregate

• Domestric Level
  • GDPPC
  • GDPMP
  • NDPFC
  • NDPMP
• National level is the same thing
  • GNPFC
  • GNN@Mp
  • NNPFC
  • NNPMp

Formulae

• Domestic Income: NDP @FC
• National Income: NNP @ FC

Problem solving for finding NI via GDP etc

• Step 1, keep destination point on left
• Everything else on the right

Calculation Example

• GDP at MP = 50000
• Depreciation = 500
• Factor income from abroad = 5000
• Factor income to abroad = 2000
• GST = 400
• Subsidies = 500
• Find NNPFC i.e., national income
• NNPFC = GDP at MP - depreciation + NFIA (FIFA - FITA) - NIT (GST-Subsidies)
• NNPFC = 50000 - 500 + (5000 - 2000) - (400-500)
• = 50000 - 500 + 3000 - (-100)
• = 50000 - 500 + 3000 + 100
• = 52600

The methods to measure National Income

• 3 methods exist
  • Income Method
  • Expenditure Method
  • Value Added Method

Which is more important, the Value Added method of production?

• Formula:-
  • Value of Output (VO) - Intermediate Consumption (IC) = GVA at MP = GDP at MP
• When a firm produces a good, get value of output from it before extracting material cost
• The same formula at VO - IC (Raw material cost to get it too market produce the product.)

How to determine the variable for each stage in production

• In initial calculation the production can be negative due to IC being higher than VO
  • When calculating the VO make sure you take into sales plus change in stock/inventory

Steps to make calculation easier

• Work out the value of all 3 methods
• VO(Sales + Change in stock/inventory)
• Raw Material + Expenses + transportation etc. cost Include Export if Domestic, else total sale will be all you need to make Sales as the starting point
• Goods produced for self Consumption this is always included into the VO output

From the following data, calculate the value added by Firm A and B and their GPD @MP and NDP at FC

• Sale by A to General Government = 100 Cr
• Sale by A = 500 Cr
• Change in A = 20Cr
• Closing stock B = 40cr
• Opening stock B = 30 Cr
• Purchases by A = 320Cr
• Indirect tax = 750 Cr
• Consumption fixed capital 120
  • VO
  • Firm A
    • V = 500Cr + 20CR = 520cr
  • VO B
  • Closing - opening = 10 cr,
  • Sale to general government and household, 10 cr + 350 = 450Cr
• Intermediate Consumption (IC) is the key variable to remember

Expenditure method calculations.. The GDP part

• Government Final Consumption Expenditure (GFCE)
• Gross Domestic Capital Formation (GDCF)
• Net Exports
• Private Final Consumption Expenditure (PFCE)

Income Level determination

Government final consumption

• Salaries to government, or the operation etc

Investment

• Gross domestic capital formation
• Net Domestic Fixed Capital Formation (NDFCF) plus change in stock

Export

• Export minus IMPORT

Private final consumption

• Households

Value the investment of different items on expenditure

• Net Dom fix CF
• Plus Depreciation to get Gross
• Add, the stock after that

How to get to the National level from the Domestic level

• Add the Net Factor Income from Abroad (NFIA)

In come method - the components to get the income - NDP @ FC

• Profit
• Rent
• Interest
• Mixed income
• Compensation of employees (COE), make sure it is just employer

Profit

• Can be dividends, corporate tax and/or retaining earnings

Compensation of employees

• Salaries, wages and bonuses
  • Pay
  • Pay in kind (e.g., Insurance)

What constitutes operated surplus?

• Part of income method
  • Rent and royalties
  • Interest

Important components of Factor income from abroad

• Compensation of employees includes:
  • Net Retained Earnings -Net

Property and rent

• Includes Net Income from Abroad (NFIA) with both negative and positive values
• Comparison of Real income and Nominal income indicates what is best to compare from and use for

What is domestic and national income composed of?

• Domestic income is territory domestic, and resident is for national income calculations

What if you use GDP for welfare?

• Only do that if distribution is proper
• Domestic service doesn't fail
• Negative or Positive

Components of Net Income from Abroad (NIAF) and other factor related components?

• Current Price

National Income @ Constant Price (NI @ cp) vs Current Price (NI @ Conp)

• Constant price is the real price
• Base year is the comparison year

Constant price vs 1st, what it means the two to compare

• 1. Real GDP

GDP deflator

• Nominal GDP / Real GDP
• Real is $500

Index in GDP

The 3 main factors

Economic

The market

Money definitions

• Money is any means of exchange that is accepted as such:
  • A means to exchange like debit card
  • A store of value
  • A unit of account It Includes coins, and debit/credit

The functions - primary and sub

What is Money Supply

• Total money in hand of public not the government
• Held by the public
• Point and that particularity - Stock concept

M1

• The fast one to obtain, this includes the cash

1. Coins
2. Commercial bank deposits
3. Other bank deposits

What is Cential bank the function

• Apex power, controlling power

• Money supply and control money -If 2 banks need help, what occurs?:

Lender of last resort

• If commercial don't make benchmarks and what to ask bank for help
• Clearinghouse functions
• Supervising role

Reserve Ratio (RR)

• The power

Margin requirements

Credit creation

5

Foreign exchange

Commercial bank (CB)

Money Multiplier (Mutiplar) Process

• Money multiplier = 1/LRR (Legal Reserve Ratio)

Relationship with others

• What are the minimum and maximum values?

• Now the aggregate

• The aggregate demand at conc -The difference between aggregate demand and aggregate supply

• Increase sales as a key factor in a high-growth economy

• Aggregate Demand and Supply intersect at a point creating equilibrium

What's

• The gap

The expenditure part

• Aggregate Supply curve can be horizontal or upward-sloping

The income (Y) is C + I, where:

• C = Consumption
• I = Investment

In equilibrium:

• Y = C + I
• If injections > leakages, Y increases
• If leakages > injections, Y decreases

Increase national income through increasing the government expenditure