Introduction to Macro Economics

The whole purpose of the economy is production of goods or

services for consumption now or in the future. I think the
burden of proof should always be on those who would
produce less rather than more, on those who would leave
idle people or machines or land that could be used. It is
amazing how many reasons can be found to justify such
waste: fear of inflation, balance-of-payments deficits,
unbalanced budgets, excessive national debt loss of
confidence in the dollar

» James Tobin
» National Economic Policy

December 9, 2021 Vidya Suresh 1

 Contents
• Introduction to Macroeconomics
• The Keynesian revolution
• Objectives and instruments of Macroeconomics
• The tools of Macroeconomic policy
• Aggregate supply and demand
• Understanding macroeconomic data for India and rest
of the world

December 9, 2021 Vidya Suresh 2

 Introduction
• The modern economic science has two branches
– Microeconomics and macroeconomics
• Compared to micro economics macroeconomics is
a younger branch of economics.
• Until Great Depression 1930’s the subject of
economic science was broadly micro economics.
• It emerged as a separate branch in 1936 with the
publication of John Maynard Keyne’s revolutionary
book, The general theory of employment, Interest,
and Money
• Some terms were coined by Ragner Frisch, in 1933
in his paper “preposition problems and impulse
problems in dynamic economics”
December 9, 2021 Vidya Suresh 3
 A reading on Great Depression
• Historical Importance of the Great Depression: The Great Depression,
an immense tragedy that placed millions of Americans out of work,
was the beginning of government involvement in the economy and in
society as a whole.
• Dates: 1929 -- early 1940s
• Overview of the Great Depression:
– The Stock Market Crash
• Just to read:
• After nearly a decade of optimism and prosperity, the United States was
thrown into despair on Black Tuesday, October 29, 1929, the day the stock
market crashed and the official beginning of the Great Depression. As stock
prices plummeted with no hope of recovery, panic struck. Masses and masses
of people tried to sell their stock, but no one was buying. The stock market,
which had appeared to be the surest way to become rich, quickly became the
path to bankruptcy.

December 9, 2021 Vidya Suresh 4

 A reading on Great Depression
And yet, the Stock Market Crash was just the beginning. Since many banks
had also invested large portions of their clients' savings in the stock
market, these banks were forced to close when the stock market crashed.
Seeing a few banks close caused another panic across the country. Afraid
they would lose their own savings, people rushed to banks that were still
open to withdraw their money. This massive withdrawal of cash caused
additional banks to close. Since there was no way for a bank's clients to
recover any of their savings once the bank had closed, those who didn't
reach the bank in time also became bankrupt.
Businesses and industry were also affected. Having lost much of their own
capital in either the Stock Market Crash or the bank closures, many
businesses started cutting back their workers' hours or wages. In turn,
consumers began to curb their spending, refraining from purchasing such
things as luxury goods. This lack of consumer spending caused additional
businesses to cut back wages or, more drastically, to lay off some of their
workers. Some businesses couldn't stay open even with these cuts and
soon closed their doors, leaving all their workers unemployed.

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 A reading on Great Depression
– The Dust Bowl
– In previous depressions, farmers were usually safe from the severe effects
of a depression because they could at least feed themselves.
Unfortunately, during the Great Depression, the Great Plains were hit hard
with both a drought and horrendous dust storms.
– Years and years of overgrazing combined with the effects of a drought
caused the grass to disappear. With just topsoil exposed, high winds
picked up the loose dirt and whirled it for miles. The dust storms destroyed
everything in their paths, leaving farmers without their crops.
– Small farmers were hit especially hard. Even before the dust storms hit,
the invention of the tractor drastically cut the need for manpower on farms.
These small farmers were usually already in debt, borrowing money for
seed and paying it back when their crops came in. When the dust storms
damaged the crops, not only could the small farmer not feed himself and
his family, he could not pay back his debt. Banks would then foreclose on
the small farms and the farmer's family would be both homeless and
unemployed.

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 A reading on Great Depression
– Roosevelt and the New Deal
– The U.S. economy broke down and entered the Great Depression during the
presidency of Herbert Hoover. Although President Hoover repeatedly spoke
of optimism, the people blamed him for the Great Depression. Just as the
shantytowns were named Hoovervilles after him, newspapers became known
as "Hoover blankets," pockets of pants turned inside out (to show they were
empty) were called "Hoover flags," and broken-down cars pulled by horses
were known as "Hoover wagons."
– During the 1932 presidential election, Hoover did not stand a chance at
reelection and Franklin D. Roosevelt won in a landslide. People of the United
States had high hopes that President Roosevelt would be able to solve all
their woes. As soon as Roosevelt took office, he closed all the banks and only
let them reopen once they were stabilized. Next, Roosevelt began to establish
programs that became known as the New Deal.
– These New Deal programs were most commonly known by their initials, which
reminded some people of alphabet soup. Some of these programs were aimed
at helping farmers, like the AAA (Agricultural Adjustment Administration).
While other programs, such as the CCC (Civilian Conservation Corps) and the
WPA (Works Progress Administration), attempted to help curb unemployment
by hiring people for various projects.

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 A reading on Great Depression
– The End of the Great Depression
– To many at the time, President Roosevelt was a hero. They believed that
he cared deeply for the common man and that he was doing his best to
end the Great Depression. Looking back, however, it is uncertain as to
how much Roosevelt's New Deal programs helped to end the Great
Depression. By all accounts, the New Deal programs eased the hardships
of the Great Depression; however, the U.S. economy was still extremely
bad by the end of the 1930s.
– The major turn-around for the U.S. economy occurred after the bombing of
Pearl Harbor and the entrance of the United States into World War II.
Once the U.S. was involved in the war, both people and industry became
essential to the war effort. Weapons, artillery, ships, and airplanes were
needed quickly. Men were trained to become soldiers and the women
were kept on the homefront to keep the factories going. Food needed to
be grown for both the homefront and to send overseas.
– It was ultimately the entrance of the U.S. into World War II that ended the
Great Depression in the United States.

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What is Economics & why do people economize?
– Adam Smith, Economics is a science of wealth
– Alfred Marshall, Economics is a study of mankind in the ordinary business
of life; it examines that part of individual and social action which is most
closely associated with the attainment, and with the use of material
requisites of well being.
– Why do people Economize?
• Human wants desires and aspirations are endless
• Resources are limited and scarce
• People are of optimizing nature

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 What is Macroeconomics
– Gardner Ackley, “concerns the over-all dimensions of economic life. ..
More specifically, macroeconomics concerns itself with such variables as
aggregate volume of an economy, with the extent to which its resources
are employed, with size of the national income, with the ‘general price
level’.
– J.M. Culbertson “ Macroeconomic theory is the theory of income,
employment, prices and money’.
– P.A. Samuelson “Macroeconomics is the study of the behaviour of the
economy as a whole. It examines the overall level of a nation’s output,
employment, prices, and foreign trade”. More importantly, it studies the
relationship and interaction between the factors or forces that determine
the level and growth of national output and employment, general price
level, and the balance of payments positions of an economy.

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 What is Macroeconomics
Look at the questions that macroeconomics seeks to answer:

– What determines the levels of economic activities, total output, the general
price level, and the overall employment in a country?
– How is the equilibrium level of national income determined?
– What causes fluctuations in the national output and employment?
– What determines the general level of prices in a country?
– What determines the level of foreign trade and trade balance?
– What causes disequilibrium in the balance of payments of a country?
– How do the monetary and fiscal policies of the government affect the
economy?
– What economic policies can steer the economy on the path of growth?

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 Origin and growth of macroeconomics
– The foundation was laid by British economist, John Maynard Keynes
(1883- 1946) in his revolutionary book The general Theory of Employment,
Interest and Money (1936).
– In fact the use of macroeconomics dates back to the writings of the 16th
century economists called “mercantilits”.
– Thus the growth of ME is divided into 3 subsections:
• Classical ME
• Keynesian revolution and ME
• Post- keynesian developments

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 The classical macroeconomics
– The classical economists had not developed any coherent theory.
– The summary their thought:
– According to classical school of thought, if market forces of demand and
supply are allowed to work freely, then
– There will always be full employment in the long run, and unemployment, if
any, will be a short-run phenomenon;
– There will be neither over-production nor under- production at the
aggregated level; and
– The economy will always be in equilibrium in the long run.
• The great depression of 1930s however, proved all the classical assumptions wrong.
During that period there was large scale unemployment in the most fre market industrial
economies and their GNP declined heavily.

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 The Keynesian Revolution
– Keynes departure from the classical school was caused by his realization
that the classical economics was not capable of predicting , explaining and
providing solution to economic problems.
– The Keynesian theories are associated mainly with employment growth
and stability
– The central theme of Keynesian theory are :
– The level of output and employment in an economy is determined by the
aggregate demand given the resources
– The unemployment in any country is caused by lack of aggregate
demand and economic fluctuations are caused by demand deficiency.
– The demand deficiency can be removed through compensatory
government spending.
– India’s development plans are largely based on the Keynesian theory of
growth and employment.

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 The post Keynesian developments
– Monetarism (1970)
• A group of economists led my Milton Friedman.
• The role of money is central to the growth and stability of national output, not the role of
aggregate demand for real output, as Keynesians believe.
• At the theoretical level, the emphasis shifted from the analysis of the role of aggregate
demand for real output to the aggregate demand for and supply of money, and at the
policy level, the emphasis shifted from demand management to monetary management.
– Neo –classical macroeconomics (1980)
• A group called “radicalists” led by Robert Lucas, the Nobel laureate of 1995
• The emphasis was on individual’s rational expectations about future
• People’s rational expectations about government monetary and fiscal policies determine
the behavior of aggregate supply and aggregate demand curves in such a way that real
output remains unaffected, though prices and wages go up.
– Supply-side economics
• The team led by Arthur Laffer, emphasized the role of the factors operating on the supply
side of the market.
• Cut in tax rate shifts aggregate supply curve rightward and leads to a rise in output and
employment.
– Neo-Keynesianism
• Market does not clear always, in spite of individuals working for their own interest. They
give reason that ‘information problem and cost of changing prices lead to some price
rigidities’ which cause fluctuations in output and employment.

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Importance/Limitations of macroeconomics
– Importance:
– Growing importance of macroeconomics issues
– Persistence of macroeconomic problems
– Growing complexity of Economic system
– Need for government intervention with the market system
– Use of macroeconomics in business management
– Limitations:
– It ignores the structural changes in the constituent elements of the
aggregate.
– Aggregates are not a reality but a picture or approximation of reality
– People consider it only as a intellectual attraction without much practical
use.

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Objectives and Instruments of macroeconomics
– OBJECTIVES
– Output:
• High level and rapid growth of output
– Employment:
• High level of employment with low involuntary unemployment
• Stable prices
– Stable prices

– INSTRUMENTS

– Monetary Policy:
• Buying and selling bonds, regulating financial institutions

– Fiscal Policy:
• Government expenditures
• Taxation

December 9, 2021 Vidya Suresh 17

 Aggregate supply and demand
– Aggregate supply refers to the total quantity of goods and services that
the nation’s businesses willingly produce and sell in a given period.
Aggregate supply depends upon the price level, the productive capacity of
the economy, and the level of costs.
– Business would like to sell everything they can produce at high price.
– AS also depends on the price level that businesses can charge as well as
on the economy’s capacity or potential output. Potential output in turn is
determined by the availability of productive inputs(land, labour, capital,
managerial efficiency with which inputs are combined)
– Aggregate Demand: refers to the total amount that different sectors in the
economy willingly spend in a given period. AD equals spending on goods
and services. It depends on the level of prices, as well on monetary policy,
fiscal policy and other factors.
– AD = consumption + investment+ government purchase+ net exports
– AD is also affected by the prices exogenous forces like wars and weather,
and by government policies

December 9, 2021 Vidya Suresh 18

 Web references
– www.access.gpo.gov/eop.
– www.cbo.gov.
– www. aei.org.
– Macro economic data for the US (www.fedstatgs.gov)
– www.bea.gov
– www.bls . Gov
– India: www.rbi.org
– http://finmin.nic.in/
– (http://planningcommission.gov.in/)
– www.dgciskol.nic.in/
– CMIE data base-prowess available in your lab

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 The central tasks of a society
– The major considerations of any society in the economic field, irrespective
of the way in which it is organised, are:
• What to produce (necessities v/s luxury, present v/s future, perishable v/s non
perishable, capital/ consumer)
• How to produce (technique of production- capital and labour intensive)
• For whom to produce (how to share the goods and services)

– The ultimate goal of economic science is to improve the

living conditions of people in their everyday lives.

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Market / Capitalism and the central tasks
– The private ownership of resources or means of production.
– How does such a system solve the main tasks of what, how, and for whom
to produce?------- market mechanism
– Society consists of two classes of people: Producers and consumers.
– The producers in market economy are motivated by the desire to make
profits. Their decision to produce a commodity will be determined by the
costs incurred and the price at which it can be sold.
– The consumers desire goods and services. However, their ability to fulfill
their wants is conditioned by their income.
– The market provides link between producers and consumers.
– Thus capitalism is individualistic with self-interest being the primary driving
force. It is a decentralized, decision-making system.
– The extreme case of a market economy, in which the government keeps
its hands off economic decisions, is called a laissez-faire economy.

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Command Economy and the central tasks
– Command economy is one in which the government makes all important
decisions about production and distribution. In a command economy, such
as the one which operated in the Soviet Union during most of the 20th
century, the government owns most of the means of production; it also
owns and directs the operations of enterprises in most industries; it is the
employer of most workers and tells them how to do their jobs; and it
decides how the output of the society is to be divided among different
goods and services.
– The government answers the major economic questions through its
ownership of resources and its power to enforce decisions
– The basic problems of the economy are decided on the basis of need
votes rather than money votes.

December 9, 2021 Vidya Suresh 22

Mixed Economies and the central tasks
– No contemporary societies falls completely into either of these polar
categories. Rather, all societies are mixed economies, with elements of
market and command.
– Economic life is organized either through hierarchical
command or decentralized voluntary markets. Today
most decisions in the United States and other high-
income economies are made in the market place. But
the government plays and important role in overseeing
the functioning of the market; governments pass laws
that regulate economic life, product educational and
police services, and control pollution. Most societies
today operate mixed economies.

December 9, 2021 Vidya Suresh 23

 National Income

CONCEPTS
&
MEASUREMENT
OF

NATIONAL INCOME

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Measuring Economic Activity through National
Income

When you can measure what you are speaking

about, and express it in numbers, you know
something about it; when you cannot measure it,
when you cannot express it in numbers, your
knowledge is of a meager and unsatisfactory
kind; it may be the beginning of knowledge, but
you have scarcely, in your thoughts, advanced to
the stage of science.
– Lord Kelvin

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Measuring Economic Activity through National
Income
• The single most important concept in macroeconomics is the gross
domestic product (GDP), which measures the total value of goods
and services produced in a country during a year.
• When economists/policy makers want to determine the level of
economic development of a country, they look at its GDP per capita.
• What is GDP? GDP is the total market value of the final goods and
services produced within a nation during a given year measured in
monetary units.
• It is sum of the dollor values of consumption (C), gross investment
( I), government purchases of goods and services (G), and net
exports (X) produced within a nation during a given year.
• GDP = C+I+ G+ X
– X = Exports - imports

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 CONTENTS
• Circular flow of Income
• Approaches to measurement of National Income
• Measures of Aggregate Income
• Problems in National Income Accounting
• Comparison of NI over time
• Estimation of National Income in India
• Methodology of Estimation

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 Circular flow of Income
• The mechanism of income and expenditure flows is extremely
complex in reality.
• To present the flows of income and expenditure, the economy
is divided into four sectors:
• Household, business, government and foreign
• These 4 sectors are combined to make the following 3 models:
• Two-sector model including the household and business
sectors
• Three-sector model including the household, business and
government sectors
• Four-sector model including the household, business,
government and the foreign sectors.

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 The Circular-Flow Diagram
Revenue Spending
Market for
Goods
Goods & Goods &
Services sold and Services
Services
bought

Firms
Households

Inputs for Labor, land,

production Market for and capital
Factors
Wages, rent, of Production Income
and profit
Approaches to measurement of National
Income
• Net product method or value added method
• Factor Income method
• Expenditure method
– Refer www.cia.gov

12/09/21 Vidya Suresh 30

Net product method / value added method

• This method consists of 3 stages

– Estimating the gross value of domestic output in the
various branches of production;
– Determining the cost of material and services used
and also the depreciation of physical assets;
– Deducting these costs and depreciation from gross
value to obtain the net value of domestic output

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Net product method / value added method

– Estimating the gross value of domestic output in the

various branches of production
• For measuring gross value of domestic product, output is
classified under various categories. The classification of products
varies form country to country depending on
– The nature of domestic industries
– Their significance in aggregate economic activities
– Availability of requisite data
– 71 divisions are used in the US, a dozen in Netherlands half a
dozen in Russia, and 21-24 in India in CSO
• After classifying the output in categories, the gross value of
output of each category is computed by any of the following two
alternative methods, by multiplying the output of each sector or
category by their respective prices and adding them together OR
by collecting the data on gross sales and inventories from the
records of the companies and adding them up.
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Net product method / value added method

• Determining the cost of material and services

used and also the depreciation of physical assets
• The next step in estimating the net national product is
to estimate the intermediate cost of production
including depreciation.
• Conventionally depreciation is estimated as some
percentage of original cost of capital, permissible
under the taxation laws.
• In some countries dep is estimated as some
percentage of total output rather than cost of capital

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Net product method / value added method

• Deducting these costs and depreciation from gross value to obtain

the net value of domestic output (Value added)
Product Value of Value of Final Gross Value
Inputs Output Added
1 2 3 4

Wheat Nil 1000 1000

Flour 1000 1500 500

Bread 1500 2000 500

Sandwich 2000 3000 1000

Total 4500 7500 3000

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 Factor Income Method

• This is also known as factor share method. In this method

the national method is treated to be equal to all the
incomes accruing to the basic factors of production used
in producing the national products.
• National Income (GDP) = Rent + Wages + Interest +
Profit + Depreciation
– Labour Income: wages and salaries, supplementary income,
employers contribution , transfer payments
– Capital income: dividends, undistributed before tax profits,
interest on bonds, mortgages and saving deposits, interest
earned by insurance companies, net rents from land building,
royalties, profit of govt. enterprises
– Mixed Income: farming enterprises, sole proprietorship, medical,
legal practice, consultancy, trade , transportation

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 Expenditure Method

• This is also known as final product method- 2 methods

are used
– Income disposal method- money expenditures at market prices
are added up together to obtain the total final expenditure
( private consumption expen. Direct tax payments, payments
made to the non-profit organizations, charitable institutions,
private savings)
– Product disposal method- the value of the products finally
disposed of are computed are added together ( private consumer
goods and services, private investment goods, public goods and
services, net investment abroad)

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Measurement of National Income in India
 The history of measurement of NI can be divided under 2 phases:
 Pre independence phase- The first attempt was made by
Dadabhai Naroroji in 1867-68. Subsequently, several attempts
were made by economists and government officials to estimate
India’s NI. Then Prof. V. K.R. V. Rao estimated NI in the year
1925- 29 and1931-32. Though it was considered to be superior
it had serious limitations.
 Post independence phase- The first official estimate of India’s
NI was made in 1949 by the Ministry of Commerce,
Government of India.
 National Income Commission (NIC) was set up in 1949 my
MOC with P. C. Mahalanobis, D. R. Gadgil and V.K.R.V. Rao
as its members. NIC estimated NI for 1948-49, and for 1951-
52. The methodology developed by NIC was followed till 1967.
 After 1967, the job went to Central Statistical Organization
(CSO) and it adopted improved methodology to estimate NI.

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Measurement of National Income in India
• Sectors of an economy: An economy comprises of a
variety of economic activities resulting in different sources
and nature of income. To make the NI data easy and
comprehensive we classify different activities into
sectors. This is called sectoral accounting of National
Income.
• CSO uses following sectors for classification:
– Primary sector
– Secondary sector
– Tertiary or service sector

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Measurement of National Income in India

– PRIMARY SECTOR
• Agriculture
• Forestry and logging
• Fishing
• Mining and Quarrying

– SECONDARY SECTOR
• Manufacturing
• Registered manufacturing
• Unregistered manufacturing
• Construction
• Electricity, water and gas supply

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Measurement of National Income in India

– TERTIARY SECTOR
• Transport, Trade and Communication
– Transport, storage and communication
– Railways
– Other means of transport
– Communication
– Trade hotels and restaurants
• Finance and Real Estate
– Banking and insurance
– Real estate for residential and business purpose
• Community and Personal Services
– Public administration and defense
– Other services

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 Methods of measuring NI in India
– Production method or value added method: This is also called
net output method or value added method is used to estimate
income or domestic product of the following production sectors:
• Agriculture
• Forestry and logging
• Fishing
• Mining and Quarrying
• Registered manufacturing
– Income method is used for estimating domestic income of the
following sectors:
• Unregistered manufacturing
• Electricity, water and gas supply
• Banking and insurance
• Transport, storage and communication
• Real estate and business services
• Trade hotels and restaurants
• Public administration and defense
• Other services
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 Methods of measuring NI in India
• For the sake of comparison of estimates and to check their reliability,
CSO estimates national income also on the basis expenditure
method. In India, the sectoral accounting of GDP, based on the
expenditure method, follows the following classification of the NI
given below.
1. Private final consumption expenditure including expenditure on
i. Durable goods
ii. Semi durable goods
iii. Non-durable goods
iv. Services
2. Government final consumption expenditure
3. Gross fixed capital formation including construction, machinery
and equipments
4. Change in stocks, and
5. Net export of goods and services

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 Estimates of India’s NI and the data
some websites
• http://indiabudget.nic.in/es2009-10/esmain.htm
• http://indiabudget.nic.in/es2009-10/chapt2010/chapter01.
pdf
• http://www.mospi.nic.in/cso_test1.htm CSO
• UNIDO
• OECD

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 Some concepts related to NI
• Economic and Non-Economic Production
– Economic Production
• Marketable and non- marketable production
– Non Economic Production
• Services rendered to self, family and neighbor
• Intermediate and Final Products
• Transfer Payments
• Consumer and Producer Goods

12/09/21 Vidya Suresh 44

 National Income Measures

• Gross and net concepts

• National and domestic concepts
• Market prices and factor costs
• GNP--- Gross national product
• NNP--- Net national product
• GDP---gross domestic product
• NDP---net domestic product
• Personal income
• Disposable income

12/09/21 Vidya Suresh 45

 National Income Measures

• Personal income
– PI= NNP at factor cost-undistributed profits-corporate
taxes + transfer payments
• Disposable income
– D I= personal income – personal taxes
– PI = DI +T
– DI =C+ S
– Thus PI = C+S+T
• C= Consumption spending
• S = personal saving

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 National Income Measures
• NOMINAL and REAL GNP

– The GNP/GDP are estimated at both current and constant prices. The
GNP estimated at current prices is called nominal GNP and the one
estimated at constant prices in a chosen year (base year) is called real
GNP.
– The need for estimating GNP at constant prices arises because GNP at
the current prices produces a misleading picture of economic
performance when prices are continuously rising or decreasing.
– GNP valued at current prices shows rise in GNP under the following
conditions:
• Actual production is decreasing but prices are rising
• Actual production remains constant and prices are rising
– Estimating GNP at the prices of the base year is not an easy task.
Therefore we use GNP deflator or National Income Deflator to eliminate
the effect of rising prices on the GNP and to work out real GNP at the
base year prices.

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 National Income Measures
• The GNP Deflator and its Application
• The GNP deflator is essentially an adjustment factor used
to convert nominal GNP into real GNP.
• The GNP deflator is the ratio of price index number (PIN)
of a chosen year to the price index number (PIN) of the
base year.
– GNP Deflator = PIN of the chosen year/ 100
• The formula for converting nominal GNP of a year into
real GNP:
– Real GNP = Nominal GNP/ GNP Deflator

– Real GNP = Nominal GNP/ PIN (cy)/100

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 National Income Measures
• Given the data:
– Nominal GNP of India/ GNP estimated at current prices in year 2000 = Rs 500
billion
– Price of Index number (PIN) , base year 2000 = 100
– Nominal GNP at year 2005 = 600 billion
– PIN rises = 110
• GNP deflator = PIN (2005) = 110 = 1.10
100 100

• Given the GNP Deflator at 1.10, the real GNP for the year 2005 can
be :
• Real GNP = Nominal GNP/ GNP Deflator
= Rs. 600 billion / 1.10
= Rs. 545.45 billion
12/09/21 Vidya Suresh 49
 National Income Measures

• Note that the Nominal GNP increases from Rs.500 billion

to Rs 600 billion that is by 20 percent over a period of 5
years or at an annual average rate of 4 percent.
• Since PIN increases from 100 to 110, i.e., by 10 percent
over 5 years, real GNP increases at a lower rate, i.e., at
9.12 percent or at an annual average rate of 1.8 percent.

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 National Income Measures
• GNP Implicit Deflator
– Another variant of GNP deflator is GNP implicit deflator, also called implicit price
deflator. It is the ratio of nominal GNP to real GNP, i.e.,
– GNP Implicit Deflator = Nominal GNP/ Real GNP
• The GNP implicit deflator can be used for the following:
– To construct price index
– To measure the rate of change in prices or to measure inflation
• Nominal GNP in the year 2005 = Rs 600 billion
• Real GNP in the year 2005 = Rs 545.45 billion
– GNP Implicit Deflator = 600/ 545.45
= 1.10
• The GNP implicit deflator multiplied by 100 give the Price Index
Number (PIN)
– PIN (2005) = GNP Implicit Deflator * 100
= 1.10 * 100 = 110

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 National Income Measures

• Thus, 110 is the price index number for the year 2005. The same
procedure can be adopted to calculate PIN for other years.
• Once PINs for different years are calculated, the same can be used
to calculate the rate of change in price, i.e., the rate of inflation.

• Rate of Inflation = PIN 2005 – PIN 2000 * 100

PIN 2000
= 110 – 100 * 100 = 10 percent
100

• This means that inflation over a period of 5 years was 10 percent or

at an annual average rate of 2 percent.

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 Some problems in National Income
Accounting
• Demarcation of productive activity
• Treatment of non marketed output
• Distinction between final and intermediate goods
• Avoiding double counting and the concept of
value added
– Value added = Total sales + Closing stock of finished and semi
finished goods- total expenditure on raw materials and
intermediate products purchased from other firms- opening stock
of finished and semi finished goods.

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 Is national income true measure of
economic welfare?
• Can national income be dependable measure of
economic welfare? Does its increase bring about a
corresponding increases in economic welfare?
• NI cannot be reliable as it takes into consideration
tractions done in terms of money. Barter system doesn’t
get into account.
• Again, the NI may increase or decrease according to an
increase or decrease in the general price level, because
it is expressed on the basis of current money value even
when the actual NI has not changed at all.
• Increase in NI may not mean rise in welfare as the more
than proportionate increase in population may decrease
the per capita income, people may spend the increased
income on harmful goods and activities.
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 Is national income true measure of
economic welfare?
• If the increase in NI is due to an increase in the output of
capital goods, it means that either there is no improvement
in the economic welfare of the people or if there is any,
then it is only marginal, because consumer goods are
more important than capital goods from the economic
welfare view-point.
• If the increase in NI is caused by the increase in the output
of war material, it will not increase the economic welfare.
• If NI is increased after employing child and women labor
on low wages, or by distorting environment , it doesn’t
mean welfare.
• If increase in NI is accompanied in favor of rich then its not
welfare.

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