Module - 4

National Income
• National Income is defined as the money value
of the goods produced and services made by the
people of a country.
• This suggest that labour and capital of a country
working on natural resources produces certain
amount of goods and services, the aggregates of
which is known as national income.
• By national income we need the annual flow of
goods and services. It is a flow and not a stock.
• The concept of national income has 3
interpretations i.e
• Receipt Total
• Expenditure Total
• Sale or consumption Total
Which means the value received equals the
value paid equals the value of goods and
services given in exchange.
 Concept of National Income
There are many concepts of National Income which
are used by different economists, these are explained
below:-
• Gross Domestic Product (GDP)
• Gross National Product(GNP)
• Net National Product at market price
• Net National Product at Factor cost
• Personal Income(PI)
• Disposable Income(DI)
 GDP
• Gross Domestic product is the total market value of
all final goods and services currently produced with
in the domestic territory of a country in a year.
• GDP= C+I+G+(X-M)
Consumption (c)
Investment (I)
Government Expenditure (G)
Exporting (X)
Importing (M)
4 things must be noted regarding this definition.
• It measures the market value of annual output
of goods and services currently produced. This
implies that GDP is a monitory measure.
• For calculating GDP accurately ,all goods and
services produced in any given year must be
counted only once so as to avoid double
counting. So GDP should include the value of
only final goods and services and ignores the
transaction involving intermediate goods.
• E.g Consider the production of a motor car
which has a retail price of Rs. 25,000/-. The
price includes Rs. 21,000 for all the cost of
Production ( 6,000 –components, 10,000 for
assembling & 5,000 for marketing) + Rs. 4,000
for profit.
• To avoid double counting the national income
accounts only the record value of the final
stage which in this case is the selling price of Rs
25,000/-
• GDP includes only currently produced goods
and service produced in a year.
• GDP refers to the value of goods and services
produced within the domestic territory of a
country by nationals or non nationals.
 GNP
• Gross national Product is the toal market value of
all final goods and service produced in a year
plus net factor income from abroad where as
GDP does not.
• GNP=GDP+ NFIA
• NFIA= Net factor income from abroad
A factor income received by Indian national from
abroad – Factor income paid to foreign national
working in India.
 NNP at Maket Price
• NNP is the market value of all final goods & services
after providing for depreciation i.e when charges for
depreciation are deducted form GNP, we get NNP at
market price.
• NNP at market price = GNP – Depreciation
• Depreciation is the consumption of fixed asset or
decrease or fall in the value of fixed assets due to
wear & tear.
• Market price is the price paid by the buyer of a
commodity in the market.
 NNP at factor Cost
• NNP at factor cost or National income is the
sum of wages , rent, interest and profit paid to
factor for their contribution to the production
of goods and services in a year.
• NNP at factor cost = NNP at market price –
indirect taxes + subsidies.
• Factor cost is the cost paid by the producer to
the factors of production for their contribution
in the production of the commodity.
 Personal Income
• It is the sum of all incomes actually received by all individuals
or households during a given year.
• In national income there are some income which is earned
but not actually received by the households such as social
security contribution, corporate income , taxes,
undistributed profits etc.
• On the other hand there are income (transfer payments)
which is received but not currently earned such as old age
pension, relief payments etc.
• Personal Income= Income earned but not actually
received + transfer payments.
 Disposable Income
• From personal income if we deduct personal
taxes like income taxes, personal property taxes
etc…is called Disposable Income.
• Disposable Income = Personal Income -
Personal taxes or direct tax.
• Per capita Income = Total National Income
Total Population of a
Country
 Goods & Services
Goods:-
Food ,clothes, spare parts, oil, Jewellery, wine,
stocks, currencies, water etc.
Services:-
Tourism, banking, consulting and transportation
etc.
Final goods are those which are being purchased
for final use, not for resale or for further
processing.
 Circular flow of Income
• Macroeconomics focuses on understanding the overall
performance of an economy.
• Production, consumption and investment are the basic
parameters that indicate the level of economic activity in an
economy.
• Behavior of these parameters are analyzed through circular
flow of money across the various sectors of an economy.
• Studying interdependence among these sectors, we came to
know what is the level of these macro variables indicates
the overall level of economic activity in the economy.
 Kinds of Flows
• There are following two kinds of flows:
 Real flows:
Which include the flows of the factors of
production and the goods and services between
the different sectors.
 Money Flows:
Which include the monetary flows between the
different sectors.
Circular flow of income in a two sector
economy
• In a two sector economy, only two sectors are considered that is Households and firms.
• There is no government sector and no foreign sector.
• There exists a flow of service from the households to the firms and a corresponding of
factor incomes from the firms to the households.
• Firm produces goods and services with the help of factor services from households and
pay rewards to households sectors for their factor services in the form of rent, wage,
interest etc.
• After this first round firms have goods and services and households sectors have income
which they want to spend for satisfying their wants.
• Household sector spends its earned money to buy goods and services from firm and
thus firm in return gets money in this exchange. This two way circulation (one clock wise
and the other anti-clock wise) goes on moving and recycling of economic activities in
both the sectors takes place.
Circular flow of income in a multi sector
economy
• The circular flow of income in a four sector
economy is shown above. It consists of
households, firms, government and Foreign
countries.
• Circular flow of income, each sector plays a
dual role, it receives certain payments from
other sectors as well as makes certain
payments to other sectors of the economy.
 Circular flow of income in different sectors

 Household sector:
Households provide factor services to firms, government and foreign
sector. In return it receives factor payments. Households also receive
transfer payments from the government and the foreign sector,
households spend their income on payment for goods and services
purchased from firms, tax payments to government and payments for
imports.
 Firms:
Firms receive revenue from households, government and the foreign
sector for sale of their goods and services. Firms also receive subsidies
from the government. Firm makes payments for factor services to
households, taxes to the government and imports to the foreign sector.
 Government:
Government receives revenues from firms, households and the
foreign countries for sale of goods and services, taxes, etc.
Government makes factor payments to households and also
spends money on transfer payments and subsidies.
 Foreign sector:
Foreign sector receives revenue from firms, households and
government for export of goods and services. It makes payments
for import of goods and services from firms and the government.
It also makes payment for the factor services to the households.
 Measurement of National Income

National Income can be measured by three

methods:
• Output or Production Method
• Income Method
• Expenditure Method
 Output Method or Production Method
• This method approaches national income from the
output side.
• This method is also called the value added method.
• Under this method, the economy is divided into
different sectors such as agriculture, fishing, mining,
construction, manufacturing ,trade and commerce,
transport, communication and other services.
• Which is the combined value of the new and final
output produced in all sectors of the economy.
 Income Method
• This method approaches national income from
the distribution side.
• According to this methods, national income is
obtained by summing up of the incomes of all
individuals in the country.
• Thus national income is calculated by adding up
the rent of land, wages and salaries of employees,
interest on capital and profits of entrepreneurs
and income of self employed people.
 Expenditure Method
• This method arrives at national income by adding up all the expenditure made
on goods and services during a year.
• Thus the national income is found by adding up the following types of
expenditure by households, private business enterprises and the government.
• GDP= C+I+G+(X-M)
• Expenditure on consumer goods and services by individuals and households
denoted by (C)
• Expenditure by private business enterprises on capital goods and services on
making addition to inventories denoted by (I)
• Government expenditure on goods and services i.e. government purchases
denoted by (G)
• Expenditure made by foreigners on goods and services
• of the national economy denoted by (X –M).
 Difficulties of measurement of NI
Following are some of the notable difficulties in measuring NI in India.

Non monetized sector:

In india, the bulk of goods ad services produced do not come to market for sale, these are
either consumed by the producers themselves or exchanges through barter system. That
is goods and services are exchanged for money.

Lack of distinct differentiation:

A large number of workers are engaged in many activities simultaneously. That is many
small farmers of india are also engaged in cottage and small industries.

Black Money:
It is defined as the money generated activities which are kept secret and are not reported
to the fiscal authorities that is taxes are not paid on this money. To evade income tax,
income of different sources are under reported. So the estimates of NI become wrong.
Non availability of data about certain incomes:
Data about income of small producers and household
enterprises is not available. Similarly there is no correct
estimation of value added from agriculture, horticulture
etc. It is made only on the basis of guesswork.

Fluctuation in Price level:

When prices are rising, the NI figures are rising even
though the production might have go down. On the
other hand, when prices are falling, the NI figures are
falling, even though the production might have gone up.
 Inflation
• In economics, inflation is a rise in the general
level of prices of goods and services in an
economy over a period of time.
• Inflation is a process of rising price.
• Money buys less when the price level rises.
• The value of money varies inversely with the
price level.
• Prof. coulborn has defined inflation as “ too much
money chasing too few goods”.
• An increase in the price to pay for goods. It is the
general increase in prices and fall in the purchasing
value of money.
• It means your money cannot buy as much as it
would and make it difficult for the consumers to
afford even the basic commodities in our life.
• E,g Food, housing, gas, automobiles etc.
• Inflation is monitored by the government usually
yearly.
 Features of Inflation
• It is a process of the rising prices.
• It is initiated by some changes which make it
impossible to meet the whole of the demand
at the existing prices.
• It is propagated by the reaction of the buyers.
 Types of Inflation
The various types of inflation are discussed below:
• Demand pull inflation
• Cost push inflation
• Pricing power inflation
• Sectoral inflation
Other types of inflation:
• Creeping Inflation
• Walking inflation
• Running Inflation
• Galloping Inflation
• Hyper Inflation
 Demand pull inflation
• Demand pull inflation is also called wage inflation.
• It occurs when the total demand for goods and
services in an economy exceeds the available supply,
so the prices for them rise in a market economy.
• Demand pull inflation is caused by excess demand,
which can originate form war, high exports, strong
investment, rise in money supply or government
financing its spending by borrowing.
• E.g Imagine that there were 100 people who all wanted to buy
big screen TVs but only 50 were available.
• In this scenario, only half of the people are going to end up with
what they want. Because of this everyone is going to be willing
to pay a higher amount to get access to the limited resources.
The company owns the TVs can keep jerking up the price until
they find a point that customers wont pay anymore.
• Those last 50 big screen TVs might sell for much more than
what the first batch of TVs sold for.
• This says that there are “Too much money chasing Too few
goods”
 Cost push inflation
• Cost push inflation is the situation where even though
there is no aggregate increase in demand, prices may still
rise.
• This is caused by an increase in the cost of production,
which can be due to an increase in wage cost and an
increase in profits.
• The increase on wage cost will result in the prices of the
commodities produced by the industry. soon the workers
of other industries will also demand higher wages and
there by inflation spreads to all sectors of economy.
 Pricing power inflation
• It is more often called as administered Price inflation.
• This type of inflation occurs when the business houses
and industries decided to increase the price of their
respective goods and services to increase profit.
• This does not occur normally in recession but when the
economy is booming and sales are strong.
• This type of inflation is also called as oligopolistic
inflation because oligopolistic have the power of pricing
their goods and services.
 Sectoral inflation
• The sectoral inflation takes place when there is an
increase in the price of the goods and services
produced by a certain sector of industries.
• For instance, an increase in the cost of crude oil would
directly affect all the other sectors, which are directly
related to the oil industry.
• Eg. When price of oil increases, the air ticket fares and
road transportation cost would also go up. This leads
to a widespread inflation throughout the economy
even though it had originated in one basic sector.
 Other types of Inflation
Creeping Inflation:
• When prices are gently rising ,it is referred as creeping inflation.
• It is the mildest form of inflation and also known as Low inflation.
• When prices rise by not more than (up to) 3% per annum (year) it is called creeping inflation.

Walking inflation:
• When the rate of rising prices is more than the creeping inflation. It is known as walking
inflation.
• When prices rise by more than 3% but less than 10% per annum( i.e between 3% and 10% per
annum) it is called as walking inflation

Running inflation:
• A rapid acceleration in the rate of rising prices is referred as running inflation.
• When prices rise by more than 10% per annum, running inflation occurs.
• We may consider price rise between 10% to 20% per annum( double digit inflation rate) as a
running inflation
Galloping inflation:
• If prices rise by double or triple digit inflation rates like 30% or 400% or 999%
per annum, then the situation can be termed as galloping inflation.
• When the prices rise by more than 20% but less than 1000% per annum
( i.e between 20% to 1000% per annum) galloping inflation occurs. It is also
referred as jumping inflation.

Hyper Inflation:
• It refers to a situation, where the prices rise at an alarming high rate. The
prices rise so fast that it becomes very difficult to measure its magnitude.
• When prices rise above 1000% per annum( Four digit inflation rate) it is
termed as hyper Inflation.
 Causes of Inflation
• Excessive printing of currency notes
• Deficit financing
• Black money
• Increase of wages and salaries
• Excessive taxation
• Fall in production
• War
 Control of inflation
• Monetary measures
• Fiscal measures ( Government Revenue and
expenditure)
• Direct or non monetary measures.
Monetary measures
• Control on Bank Credit
• Control on printing of currency notes
• Abolish the currency with higher denominations
• Blocking of liquid assets.

Fiscal measures
• Reduction of rate of interest for government securities.
• Do not levy excessive tax
• Increase excise duty
• Forcing people to save

Direct or non monetary measures

• By increasing production in industries
• By controlling wages and salaries
• By controlling the prices of commodities
• By opening more ration shops
• By controlling the black money.
 RBI- Reserve bank of India
• Every country in the world have a central bank.
• RBI act was passed in 1934 and the bank started working on April 1st
of 1935.
• The RBI was nationalized in 1949.
• The main role of central bank is to control the entire banking system.
• A central bank is an institution which is responsible for safeguarding
the financial stability of the country.
• It holds the ultimate reserves of the nation.
Definition:
The central bank is defined as the apex banking and monetary
institution, whose main activity is to regulate and control the banking
and the monetary system of the country in the interest of the nation.
 Functions of Central Bank ( RBI)
The activities of central bank Varies from time to
time and country according to the economic
situation.
• Central bank acts as the note issuing agency
• Central Bank acts as the Banker to the state/
Govt.
• Central bank acts as the Bankers Bank.
• Central bank acts as the controller of Credit.
• Central Bank acts as the not issuing agency:

In India the right of note issue has been conferred on the RBI. In the issue of notes, the
RBI follows the principle of Minimum Reserve System.
According to the this system, the bank keeps a minimum reserve of Rs.200 crores worth of
gold and foreign securities, out of which gold alone must be of the value of Rs.115 crores.

• Central bank act as the Banker to the State or Govt:

As the banker to the state, the central bank act as a banker, agent and adviser to the
govt.
Banker:- Central bank keeps the accounts of various govt departments and institution.
Agent: It floats public loans and manage the debt on behalf of the Govt.
Adviser: The central bank gives useful advice to the govt on important economic problems
like foreign exchange policy , budgetary policy etc.
• Central bank act as the Bankers bank:

The central bank act as a bankers bank in four ways:

Firstly, Custodian of the Cash reserve: All commercial banks will have to keep a part of their
cash balance with the central bank.

Secondly, No bank can function without a license from the RBI.

Thirdly, RBI act as the lender of the last resort: RBI gives financial help against eligible securities
to commercial banks in times of financial difficulties. Generally the commercial banks go to RBI
only when they fail to get help from all other sources.

Finally, RBI performs the functions of central clearing: Since the commercial banks keep cash
reserves with the RBI, settlement between them is effected by means of debits and credits in
the books of RBI
• Central Bank act as the controller of credit.
Central bank controls credit by using two methods:
• Quantitative methods or general method
• Qualitative methods or selective method

Quantitative methods or general method:

The aim of quantitative method is to expand the total volume of credit in the banking system. The
following methods are included
• Bank rate policy: Bank rate refers to the official minimum lending rate of interest of the central
bank. It is the rate ate which the central bank advances loans to the commercial banks.
• Open market operations: It consist of buying and selling of govt securities by the RBI.
• Variation in the Reserve Ratios (VRR): The commercial banks have to keep a certain proportion of
their total assets in the form of cash reserves. A part of these cash reserves are also to be kept
with the RBI for the purpose of maintaining liquidity and controlling credit in an economy. These
reserve ratios ae named as Cash Reserve Ratio (CRR) and a Statutory Liquidity Ratio (SLR)

CRR refers to the minimum amount of funds that a commercial bank has to maintain with the RBI
in the form of deposits.
SLR refers to percent of reserves to be maintained in the form of gold or securities.
In India the CRR by law remains in between 3-15 percent while, the SLR remains in between 20-
40 percent of bank reserves. Any change in VRR( CRR+ SLR) brings out a change in commercial
banks reserves.
Qualitative method or selective method:
The qualitative or selective methods aim to
control and regulate the flow of credit into
particular industries or businesses. It includes the
following methods;
• Selective credit control
• Moral persuasion
• Publicity
• Direct action
• Control of bank advances.
 Commercial bank
• Commercial banks are banks which accept deposits from the
public and lend them mainly to commerce for short periods.
• As they finance, mainly to commerce they are called
commercial banks.
• The commercial banks are also called deposit banks, as they
accept deposit from the public and lend them for short
periods.
• The commercial bank make profit from the difference in the
interest rate at which it borrows and lends money i.e it
borrows at a lower rate and lends at a higher rate.
• Thus commercial bank is a financial intermediary.
 Deflation
• The opposite of inflation is deflation which occurs
when the general level of prices is falling.
• There will not be sufficient money circulation.
• Prices of commodities will come down.
• People cannot buy commodities due to lack of
money.
• The income of the people will decrease.
• The land value will decrease.
• The land will be available for cheaper cost.
 Trade Cycles
• Trade cycle or business is the periodic fluctuations in
economic activities. It has been seen that economic
activities measured in terms of production,
employment and income move in a cyclical manner
over a period of time. This cyclical movement
consists of alternating periods of economic growth.
• The upward phase of a trade cycle or prosperity is
divided into two stages— recovery and boom, and
the downward phase of a trade cycle is also divided
into two stages— recession and depression.
 Phases of Trade Cycles
Business cycles are considered to have four different phases that is recovery and
boom , recession and depression .

Recovery:
During the period of revival or recovery there are expansions and rise in economic
activities. During this phase, demand starts rising, production increases causing an
increase in investment . There is a steady rise in output, income, employment,
prices and profits. Business man gain confidence and become optimistic. The banks
expand credit, business expansion takes place and stock markets are activated .

Boom:
Peak is the highest point of growth. In this phase, economic activities go on and
factors of production are put to optimum use. It is characterized by increase in
income, employment, consumption. At the same time price moves up, wage rate
rises, rise in the standard of living and there will be expansion in bank credit.
Recession:
During this phase, economic activities slow down. During this phase
demand starts falling and future investment plans are also given up. There
is a steady decline in the output, income, employment, prices and profits.
This reduces investment. Generally recession lasts for a shot period.

Depression:
Depression is a recession that is major in scale and duration. The main
feature of depression is a general fall in economic activity. Production,
employment, income decline. Machines are not used to their full capacity
in factories, because effective demand is much less. The aggregate
economic activity is at the lowest causing a decline in prices and profits
until the economy reaches its trough.
 Money
• Money is anything that is generally acceptable as a means of
payment in the settlement of all transactions, including debt
is money.
• The unique feature of money is that it is generally accepted
as a medium of exchange or as a means of payment.
• Money has the power to buy things directly in all markets.
• It need not require to be converted into something else
before it can be spent or used for the settlement of debt.
• In simple terms, what we use to pay for things or services is
referred to as money.
 Characteristics of Money:

Money has distinct characteristics that separates or distinguishes it

from other assets.
• Liquid assets: Liquid asset is an asset that can be easily be exchanged
for goods and services with less loss of value.
• General acceptability: People must accept money, without any doubt
or hesitation, as a means of payment of debts and other transactions.
• Voluntary acceptability: People are eager to acquire it.
• Medium of exchange: Money serves as a medium of exchange. All
other goods and services are exchanges for money.
• Means and not an end: Using money we buy those goods and
services which satisfy our wants. Money therefor is a means to meet
our demands. It is not an end.
 Stock and flow concept
• Capital income, money, savings, investment,
interest are the widely used terms in
economics.
• Some of these are stocks concepts while
others are flow concepts. In order to
distinguish between the stock and flow, let us
understand their meaning.
• Stock refers to a quantity of a commodity accumulated at a
point of time.
• The quantity of the current production of a commodity which
moves from a factory to the market is called flow.
• A stock is always specified to a particular moment.
• Other aggregates are a flow concept, such as income, output,
consumption and investment. A flow variable has the time
dimension, it specified per unit of time. 
• Stock is the quantity of an economic variable relating to a
point of time. For example, store of cloth in a shop at a point
of time is a stock concept. Flow is the quantity of an economic
variable relating to a period of time. The monthly income and
expenditure of an individual, receipt of yearly interest rate on
various deposits in a bank, sale of a commodity in a month
are some examples of a flow concept.
 Velocity of circulation of money
• A unit of money can be used many a time over a period of time. Thus,
that unit of money serves the purpose of more that one unit.
• Suppose in India, one unit of money serves the purpose of seven
units. It is called transaction velocity of money (V) i.e V is seven.
• Thus velocity of money means the number of times one unit of
money is used during a given period to buy goods and services.
• Thus supply of money can be estimated at a given period of time, by
multiplying the quantity of money by its velocity. In other words,
• Supply of money = M x V
• Where, M = The stock of supply of money in the country at a given
time and
V = Transaction velocity of money.
 Quantity theory of money
• The quantity theory of money seeks to explain the
factors that determine the general price level in
an economy.
• The theory states that the price level is directly
determined by demand for and supply of money.
• There are two versions of the quantity theory of
money.
 Transaction approach/ Fishers Version
 Cash balance approach/ Cambridge version
Transaction approach/ Fishers version
• Prof Irving Fisher put forward the transaction approach of quantity theory of
money.
• According to fisher, demand for money is made for transaction motive.
• Value of money, like any other goods is determined by the demand for and supply
of money.
• Hence the value of money or price level is determined at that point where
demand for money is equal to supply of money.
• Fisher, which may be explained with the help of following equation of exchange:
MxV=PxT
Where, M = The total supply of money
V = The velocity of circulation of money,
P = The general price level and
T = The total transactions in physical goods.
The equation means in an economy the total value of all goods sold during any
period (P x T) must be equal to the total quantity of money spent during that period
(M x V).
Cash balance approach or Cambridge version

•• The
  cash balance approach to the quantity theory of
money may be expressed as follows:
• =kxR
M
Where, = The purchasing power of money,
k = Proportion of income that people like to
hold in the form of money,
R = The volume of real income and
M= The stock of supply of money in the
country at a given time.
•   equation shows that the purchasing power of money or the
This
value of money () varies directly with k or R, and inversely with M.
Since is the reciprocal of the general price level, = 1
P
=KxR
M
1/p = K x R
M
Therefore, M = k x R x P
If we multiply the volume of real income ® by the general price level (
P) we have the money national income (Y)
M=KxY
Where, Y = The country's total money income.
 Emerging bitcoin concept
• Bitcoin is a form of digital currency, created and
held electronically.
• Bitcoin uses peer to peer technology (P2P) to
operate with no central authority or banks,
managing transaction and the issuing of bitcoins
is carried out collectively by the network.
• Bitcoins are used for electronic purchases and
transfers. You can use bitcoins to pay friends,
merchants etc.
 Repo and Reverse Repo Rate
• Repo rate is the rate at which the RBI lends money to
the banks for short term.
• Increase in repo rates will contract credit as now
commercial banks get funds from RBI at higher rate of
interest.
• Reverse repo rate is the short term borrowing rate at
which RBI borrows money from banks.
• Similarly increase in reverse repo rates will also
contract credit as commercial banks are more inclined
to deposit their funds with RBI to earn higher interest.