NATIONAL INCOME

Macroeconomics
• In 1933 Ragnar Frisch used the words
micro and macro. Before 1930 the subject
matter of economics was considered as
micro. After establishing the theory of Lord
Keynes – ‘ the general theory of
employment, interest and money, it can be
divided as micro and macro.
• The word macro comes from the greek
word ‘makros”. It means large or big. So it
is concerned with aggregate and average
of the entire economic system.

• It deals how an economy can grow.

• It includes GNP, NNP, GDP, NI,
Employment level, Total output level,
General price level etc.
 Macroeconomics

• Macroeconomics is the study of the

behavior of the economy as a whole. It
concerns the business cycles that lead
to unemployment and inflation, as well
as the longer-term trends in output and
living standards.
 Macroeconomic Goals
• Output
– High level and sustainable growth
• Employment
– High level of employment and low involuntary
unemployment
• Stable Prices
The condition in which the average price level in the
economy does not change or changes very slowly.
• International trade
– Export and import equilibrium and exchange rate
stability
 GNP
• Gross National Product
1. monetary value
2. flow variable
3. only includes final goods and services
4. doesn’t include transfer payment
5. it has 3 aspects
production
income
expenditure
• Gross national product (GNP) is the total
income earned by a nation’s permanent
residents (called nationals).

• It differs from GDP by including income

that our citizens earn abroad and
excluding income that foreigners earn
here.
• GNP= GDP+ Remittance-Foreigners
earnings
 GDP
Gross Domestic Product

• It is the total market value of all final

goods and services produced within a
country in a given period of time.

• The Components of GDP

GDP = C + I + G + (X – M)
• Consumption (C):
The spending by households on goods and
services, with the exception of purchases of
new housing.
• Investment (I):
The spending on capital equipment,
inventories, and structures, including new
housing.
• Government Purchases (G):
The spending on goods and services by local,
state, and federal governments.
Does not include transfer payments because
they are not made in exchange for currently
produced goods or services.
• Net Exports (NX):
Exports minus imports.
 The Measurement of GDP
• Output is valued at market prices.

• It records only the value of final goods, not

intermediate goods (the value is counted
only once).

• It includes both tangible goods (food,

clothing, cars) and intangible services
(haircuts, doctor visits).
• It includes goods and services currently
produced, not transactions involving goods
produced in the past.

• It measures the value of production within

the geographic boundaries of a country.

• It measures the value of production that

takes place within a specific interval of time,
usually a year or a quarter (three months).
 There are 3 methods of
measuring GDP
• Income Approach

• Output / product Approach

• Expenditure Approach

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 Income Approach
• It is shown by the distribution side
• W+I+R+P = GDP
• Profits are stated net of depreciation /
capital consumption allowances
• It can indicate the distribution of NI among
the factors of production

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 Output Approach

• The total value of the final goods and services

produced by the primary / secondary / tertiary
industries
• In order to avoid double counting, the value-added
method is adopted to exclude intermediate goods.
GDP= P1Q1 + P2Q2 +………+PnQn

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 Expenditure Approach
• People spend their income. Thus, the total
expenditure on final goods and services
must be equal to the total value of final
goods and services produced
domestically.

• C+I+G+(X-M) = Aggregate / Total

expenditure

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 NNP
• Net National Product is the total income
of the nation’s residents (GNP) minus
losses from depreciation.

• Depreciation is the wear and tear on the

economy’s stock of equipment and
structures.
• NNP= GNP-depreciation
 NI
• National Income is the total income earned
by a nation’s residents in the production of
goods and services.

• It differs from NNP by excluding indirect

business taxes (such as sales taxes) and
including business subsidies.

• NI=NNP-IBT+subsidies
 PI
• Personal income is the income that
households and noncorporate businesses
receive.
• In addition, it includes household’s interest
income and government transfers.
 DI
• Disposable personal income is the income
that household and noncorporate
businesses have left after satisfying all
their obligations to the government.
• It equals personal income minus personal
taxes.
• DI= PI-personal tax
• The GDP deflator measures the current level of
prices relative to the level of prices in the base
year.

• The GDP deflator is calculated as follows:

Nominal GDP
GDP deflator =  100
Real GDP
 Nominal vs Real
• Nominal GDP values the production of
goods and services at current prices.
• Real GDP values the production of goods
and services at constant prices.
• An accurate view of the economy requires
adjusting nominal to real GDP by using the
GDP deflator.
 Real and Nominal GDP

Price of Quantity of Price of Quantity of

Year Hot dogs Hot dogs Hamburgers Hamburgers
2001 $1 100 $2 50
2002 $2 150 $3 100
2003 $3 200 $4 150
Calculating Nominal GDP:
2001 ($1 per hot dog x 100 hot dogs) + ($2 per hamburger x 50 hamburgers) = $200
2002 ($2 per hot dog x 150 hot dogs) + ($3 per hamburger x 100 hamburgers) = $600
2003 ($3 per hot dog x 200 hot dogs) + ($4 per hamburger x 150 hamburgers) = $1200

Calculating Real GDP (base year 2001):

2001 ($1 per hot dog x 100 hot dogs) + ($2 per hamburger x 50 hamburgers) = $200
2002 ($1 per hot dog x 150 hot dogs) + ($2 per hamburger x 100 hamburgers) = $350
2003 ($1 per hot dog x 200 hot dogs) + ($2 per hamburger x 150 hamburgers) = $500
 Real and Nominal GDP

Calculating the GDP Deflator:

2001 ($200/$200) x 100 = 100
2002 ($600/$350) x 100 = 171
2003 ($1200/$500) x 100 = 240
 Importance Of Measuring NI
• It helps us to estimate the level of economic
development of nation.

• It is used in computing per capital income.

• It is used for analyzing various phases

of business cycles.

• It is used for framing various policies by the

government.
•
• It helps in comparing economic growth of our country
with other nations.

• By comparing NI of different years , we can know the

economy is growing, stagnant or declining.

• NI estimates reveal the overall production

performance.

• NI estimates are valuable guide to economic policy.

• Sectoral contribution

• Distribution
Difficulties in Estimating
National Income
 National Income

National income is the money value of all the

final goods and services produced by a
country during a period of one year.
 Difficulties/Limitations in calculating
National Income
➢ Lack of knowledge.
➢ The service of housewives is not included in
the national income because this service is
not sold in the market.
➢ To keep incorrect account of
their consumption.
➢ ignorance and lack of literacy
➢ Lack of measuring the proper value
of services.
The first difficulty regarding the concept of
national income relates to the treatment of
non-monetary transactions.
Example: Services of Housewife

The national income accounts involves

inventory adjustments.
The unused stock of the previous year may be
sold in the current year, but the income will be
included in the previous years account.
Illiteracy: A large majority of people in the
underdeveloped countries being illiterate, do
not keep any accounts of the actual quantity of
goods they have produced.
Transfer Payments :Individual get pension,
unemployment allowance and interest on
public loans, but these payments creates
difficulty in the measurement of national
income. These earnings are a part of individual
income and they are also a part of government
expenditures.
National income difficulty arises with regard
to the treatment of output product by the
foreign firms in the country.
o Should their income from a part of national
income of the country in which they are
located?
o Or, should this income be treated as a part of
national income of the country to which the
ownership of the firms belongs?
There are some difficulties which are
particular to underdevelopment country: Barter
System.
o In the underdevelopment countries there is
large non-monetized sector. A non-monetized
sector refers to that part of economy where
output is not bought or sold with the help of
money.
o Money does not enter into exchange, and
hence the value of commodities is not
expressed in terms of money.
In underdeveloped countries, agriculture is the
predominant from of economic activity.

o But the farming being still of subsistence in

nature, a considerable amount of production is
consumed by the farmers themselves.
o This is that part of output which has been
produced in the country, but does not come to
the market.
• Problem of Double Counting

Only final goods and services should be

included in the national income accounting.
• But, it is very difficult to distinguish between
final goods and intermediate goods and
services. An intermediate goods and service
used for final consumption. The difference
between final goods and services and
intermediate goods and services depends on the
use of those goods and services so there are
possibilities of double counting.
More than one jobs: In the underdeveloped
countries, there is no clear-cut demarcation of
the occupations from which people derive their
income.
o Many people are simultaneously engaged in
more than one occupation thus derive their
income from many source of livelihood.
Inadequate information: Information regarding
small agriculturists, household industries and
other unorganized enterprises is generally not
available.
Business in statistical process: The national income
accounting is a statistical process and it involves huge
time, energy and money costs.
o Business of these inherent difficulties, an individual
investigator may cheat in the process of accounting.

o The Underground Economy :The underground economy

consists of illegal and uncleared transactions where the
goods and services are themselves illegal such as drugs,
gambling, smuggling. Since, these incomes are not
included in the national income, the national income
seems to be less than the actual amount as they are not
included in the accounting.
• Price Changes: National income is the
money value of goods and services.
Money value depends on market price,
which often changes. The problem of
changing prices is one of the major
problems of national income accounting.
Due to price rises the value of national
income for particular year appends to
increase even when the production is
decreasing.
Circular flow model of income &
expenditure
• To study a part of the economy,
economists use economic models.

• These are simplified representations of the

real world, based on economic theories.

• Business and government often base

decisions on solutions that emerge from
testing economic models. 40
Income of one hand go to the other hands and
come back again. This is a everlasting process.
Two major units in the economy:
a) Firm: Hire labor, land … (give money), Produce
goods and sell (take money)
b) Household: Sell labor(take money) and
consume goods (give money).
Put this relationship in a cirular form!!!
• The circular flow diagram is a model and
as such it is a simplification of economic
reality which shows only two sectors in
the economy.
• (i)Household and (ii) Firm
Households consist of individuals or groups
of people living together and firms are
organizations involved in the production
of goods and services.
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We will assume that the goal of firms is to
maximize profits which means they
benefit from high prices.

On the other hand households have only

limited incomes for which they benefit
from low prices.

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• Markets are important co-ordinating
mechanisms to reconcile these conflicting
goals.

• There are two basic kinds of markets in the

economy: factor or input market which
means the market for inputs – land, labour,
capital and organization; and product
or output market which means the market
for goods and services.
• So, markets are important co-ordinating
mechanisms to reconcile these conflicting
goals.

• There are two basic kinds of markets in the

economy: factor or input market which
means the market for inputs – land, labour,
capital and organization; and product
or

• output market which means the market for

goods and services.
• This circular flow diagram illustrates the flow of
income and expenditure in a two sector economy.

• Households own the factors of production and

supply them in the factor market to earn income
in the form of rent, wage, interest and profit and
this income is used to buy goods and services
from the product market.
• On the other hand, firms buy these factors of
production for producing goods and services to
supply in the product market.

• Thus factor payments are determined by the

interaction of supply and demand of each factor in
the factor market.

• Similarly the price of goods and services is

determined by the interaction of supply and
demand of each good and service in the product
market.
• So the circular flow diagram shows the flow of
goods and services from producers to households
and the flow of factors of production from
households to business firms.