National Income 2024 PDF

Macroeconomics & Business Environment MBA Sem II Dr. Subhendu Dutta, Dept. of Economics, IBS Hyderabad National Income & related Aggregates 2 After attending this session, you will learn: Key Terms ∙ economic growth and di...

Macroeconomics & Business Environment MBA Sem II Dr. Subhendu Dutta, Dept. of Economics, IBS Hyderabad National Income & related Aggregates 2 After attending this session, you will learn: Key Terms ∙ economic growth and distinguish it Final goods and Intermediate goods from economic development Consumer and Capital goods ∙ how economic indicators like GDP Stocks and Flows are used to assess the state of an Gross investment & Net investment economy. Depreciation, Inventories Wage, Interest, Profit & Rent how does the flow of production Circular flow of income arise in an economy using the National Income, GDP, GNP, NDP, NNP Circular flow of money or income Value added market price and factor cost ∙ Key national income aggregates Transfer payments ∙ Difference between nominal and Personal Disposable Income real GDP Nominal GDP vs. Real GDP GDP deflator Green Economy 3  What generates the economic wealth of a nation? Or What makes countries rich or poor? How does the flow of production arise? The economic wealth, or well-being, of a country does not necessarily depend on the mere possession of resources; but on: How these resources are used in generating a flow of production and How, as a result, income and wealth are generated from that process. We need to know a few important terms to get into the crux of these questions Basic concepts of ECONOMICS 4 Important terms 5. Gross investment and net investment: 1. Final and intermediate goods an item that is meant for final use and will not pass gross investment is the addition to through any more stages of production is a final good. the capital stock of an economy. Intermediate goods are goods that are used by These may be machines, tools, and producers as material inputs for producing a final good. implements, buildings, office spaces, 2. Consumption goods and capital goods storehouses, or infrastructure like consumer goods are mainly used for final consumption roads, bridges, and airports such as food and clothing, and services like recreation. (Inventories, fixed business These are not used for further production. investment, and residential Capital goods are of durable in character which are investment). used in the production process such as tools, Net Investment = Gross investment – implements and machines. Depreciation 3. Stocks and flows: stocks are defined at a particular point of time. Eg. 6. Inventory is the stock of unsold wealth finished goods, or semi-finished goods, Flows are defined over a period of time. Eg. income or raw materials which a firm carries 4. Depreciation/consumption of fixed capital: from one year to the next. Change in the an annual allowance for wear and tear of a capital good. inventory of a firm is treated as an  Important terms Household Consumption Domestic Product : Domestic product by definition is a Expenditure(C): The household measure in monetary terms of the volume of all goods consumption expenditure referred to and services produced by an economy during a given as private final consumption period of time, accounted without duplication. The expenditure (PFCE), consists of measure obviously has to be in value terms as the household expenditure (including non- physical units of production and different measures of profit institutions) on non-durable services are not capable of simple addition. In the case of consumer goods and services and all a closed economy, this measure amounts to domestic durable goods except land and product. buildings. Categories Of Expenditure: The income available to the Government Final Consumption individuals in the form of labour income or capital Expenditure (G): Government final income or to the productive units in the form of retained consumption expenditure comprises income is spent. The utilization or expenditure of the the compensation to the Government income can take various forms, namely, Employees and purchases of goods and (a) household consumption expenditure(C); services by the Government, including (b) government consumption expenditure(G); and purchases abroad. Compensation of (c) capital formation comprising fixed capital formation general Government employees and stock accumulation(I). consists of wages and salaries and social security contribution. Important terms Gross Capital Formation(I): Gross Capital Formation includes only produced capital goods (machinery, buildings, roads, softwares, hardwares etc.) and improvements to non-produced assets. Gross Capital Formation measures the additions to the capital stock of buildings, equipment and inventories, i.e. additions to the capacity to produce more goods and income in the future. The components of gross capital formation are Gross fixed capital formation Changes in inventories Residential investment Gross Fixed Capital Formation includes purchases of new assets within the domestic market like buildings, transport equipment, machinery, breeding stock etc.; import of new assets; own account production of new assets such as production of rail engines, wagons, trucks, aero-planes, farm machinery, breeding stock of fish, sheep, cows etc. by the enterprise; and net purchase of second hand physical assets from abroad. Change in stocks (inventories) consists of the difference between the opening stock and the closing stock. Important terms Saving: Saving represents the excess of current income over current expenditure of various sectors of the economy. It is the balancing item on the income and expenditure accounts of the producing enterprises, households, government administration and other final consumers. For a closed economy, savings(S) equals capital formation(I) during the year, whereas for an open economy, savings equals capital formation plus net capital inflow from abroad during the year. Current Versus Constant Prices: National income, when calculated over a number of years, include implicitly not only the effect of the changes in production but also the changes in prices. This estimate compared over the period would not, therefore, give a proper measure of the overall real increase in production of the country or the economic welfare of the people or growth of the economy. Therefore, it would be necessary to eliminate the effect of prices, or in other words to recompute the whole series at given prices of one particular base year. National income thus computed, is termed as National Income at constant prices or in real terms. Production/Income/Expenditure: The national income of a country can be measured in three different ways: from the angle of production, from income generation, and from final spending. These three forms are circular in nature. Undistributed Profits is a part of profit that is not distributed among the factors of production. Sources Of Data for measuring NI in India: National Accounts Statistics in India are compiled by National Accounts Division in the Central Statistics Office, Ministry of Statistics & PI. The data are available on the website of the Ministry (www.mospi.nic.in ). The four macroeconomic sectors All the individuals and non-profit The Household institutions. The primary function is to Sector provide the factors of production & consume G+S. business entities, corporations and partnerships. The primary function is to The Firms Sector produce goods and services for sale in the The Four market Macroeconomic Sectors center, state, and local governments. The Government Sector The prime function is to regulate the functioning of the economy. This sector includes transactions with The Foreign Sector the rest of the world. 10 The Three markets goods and services are The Goods market exchanged among the four macroeconomic sectors factors of production are traded The Three Markets The Factor market through this market The financial Includes financial institutions who market/Money engage in borrowing (savings from market households) and lending of money. 11 Circular flow of INCOME The circular flow is the basis for all the macroeconomic models of the economy. It describes the movement of goods or services and income among the different sectors of the economy. It illustrates the interdependence of the sectors and the markets to facilitate both real and monetary flow. A continuous flow of production, income, and expenditure is known as the circular flow of income. Circular flow of INCOME 12 Circular flow of INCOME-Two sector model the economy is assumed to be a closed economy and consists of only two sectors, i.e., the household and the firms. In this model, Y=C Circular flow of INCOME 13 Circular flow of INCOME-Three sector model In this model, the equilibrium condition is as follows: Y=C+I+G Circular flow of INCOME 14 Circular flow of INCOME-Four sector model This is an ‘open economy’ model. In this model, the equilibrium condition is as follows: Y = C + I + G + NX What are the leakages and injections here? A leakage is referred to as an outflow of income from the circular flow model. An injection is an inflow of income to the circular flow. injections include investment, government purchases, and exports Leakages include savings, taxes, and imports. Circular flow of INCOME 15 Questions 1. What is the difference between intermediate goods and capital goods? 2. List three items included in the gross investment. 3. What do you mean by change in stocks? 4. How is the household sector different from the producers’ sector? 5. What is a factor market? 6. In a two-sector circular flow of income model, Y=C. Explain. 7. Is the three-sector model of circular flow- a closed or open economy model? 8. What constitutes National income? 9. What reduces the flow of income? 10. What increases the flow of income? 11. Write examples of leakages in 2 (closed economy), 3, and 4 sectors’ circular flow of income. 12. Write examples of injections in 2 (closed economy), 3, and 4 sectors circular flow of income. Circular flow of INCOME 16  National Income-selected Identities Gross Domestic Product (GDP) is the market value of all final goods and services produced within a country in a given period of time. Gross National Product (GNP) is the total income earned by a nation’s residents (called nationals). Net Factor Income from Abroad(NFIA) = Factor income earned by the domestic factors employed in the rest of the world – Factor income earned by the factors of production of the rest of the world employed in the domestic economy Net National Product (NNP) is the total income of a nation’s residents (GNP) minus depreciation. Market price and factor cost: Market price includes net indirect taxes. Transfer payments result from transactions that do not give rise to the exchange of commodities or factor services. A payment of money is made without a corresponding flow of goods and services in the opposite direction. The value of transfer payments to households is included in the income aggregate of private income. The measurement of GDP 17  National Income-selected Identities Domestic Income (NDPFC) is divided into two parts: 1. Income from domestic product accruing to the Private Sector 2. Income from Domestic Product accruing to the Public/Govt. Sector. It has two components: Income from property and entrepreneurship that accrues to government administrative departments: i.e, income earned by government departmental enterprises (such as railways, postal, and telegraphs, etc.) from property (rent and interest) and business (profit). Savings of non-departmental enterprises: This includes undistributed profits by non-departmental government-owned enterprises (such as ONGC, MTNL, LIC, etc.). The measurement of GDP 18 National Income-Selected Identities Private income is the income accruing to the private sector both from domestic and international sources. It includes income from domestic products accruing to the private sector, NFIA, and transfer incomes such as interest on the national debt, current transfers from the government, and net current transfers from the rest of the world. Therefore, private income consists of two different types of income: (1) factor income-from within the country and NFIA; (2) Transfer income-interest on national debt and net current transfers from the ROW. Interest on National Debt: The government borrows funds from the people (by issuing bonds such as National Saving Certificates, Saving Bonds, and so on). Interest on these debts is considered transfer income for private enterprises. Current transfers from the Government: transfer payments received from the government, such as subsidies, unemployment benefits, and scholarships. Net Current transfers from the rest of the world: It includes net gifts and remittances received from abroad. Private Income= Income from Domestic Product Accruing to the Private Sector + Net Factor Income from Abroad + National Debt Interest + Current Transfers from Government + Net Current Transfers The measurement of GDP from the rest of the world. 19  National Income-Selected Identities Personal Income is the total of all the incomes that are received by households from all sources. It also includes factor and transfer incomes. Personal income exclusively refers to that part of private income that is received by households only. Personal Income does not include Corporate Tax and Retained Earnings Personal Income = Private Income – Corporate Tax – Retained Earnings Personal Disposable Income (PDI ) = Personal income – Personal tax payments – Non-tax payments. The measurement of GDP 20  National Income-selected Identities Net Indirect taxes = Indirect taxes – Subsidies NNP at factor cost or National Income = NNP at market prices – Net Indirect taxes GNP= GDP + Net factor income from abroad NNP = GNP – Depreciation NDP= GDP – Depreciation NDP = NNP – NFIA GDPfc =GDPmp − NIT NDPmp =GDPmp −Dep GNPmp = GDPmp + NFIA NNPmp= GNPmp - Depreciation The measurement of GDP 21 National Income-selected Identities Gross value added = Output – Intermediate consumption GDP at Market Prices = Gross value added + Indirect taxes – Subsidies GDP = final consumption expenditures/actual final consumption + changes in inventories + gross fixed capital formation + acquisition less disposals of valuables + exports of goods and services – imports of goods and services GDP at Market Prices = compensation of employees + operating surplus / mixed income + CFC+ Indirect taxes – Subsidies GDP at factor cost = GDP at market prices – indirect taxes + subsidies NDP = GDP –Consumption of fixed capital The measurement of GDP 22 National Income-selected Identities Gross National Income (GNI) = GDP at market prices + taxes less subsidies on production and imports at market prices (Net receivable from abroad) + Compensation of Employees(Net receivable from abroad) + property income (Net receivable from abroad) Net National Income (NNI) = GNI at market prices - consumption of fixed capital at market prices Net National Disposable Income = NNI + net taxes on income and wealth receivable (NNDI) from abroad + net social contributions and benefits receivable from abroad. Net saving = NNDI-final consumption expenditure + net equity of households on pension funds receivable from abroad + net capital transfers receivable Net saving + net capital transfers = changes in net worth due to savings and capital transfers The measurement of GDP 23  Questions What is the difference between Personal Income = and Personal Disposable Income? What is Private Income? What is the difference between GNP and GDP? How is Net factor income from abroad different from net exports? How do you find out the ‘net’ from gross? What is the difference between Market price and factor cost? What is net indirect tax? What is double counting? The measurement of GDP 24 National Income-calculations 1. Calculate NDP at FC 2. Calculate GDP at MP Items Amount Items Amount 1. GNP at MP 8000 1. NNP at Fc 2000 2.Dep 600 2.Dep 200 3. NFIA 300 3. FIA 110 4. Net Indirect 700 4. FI to Abroad 50 Taxes 5. subsidies 70 6. Indirect taxes 180 Solution: 1. 6400; 2. 2250 The measurement of GDP 25 National Income-calculations 1. Calculate NDP at FC 2. Calculate NNP at FC Items Amount Items Amount 1. GNP at MP 6000 1. GDP at MP 5500 2.Dep 100 2.Consumption 300 3. NFIA 400 of fixed capital 4. Indirect Taxes 300 3. FIA 150 5. subsidies 200 4. FI to Abroad 250 Solution: 1. 5400; 2. 5050 5. subsidies 70 6. GST 120 The measurement of GDP 26 National Income-calculations 1. Calculate Dep 2. Calculate Net Indirect tax Items Amount Items Amount 1. NNP at FC 4000 1. GNP at MP 7000 2.GDP at MP 5000 2.NDP at FC 6200 3. NFIA 200 3. Dep 600 4. Net Indirect 300 4. NFIA -400 Taxes Solution: 1. 900; 2. 600 The measurement of GDP 27  Nominal and Real GDP Real GDP is calculated by taking the prices of a base year. Real GDP is calculated at constant prices. Nominal GDP is simply the value of GDP at the current prevailing prices. The GDP Deflator: The GDP deflator measures the current level of prices relative to the level of prices in the base year. It can be calculated as below: GDP deflator= (Nominal GDP/Real GDP) x 100 Using the GDP deflator, the inflation rate between two consecutive years can be computed. Inflation rate in year 2 =(GDP deflator in year 2 - GDP deflator in year 1/GDP deflator in year 1) x 100. The measurement of GDP 28 Nominal, Real GDP & GDP deflator computation Let us calculate real GDP, nominal GDP, and the GDP deflator for a hypothetical economy: year Price of Price of Qnty of Qnty of Nomi Real GDP GDP x y x y nal Base deflator GDP year=2019 2019 1 2 100 50 200 200 100 2020 2 3 150 100 600 350 171 2021 3 4 200 150 1200 500 240 Inflation rate (2019 to 2020) = (171-100)/100 =71% 29  Measurement of National Income Performance of an economy depends on the amount of goods and services produced in that economy. In monetary terms its measure is the Gross Domestic Product (GDP), Gross National Income (GNI), and Net National Income (NNI). The national income of a country is measured in three different ways-from the angle of production, from income generation and from final spending. GDP and GVA are the two main ways to ascertain the country’s economic performance. The GDP measures the monetary measure of all “final” goods and services produced in a country in a given period, i.e, C+G+I+NX. The GVA calculates the national income from the supply side by adding up all the value added across different sectors. That is, the value of output minus the value of its intermediary inputs. The measurement of GDP 30 The measurement of national income Three methods to measure national income are: 1. Product method: NI is measured in terms of the aggregate value of final goods and services produced by all the firms. 2. Income method: measuring national income by the sum total of all factor payments. 3. Expenditure method: NI is measured by the aggregate value of spending by all for the final goods and services. The measurement of GDP 31  1. The Product or Value-Added Method steps: ∙ This method measures national income as the sum of net final 1. IDENTIFICATION OF PRODUCTION UNITS AND CLASSIFYING THEM INTO INDUSTRIAL SECTORS: output produced or net value o The first step is to identify all the production added by all the firms in a year. units and classify these into three industrial ∙ In this method, we calculate the sectors (i) primary sector, (ii) secondary sector, value added by each firm and then and (ii) tertiary sector. sum it up to get national income. 2. ESTIMATION OF GROSS VALUE ADDED and NET ∙ Value added means the net VALUE ADDED: contribution made by a firm, o Net value added is estimated by estimating Value added= sales –intermediate gross output produced by each enterprise, costs intermediate consumption, depreciation and net indirect taxes, as shown below: The measurement of GDP 32  The Product or Value-Added Method (a) Gross value of added/output 3. ESTIMATION OF NET FACTOR INCOME =Sales + Change in stocks of all firms- FROM ABROAD: Intermediate consumption The final step is to estimate net factor (b) Net value added at market price income from abroad and add it to the Net value added (NVA) at market net domestic product to get national price = GVA - Depreciation income or NNPfc. Net factor income (c) Net Value Added/NDP at factor from abroad is the factor income of the residents of a country earned abroad cost less the factor income of foreign NVA/NDP at Factor Cost = Net value nationals earned in the domestic added at Market price - Net Indirect territory of the country. Therefore, Taxes. National Income or NNPfc = NDPfc + Net factor income from abroad(NFIA) 33 The measurement of GDP  Points to remember 1. Imports are not included if intermediate consumption is only given. 2. If the domestic purchase of raw materials is given separately, then import value is to be included. 3. When the entire output is not sold, then change in stocks has to be added to sales to get the value of output. 4. If sales are given and domestic sales are not specifically mentioned, do not include export value. The measurement of GDP 34  The Product Method- an example Gross Value Added/GDP= (sales or output + Change in stocks) – Value of intermediate goods Production Total Intermediate Gross Value Gross units production/ costs Added (or Domestic Product Output/ GDP) (GDP) = sales sum of the Farmer 100 0 100 gross value added of all Baker 200 50 150 firms in a Total 300 50 250 year. Therefore, the aggregate value of goods produced by an economy is Rs. 250. The measurement of GDP 35  Calculations on the Product Method 1. Calculate value added by firm A 2. Calculate Net Value Added at MP and firm B Items Amount Items Amount 1. Sales 90 2.Closing stock 25 1. Sales by A 4000 3. Opening stock 15 2.Exports by A 1000 4. Indirect taxes 10 3. Purchase by A 200 5. Depreciation 20 4. Sales by B 2940 6. Intermediate 40 5. Purchase by B 1300 consumption 7. Purchase of raw 15 materials Solution: (1). 3800; 1640; (2) 60 8.Rent 5 3. Calculate: (a). Value added by A and B; (b). 4. Calculate Gross Value Added at GDP at MP and (c). Net value added at FC FC Items Amount Items Amount 1. Sales by firm B to govt. 100 1. Units of output sold 1000 2.Sales by A 500 2.Price per unit of 30 3. Sales by B to households 350 output 4. Change in stocks of firm A 20 3. Depreciation 1000 5. Closing stock of B 40 4. Intermediate cost 12000 6. Opening stock of B 30 5. Closing stock 3000 7. Purchase by A 320 6. Opening stock 2000 8.Indirect taxes paid by both 75 7. GST 6000 the firms 9. Depreciation 120 Solution: (3). 200; 260; 460; 265 (4). 10. Purchase by B 200 13000 The Product Method-Problems and Precautions 2. GDP does not include the value of 1. Some goods and services are not sold in secondhand goods. However, markets. brokerages generated in these For example, Homemaking and child- transactions are included. rearing services performed within the 3. Only final goods and services are family. These are not included in GDP. counted in GDP to avoid double Activities hidden from government records, counting. such as drug dealing, gambling, etc., are 4. Capital goods are treated as final not included in NI. goods and are included in GDP because the value of the services provided by the this adds to the productive capacity of government (defense, public education, an economy. maintenance of roads and bridges). In this 5. Inventory investment is treated as a case, the value of government services is final good and thus part of GDP because included by estimating their cost of increased inventories imply greater production. productive capacity in the future. The measurement of GDP 38 Income Method The income method calculates GDP by adding the factor incomes. In other words, GDP= Wages/Salaries+Rent+Interest+Profit National income is the sum of eight types of income: 1. Compensation of employees. It includes wages, salaries, employee benefits (including contributions by employers to pension plans), and employer contributions to Social Security. It excludes the income of the self-employed. 2. Proprietors’ income. The income of the nonincorporated self-employed such as small shopkeepers, retail traders, etc., and own-account workers like farmers, barbers, etc.. Proprietors’ income includes labor and capital income (mixed income). 3. Rent & Royalty. The income earned by individuals who own land or buildings (both actuals and imputed). Miscellaneous types of income, such as royalty income paid to authors, recording artists, and others, also are included in this category. The measurement of GDP 39 Income Method 4. Corporate profits. profits earned by corporations and represent the remainder of corporate revenue after wages, interest, rents, and other costs have been paid. 5. Net interest. interest earned by individuals from businesses and foreign sources minus interest paid by individuals. 6. Taxes on production and imports. include indirect taxes, such as sales and excise duties as well as customs duties and taxes on residential real estate and motor vehicle licenses paid by households. 7. Business current transfer payments (net). payments made by businesses to individuals or governments or foreigners such transactions as charitable donations, insurance payments, insurance premiums paid by banks, and legal settlements are covered by this category of income. 8. Current surplus of government enterprises. the profit of businesses that are owned by governments, such as water, electric, and sewer companies, mass transit firms etc. The measurement of GDP 40 Income Method- Steps Step 1 Identify and classify the factors of production of all the producing firms into primary, secondary and tertiary sectors. Step 2 The estimation of the factor income paid by each sector. The factor income paid by various sectors is classified as: Compensation of Employees, Rent and Royalty, Profit, Interest, and Mixed Income. Step 3 Calculate domestic income NDPFC. The total of all the factor incomes is Domestic Income(NDPFC ). NDPFC = Compensation of Employees + Profit + Rent & Royalty + Interest + Mixed income. Step 4 The estimation of Net Factor Income from Abroad(NFIA). NFIA is added to domestic income (NDPFC) to get the National Income(NNP FC). NNPFC = NDPFC + NFIA. The measurement of GDP 41  Components Amount in Rs. cr 1. Compensation of employees 9228 2. Proprietors’ income 1380 Income 3. Rent and Royalty 640 Method- 4. Corporate profits 5. Net interest 2090 486 Example 6. Taxes on production and imports 1146 7. Business current transfer payments 141 8. Current surplus of government -34 enterprises Total (1 to 8)= NDP fc 15077 - Factor income received from rest of world 828 + Payments of factor income to rest of 616 world = NNP fc 15289 The measurement of GDP 42  Precautions of Income Method 1. Transfer Income will not be included: Transfer incomes such as donations, charity, scholarships, old age pensions, etc., are not counted in the National Income, as these activities are not connected to any production activity. 2. Income from the Sale of Second Hand Goods will not be included: Income received from the sale of second-hand goods, also known as capital gains, is not calculated in National Income, as their original sale has already been included at the time of purchase. If these goods are calculated again, then it will lead to the problem of double counting. However, commission or brokerage received by agents on the sale of these goods will be included, as it is an income received for rendering productive services. 3. Income from Sale of Securities will not be included: Income from the sale of bonds, shares, and debentures will not be calculated, as these transactions do not contribute to the current flow of goods & services. These financial assets are just paper claims and include the transfer of title only. However, any kind of commission or brokerage on such assets is included in National Income, as it is a productive The measurement of GDP 43 service.  Precautions of Income Method 4. Windfall Gains will not be included: Income that arises from windfall gains like horse racing, lotteries, etc., are not calculated in the determination of National Income, as they are not connected with any kind of production activity. 5. Imputed Value of Services by Owners of Production Units will be included: The imputed value of self-occupied houses, production for self- consumption, interest on own capital, etc., are included under National Income, as these are productive activities and add to the current flow of goods & services of the economy. 6. Payment out of Past Savings will not be included: Payment out of past savings such as interest tax, gift tax, death duties, etc., is not calculated in National Income, as they are paid out of past savings or wealth and do not contribute to the current flow of goods & services of the economy. The measurement of GDP 44 Expenditure Method In this method, the income is calculated as 1. CONSUMPTION (C) is household the sum of all expenditures incurred by spending on goods and services. households, firms, government, and Consumption expenditures are foreigners. grouped into three categories: The expenditure method measures GDP as consumer durables- long-lived total spending on final goods and services consumer items, such as cars, produced within a nation during a specified televisions, furniture, and major period of time. appliances GDP is the sum of four components: nondurable goods- are shorter- consumption expenditure (C), investment lived items, such as food, expenditure (I), government expenditure clothing, and fuel; and (G),and net exports (NX): Services- such as education, Y = C+ I+ G+NX health care, financial services, and transportation. The measurement of GDP 45 Expenditure Method 2. INVESTMENT (I) is the sum of purchases of business capital (fixed investment), residential investment, and inventories. Business fixed investment- spending by businesses on structures (factories, warehouses, and office buildings, for example), equipment (such as machines, vehicles, computers, and furniture), and intellectual property products (such as software, investment in research and development, etc) Residential investment-spending on the construction of new houses and apartment buildings. Houses and apartment buildings are treated as capital goods because they provide a service (shelter) over a long period of time. The measurement of GDP 46  Expenditure Method 3. GOVERNMENT PURCHASES (G) Government 4. NET EXPORTS (NX) purchases of goods and services include any equal the foreign expenditure by the government for a currently purchases of produced good or service, foreign or domestic. Note: domestically produced Transfer payments such as Social Security and goods (exports) minus Medicare benefits, unemployment insurance, the domestic welfare payments, and so on, are not made in purchases of foreign exchange for current goods or services. As a result, goods (imports). they are excluded from the (G) and are not counted in GDP as calculated by the expenditure approach. Interest payments on the national debt are not counted as part of government purchases. investment by government is a part of government purchases of goods and services. The measurement of GDP 47 Expenditure Method-steps Step 1 The identification of economic units operating Step 4 within the country, namely households, business Calculate Net Factor Income firms, government, and foreign trade. from Abroad (NFIA) to get Step 2 National Income. Classify economic units under final expenditure: Private Final Consumption Expenditure (C), NNPFC = NDPFC + NFIA Government Final Consumption Expenditure (G), Gross Domestic Capital Formation (I), and Net Exports (NX) GDPMP = C + I + G + NX Step 3 Calculate Domestic Income (NDPFC). NDPFC = GDPMP – Depreciation –Net Indirect taxes The measurement of GDP 48  Calculations on Expenditure Method Components Amount in Rs. cr 1. Consumption expenditures (C) 11,930 Consumer durables 1303 Nondurable goods 2666 Services 7962 2. Gross private domestic investment (I) 2852 Business fixed investment 2211 Residential investment 559 Inventory investment 82 3. Government purchases of goods and services (G) 3175 4. Net exports (NX) -538 Total (equals GDP) (Y) 17,419 49 The measurement of GDP Calculations on Expenditure Method 1. Calculate GDP at MP 2. Calculate GNP at FC Items Amount Items Amount 1. Private final 1200 1. Net domestic fixed capital formation 350 consumption expenditure 2.Closing stock 100 2.govt. final consumption 200 3. govt. final consumption expenditure 200 expenditure 4. Net indirect taxes 40 3. Gross fixed capital 300 5. Opening stock 60 formation 6. Consumption of fixed capital 50 4. Change in stocks 400 7. Net exports -10 5. Imports 500 8. Private final consumption expenditure 1500 6. Exports 600 9. imports 20 Solution: (1).2200; (2). 2060 10. NFIA -30 The measurement of GDP Questions 1. How are real and nominal GDP different? 2. What is a GDP deflator? Why do you calculate GDP deflator? 3. What do you understand by value-added? How useful is measuring national income by value- added method? 4. How do you calculate Net value added? 5. Why do we not include homemaking and child-rearing services performed within the family in GDP? 6. How do we treat the value of the services provided by the government in national income? 7. Why are we including capital goods as final goods, while calculating national income? 8. List out the limitations/problems of measuring national income by the product method. 9. What are the major types of income that are included in calculating national income by income method? 10. What is a statistical discrepancy? 11. What are the major components of expenditure that are included while calculating national income by expenditure method? 51 Summary Consumption includes spending on goods and Because every transaction has a buyer and a services by households, with the exception of seller, the total expenditure in the economy purchases of new housing. must equal the total income in the economy. Investment includes spending on business Gross domestic product (GDP) measures an capital, residential capital, and inventories. economy’s total expenditure on newly produced Government purchases include spending on goods and services and the total income earned goods and services by local, state, and federal from the production of these goods and services. governments. More precisely, GDP is the market value of all Net exports equal the value of goods and final goods and services produced within a services produced domestically and sold abroad country in a given period of time. (exports) minus the value of goods and services GDP consists of four components of produced abroad and sold domestically expenditure: consumption, investment, (imports). government purchases, and net exports. Nominal GDP uses current prices to value the GDP is a good measure of economic well-being economy’s production of goods and services. because people prefer higher to lower incomes. Real GDP uses constant base-year prices to But it is not a perfect measure of well-being. For value the economy’s production of goods and example, GDP excludes the value of leisure and services. The GDP deflator—calculated from the the value of a clean environment. ratio of nominal GDP to real GDP—measures the level of prices in the economy. 52 Summary The circular flow of income forms the basis for all the macroeconomic models of the economy and it is imperative to understand the circular flow model for understanding essential concepts like national income, aggregate demand and aggregate supply. 53  Analyse the news (https://www.businesstoday.in/latest/economy/story/india-to-surpass-japan-to-become-second-largest-economy- in-asia-by-2030-sp-global-403103-2023-10-24) India to surpass Japan to become second largest economy in Asia by 2030: S&P Global India, the world's fifth largest economy in the world, is likely to overtake Japan to become the world's third- largest economy with a GDP of $7.3 trillion by 2030 (S&P Global Market Intelligence). The acceleration of foreign direct investment inflows into India over the past decade reflects the favourable long- term growth outlook for the Indian economy, helped by a youthful demographic profile and rapidly rising urban household incomes. India's nominal GDP measured in dollar terms is forecast to rise from $3.5 trillion in 2022 to $7.3 trillion by 2030, making India the second largest economy in the Asia-Pacific region. The US at present is the world's largest economy with a GDP of $25.5 trillion. It makes up for a quarter of the world's GDP. China is the second largest economy with a GDP size of about $18 trillion, which is almost 17.9 per cent of the world GDP. Japan is a distant third with $4.2 trillion GDP, followed by Germany with $4 trillion GDP. An important positive factor for India is its large and fast-growing middle class, which is helping to drive consumer spending. The rapidly growing Indian domestic consumer market as well as its large industrial sector have made India an increasingly important investment destination for a wide range of multinationals in many sectors, including manufacturing, infrastructure and services. The measurement of GDP 54