National Income PDF

Chapter 5 [10 marks] National Income and related Aggregates measurement of National Income. Meaning of Macro Economics 1) Macro economics is defined as that branch of economics that makes the study of economic problems and economic issues at the level of the whole economy. 2) Vital...

Chapter 5 [10 marks] National Income and related Aggregates measurement of National Income. Meaning of Macro Economics 1) Macro economics is defined as that branch of economics that makes the study of economic problems and economic issues at the level of the whole economy. 2) Vital theories study under macroeconomics 1. Aggregate demand 2. Aggregate supply 3. The general level of price in the economy. Chapter 5 3 3) Macroeconomics studies the determination of aggregate output and the general level of price of the whole economy. 4) When we study macro economics it is assumed that microeconomic variables remain constant. For example : if we are studying the level of output in the economy it is assumed that the distribution of income remains constant. Chapter 5 4 Meaning of National Income ▪ National income is defined as the market value of all final goods and services produced in the economy during the time period of one year. OR ▪ National income is defined as the sum total of value added by all the producing units in the economy during a time period of one year. Chapter 5 5 The circular flow of National income in a simple economy on the basis of the two sector model. ▪ CIRCULAR FLOW OF INCOME (TWO SECTOR MODEL) ▪ INTRODUCTION ▪ In every economy, people undertake economic activities. One person’s expenditure becomes the income of another and so national income is generated. ▪ STATEMENT ▪ “THE CIRCULAR FLOW OF NATIONAL INCOME IS THE CIRCULAR FLOW OF PRODUCTION EXPENDITURE AND PRODUCTION INCOME IN A CONTINUOUS MANNER” ▪ ASSUMPTIONS: ▪ 1. THERE IS CLOSED ECONOMY WITH NO IMPORTS AND NO EXPORTS ▪ 2. THERE ARE ONLY TWO BASIC ECONOMIC UNITS , THAT IS FIRMS AND HOUSEHOLDS ▪ 3. THERE ARE NO SAVINGS IN THE ECONOMY, I.E. NEITHER THE HOUSEHOLDS SAVE FROM THEIR INCOME, NOR THE FIRMS SAVE FROM THEIR PROFITS. ▪ 4. THERE IS NO GOVERNMENT INTERVENTION. Chapter 5 6 ▪ In every economy there are two basic economic units as follows:- a) HOUSEHOLD It refers to the members of the family where basic function is to consume the goods and services. They are the owners and suppliers of their own factor of services of land, labour, capital and enterprises. They also receive rewards in the form of rent, wages, interest etc. b) FIRMS ▪ It refers to the businessmen, who earns factor of income in the form of profits for their business organisations. They also make factor payments like rent, wages, and interest. Chapter 5 7  ▪ The circular flow between households and firms takes place in the following two ways: ▪ 1. REAL FLOW ▪ It refers to the physical flow of goods and services from the firm to the households. Similarly, the flow of factor services like land, labour, cpital from the household to the firm ▪ 2. MONEY FLOW ▪ It refers to the flow of money in the form of consumption expenditure from the households to the firms. Similarly the flow of factor of payments like rent, wages and interest from the firms to the households. ▪ This can be explained with the help of a diagram: Chapter 5 8 Chapter 5 9 ▪ OBSERVATIONS: ▪ 1. The total production made by firm is equal to the total consumption of goods and services by the households. (TOTAL PRODUCTION = TOTAL CONSUMPTION) ▪ 2. The total factor payment made by the firms is equal to the total factor income received by the households. (factor payment = factor income) ▪ 3. The total consumption expenditure by the household is equal to the total income of the firm with no savings. ▪ CONCLUSION ▪ The national income is generated in a circular manner between the firm and the households. Chapter 5 10 Meaning of aggregates of national income {with formula} 1)GDP at MP 2)NDP at MP 3)GNP at MP 4)NNP at MP 5)GDP at FC 6)NDP at FC 7)GNP at FC 8)NNP at FC Chapter 5 11 1) GDP at MP ( Gross Domestic Product at Market Prices) ▪ GDPMP i.e. Gross Domestic Product at market price is defined as the market value of final goods and services produced by the resident producers and foreign producers within the domestic territory of the country during a time period of 1 year inclusive of depreciation. Chapter 5 12 2) NDP at MP ( Net Domestic Product at Market Prices) ▪ NDPMP i.e. Net Domestic Product at market price is defined as the market value of final goods and services produced by the resident producers and foreign producers within the domestic territory of the country during a time period of 1 year exclusive of depreciation. ▪ NDPMP = GDP - Depriciation MP Chapter 5 13 3) GNP at MP ( Gross National Product at Market Prices) ▪ GNPMP i.e. Gross National Product is the market value of final goods and services produced by the resident producers and foreign producers within the domestic territory of a country during a time period of 1 year inclusive of depreciation + Net factor income from abroad. ▪ Net factor Income from abroad is defined and calculated as factor incomes in the form of (rent, wages/ salary, interest and profits earned by our residents from the rest of the world – Factor incomes earned by non residence within the domestic territory of the country) Chapter 5 14 3) GNP at MP ( Gross National Product at Market Prices) ▪ In this concept we take factor incomes of Indians abroad but we do not take factor income of foreigners working in India. ▪ Components of Net factor income from abroad ▪ Net compensation of employees is defined as……. Chapter 5 15 4) NNP at MP ( Net National Product at Market Prices) ▪ NNP MP : Is the market value of final goods and services produced in the country during a time period of 1 year inclusive of net factor income from abroad and exclusive of depreciation. ▪ NNP MP= GNP MP – Depreciation ▪ or ▪ GDP MP + Net factor income from abroad - depreciation Chapter 5 16 5) GDP at FC ( Gross Domestic Product at Factor Cost) ▪ GDP FC : Is the sum total of factor income in the form of rent, wages or salary, interest and profit generated within the country during a time period of 1 year inclusive of depreciation. Chapter 5 17 6) NDP at FC ( Net Domestic Product at Factor Cost) ▪ NDP FC : Is the sum total of factor income in the form of rent, wages or salary, interest and profit generated within a country during a time period of 1 year exclusive of depreciation. Chapter 5 18 7) GNP at FC ( Gross National Product at Factor Cost) ▪ GNP FC : Is the sum total of factor income in the form of rent, wages or salary, interest and profits earned by the normal residence of a country during a time period of 1 year inclusive of net factor income from abroad and depreciation. Chapter 5 19 8) NNP at FC ( Net National Product at Factor Cost) ▪ NNP FC : Is the sum total of factor income in the form of rent, wages or salary, interest and profits earned by the normal residence of a country during a time period of 1 year inclusive of net factor income from abroad exclusive of depreciation. Chapter 5 20 Meaning of the following concepts ▪ Private income ▪ Personal income ▪ Personal disposable income ▪ Difference between personal income and Personal disposable income. Chapter 5 21 Private Income ▪ Is the sum total of income of the private sector which can be from production, otherwise and retained earnings of cooperation ▪ Calculation of private income ▪ Factor income from NDP going to the private sector + Net factor income from abroad + Interest on national debt + Current transfers of the government + Current transfers from the rest of the world Chapter 5 22 Personal Income ▪ Is the sum total of current income received by individuals and households which can be factor incomes + current transfers. ▪ Calculation of personal income Personal income = Private income - Undistributed profits (corporate savings) - Cooperation tax (Cooperate savings and cooperation tax are deducted because these incomes do not reach the households.) Chapter 5 23 Personal disposable income ▪ Is the sum total of income at the disposable of individuals and families after paying all direct taxes on income and property levied by the government. ▪ Calculation ▪ Personal disposable income = Personal income - Direct taxes - Miscellaneous receipts of the government administrative department. Chapter 5 24 THREE METHODS OF MEASURING NATIONAL INCOME:- I. OUTPUT METHOD/PRODUCT METHOD /VALUE ADDED METHOD ;- Product Method or Value Added Method is that method which measures national income in terms of value added by each producing enterprise in Primary sector, Secondary sector and Tertiary sector of the economy during an accounting year to avoid the problem of double counting. Value added is equal to value of output minus the value of intermediate consumption i.e. Expenditure on raw materials. Chapter 5 25 Calculation of gross value added (value added method problems ) ▪ The value added method or the product method arrives at the national income figure of the country with the help of the following steps. Step 1- To identify a producing enterprise and classify it into different sectors. Calculate the Gross value added of all the producing enterprises in all the sectors to arrive at GDP at market price. Chapter 5 26 Step 2 – Value added = Value of output - Intermediate consumption Value of output = sales + change in stock Sales = Total product sold X Price S = Closing stock at the end of the accounting year- openings stock at the end of the accounting year. Chapter 5 27 Intermediate consumption is the expenditure on non factor inputs like raw materials, electricity, water supply etc. ( all other expenditure other than factor inputs ) Name of the Value of output Intermediate Value added producing Consumption enterprise Farmer (Wheat) 600 - 200 400 Flour miller 800 - 600 200 Baker (Bread) 1000 - 800 200 Shopkeeper (sells 1200 - 1000 200 bread) 3600 - 2600 1000 Chapter 5 28 Step 3 conclusion Gross value added of the primary sector + Gross value added of the secondary sector + Gross value added of the tertiary sector = GDP MP -Depreciation = NDP MP -Indirect taxes = NDP FC = NDP FC + NF IN AB = NNP FC ( it is a standard practice to consider NNPFC as the national income of the country) Chapter 5 29 Precautions to be taken while estimating national income using Value added method (i) Value of intermediate goods should not be included in the estimation of national income because value of these goods is already included in the value of final goods. If they are included again, it will lead to double counting. (ii) Own account production means output produced by production units for self-consumption and investment should be included. For example, output produced by farmers for self-consumption. Imputed value of production of goods for self- consumption should be included as they contribute to the current output. These goods are like those produced for the market; they are not simply sold because of their need by the producers themselves. (iii) Imputed rent of the owner-occupied houses should be included in national income because all houses have rental value, no matter they are self-occupied or rented one. (iv) Imputed value of free services produced by general government and private non-profit institutions serving households must be taken into account. If it is not done, it will lead to underestimation of total output consequently of national income. (v) Production of services for self-consumption (domestic services) like services of house wife, kitchen gardening etc. are not included in the national income since it is difficult to measure their market value. These services are produced and consumed at home and never enter the market place and are termed as non-market transactions. (vi) Output of only newly produced goods i.e. goods produced in the current year should be included in the total output of that year. Sale and purchase of second hand goods and property should not be included because they were included in the year in which they were produced. They do not add to the current flow of goods and services (i.e. not a part of the current year production). However, any commission or brokerage on sale or purchase of such goods will be included in the national income as it is a productive service. Chapter 5 30 ▪ Concept on Double counting ▪ The term “Double counting” means measuring the value of a good more than once. While calculating National Income, if care is not taken to avoid the problem of double counting, it will lead to over estimation of National Income Chapter 5 31 Stages of Value of output (2) Value of Value added (4) production (1) intermediate = (2 – 3) consumption (3) Farmer (sells wheat 400 0 400 to) Miller (sells flour 600 400 200 to) Baker (sells bread 800 600 200 to) Shopkeeper (sells 900 800 100 to consumer) Total 2700 1800 900 Chapter 5 32 ▪ It is clear from the above table that Gross value of output is Rs. 2700 (= 400 + 600 + 800 + 900). This is not the actual value of physical output because in this the value of wheat, value of services of miller and value of baker services is counted more than once. The value of final good i.e. bread is Rs. 900. Chapter 5 33 Income method of measurement of National income ▪ Classification of factor incomes (3 types of incomes ) ▪ Compensation of employees ▪ Operating surplus ▪ Mixed income of self employed Chapter 5 34 II) INCOME METHOD: ▪ This is also called distributed share method or Factor payment method. The factor incomes generated within the domestic territory of a country during an accounting year are added up and to this net factor income from abroad is added to get the National Income of the country. ▪ CLASSIFICATION OF FACTOR INCOMES (3 types of Incomes) ▪ a) Compensation of employees: It includes wages and salaries in cash and in kind, employer`s contribution to social security schemes, and pension on retirement. b) Operating surplus: It refers to income from property and entrepreneurship. It includes rent interest, and profit. ▪ Profit is further divided into: i. Dividends: This is the part of profit which is distributed to the shareholders so it is also called distributed profit. ii. Corporate Profit Tax: This is the part of profit which which is paid to the government. iii. Undistributed: This is the part of profit which is retained by firms for future use. Particularly to meet some contingent expenses. They are also called ‘Corporate savings’ c) Mixed income: Mixed Income refers to the incomes of the self- employed persons using their own labour, land, capital and entrepreneurship to produce goods and services. These incomes are a mixture of wages, rent, interest, and profit. Chapter 5 35 Precautions to be taken while estimating national income using Income method ▪ (i) National income includes only factor payments, i.e. payment for the services rendered to the production units by the owners of factors. Any payment for which no service is rendered is called a transfer, and not a production activity. Gifts, donations, charities etc are main examples. Since transfers are not a reward for production activity it should not be included in national income. ▪ (ii) Capital gain refers to the income from the sale of second hand goods like old cars, old house, machinery, buildings etc. These transactions are not a current production activity of the owners of these goods, they do not add to the current flow of goods and services in the economy. So, any income arising to the owners of such things is not a factor income hence not included. ▪ (iii) Income arising from the sale of financial assets like shares, bonds, debentures, government securities etc. will not be included as these transactions are not related to the production of goods and services. Any profit arising from the sale of these is capital gain which is not treated as factor payment. These financial assets are mere paper claims and involve a change in title only. (However, any commission or brokerage paid is the payment for services and must be included in factor payments.) (iv) Imputed value of services provided by owners of production units will be included. Imputed value of owner-occupied houses, interest on own capital, production for self-consumption, etc. will be included as these are productive activities and add to the flow of goods and services. (v) Windfall gains (like income from lotteries, horse race, etc.) are not included as there is no productive activity connected with them. Chapter 5 36 III) EXPENDITURE METHOD OF MEASUREMENT OF NATIONAL INCOME ▪ In this method the National Income is measured in terms of expenditure on the purchase of final goods and services produced in the economy. It consists of the following components. a) Private final consumption expenditure (C) It refers to expenditure on final goods and services by the individuals, households and non-profit private institutions. It includes expenditure on consumer goods and services. b) Government final consumption expenditure (G) It refers to expenditure on final goods and services by the government, like expenditure on the purchase of goods for consumption by the defence personnel. c) Investment expenditure (I) Fixed Investment: This refers to expenditure by the producers on the purchase of fixed assets like plant and machinery. Inventory Investment: it refers to change in stock during the year, that is the difference between closing stock and opening stock of the year. d) Net exports (X- M) Net exports refer to the difference between exports and imports during an accounting year. Expenditure on domestically produced goods is included while that on foreign goods is deducted. Chapter 5 37 Precautions to be taken while estimating national income using Expenditure method i) By definition the method includes only final expenditures, i.e. expenditure on consumption and investment. Intermediate expenditure is already a part of final expenditures. So, including intermediate expenditure like that on raw materials, etc, will mean double counting. It may lead to overestimation of national income. Therefore, proper identification of expenditure on intermediate products is necessary. ii)Expenditure on second hand goods should not be included as it does not lead to any addition to the current flow of goods and services (they have already been accounted during the period of their production; they are not part of current production). However, any commission or brokerage paid in such transactions are treated as final expenditure because it is a payment for the services purchased. iii)Expenditure on financial assets in the form of expenditure on buying shares, bonds, debentures, government securities etc will not be included as they are simply paper claims. It only leads to transfer of money from one person or institution to another person or institution. But any brokerage or service charged or paid in buying financial assets is treated as expenditure on buying services. vi) Imputed expenditure on own account output like self-consumed output by farmers etc. must be counted as final expenditure and hence included. self-consumed services of owner-occupied houses, services got free from general government and non-profit making institutions serving households are other example They will be included as they are productive services. (v) A transfer payment is one against which no goods or service is rendered. For example: payment of gifts charities, donations, scholarships, taxes, old age pension, unemployment allowances etc. Such an expenditure is not concerned with production activity hence not included. Chapter 5 38 REASONS WHY GDP IS NOT A GOOD INDICATOR OF WELFARE. ▪ GDP is often considered as an index of welfare of the people. Welfare means sense of material well- being among the people. It depends on greater per head availability of goods and services. So higher GDP is generally taken as greater welfare of people. ▪ However, this generalization may not be correct due to following limitations or reasons. a) Distribution of GDP: If with every increase in the level of GDP, distribution of GDP becomes more unequal, welfare level in the society may not rise. That is the gap between rich and poor increases. GDP does not take into account changes in inequalities in the distribution of income. So welfare of the people may not rise as much as the rise in GDP. b) Composition of GDP: If GDP rises because of increase in the production of defense goods there is no direct increase in the welfare of the masses. But a strong defense provides a peaceful environment for production and indirectly contributes to the level of welfare in the economy. c) Non-monetary exchanges: Non –monetary exchanges exist in rural areas where payments for farm labour are often made in kind rather than cash. Such transactions are not recorded because they are outside the monetary system of exchange. The GDP then is underestimated, so it is not a proper index of welfare. d) Externalities: Externalities both Positive and Negative refer to the good as well as bad impact of any activity caused by the firm or an individual, for which they are not paid or penalized. Activities which results in benefits to others are termed as positives externalities and activities which result in harm to others are termed negative externalities. ▪ Hence there is no valuation of it in the GDP. For example in a refinery when we refine oil we add value to GDP but we also destroy marine life. Chapter 5 39