Economics2024_Handouts_Vajiram_KING_R_QUEEN_P.pdf

UNIT-I INTRODUCTION Downloaded By:- KING R QUEEN P[ऋषभ राजपूत]  CHAPTER 1 INTRODUCTION TO MACROECONOMICS Economic decisions of individual happening in the economy. Perhaps, it households or firms are guided by their is the...

UNIT-I INTRODUCTION Downloaded By:- KING R QUEEN P[ऋषभ राजपूत]  CHAPTER 1 INTRODUCTION TO MACROECONOMICS Economic decisions of individual happening in the economy. Perhaps, it households or firms are guided by their is the concern about the rate of rational behaviour in a given market inflation, level of unemployment, decline situation. Here, in our pursuit to study in the agricultural and industrial the logic of consumption or production output, fluctuations in business decision, we limit our analysis to the activities, accumulation of foreign determinants of choice and preferences exchange reserves, capital market of households or firms, respectively. changes, recession in the world Though the study of individual decision economy and so on. units is a necessary aspect of our These are macroeconomic events enquiry into the rationale of their that engage the attention of govern- economic behaviour, it is by no means ments, economists, entrepreneurs and a sufficient condition for a complete even ordinary people, as all of them study. So, there has to be another level receive the impact of these of study in which the enquiry is macroeconomic events. To understand directed to understand the general the forces behind the overall economic economic conditions in the economy. It performance, we need concepts and is this distinction between the exercises theoretical frameworks and empirical to understand and interpret the measurements to assess performance behaviour of individual units on the one in the given reference year. The subject hand and the general state of the of macroeconomics accomplishes economy on the other establishes the this objective. basic difference between the subject Macroeconomic concepts are not matter of microeconomics and often simple and direct; on the contrary, macroeconomics. in microeconomics concepts such as Now, what is macroeconomics all price, profit, cost, quantity, etc. are about? In simple terms it is the study intuitive and easy to understand. So, of the economy as a whole. Everyone is there is nothing difficult in interested in knowing what is comprehending a basket of apples as Downloaded By:- KING R QUEEN P[ऋषभ राजपूत]  + INTRODUCTION TO MACROECONOMICS 3 an output and its price. But in happens in India, to take away a part macroeconomics, we have a variety of of the output to prevent prices falling problems in the stage of definition itself. to an unremunerative level for the While it is relatively easy to define and farmers. Therefore, what is a good and measure individual’s income, it is not proper decision at the individual level so in the case of aggregate income and need not be so at the aggregate level. It output. The scope of macroeconomics is to understand this difference that a could be further made clear if we separate study of economic aggregates attempt to distinguish it from is designed in macroeconomics. microeconomics. Given all the aggregates such as total employment, output, income, etc. Microeconomics and it is essential to find the Macroeconomics interrelationship between them. Does In microeconomics we study the an increase in national output mean an individual household, individual firm increase in employment? Can the value or small groupings of firms. If we study of foreign exchange rate be fixed in one automobile firm or the automobile terms of domestic country’s prices? We industry it is microeconomic approach; will obtain meaningful explanations for but when we take up the entire the working of the economy only if we manufacturing sector, we are in the area systematically work out the of macroeconomics. In this sense, interrelationships between the aggregates. Hence, it is said that macroeconomics studies the macroeconomics is also the study of aggregates of an economic system. We relations between economic aggregates. need to make a separate study of these Basically, macroeconomics is concerned economic aggregates because what is with aggregate level of output, income true at the individual level need not be and spending for all goods and services. true at the aggregate level. In contrast, microeconomics deals Just imagine a case wherein a with output of individual firm and with single farmer produces paddy or wheat. the spending by a single household. In terms of individual rationality, this Microeconomics is primarily concerned farmer has to produce as much output with the allocation of resources by a as possible to reach the maximum level single firm or household. of profit. This is perfectly logical insofar Whatever microeconomics takes as as an individual farm is concerned. But, given is what macroeconomics considers what if all the farmers produce as the prime variable, whose size and maximum output in their respective value are to be determined. farms? For the economy as a whole, this Alternatively, what microeconomics would create more problems than takes as variable is considered to be good. There may be excess supply of given in macroeconomics. For instance, paddy or wheat relative to demand. aggregate output of the economy is Government will have to intervene, as it taken as given in microeconomics but + Downloaded By:- KING R QUEEN P[ऋषभ राजपूत] + + 4 INTRODUCTORY MACROECONOMICS in macroeconomics aggregate output is namely households and firms. an important variable. Similarly, Therefore, micro and macroeconomic macroeconomics takes the distribution analyses are not mutually exclusive of output, for example, as given, but in categories. Each of them attempts to microeconomics it is an important focus its attention on one aspect that variable. the other does not. While it is the price Consider our example of a farmer system and resource allocation that given earlier. An individual farmer is occupies the centre stage in hardly conscious of the aggregate microeconomics, the twin areas of output of paddy or wheat. He is income determination and primarily concerned with his own stabilisation and growth of the output in his farm. Similarly, when economy form the core of government decides its policy of macroeconomics. In such a context, procurement, it considers only the state there is an inevitable interlink between of the aggregate output of paddy or these two major branches of economics. wheat and not that of any individual Which branch of economics farmer. The same thing is true of a assumes primacy and receives single manufacturing firm as against maximum attention of economists the aggregate manufacturing output. depends on whether we need a study Although microeconomics and of the ‘part’ or the ‘whole’. Individual macroeconomics areas seem to be rationality in economic behaviour is an rigidly distinct, it is not always so in important area of study insofar as we practice. Both areas of economic are concerned with demand and supply analysis are interdependent. We seek to forces in the market. On the other hand, explain economic behaviour of in the formulation of policies for individual units in the context of the arresting fluctuations in the economy’s state of the economy. performance and for attaining higher That is, a microeconomic decision growth, macro analysis assumes its by an individual unit has to necessarily importance. have a macroeconomic context. The Emergence of Macroeconomics consumption plans of households for instance cannot be independent of the Interest in macroeconomics deepened taxation of personal income and after the emergence of the ‘Keynesian commodities. Similarly, microeconomic Revolution’. 1 In the pre-Keynesian variables may exert their influence on economic theory there was no macroeconomic variables. For instance, recognition of ‘economic crises’. This is aggregate savings and investment are because the Classical economics, which usually influenced by or a function of was the ruling doctrine then, did not the pattern of savings at the micro level, provide an explanation for a major 1 John Maynard Keynes published the book General Theory of Employment, Interest and Money (Macmillan: London, 1936) in which he questioned the basis of the then existing macroeconomics of the Classical School. + + Downloaded By:- KING R QUEEN P[ऋषभ राजपूत] + + INTRODUCTION TO MACROECONOMICS 5 setback to the economy. Classical the way for Keynesian theory. This is the economists strongly believed in the starting point of the present day ‘automatic adjustment’ of the markets macroeconomic approach, which is so that the system will always be in applied extensively in policy-making. equilibrium, and that the ‘shocks’ (that There are many variants of Keynesian is, disturbances in markets) are only approach as the subject of temporary. This contention of the macroeconomics evolved since Keynes’ Classical economists was challenged contribution. when the Great Depression occurred in We may now embark upon learning 1929. The system failed to automatically macroeconomics, concentrating on the correct the crisis situation and therefore Keynesian approach to the structure the failure of the Classical doctrine paved and working of the macro economy. EXERCISES 1. What is microeconomics? 2. What do you understand by macroeconomics? 3. Distinguish between micro and macroeconomics. 4. Give examples of macroeconomic variables. + + Downloaded By:- KING R QUEEN P[ऋषभ राजपूत]  + UN IT -II NATIONAL INCOME AND RELATED AGGREGATES : BASIC CONCEPTS AND MEASUREMENT + Downloaded By:- KING R QUEEN P[ऋषभ राजपूत] + + CHAPTER 2 STRUCTURE OF THE MACRO ECONOMY : CIRCULAR FLOW OF NATIONAL INCOME Macroeconomics, as pointed out earlier, investment and tax payments are all deals with the study of aggregates made by the unit after an analysis of expressed in terms of aggregate income, the accounting information available output, employment, expenditure, to it. exports and imports and so on. In order At the macro level, accounting to determine the actual performance assumes an even greater significance as level of the economy, we need to follow the information is used for a review of a framework of measurement the economy’s performance during the procedures to find these aggregates and year under study. On the basis of this eventually we must interpret the appraisal national governments have to macroeconomic behaviour in terms of formulate their policy programmes to movements in these aggregate maximize the welfare of people. This is measures. National income accounting the basic purpose of national income facilitates the measurement of macro accounting as it renders possible a set aggregates for a given economy. of procedures for measurement of Accounting is believed to be a income and output at the aggregate necessary exercise for any economic level. This means that we are, in fact, unit to know its performance. An measuring the macroeconomic activities individual unit such as a Household or in the economy for a particular year. a Firm maintains its own accounting Accounting for transactions by information since it is interested to individual units is relatively a less know its financial position at the end of complicated and a simple process as an accounting period. 1 Important compared to macro economic decisions concerning savings, accounting of aggregate output and 1 An accounting period or a financial year often does not coincide with a calendar year. Ordinarily, a financial year refers to, for example, April 1, 2004 to March 31, 2005. + + Downloaded By:- KING R QUEEN P[ऋषभ राजपूत]  8 INTRODUCTORY MACROECONOMICS income for the economy as a whole. It is 3. National income accounting helps a rather difficult and complex procedure to find out structural changes in the to quantify the macro variables for economy. accounting purpose. It is not adequate 4. National income accounting to merely look at the macroeconomic provides the information for aggregates but it is also equally assessment of the economy’s important to learn the techniques of strengths and failures. measuring these aggregates. Therefore, 5. National income statistics enable national income accounting has evolved comparisons to be made in respect as a branch of study in its own right. of standard of living, distribution of Primarily, there are two basic income and actual composition of functions of national income accounting: the first, is to identify specific economic national income over time. achievements of a country and the 6. National income accounts facilitates second, is to provide an objective basis comparison of output among of evaluation and review of policies nations. under implementation. Hence, national Hence, the national income data may income accounts data not only help us be viewed as a monetary manifestation to measure macroeconomic aggregates of material results of human activity in but also enable us to understand, analyse and interpret the working of the the economy. They provide standards by economy as well. This is precisely the which economic achievement of policies reason why the road map to the subject could be partly judged in modern times. of macroeconomics begin with a study Structure of the Macro Economy of national income accounting. Circular flow2 of macroeconomic Uses of National Income Accounting activity There are some principal uses of National income accounting calls for an national income accounting. They may understanding of the structure of the be stated as follows: macro economy. The conceptual basis 1. National income accounting shows of measurement of national income as to how the national income is begins with a depiction of the inter- shared among the various factors related manner in which economic of production; activities are organised in an economy. 2. National income statistics indicate A pictorial illustration of this inter- the specific contributions of dependence between the major sectors individual sectors and their growth of economic activity is called the circular over time; flow of income and product. This 2 Flow refers to change in an economic variable over time. Income and product are flow concepts. This may be distinguished from stock variable which means that there is no change over time. For example, wealth is a stock concept. Downloaded By:- KING R QUEEN P[ऋषभ राजपूत]  STRUCTURE OF THE MACRO ECONOMY AND NATIONAL INCOME ACCOUNTING 9 simply means that every economic (b) Goods and services3 flow in one decision of a sector is in response to that direction and money payments to of another. Therefore, macro economy acquire these, flow in the return is in effect a system of interrelationships direction, thereby causing a circular between the decision-makers in every flow. So, the output or product or sector of the economy. real flow from the seller to the buyer The circular flow of income involves necessarily creates the income or two basic principles: payment or money flow from the buyer to the seller. (a) In any exchange process, the seller or producer receives the same We shall now explain this two-way amount that the buyer or consumer process of mutual dependence for spends; and different sectors of the economy. This Clip 2.1 Circular Flow of Income and Product The inspiration for the exposition of macro economy through a Circular Flow of Income and Product appears to have originated from the writings of Physiocrats – a group of French economists who lived in 18th century. Physiocrats strongly believed in the existence of a natural order to guide the working of the economy and hence according to them, there should not be any kind of intervention by the Government in economic activities. They advocated the policy of Laissez faire which means non-interference or minimal interference of the governments in trade and other economic activities and accorded primacy to agriculture as such. Prominent among the Physiocrats was Francois Quesnay who propounded what is called the ‘Tableau Economique’ in 1758. This economic table contains the concept of circulation of wealth and a schematic presentation of the distribution of agricultural output between all classes of society. Though this economic table was recognised as the ‘crowning achievement’ of Physiocrats, this table was not explained by Adam Smith or those belonging to the classical school of economics. It was Karl Marx who rediscovered this table in the mid-19th century. 3 A good is a tangible object (such as a can of fruit juice or a television) that has economic value. A service, on the contrary, is an intangible product (such as advertising) that has economic value. Downloaded By:- KING R QUEEN P[ऋषभ राजपूत]  10 INTRODUCTORY MACROECONOMICS would be a helpful pre-requisite to (i) Household sector has the understand the concepts used in the endowment of factors of production accounting of national income as such. (land, labour, capital and entrepreneurial ability) and sell Circular Flow in a Simple Two-sector them to the Firms that produce Model goods and services, using these To begin with, let us make the following factor inputs. The Firms, in turn, sell assumptions with regard to a simple goods and services thus produced4 economy with only two sectors of to the Household sector for its economic activity. consumption. Therefore, whatever – There are only two sectors in the the Firms produce, is consumed by economy, namely, Households and the Households. Firms. This type of interaction – Households supply factor services between Firms and Households to Firms. can be described as the real flows, – Firms hire factor services from as it involves flow of goods and households. services. – Households spend their entire (ii) Exchange of goods and services income on consumption. between Households and Firms in response to acquiring factor services – Firms sell all that is produced to the Households. from Households corresponds to flows of income and expenditure of – There is no intervention of these two sectors. That is, Firms pay government or foreign trade. the Households in the nature of Such an economy as described above wages for labour services, interest has two types of markets. First, market for capital, rent for land and profits for goods and services – Product to entrepreneurship. These are market; and second, market for factors called factor payments by Firms of production – Factor market. and factor incomes by Households. The economic interdependence This income, in turn, is used by between Households and Firms in this Households to incur expenditure on simple economy can be observed as buying consumer goods and follows: services produced by firms. 4 Firms may produce either producer goods (capital goods used for making other goods) or consumer goods that is, goods meant for only consumption as such. Consumer goods can further be classified into ‘durable’ and ‘non-durable’ variety depending upon whether they have short or long span of life in their use to the consumers. A washing machine or an air-conditioner may be called durable good while food items will fall under the category of non-durable or perishable good, as they do not last long. Downloaded By:- KING R QUEEN P[ऋषभ राजपूत]  STRUCTURE OF THE MACRO ECONOMY AND NATIONAL INCOME ACCOUNTING 11 This flow of money payments 2. Factor Payments by Firms = and expenditure can be described as Factor Incomes of Household money flows. Sector So, in the circular flow diagram (Fig. 2.1), we can recognise two real 3. Consumption expenditure of flows and two money flows. Household sector = Income of Firm As a result we can derive the following, sector in the case of our simple economy: 4. Hence, Real flows of production and 1. Total production of goods and consumption of Firms and services by firms = Total Households = Money flows of consumption of goods and services income and expenditure of Firms by Household Sector and Households PRODUCT MARKET ditu an Firms Households FACTOR MARKET Fig 2.1: The Circular Flow of Income in a Two-sector Economy Downloaded By:- KING R QUEEN P[ऋषभ राजपूत]  12 INTRODUCTORY MACROECONOMICS This simple circular flow highlights Households and Firms can lend and the following interrelationships between: from which they can borrow would – Factor Market and Product Market become relevant. – Output flow and Income flow Households are the net lenders. – Business production and This is possible due to generation of Consumer spending personal savings, which is the difference Each sector is seen in its dual role: between household income and that of the buyer and seller. This consumption. Firms are net borrowers perpetuates the circular flow between since they have to finance new the two sectors. investment in plant and equipment. All Circular Flow of Income with lendings and borrowings are Financial System channelled through the financial A wide variety of financial institutions system. So long as lending is equal to and markets constitute the financial the borrowing, that is, leakage is equal system5 in our economy. Financial to the injection, the circular flow will institutions are primarily intermediaries continue indefinitely (Fig.2.2). between savers and investors, or lenders Financial institutions pay interest to and borrowers. They are specialise in the savers as their funds are placed with their respective areas of financial them for a period of time under a function. Development economists point contract. Firms pay dividend and out the significance of financial interest for the sums they have borrowed development of an economy as a from the financial markets in the form of concomitant outcome of economic shares, bonds and public deposits. development. Therefore, understanding Financial institutions, through their role the macroeconomic activity will be of intermediation, enable funds transfer incomplete without the inclusion from ultimate lenders to ultimate of financial system in our circular borrowers. Saving and investment flow model. process create better prospects for capital So far, in our presentation of circular formation, thanks to the operations of flow of income, we have not considered financial institutions and markets. the role of saving and investment. This is mainly due to the reason that we Financial system is therefore very have assumed that the two sectors – important to the working of the modern Households and Firms are balanced economy. But it is sometimes believed spenders (that is, they neither have a that money and finances are only a surplus nor deficit). Once we relax this cover over the production of goods and assumption a financial system to which services. But we cannot dismiss the 5 Here we assume that Households and Firms save part of their income, which constitutes a leakage from the circular flow of income. The saved amount is made available in the financial system. Firms borrow for purposes of investment, which becomes injection into the circular flow. Downloaded By:- KING R QUEEN P[ऋषभ राजपूत]  STRUCTURE OF THE MACRO ECONOMY AND NATIONAL INCOME ACCOUNTING 13 PRODUCT MARKET ods Savings Savings Financial Firms Households System Borrowings Borrowings r r Pa FACTOR MARKET Fig 2.2: Circular Flow of Income in a Two-sector economy with Financial System funds flow between sectors as inclusion of the Government sector. unimportant. Finance as some Economic interrelationships between economists have held, is only a Households and the Government on the ‘lubricant’ that makes the economy to one hand and Firms and Government work smoothly. on the other are very important from the point of view of the role of Circular Flow of Income with Government as regulator and as an Government6 agent of promoting general welfare of Whatever has been presented in the the people of the country. foregoing section leads us to the All the changes which are conclusion that under the two-sector necessitated by inclusion of Government model, the value of total output flow in sector are shown in Fig. 2.3. In order to our simple economy is equal to the total make the analysis simple, now onwards value of factor incomes and the value we will see only monetary flows. of personal consumption flow. Let us Government purchases goods and now expand the two-sector model and services from Firms and labour services obtain a three-sector model with the from Households. Government collects 6 Government purchases of goods and services are included in the circular flow. Other flows include tax payments by households to government and transfer payments by governments to households. Downloaded By:- KING R QUEEN P[ऋषभ राजपूत]  14 INTRODUCTORY MACROECONOMICS Government Sector Financial Firms Borrowings System Households Borrowings Fig 2.3: The Circular Flow of Income in a Three-sector Economy taxes from Households and Firms in is connected with circular flow of order to finance its expenditure. The domestic economy (Fig. 2.4). The government makes transfer payments domestic economy and the rest of the to the Households in the form of social world are connected through security, scholarships, etc. It also gives international trade and capital flows. subsidies to the Firms for various One country’s exports are another purposes. In India, subsidies are given country’s imports. This import and to small industries, export units, and export of goods and services ultimately other priority sectors of our economy.7 decide what the domestic economy Circular Flow of Income with gains or loses in the international trade. External Sector Home economy enjoys a trade surplus We now need to study the international when there is excess of exports over dimension of macroeconomic activity imports; it suffers a trade deficit when because international economic the opposite happens.8 environment affects output and The four -sector model of the employment in the domestic economy. economy demonstrates the overall The external sector is also called the macro economic condition of income Rest of the World (ROW) sector and this and output in the following identity: 7 All taxes are leakages and all government expenditures are injections into the circular flow. 8 Note that imports are leakages and exports are injections into the circular flow of income in the economy. Downloaded By:- KING R QUEEN P[ऋषभ राजपूत]  STRUCTURE OF THE MACRO ECONOMY AND NATIONAL INCOME ACCOUNTING 15 Government Sector Financial Savings Firms Borrowings System Borrowings Households External Sector Fig 2.4 : The Circular Flow of Income in a Four-sector Economy Y  C + I + G + (X – M) Producing sectors Wherein G = Government Purchases Y = Income or output X – M = Net exports (Where, X = Exports, C = Private Consumption Expenditure M = Imports) on Consumer goods The science of national income I= Investment expenditure by accounting is based on this identity. SUMMARY Structure of the macro economy is given by the circular flow of income and output. National income accounting has its foundation in the circular flow model. National income accounting has several uses for economic policy and research. Circular flow of income can be depicted in two-sector, three-sector and four-sector models. National income accounting provides the standards by which economic activity of a country could be assessed. Downloaded By:- KING R QUEEN P[ऋषभ राजपूत]  16 INTRODUCTORY MACROECONOMICS EXERCISES 1. What are the uses of national income accounting? 2. What is the principle of circular flow of income and product? 3. Explain the circular flow in two-sector economy. 4. Explain the circular flow in three-sector economy. 5. Explain the circular flow in four-sector economy. 6. With the help of a circular flow model, show that income and product flows are equal. 7. Explain the concepts of ‘leakages’ and ‘injections’ in the circular flow of income. Downloaded By:- KING R QUEEN P[ऋषभ राजपूत]  CHAPTER 3 NATIONAL INCOME ACCOUNTING: CONCEPTS AND MEASUREMENT The structure of the macro economy has aggregate output equals the value of been portrayed in the circular flow of aggregate income, which in turn must output and income as dealt with in the equal to the aggregate expenditure. previous chapter. This circular flow Based on this, national income depiction of macroeconomic activities measurement can be categorised into provides logical foundation for the three approaches : output or product concepts and measurement of national approach, income approach and income aggregates. A strikingly unique expenditure approach. All these must, feature of national income concepts is in principle, yield the same result. that they are quantifiable and are not Measuring Gross Domestic Product abstract ones. Hence, they render as Let us first take up the measurement much precision as feasible in the of the value of all that is produced in national income statistics, given the the economy. This is expressed as Gross limitations in the estimation of national Domestic Product. Here, the income aggregates and in the measurement procedure is actually construction of national income three-fold. We use the product method, accounts. There have been many the income method and the expenditure attempts in the past to evolve methods method to compute the Gross Domestic of national income accounting and these Product. As this aggregate is held to be efforts have contributed to the system very important for macroeconomic that we have at present. In this chapter, assessment, greater attention is called we shall present principal methods to for in the computation of this measure. measure national income aggregates. It is pertinent at this juncture to remind Gross Domestic Product : The Output ourselves of an important observation Approach made in respect of the circular flow of Gross Domestic Product (GDP) is a macroeconomic activities. We have, in summary statistic, which is widely used that context, stated that the value of by economists and policy analysts to Downloaded By:- KING R QUEEN P[ऋषभ राजपूत]  18 INTRODUCTORY MACROECONOMICS assess the rate of growth of an economy taken into account in the measurement during a year. GDP is generally of GDP. recognised to be the primary measure. Intermediate goods are those GDP is defined as the market value goods that are used to produce other of all final goods and services produced goods and therefore they always move by the factors of production located in from one stage of production to another the country during a period of one year. in the manufacture of a final product. A key phrase in this definition is ‘final Let us now show the difference goods and services’ which require some between final and intermediate goods with elaboration. the example of producing an automobile. Final goods are those that are meant The industrial process to manufacture an automobile involves for final use by consumers or firms. These materials such as steel, paint, rubber, goods are not required to enter into foam, plastic, glass, cables, battery, etc. further stages of production or resale to and a variety of component parts. All change their form and content. They are these items are produced by the finished goods meant only for final respective firms only to be used in the consumption and investment. production of another product; in our Measurement of GDP includes only example it is the automobile. But once the aggregate value of final goods. Also, the process of producing an automobile from a development perspective, the starts, all these are converted into strength of an economy is seen in its integral parts of an automobile. So, capability of producing final goods and these goods are not important in their services. own right; they are just a means to an It may be useful at this stage to draw a distinction between final goods and end. Such goods are called intermediate intermediate goods. The latter are not goods. The automobile that is produced Clip 3.1 PIONEERS IN NATIONAL INCOME ANALYSIS In the contemporary world now, national income concepts and accounting methods are widely recognised and applied to measure the economic performance of countries. However, these concepts and methods became popular only a few decades ago. A seminal contribution to the field of National Income and Product Accounts (NIPA) made by Simon Kuznets (1901–1985) set the trend of using national income aggregates to measure the direction of growth of economies. He was a great pioneer in this field and due to his research efforts, the first national income figures for the US economy was published in 1934 as an official document of the US Senate. This helped immensely to understand the severe impact of the Great Depression in 1929. His monumental book of two exhaustive volumes, National Simon Kuznets Income and its Composition, 1919-1938 (New York; NBER, 1941) Downloaded By:- KING R QUEEN P[ऋषभ राजपूत]  NATIONAL INCOME ACCOUNTING : CONCEPTS AND MEASUREMENT 19 earned him the worldwide recognition. This was followed by two of his landmark contributions, namely, National Product since 1869 (New York; NBER, 1947) and Economic Growth of Nations : Total Output and Production Structure (Cambridge Mt, Harvard University Press, 1971). For his contributions, Kuznets was honoured with the Nobel Prize in 1971 in recognition of his empirical interpretation of economic growth. Another important contribution in this field is that of Richard Stone (1913-1991). Stone worked with John Maynard Keynes as a research assistant. Stone during the early 1940s prepared a statistical profile of the British economy. After the World War II, Stone headed a United Nations project to develop standard national income accounting model. In India, prior to 1947, the estimation of national income was attempted by individual economists and scholars for Richard Stone specific years. V.K.R.V. Rao P.C. Mahalanobis D.R. Gadgil Among these, the most systematic work was that of V.K.R.V. Rao in his book National Income in British India 1931-32 (London; MacMillan 1940), which formed the basis of national income estimation in the post-independence period. In 1949, the Government of India formed the National Income Committee under the Chairmanship of P.C. Mahalanobis, with V.K.R.V. Rao and D.R. Gadgil as members. From then onwards the national income estimation has been steadily strengthened. Now, the Central Statistical Organization (CSO) is entrusted with the task of publishing National Accounts Statistics (NAS). in the final stage of the assembly line is is, no product should be counted two the final good. or more times. Double counting will Hence, the rationale for not taking only exaggerate or over-estimate the into account the value of intermediate value of GDP. goods in the measure of GDP is to avoid The procedure by which we eliminate the problem of double counting. That the values of intermediate goods from GDP Downloaded By:- KING R QUEEN P[ऋषभ राजपूत]  20 INTRODUCTORY MACROECONOMICS is through the method of value added. a good’s value increases at each stage This is discussed in the following section. until its final value is obtained in the last stage. It follows therefore that the Concept and Measurement of Value value of final good will have to be equal Added to the sum of the value-added at each The concept of value added is very basic stage of production. This is shown with to the measure of GDP. Value-added is a numerical illustration in Table 3.1. defined as the difference between total Consider the production and sale value of output of a firm and value of of a cake to the Household sector for inputs bought from other firms. It thus final consumption. The process of measures the value, which the firm production starts with a farmer raising concerned has added by its process wheat crop and harvesting it. Since we of production. are starting with the stage of wheat Most goods go through multiple cultivation, let us not go into the stages of production. This means that backward production linkages of the Table 3.1 : Numerical Illustration of GNP Measurement using Value Added Method Stage I Stage II Stage III Stage IV (Wheat) (Flour) (Cake at Bakery) (Cake at Retailer) Farmer Black’s Purchases Miller White’s Baker Brown’s Retailer Green’s from other firms None Value Added Rs. 1.00 Purchases Rs. 1.00 Purchases Rs. 1.50 Purchases Rs. 2.00 from Farmer from Miller from Baker Value Rs. 0.50 Added Value Rs. 0.50 Added Value Rs. 0.50 Added Break-up of Value of Final value added good = Rs.2.50 Profit = 0.20 + 0.25 – 0.40 + 0.28 = 0.33 Wages = 0.60 + 0.10 + 0.70 + 0.05 = 1.45 Rent = 0.05 + None + None + None = 0.05 Interest = 0.05 + 0.10 + 0.01 + 0.02 = 0.18 Depreciation = 0.02 + 0.02 + 0.09 + 0.07 = 0.20 Property and = 0.08 + 0.03 + 0.10 + 0.08 = 0.29 sales taxes Sum of value added Total (in Rs.) 1.00 + 0.50 + 0.50 + 0.50 2.50 Downloaded By:- KING R QUEEN P[ऋषभ राजपूत]  NATIONAL INCOME ACCOUNTING : CONCEPTS AND MEASUREMENT 21 farmer. Therefore, the farmer’s value- (iii) Net-value added at Market Price = added in the cultivation stage will be Gross value added at Market price just the value of his output as such (that – Consumption of fixed capital is one rupee). In the second stage, the (Depreciation) miller buys the wheat from the farmer (iv) Net-value added at Factor Cost = and grinds it into flour, and sells it to Net value added at Market Prices – the baker for Rs.1.50. By this, he adds Net indirect taxes (Net Indirect Taxes a value of 50 Paise. The baker makes = Indirect Taxes – subsidies) the cake and sells it to the retailer for (v) Net value added at factor cost = Total Rs. 2.00, thereby adding a value of 50 Factor Income paise. The retailer who buys the cake Now, let us look into the from the baker sells it to the final computation of value added as shown consumer for Rs. 2.50, thereby adding in the illustration below: a value of 50 paise. This means that the Example 1: From the following data value of the final good, namely, the cake calculate the value added by Firm A and is Rs. 2.50 at the retail store. This final Firm B. value of the cake is the sum of the value (Rs. in Lakhs) added from the stage of cultivation to (i) Closing stock of Firm A 20 that of retail sale at the shop, that is, (ii) Closing stock of Firm B 15 total value added equals Rs.1.00 + 50 (iii) Opening stock of Firm A 5 Paise + 50 Paise + 50 Paise = Rs. 2.50. (iv) Opening stock of Firm B 10 On the other hand, if we had (v) Sales by Firm A 300 included the value of all the (vi) Purchases by Firm A from 100 intermediate stages, preceding the retail Firm B sale, cake’s value would have increased (vii) Purchases by Firm B from 80 manifold, due to the problem of double Firm A - counting. That is, wheat would have (viii) Sales by Firm B 250 been counted four times, floor three (ix) Import of raw material 50 times and baked items twice. This is the by Firm A reason why we take the final value of (x) Exports by Firm B 30 the output as a sum of all values added in producing a good. As first step calculate the value of This procedure of value added output for each Firm. Then find the method demonstrated for an individual value added. product is applied at the aggregate level Step 1. Value of output of Firm A for the measurement of GDP. = Sales + Change in stock (Closing stock – Opening stock) Concepts of Value Added = 300 + (20 – 5) (i) Value of output by a Firm = Sales + = Rs. 315 lakhs Change in Stock (ii) Value Added = Value of output – Step 2. Value added by Firm A Intermediate goods cost = Value of output – purchases Downloaded By:- KING R QUEEN P[ऋषभ राजपूत]  22 INTRODUCTORY MACROECONOMICS from Firm B – imports by goods and services that are purchased Firm A by households and non-profit = 315 – 100 – 50 institutions for current use during a = Rs. 165 lakhs time period. Considering the fact that Repeat the same procedure for Firm B consumption expenditure is a Step 3. Value of output of Firm B significant part of GDP, it requires = Sales + Change in stock special attention by economists and (Closing stock – Opening stock) government. Private consumption is the demand for consumer goods and + Exports by Firm B services. While goods are tangibles, = 250 + (15 – 10) + 30 (that is, you can see a car) the services = Rs. 285 lakhs are intangibles (that is, you cannot see Step 4. Value added by Firm B a service such as car insurance). = Value of output – purchases Further in the case of goods, from Firm A consumption or use of a good can be = 285 – 80 separated from the place of its = Rs. 205 lakhs production and can be separated in Gross Domestic Product : As Sum of time, that you can consume or use a Expenditure good at your convenient place or time. GDP can be measured by taking into But services should necessarily be used account all final expenditures in the at the time and place in which they are economy. There are three distinct types produced. For instance, banking service of expenditure as they are committed will take place at the place and time specified by the banker and customers by Households, Firms and Government utilise their banking facilities accordingly. respectively. These expenditures are Consumption can be divided into classified into following types : three sub-categories such as, (i) Private Consumption (C) consumer services, consumer non- Expenditure durable goods and consumer durable (ii) Investment Expenditure (I) goods. Non-durable goods are used up (iii) Government Purchases of (G) immediately or within a short span of time. Durable goods in contrast could Goods and Services be used for a longer period of time. (iv) Net Exports (X – M) Food items are non-durable Let us discuss these items of final consumption goods whereas furniture, expenditures with respect to the sectors stereo equipment, washing machines concerned. are durable consumption goods. But usually this distinction is based only (i) Private Consumption expenditure on the given length of time within which The private consumption component of consumer goods are used. Durability GDP measures the money value of does not imply a state of permanence. Downloaded By:- KING R QUEEN P[ऋषभ राजपूत]  NATIONAL INCOME ACCOUNTING : CONCEPTS AND MEASUREMENT 23 Durable goods also have their limited (b) Inventory investment period of use value, after which they are (c) Residential construction investment given up. Private final consumption will (d) Public investment include expenditure on all these three (a) Business Fixed Investment (BFI) is categories mentioned here. the amount spent by business units on (ii) Investment purchase of newly produced plant and Investment is an addition to the stock of equipment. The two measures of BFI are capital during a period. The Gross Gross Business Fixed Investment (GBFI) Private Domestic Investment shows the and Net Business Fixed Investment aggregate value in this regard. Unlike (NBFI). Gross Business Fixed investment the intermediate goods which are used is the gross amount spent on newly up entirely in the process of making provided plant and equipment, that is, other goods, capital is only partially capital goods. If depreciation is depleted in making other goods. That deducted from it, then we obtain Net is, a steel mill may have a useful life of Business Fixed Investment. say, 50 years. In providing steel in any The inclusion of capital goods in the one year, only a small portion (1/50th) final product along with the goods and of the mill is used. This using up of services produced by them would capital is called depreciation. involve double counting. For this reason Depreciation is the value of the existing it is important to make provision for capital stock that has been consumed depreciation. If in every year we deduct or used up in the process of producing from investment (and therefore from output. Usually an asset is depreciated domestic product) the amount by which at a predetermined rate and monetary capital stock has been used up over the value is assigned to the rate of year, then over the whole lifespan of the depreciation of a physical asset in capital good, we will have deducted one year. This is also described as from the domestic product the whole capital consumption allowance1. When value of the capital good. In this way investment is expressed as Gross we will have avoided counting in the Investment or Net Investment it means domestic product both the asset and whether investment has or has not been the goods produced by it and so shall adjusted against depreciation. Gross have avoided double counting. BFI is term includes depreciation while Net usually the result of a conscious term is obtained after deducting the decision by firms to augment their depreciation amount. Investment component could be productive capacity. classified under four categories : they are (b) Inventory Investment is the net (a) Business fixed investment change in inventories of final goods 1 The usage of fixed assets lead to their wear and tear; so, we must provide for consumption of fixed capital as a prerequisite in accounting the product. Downloaded By:- KING R QUEEN P[ऋषभ राजपूत]  24 INTRODUCTORY MACROECONOMICS awaiting sale, semi-finished goods, or Now the investment component as of materials used in the production a whole can be thought of in the process (inputs). These must be following two ways : included since they represent currently produced output not included in the Gross Investment = Gross Business current sales of final output. Fixed Investment + Gross Residential Changes in inventory are usually Construction Investment + Gross Public the result of unintentional short run Investment + Inventory Investment deviations between supply and Net Investment = Net Business Fixed demand. Stock changes play a crucial Investment + Net Residential role in income determination. For Construction Investment + Net Public example, if there is a sudden doubling Investment + Inventory Investment of the demand for television sets, it is As pointed out earlier, the difference unlikely that the production of them will between gross investment and net also double overnight. So, the first effect investment is depreciation. of the increase in demand relative to supply will be a fall in the inventory of (iii) Government Purchases of television sets normally held in the Goods and Services economy (inventory that is held by the This component summarises the producer, wholesaler or retailer), in the government spending on goods and attempt to satisfy the sudden increase services. Remember that government in demand. This process will continue purchases is a proxy measure for until production is augmented to government output. match the increased demand. As a matter of fact, government Conversely, a sudden fall in demand will purchases from private producers lead to a rise in inventories of television would be intermediate goods and sets until production adjusts itself to government wages and salaries would the lower level of demand. be part of the income side of the (c) Residential Construction Investment national accounts. Instead of doing this is the account spent on the building of we take the government purchases as housing units. This is also expressed part of the final product. in terms of either gross or net depending In the above we have understood on whether depreciation has been government as a producer of goods and subtracted or not. services. This is an important function (d) Public Investment includes all of the government. At the same time we capital formation carried out by the should also be aware of another function government such as building of roads, of government – that is, making hospitals, schools etc. This is also given payments to certain categories of people in gross or net value depending on or firms to compensate them as a matter whether depreciation has been of its social obligation. This is called subtracted or not. Government Transfers, which refer to the Downloaded By:- KING R QUEEN P[ऋषभ राजपूत]  NATIONAL INCOME ACCOUNTING : CONCEPTS AND MEASUREMENT 25 total value of payments made by did on the product side. While measuring government sector towards households GDP we must include only those income and firms as income supplements and flows that originate with the production subsidies respectively. This is also known of the goods and services within the as Transfer Payments, and they are not particular time period. counted in the GDP because there is no The components of factor income are: production of goods due to them. 1. Employee compensation Transfer Payments are basically welfare- 2. Profits oriented expenditures of the 3. Rent Government. 4. Interest (iv) Net Exports 5. Mixed income This is the difference between Exports (X) Now let us look into the details of and Imports (M) of a country, that is each one of these. (X – M). Based on the expenditure flows 1. Employee Compensation in the economy, Gross Domestic Compensation to employees in the form Product is the total value of the sum of wages, salaries and benefits makes of consumption and investment expenditure along with government up the largest single component of purchases and net exports. income generated with production of In other words GDP. Wages and salaries are payable GDP = C + I + G + (X – M) in cash, kind or both. Where, 2. Profits C = Consumption expenditure by Profits are the reward the owners of households firms receive for being in business. I = Investment expenditure by firms Firms’ desire to earn profits is the main G = Government purchases of goods motivating force behind production in and services. a market economy. X-M = Net Exports. 3. Rent Rental income is, for example, income Gross Domestic Product : A Measure earned by owners of rental housing. The of Income meaning of rent in the national income The third approach to the measurement accounts is that it is a charge for the of GDP is to compute it by addition of all temporary use of some capital asset. factor incomes generated in the 4. Interest production of goods and services. Households both receive and pay Because each rupee of goods and interest. We include in GDP only the net services produced is matched by a rupee interest, that is the difference between of income, we can arrive at the same interest amount paid and the interest figure for GDP on the income side as we income received by households. Downloaded By:- KING R QUEEN P[ऋषभ राजपूत]  26 INTRODUCTORY MACROECONOMICS 5. Mixed Income to non-residents working in the Mixed income will include the income of domestic territory during a given own account workers and profits and accounting year. Hence, the components dividends of unincorporated enterprises. of Net Factor Income from abroad are : In other words, it may be called as mixed (i) Net compensation to employees income of the self employed. (ii) Net income from property and All the above mentioned components entrepreneurship, which includes of income measure of the GDP have an rent, interest, dividends, etc. important implication for the economy (iii) Net retained earnings of resident as such. Their relative share in GDP companies abroad shows the manner in which each of Hence, these income flows changes overtime. Gross Domestic Product + Net Factor It is possible to show by way of an Income from abroad = Gross National illustration as to how the sum of value Product added is equal to the total of the above types of income earned during the Now we may distinguish between process of production. This is shown Gross National Product and Gross in Table 3.1 Domestic Product. The difference GDP as measured by the between the two arises from Net Factor aggregation of factor incomes is also Income from Abroad. Note that the called as Gross Domestic Income (GDI). (X – M) component of GDP represents only goods and services other than Gross National Product factor incomes. After getting GDP we can add Net Factor Real and Nominal GNP Income from abroad to estimate the Having presented the measurement of value of Gross National Product (GNP). GNP it remains to be seen as how the How is Net Factor Income from Abroad changes in the GNP value are expressed defined? What are included in it? in relation to price level changes as price Net Factor Income from Abroad is changes affect the value of the national the difference between the factor income income aggregates. For this we must received from the rest of the world, i.e. explain the two ways of computing abroad for rendering factor services, and national income data at current market the income paid for factor services prices and constant prices. rendered by non-residents inside the domestic territory of the country. As we Current Market Prices know that factor incomes include If the GNP (or any other related compensation to employees and income aggregates) is measured in terms of from property and entrepreneurship, current market prices, then it is referred then Net Factor Income from abroad is to as Nominal GNP. Since the nominal the difference with respect to these items GNP measures the value of currently received by residents abroad and given produced goods and services at market Downloaded By:- KING R QUEEN P[ऋषभ राजपूत]  NATIONAL INCOME ACCOUNTING : CONCEPTS AND MEASUREMENT 27 prices, GNP will change when either the (c) Real GNP is also often used in overall price level changes or when the making international comparisons actual volume of production changes of economic performance across the or when both change simultaneously. countries. Constant Prices Having explained the concepts of Nominal and Real GNP, let us proceed However, for certain purposes we may to know the method by which we obtain want to have a measure of output that the value of Real GNP through the changes only when the quantity of goods constant prices. produced changes. This measure of only The purpose of using constant quantity change, not prices, is the method prices is to eliminate the effect of price of using constant prices. Accordingly, GNP that is computed at constant prices changes. For this, we are supposed to will be called the Real GNP. Usually, express the value of current year’s GNP under this method GNP value is (Nominal GNP) in terms of prices expressed in terms of prices prevailing in prevailing during a reference year in the a year chosen to be the base year. past, which is called the Base year. That Real GNP has the following is, the account for the value of current advantages: year’s GNP as if the price level is same (a) It is useful in finding out the effect of as that of the base year. As you may be increased production of goods and aware that the price level is usually services on the real development measured by the Wholesale Price Index capacity of the economy in general. or the Consumer Price Index Number.2 But the nominal GNP cannot show If the GNP in the current year is this as we cannot segregate the valued at current market prices, it will change in output alone, since, the not be possible for us to find out how current market prices in terms of much of the increase in GNP is due to which it is measured prevent such increase in prices (inflation) and how an exercise; much of the increase is due to an (b) Real GNP also enables one to make increase in the production of goods and a year-to-year comparison of the services. To know whether GNP changes in the growth of output of increase actually means an increase in goods and services. An expansion the output of goods and services, we phase of the economy is a period of must eliminate the effect of price rising real GNP. On the contrary a increases. recession is a period in which real We shall explain, through the GNP falls consecutively; and following illustration, the calculation of 2 An index number is a representative number to decode the changes in price level. The consumer price index number is used to represent the average change over time in the prices paid by the final consumer of a specified group of goods or services. Downloaded By:- KING R QUEEN P[ऋषभ राजपूत]  28 INTRODUCTORY MACROECONOMICS nominal GNP and real GNP as well as Let us take up the calculation GNP deflator (Table 3.2). of nominal GNP through the Let us assume that our imaginary expenditure approach. Let us therefore economy has only three final goods : find out the expenditure on each good and obtain the total expenditure at Oranges - Consumption good current prices. Computers - Capital good Consumption expenditure (oranges) and Government purchases of cloth. is Rs. 4452, investment (computers) is Table 3.2: Nominal GNP, Real GNP and the GNP Deflator Current Period Base Period Item Quantity Price Expenditure Price Expenditure (Rs) (Rs) (Rs) (Rs) Oranges 4,240 Kgs. 1.05 per kg. 4,452 1 per Kg 4,240 Computers 5 2100 each 10,500 2000 each 10,000 Government 1,060 1 per 1,060 1 per meter 1,060 Purchases meters meter of Cloth Nominal GNP 16,012 Real GNP 15,300 Deflators for the current period Nominal GNP  100 Rs.16012 GNP Deflator   100  104.7 Real GNP Rs.15300 Consumption Expenditure Deflator Current period consumption expenditure Rs. 4452  100  100  105.0 Base period consumption Rs.4240 expenditure Current period investment Rs.10500 Investment Deflator  100  100  105.0 Base period investment Rs.10000 Current period Government  purchases Rs.1060 Government Purchases 100  100  100.0 Base period Government Rs.1060 purchases Downloaded By:- KING R QUEEN P[ऋषभ राजपूत]  NATIONAL INCOME ACCOUNTING : CONCEPTS AND MEASUREMENT 29 Rs. 10,500, and government expenditure measures the average level of the prices of is Rs. 1,060, so the nominal GNP is Rs. all the goods and services that make up 16012. GNP. It is calculated as the ratio of nominal Now, let us calculate real GNP. This GNP to real GNP, multiplied by 100. is, as mentioned before, calculated by In the above example, we divide valuing the current period quantities at nominal GNP (Rs.16,012) by real GNP the base period prices. Accordingly, the (Rs. 15,300) and multiply the results by consumption expenditure is Rs. 4240, 100. We obtain GNP deflator as 104.7. investment is Rs.10,000 and government It is also possible to calculate expenditure is Rs.1,060. So the real deflator for specific expenditures as we GNP is Rs.15,300. would like to know the real value of Finally, the concept of GNP deflator these expenditures. This is also shown requires explanation. The GNP deflator in Table 3.2. GNP MP (-)net income from abroad NNPMP GNP GDPMP FC (–)net income (–)net income from abroad from abroad NDPMP GDP NNPFC FC (–)net income from abroad NDPFC Fig 3.1: Relationships between Different aggregates of National Income 3 3 Wilfred Beckerman, An Introduction to National Income Analysis, 3rd Edition, Universal Book Stall, New Delhi, 1999. Downloaded By:- KING R QUEEN P[ऋषभ राजपूत]  30 INTRODUCTORY MACROECONOMICS Important National Accounts 5. GNP at Factor Cost (GNPFC) = GDPMP Aggregates + Net Factor Income from Abroad – Net Indirect taxes Gross National Product is the core concept of national income accounting. 6. NNP at Factor Cost (NNP FC ) = From this several other measures are GNPFC – Depreciation derived, each having its specific purpose 7. GDP at Factor Cost (GDPFC) = GDPMP to interpret the performance of a given – Net Indirect taxes economy. All these concepts and 8. NDP at Factor Cost (NDP FC)= GDPFC measures are interrelated which is – Depreciation shown in Figure 3.1. From this, we may National5 Disposable Income observe eight major national accounts concepts as given below and they may In addition to the above, we may also be derived following the direction given include the concept of National in the diagram. Disposable Income. National Disposable Income is the income from all sources to 1. GNP at Market Prices (GNPMP)4 = the residents of a nation for spending on Value of all the final goods and consumption as well as saving during a services produced in the economy year. It is given by the following : + Net Factor Income from Abroad National Disposable Income 2. NNP at Market Prices (NNPMP) = = NNPMP + Other Current Transfers GNPMP –Depreciation from the rest of the world6 3. GDP at Market Prices (GDPMP) = This is the maximum available income GNPMP – Net Factor Income from for a country. National Disposable Abroad Income for a country is what the Personal Disposable Income (Personal 4. NDP at Market Prices (NDPMP) = Income – Personal Taxes) is for an GDPMP – Depreciation individual. 4 A particular value may be expressed at Market Prices or at Factor Cost. If a quantity is expressed in terms of its current prices it is referred to as market price. Suppose the total value added is computed on the basis of current prices of inputs then we may call this as value added at Market Prices. On the other hand, if the value added is arrived at by adding the payments to factors (land, labour, capital and entrepreneurship) such as rent, wages, interest and profit, (as was done in Table 3.1) then it is described as value added at Factor Cost. In the same manner, all the concepts of national income may be shown either at market prices or at factor costs. 5 It may be necessary to give the meaning of ‘Domestic’ and ‘National’ used in National Income aggregates. Domestic here simply means ‘domestic territory’. So, domestic product would imply the value of all goods and services produced by the normal residents of a country. ‘National’ refers to the addition of the net factor income from abroad to the domestic product. 6 Current transfers from the rest of the world may include gifts, cash, consumer goods and even military equipment. Downloaded By:- KING R QUEEN P[ऋषभ राजपूत]  NATIONAL INCOME ACCOUNTING : CONCEPTS AND MEASUREMENT 31 The above definitions may be Government purchases of goods and understood as general principles of how services+Netexports(Exports–imports) these measures are conceptualised. In + Net factor income from abroad. practice each country follows its own (ii) Income Method method of compilation and hence GNPMp = Employee compensation definition of specific items, which (wages and salaries + employers’ constitute an aggregate measure, will contribution towards social be different from others. In India, the security schemes) + profits + rent + national accounts are prepared in interest + mixed income + accordance with System of National depreciation + net indirect taxes Accounts (SNA) since 1975. (Indirect taxes – Subsidies) + Net Subsequently, there has been a factor income from abroad. significant improvement in the (iii) Value Added Method statistical statements in terms of GNPMp = (Value of output in primary database and coverage. Presently the sector – intermediate consumption SNA 1993 is being used. of primary sector) + (value of output Concepts of National Product and in secondary sector – intermediate National Income: A Summary consumption of secondary sector) + (value of output in tertiary sector GNPMP = Value of all final goods and – intermediate consumption of services produced in the tertiary sector) + Net factor income economy+Net factor income from aboard. from abroad NNPMp = GNPMp – Depreciation The following numerical examples will help us to understand various national GDPMp = GNPMp – Net factor income from abroad income aggregates. NDPMp = GDPMp – Depreciation Example 1: From the following data GNPFc = GNPMp – Net indirect taxes calculate the Gross National Product at NNPFc = GNPFc – Depreciation = Market Price through the Expenditure Method National income GDPFc = GDPMp – Net indirect taxes (Rs. in crores) i. Inventory Investment 10 NDP = GDPFc – Depreciation Fc ii. Exports 20 Three Methods of Measurement of iii. Net factor income from abroad (–5) National Product iv. Personal consumption 350 expenditure (i) Expenditure Method v. Gross residential 30 GNPMp = Personal consumption construction investment expenditure + Gross Investment vi. Government purchases of (Gross business fixed investment + goods and services 100 vii. Gross public investment 20 Inventory investment + Gross viii. Gross business fixed 30 residential construction investment investment + Gross public investment) + ix. Imports 10 Downloaded By:- KING R QUEEN P[ऋषभ राजपूत]  32 INTRODUCTORY MACROECONOMICS Solution: + Mixed Income = 400 GNPMp = + Depreciation = 50 Personal consumption = 350 + Net Indirect taxes which = 200 expenditure include + Gross Investment = 90 Indirect taxes = 300 which include: Subsidies = 100 Gross Business Fixed = 30 + Net Factor Income from Abroad = –10 Investment Gross Residential = 30 GNPMp =1930. So the GNPMp is Rs.1930 crores Construction Investment Gross public Investment = 20 Example 3: From the following data Inventory Investment = 10 calculate the Gross National Product at + Government purchases of = 100 Market Price via the Value Added method goods and services + Net exports = 10 (Rs. in croroes) which include: i. Value of output in primary 1,000 Exports = 20 sector Imports = 10 ii. Net factor income from abroad –20 +Net Factor Income From Abroad = –5 iii. Value of output in tertiary sector 700 GNPMp = 545 iv. Intermediate consumption 400 So, GNPMp is Rs. 545 crores. in secondary sector Example 2: From the following data calculate the Gross National Product at v. Value of output in secondary 900 Market Price via the Income method sector (Rs. in crores) vi. Intermediate consumption in 500 i. Wages and Salaries 700 primary sector ii. Rent 100 vii. Intermediate consumption in 300 iii. Depreciation 50 tertiary sector iv. Net factor income from abroad 10 v. Mixed income 400 Solution: vi. Subsidies 100 Value of output in primary sector = 1,000 vii. Profits 400 – Intermediate consumption of viii. Indirect taxes 300 primary sector = 500 ix. Employers contribution 50 + Value of output in secondary = 900 to social security schemes sector x. Interest 40 – Intermediate consumption in = 400 Solution: secondary sector Employee Compensation which + Value of output in tertiary = 700 include = 750 sector Wages & Salaries = 700 – Intermediate consumption = 300 Employers’ contribution to = 50 social security schemes of tertiary sector + Profits = 400 + Net factor income from abroad = 20 + Rent = 100 GNPMP = 1380 + Interest = 40 So, GNPMp is Rs. 1380 crores. Downloaded By:- KING R QUEEN P[ऋषभ राजपूत]  NATIONAL INCOME ACCOUNTING : CONCEPTS AND MEASUREMENT 33 Example 4: From the following data So, GDPFC = Rs. 545 crores calculate the GNP, GDP, NNP, NDP at both h) NDPFC = GDPFC – Depreciation factor cost and market prices. = 545 – 15 = 530 (Rs. in crores) So, NDPFC = Rs. 530 crores i. Gross Investment 90 ii. Net exports 10 Items that are Excluded from GNP iii. Net indirect taxes 5 Measurement iv. Depreciation 15 It may be recalled that GNP is the v. Net factor income from abroad 5 measure of the value of the final goods vi. Personal consumption 350 and services produced in one year. But expenditure in reality many transactions occur in vii. Government purchases of 100 the economy that have either nothing goods and services to do with the final goods and services Solution: produced or that they are non-market a) GNPMP = activities or illegal activities whose Personal consumption expenditure = 350 measurement has its own limitations, + Gross investment = 90 both conceptual and empirical. We shall + Government purchases of = 100 now enumerate a few of these goods and services transactions that are excluded in the + Net exports = 10 estimation of GNP. + Net factor income from abroad = 5 1. Purely Financial Transactions GNPMP = 545 There are three generate types of purely So, GNP is Rs. 545 crores financial transactions. They are MP b) NNPMP = GNPMP – Depreciation (a) Buying and Selling (b) Government of securities Transfer Payments = 545 – 15 = 530 So, NNPMP = Rs. 530 crores (c) Private Transfer Payments c) GDPMP = GNPMP – Net Factor Now, let us examine these Income from Abroad transactions in detail. = 545 – (–5) = 545 + 5 = 550 (a) Buying and selling of securities So, GDPMP = Rs. 550 crores d) NDPMP = GDPMP – Depreciation In the financial markets as shown = 550 – 15 = 535 earlier in circular flow model, potential So, NDPMP = Rs. 535 crores savers and investors buy and sell e) GNPFC = GNPMp – Net indirect financial assets such as shares and taxes bonds. While someone buys a share = 545 – 5 = 540 there is only a transfer of ownership So, GNPFC = Rs. 540 crores right. It is a claim to ownership of assets. f) NNPFC = GNPFC – Depreciation = 540 – 15 = 525 In the case of bonds, it is So, NNPFC = Rs. 525 crores acknowledging a debt transaction. g) GDPFC = GDPMp – Net indirect There is no production activity but only taxes exchange of funds for financial claims. = 550 – 5 = 545 Trading in financial instruments does Downloaded By:- KING R QUEEN P[ऋषभ राजपूत]  34