g

National
Income
Dr. Shylajan, C.S

Topics of Discussion

Circular Flow of Income and

Expenditure
Gross Domestic Product (GDP)
Measurement of GDP
Other Measures of Income
Nominal vs Real GDP
Limitations of using GDP as a
measure of well-being
HDI & Gross National Happiness

Macroeconomic Policy
Objectives
Macroeconomic Policy
Objectives

Sustained
Economic Growth

Price Stability

The Economys
Income and Expenditure

To judge whether the

economy is doing well or
poorly, it is natural to
look at the total income
that everyone in the
economy is earning.

The Economys
Income and Expenditure
For an economy as a whole, income
must equal expenditure because:
Every transaction has a buyer and
a seller.
Every rupee of spending by some
buyer is a rupee of income for
some seller.

The Economys
Income and ExpenditureSimple economy (2
sector model)
This

process can be seen using

a Circular Flow Diagram.

Two

sector model where all

income is consumed

The Circular-Flow of
Income and Expenditure
(2 sector )
Revenue

Goods &
Services
sold

Market for
Goods
and Services

Business
ector or Productive
Sector
Inputs for
production
Wages,
rent, and
interest,

Spending

Goods &
Services
bought

Household
Sector or Consumer
Sector
Market for
Factors
of Production

Labor, land,
and capital
Income

Measurement of Gross
Domestic Product (GDP)

The

market value of final

goods and services
produced in an economy in
a given period of time (say
2013-2014)

Measurement of Gross
Domestic Product (GDP)

Change in GDP over time due to

1.change in Price

2.change in volume of goods and

services

Calculation of Nominal Vs
Real GDP
Example # 1

Goods

P Q
X1 2
X2 8
X3 80
X4 70

Year 2004
P
Q
40 3
90 10
100 90
120 80

60
150
110
130

Year 2013

Calculation of Real
GDP
Example
# 1.
Nominal GDP of Year
2004 (Base Year)

40*2+90*8+100*80+120*70 =17200

Nominal GDP of Year 2013

60*3+150*10+110*90+130*80=21980

What is Real GDP of 2013?

Hold the prices constant at the base year
Then,
Real GDP=60*2+150*8+110*80+130*70
=19220

What Is Counted and Not

Counted in GDP?
GDP excludes services that
are produced and
consumed at home and
that never enter the market
place.

What Is Counted and Not

Counted in GDP?

Services of housewives

Because GDP does not count it,

it diminishes its importance.

GDP also excludes black market

items, such as illegal drugs.

GDP vs GNP

GNP = GDP + NFIA

Net Factor Income from Abroad

(NFIA) = Factor Income received
from Abroad Factor Income
paid Abroad
That is, inflow of factor incomes
from abroad minus the
corresponding outflow

GDP vs GNP

That is,
Factor incomes earned by our residents
from the rest of the world (Indian working
in US for instance) minus factor incomes
earned by the non-residents from our
country(Japanese working in India for
instance)
Factor Incomes: incomes accrued to various
factors of production, rent for land, wages
for labour, interest for capital and profit for
organisation

GDP Measurement: Three

Ways
Expenditure Method: by measuring
the size of total expenditure
incurred in the economy
Output Method: by measuring the
value of output at production stage
Income Method: by measuring the
amount of factor income earned

The circular flow of national income

and expenditure
(1) Production

(2) Incomes

(3) Expenditure

Expenditure method of
estimating GDP
By measuring the annual
flow of expenditure on final
goods and services incurred
by the household sector (C) ,
business sector (I) and
government sector (G)and
external sector (X-M)

The components of
GDP (Expenditure
method)
GDP
(Y ) is the sum of the following:

Consumption spending (C)

Investment spending(I)
Government Purchases (G)
Exports minus Import (X-M)

Y = C + I + G + X-M

The components of
GDP at market price
for 2013-14 for India
(INR Billion)
Visit

RBI website
www.rbi.org and find
out the value for each
components.
Y = C + I + G + X-M

The circular flow of income

INJECTIONS
Export
expenditure (X)
Investment (I)

Factor
payments

Consumption of
domestically
produced goods
and services (Cd)

Government
expenditure (G)
BANKS, etc

saving (S)

GOV.

taxes (T)

ABROAD

Import
expenditure (M)

WITHDRAWALS

GDP by category of expenditure, GNP and NNP

Consumption expenditure of households (C)

Government final consumption (G)
Gross capital formation (I)
Exports of goods and services (X)
less Imports of goods and services (M)
=

Gross Domestic Product (GDP)

plus Net income from abroad

=Gross National Product (GNP)

less Depreciation

=Net National Product (NNP)

Income method
By calculating Factor incomes
Factor incomes means factor
payments such as wages, interest,
rent, and profit

The total amount earned by the factors of

production for their contribution to the final
output.

Output method

By adding up the value added at each

stage of production

GDP vs NDP

GDP Depreciation = Net

Domestic Product

GNP at market price

The value of national product at market

price indicates the total amount
actually paid by the final buyers

GNP at market price would include net

indirect taxes

Net Indirect Taxes = (Indirect Taxes

Subsidies)

GNP at Factor cost

The value of national product at

factor cost is the total amount
earned by the factors of
production for their contribution
to the final output

GNP at factor cost = GNP at

market price Net Indirect Taxes

Net National Product

(NNP) or National
Income

NNP at factor cost = GNP at

factor cost Depreciation

NNP at factor cost is called

National Income

National Income and

Per Capita Income

National Income divided by

population gives per capita income

Per capita income signifies the

average standard of living of the
people

Personal Income

Factors of production also receive

incomes that are not earned.

For example, gifts, welfare payments,

pensions, unemployment benefits etc

These are called Transfer

Payments

Personal Income

Also all earned income is not received by

the factors of production in the same
year

Examples: Undistributed profits

Personal Income = National Income

minus income earned but not received
plus income received but not earned

Disposable Income

Disposable Income = Personal

Income Personal Taxes

That is, income that goes either

towards Consumption or Saving

Example

Given GNP at factor cost = 1,14,601;

Depreciation = 8062 ; Subsidies =
2822 ; NFIA = +330 and Indirect
taxes = 16,745 , compute

(a) GNP at market price

(b) NNP at market price
NDP at market price and

Hints:

(a) GNP at market price=GNP at

factor cost +Net indirect taxes
(b) NNP at market price=GNP at
market price Depreciation
NDP at market price =GDP at
market price Depreciation
GDP at market price =GNP at
market price-Net factor income from
abroad

Is GDP a Measure of
social welfare?

GDP as a measure of social welfare

benefits of using GDP
Why GDP is not a perfect measure of
economic well-being?

The Human Development Index (HDI)

Gross National Happiness

Calculation of Nominal
GDP, Real GDP and
GDP Deflator

Nominal GDP values the production of

goods and services at current prices.

Real GDP values the production of goods

and services at constant prices (base year
price)

Real values eliminate the impact of

changes in the price level.

Goods

P Q
X1 2
X2 8
X3 80
X4 70

Calculation of Real
GDP
Example # 1
Year 2004
P
Q
40 3
90 10
100 90
120 80

60
150
110
130

Year 2013

Calculation of Real
GDP
Example
# 1.
Nominal GDP of Year
2004 (Base Year)

40*2+90*8+100*80+120*70 =17200

Nominal GDP of Year 2013

60*3+150*10+110*90+130*80=21980

What is Real GDP of 2013?

Hold the prices constant at the base year
Then,
Real GDP=60*2+150*8+110*80+130*70
=19220

Measurement of
General Price LevelPrice Indices
GDP Deflator: It is Nominal GDP/Real GDP *100
In our example, 21980/19220*100
=114.36
Consumer Price Index
Wholesale Price Index

Consumer Price
Index

CPI, WPI and GDP Deflator are

measures of inflation in the
economy

CPI covers all goods and services

(including imported) that enter the
consumption basket

Consumer Price
Index

The relevant price is the retail

price

The quantity weights are

constant

How CPI is
constructed? An
Example

We have the cost of the consumption

basket for 1993-94 and 2007-08.

Items in consumption basket are rice,

wheat, milk, cloth and house

We need to calculate the cost of the

consumption basket in 2007-08
compared to 1993-94.

Calculation of rate of
inflation of the CPI/WPI

Rate of inflation is the rate of growth or

decline of the price level from one year to
the next year
Rate of inflation = CPI (this year) CPI (last year)
100
CPI (last year)

Consumer Price Index

India

www.rbidocs.rbi.org.in

Also refer Chapter 1, Errol

dSouza Macroeconomics
Ministry of Statistics and
Programme Implementation (
http://www.mospi.nic.in)

Wholesale Price
Index

It consists of a much larger

basket

Wholesale prices are used for

estimation

Wholesale Price
Index

Base year weights are fixed

In India, movements in WPI

are used to measure inflation

Pls refer the RBI

website

www.rbidocs.rbi.org.in

Thank you