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Engineering Economics PPT-UNIT - II
Engineering Economics PPT-UNIT - II
Macroeconomic Concepts
Lavanya.K
Assistant Professor
MRIT-MBA
NATIONAL INCOME
INTRODUCTION
The term National Income is used to refer the money value of the total income of
the economy in a year.
In common parlance national income means the total value of goods and services
produced annually in a country.
In other words the total amount of income accruing to a country from economics
activities in a year's time is known as national income.
Firstly it measures the market value of annual product.
Secondly National income is a monetary measure.
Thirdly national income includes the market value of all final goods the value of
intermediate products are not included. A final product is one which is available for
immediate consumption. For example, a shirt or a sewing machine. The example of
intermediate product is raw materials.
National Income
The definitions of National income can be grouped into two classes as the traditional
definition advanced by Marshall, Pigou and Fisher and the modern definitions.
The total income obtained as wages, rent, interest and profits are the national income of
the country. Various households get their income from the firms for the production of
goods and services. The value of all the goods produced is the national product. Thus
the total national product produced by firms in a year is distributed to all factors in the
form of wages, interest rent and profits. The sum of all these factors income will be
equal to the national income. Thus the national product is equal to the national income.
There are three methods to calculate the national income of a country. They are:
The figure so obtained has to be adjusted with net income from abroad. This is
the national income at factor cost.
This method is also known as output method or value added method.
This method is very complicated because of non-availability of adequate and
requisite data. It is also difficult to calculate depreciation.
National Income
The national income is equal to total rent plus total wages and salaries of all
employees including income of self employed persons plus total interest on
capital including dividends of the shareholders plus total profit of all firms
including undistributed corporate profits and earnings of public enterprises.
In short, the national income represents the total of rent, wages, interest and
profit.
National Income
Expenditure method: This method is based on the assumption that income is
equal to expenditure plus savings.
Under this method the personal consumption expenditure, government purchase of
goods and services, gross private domestic investment and net foreign investment
are added together to get the national income of a country.
This method is also known as consumption- saving method.
The expenditure method is not generally used because the necessary data
regarding consumption expenditure are not easily available.
This method includes the total expenditure of a country during a given year.
The income is spent on consumer goods or on producer goods.
The consumption expenditure and investment expenditure of all the individuals in
a government during a year is added.
Thus
National Income = Consumption Expenditure + Investment Expenditure +
government expenditure + exports - imports.
Y = C + I + G + X-M
National Income
DEFINITION OF INFLATION
Inflation can be defined as the persistent increase in the price level of goods and
services in an economy over a period of time. Some of the important definitions of
inflation are:
In the words of Samuleson-Nordhaus, “Inflation is a rise in the general level of
prices.”
According to Coulborn, inflation can be defined as, “too much money chasing too
few goods.”
In the words of Peterson, “The word inflation in the broadest possible sense
refers to any increase in the general price-level which is sustained and non-
seasonal in character.”
TYPES OF INFLATION
Generally, inflation is categorised on the basis of its rate. There are three types of
inflation:
Moderate inflation: This type of inflation takes place when there is a rise in the
prices of goods and services at a single rate annually. Moderate inflation is also
known as creeping inflation. At the time of moderate inflation in an economy,
the prices of goods and services increase only at a moderate rate. However, the
rate of increase in prices differs in different countries. It is easy to anticipate
moderate inflation; therefore, individuals hold money as a store of value.
Inflation
Galloping inflation: This type of inflation takes place at the time of the rise in
the prices of goods and services at two-digit or three-digit rate per annum.
Another name for galloping inflation is as jumping inflation. In the words of
Baumol and Blinder, “Galloping inflation refers to an inflation that proceeds at
an exceptionally high.” The worst sufferers of galloping information are middle
and lower class individuals. Due to this, people are unable to save money for
the future. This kind of situation requires strict measures to control inflation.
Inflation
Hyperinflation: This type of inflation takes place when the rate of increase in
prices is extremely high or out of control. In other words, hyperinflation
occurs when the increase in prices is more than three-digit rate annually. The
cause behind hyperinflation is the unrestricted increase in the supply of money
in the market. This results in a situation of imbalance in the supply and
demand for money. Consequently, money loses its real worth at a rapid speed.
Inflation
Causes of Inflation
Primary Causes
In an economy, when the demand for a commodity exceeds its supply, then the
excess demand pushes the price up. On the other hand, when the factor prices
increase, the cost of production rises too. This leads to an increase in the price level
as well.
Increase in Public Spending
In any modern economy, Government spending is an important element of the total
spending. It is also an important determinant of aggregate demand.
Population Growth
As the population grows, it increases the total demand in the market. Further,
excessive demand creates inflation.
Hoarding
Hoarders are people or entities who stockpile commodities and do not release them to
the market. Therefore, there is an artificially created demand excess in the economy.
This also leads to inflation.
Inflation
Genuine Shortage
It is possible that at certain times, the factors of production are short in supply. This
affects production. Therefore, supply is less than the demand, leading to an increase
in prices and inflation.
Exports
In an economy, the total production must fulfill the domestic as well as foreign
demand. If it fails to meet these demands, then exports create inflation in the
domestic economy.
Trade Unions
Trade Union work in favor of the employees. As the prices increase, these unions
demand an increase in wages for workers. This invariably increases the cost of
production and leads to a further increase in prices.
Inflation
Tax Reduction
While taxes are known to increase with time, sometimes, Governments reduce taxes to
gain popularity among people. The people are happy because they have more money in
their hands.
However, if the rate of production does not increase with a corresponding rate, then the
excess cash in hand leads to inflation.
Non-economic Reasons
There are several non-economic factors which can cause inflation in an economy.
For example, if there is a flood, then crops are destroyed. This reduces the supply
of agricultural products leading to an increase in the prices of the commodities.
Investment in Gold, Real estate, stocks, mutual funds, and other assets are some of
the ways to deal with Inflation.
Inflation
Measures to Control Inflation
In monetary policy, the central bank increases rate of interest on borrowings for
commercial banks. As a result, commercial banks increase their rate of interests
on credit for the public. In such a situation, individuals prefer to save money
instead of investing in new ventures.
This would reduce money supply in the market, which, in turn, controls
inflation. Apart from this, the central bank reduces the credit creation capacity
of commercial banks to control inflation.
Measures to Control Inflation
Fiscal Measures:
Apart from monetary policy, the government also uses fiscal measures to
control inflation. The two main components of fiscal policy are government
revenue and government expenditure. In fiscal policy, the government controls
inflation either by reducing private spending or by decreasing government
expenditure, or by using both.
Besides this, the government expenditures are essential for other areas, such as
defense, health, education, and law and order. In such a case, reducing private
spending is more preferable rather than decreasing government expenditure.
When the government reduces private spending by increasing taxes, individuals
decrease their total expenditure.
Measures to Control Inflation
Price Control
Another method for ceasing inflation is preventing any further rise in the
prices of goods and services. In this method, inflation is suppressed by price
control, but cannot be controlled for the long term. In such a case, the basic
inflationary pressure in the economy is not exhibited in the form of rise in
prices for a short time. Such inflation is termed as suppressed inflation
New Economic Policy 1991 impact on Industry
In continuation of the 1991 policy with regard to delicensing, there are only six
industries related to health, strategic and security consideration that remain under the
preview of industrial licensing.
The main features of NIP-1991
Diminishing role of public sector: The spirit of the 1991 policy is diametrically
opposite to that of 1956 policy with regard to the role of the public sector in
economic growth and development.
The 1956 resolution reserved 17 industries in the public sector where as the 1991
policy reduced this to 8 and by 2001, the number reserved for public sector is just
3. The govt decided to open the arms and ammunition industry also to the private
sector. The govt also made its intentions clear to further reduce the importance of
the public sector by introducing a ‘divestment’ where in private sector participation
is encouraged in the important areas of the economy.
The main features of NIP-1991
These measures were undertaken to correct the inherent weakness that has
developed in Balance of Payments and control the inflation. These measures were
short-term in nature. Various Long-Term Structural Reforms were categorized as:
Liberalization
Privatization and
Globalization
Collectively they are known by their acronym LPG. The balance of Payment is the
system of recording the economic transactions of a country with the rest of the
world over a period of one year. When the general prices of goods and services are
increasing in an economy over a period of time, the same situation is
called Inflation. Let’s understand each terminology in detail
Stabilization Measures (LPG)
Liberalization
The basic aim of liberalisation was to put an end to those restrictions which became
hindrances in the development and growth of the nation. The loosening of
government control in a country and when private sector companies’ start working
without or with fewer restrictions and government allow private players to expand
for the growth of the country depicts liberalization in a country.
Privatization
This is the second of the three policies of LPG. It is the increment of the
dominating role of private sector companies and the reduced role of public sector
companies. In other words, it is the reduction of ownership of the management of
a government-owned enterprise. Government companies can be converted into
private companies in two ways:
By disinvestment
By withdrawal of governmental ownership and management of public sector
companies.
Stabilization Measures (LPG)
Forms of Privatization
Denationalization or Strategic Sale: When 100% government ownership of
productive assets is transferred to the private sector players, the act is called
denationalization.
Partial Privatization or Partial Sale: When private sector owns more than 50%
but less than 100% ownership in a previously construed public sector company
by transfer of shares, it is called partial privatization. Here the private sector
owns the majority of shares. Consequently, the private sector possesses
substantial control in the functioning and autonomy of the company.
Deficit Privatization or Token Privatization: When the government disinvests
its share capital to an extent of 5-10% to meet the deficit in the budget is termed
as deficit privatization.
Stabilization Measures (LPG)
Objectives of Privatization
Improve the financial situation of the government.
Reduce the workload of public sector companies.
Raise funds from disinvestment.
Increase the efficiency of government organizations.
Provide better and improved goods and services to the consumer.
Create healthy competition in the society.
Encouraging foreign direct investments (FDI) in India.
Stabilization Measures (LPG)
Globalization
It means to integrate the economy of one country with the global economy. During
Globalization the main focus is on foreign trade & private and institutional foreign
investment. It is the last policy of LPG to be implemented.
Globalization as a term has a very complex phenomenon. The main aim is to
transform the world towards independence and integration of the world as a whole
by setting various strategic policies. Globalization is attempting to create a
borderless world, wherein the need of one country can be driven from across the
globe and turning into one large economy.
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