National Income

National Income
National income means the value of goods and
services produced by a country during a financial
year. Thus, it is the net result of all economic
activities of any country during a period of one year
and is valued in terms of money.

Thus, the concept national income has different

meanings. It may be described as the ‘national
product’ or ‘national income’ or ‘national dividend’.
 I. Different Views on National Income by Different Economists:

1. Marshall’s Definition:
“The labour and capital of a country, acting on its natural
resources, produce annually a certain net aggregate of
commodities, material and immaterial including services of all
kinds… This is the true net annual income or revenue of the
country or national dividend.”

2. Pigou’s Definition:
According to A.C. Pigou; “National income is that part of the
objective income of the community, including, of course,
income derived from abroad which can be measured in money.”
3. Modern Definition:
The National Sample Survey defines national
income as “money measures of the net
aggregates of all commodities and services
accruing to the inhabitants of a community
during a specific period.”
 II. National Income Accounts:

• National income accounts can be defined as a set of

systematic statements which reflect the aggregate
money value of all goods and services produced in
different sectors of an economy (primary, secondary and
tertiary sectors) together with the records of distribution
of factor incomes among different groups and final
expenditures (either gross or net) of the economy.

• Economists, planners, government, busi­nessmen,

international agencies (IMF, World Bank, etc.,) use
national income data and analyse them for variety of
purposes.
III. Circular Flow of Income:
• In Fig. 2.1, goods and services flow from firms to households via the
product market in return for the money payment for these goods
and services by firms. Arrowhead indicates such goods flow and
money flow between firms and households. It is clear that the flow
of monetary payment on goods and services by buyers must be
identical to the money value of all goods and services that firms
produce and sell to households.

• Households supply factor inputs to firms via the factor markets. In

return, households receive money from firms in the form of rent,
wages, etc. These income payments to households on hiring input
services must be identical to the firms’ income. This is the essence of
the circular flow of income in a two-sector economy where there is
no governmental activity and the economy is a closed one.

• Y=C+I
• where Y stands for national income, C for private consumption
spending, and I for private investment spending.
• In a three-sector (closed) economy, the gov­ernment
intervenes. It spends not only for the benefits of the
general people and firms but also imposes taxes on
them to finance its spending. If we add government
activities (levying of taxes, T and incurring expendi­
tures, G), we have
• Y=C+I+G

• Saving and taxes— constitute leakages in the circular

flow. It is, thus, clear from Fig. 2.2 that the circular
flow of money income depends upon consumption
spending of households, investment spending of
business firm and government’s plans to tax and
spend.
Circular flows in 4 sector economies
• A four-sector economy is called an open economy
in the sense that the country gets money by
sending its goods outside i.e., exports (X), and
spends money by buying foreign-made goods and
services i.e., imports (M). In other words, in an
open economy, there occurs a trading relationship
between nations. Adding (X-M) in the above
equation, we get

• Y = C + I + G + (X-M)
 NATIONAL INCOME

National income or national product is defined as the total market

value of all the final goods and services produced in an economy in
a given period of time.
The total net value of all goods and services produced within a
nation over a specified period of time, representing the sum of
wages, profits, rents, interest, and pension payments to residents of
the nation.
Formula for National Income
National income = C + G + I + X + F – D
Where,
C denote the consumption
G denote the government expenditure
I denote the investments
X denote the net exports (Exports subtracted by imports)
F denote the national resident’s foreign production
D denote the non-national resident’s domestic production
Concept of NATIONAL INCOME

Gross Domestic Product

The total value of goods produced and services
rendered within a country during a year is its Gross
Domestic Product.
Further, GDP is calculated at market price and is defined
as GDP at market prices.
Different constituents of GDP are:
•Wages and salaries
•Rent
•Interest
•Undistributed profits
•Mixed-income
•Direct taxes
•Dividend
•Depreciation
Gross Domestic Product AT Factor Cost
Factor cost is the cost incurred on the factor of production. It
can be defined as the actual cost incurred on goods and
services produced by industries and firms is known as factor
costs.
GDP at factor cost measures the money worth of output
produced within a country's domestic constraints in a
year as received by the factors of production.
Factor Cost = Cost of Production + Subsidies – Taxes
GDP at Factor Cost= Sum of all Gross Value Added
(GVA) at factor cost

Gross Domestic Product at Market Price

GDP at market price is the price which is set after all the
levels of value additions and at which goods and
services are sold or offered in the marketplace.
Conventionally, the market price is the sum of the cost of
production and indirect taxes.
Market Price (MP) = Cost of Production or factor cost + Net
NET DOMESTIC PRODUCT
It represents the net book value of all finished goods and
services produced inside a country geographically during
a given period.
NDP = GDP – Depreciation
NDP takes into account the decrease in the value of fixed
assets (e.g. computers, buildings, transport equipment,
machinery, etc.) used in the production process.
If the gap between the GDP and NDP is narrower or smaller,
then it is considered good for an economy.
Also, it indicates economic balance. However, a wider gap
between the GDP and NDP shows an increase in the value of
obsolescence.
Gross National Product
 Gross national product (GNP) refers to the total value of
all the goods and services produced by the residents
and businesses of a country, irrespective of the location
of production.

 GNP takes into account the investments made by the

businesses and residents of the country, living both inside
and outside the country. It also takes into account the value
of the products produced by the industries of the domestic
origin.

 GNP does not take into consideration the incomes

earned by the foreign nationals in the country or any
products produced by a foreign company in the
manufacturing units in the country.
 Difference between Nominal GDP and
Real GDPNOMINAL GDP
BASI REAL GDP
S
M
E
Nominal GDP is the monetary Real GDP is the monetary value of
A value of all goods and services all goods and services produced
N
I
produced within the domestic within the domestic boundaries of
N boundaries of a country based on a country based on the price of
G the price of the goods and the goods and services of the
services of the same year. base year.
WHAT
IS IT
Nominal GDP is the Gross Real GDP is the inflation-
Domestic Product without any adjusted GDP of a country.
effect of inflation.
EXPRE
SSED
The Nominal GDP of a country is The Real GDP of a country is
expressed in terms of current expressed in terms of base year
year prices of goods and prices or constant prices of
services. goods and services.
COMP
LEXIT
It is easy to calculate Nominal It is quite difficult to calculate
Y GDP. Real GDP.
VALUE
OF
The value of Nominal GDP is The value of Real GDP is much
GDP much higher than the value of lower than the value of Nominal
Real GDP because it takes current GDP because it takes the market
market changes into price of the base year into
consideration. consideration.
GDP DEFLATOR:
GDP deflator, also known as the implicit price
deflator, is used to measure inflation. It is used to
determine the levels of prices of the new
domestically produced final goods and services
in a country in a year.
GDP deflector shows the changes in the average price
levels in an economy, and therefore, it is used in
conjunction with the Consumer Price Index (CPI) for
measuring inflation.
GDP deflator consists of two important components,
which are the nominal GDP and real GDP.

GDP deflator = Nominal GDP ×100

Real GDP
Transfer Income
The income received by an individual without rendering any productive service
in return is known as Transfer Income.

Transfer Income is a unilateral concept and is not included in National Income, as

it does not involve the production of goods and services.

For example, Old age pension, pocket money, gifts, scholarship, etc.

Transfer Income can be received either from abroad or within the domestic
territory of a country. For example, Taxes paid to the government of a country are
the transfer incomes, as they receive taxes without rendering any productive
service in return.

Similarly, subsidies provided to the citizens by the government are transfer

payments, as they do not get any productive service in return.
Private Income
Private income is the income generated by any private individual or a household
from engaging in any occupational activities or any type of income that is not
received as salary or commission.

It includes income that is generated from the private sector only.

Private Income = Income from domestic product accruing to private sector

(household & Firm) + Net factor income from abroad + All types of transfer
incomes

Personal Income:
It is the income of the household sector over an accounting year from all the
sources. It is that part of the private income which reaches the individuals in the
household sector.
In practice, it is the difference of private income over Corporate Profit Tax and
Undistributed Profits.

Personal Income = Private Income Less Corporate Tax Less Undistributed

Profits.
Personal Disposable Income:
After paying direct taxes such as income tax, government fees, fines,
etc., the income left with household sector is called the Disposable
Income. The household sector is free to spend or save the disposable
income.

Personal Disposable Income = Personal Income – Direct Taxes, Fees,

Fines, etc.

Thus, personal disposable income is a part of the personal income. It is

from this income that a household or a consumer shells out money for
consumption and savings.
Expenditure Method
GDPMP = C (household consumption) + G (government expenditure) + I (investment
expense) + NX (net exports).

Consumption expenditure (C) includes household consumption of goods and services

Government’s expenditure on goods and services to fulfil social welfare needs (G).

Investment expenditure (Gross Domestic Capital Formation) (I)

Refers to the expenditure made by companies and production units for raising capital.
For instance, investment expenditure includes the purchase of fixed capital assets
such as buildings and equipment.
Expenditure also includes an addition to the stock of raw materials.
Change in Stock = Closing Stock – Opening Stock
Investment expenditure also includes an acquisition of valuables such as precious
metals or jewelery.

Expenditure also includes imports and exports

Calculate the net exports (NX).
NET EXPORT(NX) = Total exports - Total imports.
Income Method (PRIME)

NDPFC

PROFIT RENT INTEREST MIXED COMPENSATION

& INCOME OF
ROYALTY EMPLOYEES

DIVIDEND
income of the self-
+
OPERATING employed WAGES & SLARY IN
RETAINED
SURPLUS individuals, farming CASH
EARNING
units, and sole +
+
proprietorships. WAGES & SALARY
CORPORATE
TAX IN KIND
+
Employer’s
contribution to
Funds
Product Method or Value-Added Method
First, we compute the monetary worth of all final products and services generated in an
economy over a year. The term “final goods” refers to items consumed immediately and are
not employed in the subsequent manufacturing process. Intermediate products are goods that are
utilized in the manufacturing process.
Formula: NNPfc = GDPmp – Depreciation – Net indirect taxes + NFIA, OR,
NNPfc = GDPmp – Depreciation – Net product taxes – Net production taxes + NFIA
Importance of National Income
 Setting Economic Policy
National Income indicates the status of the economy and can give a clear
picture of the country’s economic growth. National Income statistics can
help economists in formulating economic policies for economic
development.

 Inflation and Deflationary Gaps

For timely anti-inflationary and deflationary policies, we need aggregate
data of national income. If expenditure increases from the total output, it
shows inflammatory gaps and vice versa.

 Budget Preparation
The budget of the country is highly dependent on the net national income
and its concepts. The Government formulates the yearly budget with the
help of national income statistics in order to avoid any cynical policies.

 Standard of Living
National income data assists the government in comparing the standard
of living amongst countries and people living in the same country at
different times.

 Defense and Development

National income estimates help us to bifurcate the national product
 Inflation
• Inflation may be defined as ‘a sustained upward
trend in the general level of prices’ and not the price
of only one or two goods.

• G. Ackley defined inflation as “a persistent and

appreciable rise in the general level or aver­age of
prices”.

• In other words, inflation is a state of rising prices,

but not high prices.
E.g. Let’s measure inflation rate. Suppose, in
December 2007, the consumer price index was
193.6 and, in December 2008, it was 223.8.

• Thus, the inflation rate during the last one

year was:
223.8- 193.6/ 193.6 x 100 = 15.6
 Types of Inflation
A. On the Basis of Causes:

(i) Currency inflation:

This type of infla­tion is caused by the printing of cur­rency notes.

(ii) Credit inflation:

Being profit-making institutions, commercial banks sanction more loans and
advances to the public than what the economy needs. Such credit
expansion leads to a rise in price level.

(iii) Deficit-induced inflation:

The budget of the government reflects a deficit when expenditure exceeds
revenue. To meet this gap, the government may ask the central bank to
print additional money. Since pumping of additional money is required to
meet the budget deficit, any price rise may the be called the deficit-induced
inflation.
(iv) Demand-pull inflation
An increase in aggregate demand over the
available output leads to a rise in the price level.
Such inflation is called demand-pull in­flation
• In the diagram we measure output on the horizontal
axis and price level on the vertical axis. In Range 1,
total spending is too short of full employment out­
put, YF. There is little or no rise in the price level. As
demand now rises, out­put will rise.
• The economy enters Range 2, where output
approaches towards full employment situation.
Note that in this region price level begins to rise.
• Ul­timately, the economy reaches full em­ployment
situation, i.e., Range 3, where output does not rise
but price level is pulled upward. This is demand-pull
in­flation. The essence of this type of in­flation is that
“too much spending chas­ing too few goods.
(v) Cost-push inflation:
Inflation in an economy may arise from the overall increase in
the cost of production. This type of inflation is known as cost-
push inflation (henceforth CPI). Cost of pro­duction may rise due
to an increase in the prices of raw materials, wages, etc.

A wage-price spiral comes into opera­tion. But, at the same time,

firms are to be blamed also for the price rise since they simply
raise prices to expand their profit margins. Thus, we have two im­
portant variants of CPI wage-push in­flation and profit-push
inflation.
 B. On the Basis of Speed or Intensity
(i) Creeping or Mild Inflation:
If the speed of upward thrust in prices is slow but small then we
have creeping inflation.

(ii) Walking Inflation:

one-digit inflation rate is called ‘moder­ate inflation’ which is not
only predict­able, but also keep people’s faith on the monetary
system of the country.

(iii) Galloping and Hyperinflation

Running inflation is danger­ous. If it is not controlled, it may ulti­
mately be converted to galloping or hyperinflation. It is an extreme
form of inflation when an economy gets shatter­ed.”Inflation in the
double or triple digit range of 20, 100 or 200 p.c. a year is labelled
“galloping inflation”
 3. Causes of Inflation

1. Demand-pull inflation
Demand-pull inflation happens when the demand for certain goods and services is
greater than the economy's ability to meet those demands. When this demand
outpaces supply, there's an upward pressure on prices — causing inflation.

2. Cost-push inflation
Cost-push inflation is the increase of prices when the cost of wages and materials
goes up. These costs are often passed down to consumers in the form of higher
prices for those goods and services.

3. Increased money supply

If the money supply increases faster than the rate of production, this could result in
inflation, particularly demand-pull inflation because there will be too many dollars
chasing too few products.
4. Devaluation
Devaluation is downward adjustment in a country's exchange
rate, resulting in lower values for a country's currency.

5. Rising wages
"If wages rise a large amount, businesses will either have to
pass the cost on, or live with lower margins. The exception is
if they can offset wage growth with higher productivity.“

6. Policies and regulations

Certain policies can also result in either a cost-push or
demand-pull inflation. When the government issues tax
subsidies for certain products, it can increase demand
Tools to Control Inflation
 Monetary Policy
1. Rise in Bank Rate:
The increase in the bank rate results in the rise of rate of
interest on loans for the public. This leads to the
reduction in total spending of individuals.

• The main reasons for reduction in total expenditure

of individuals are as follows:
a. Making the borrowing of money costlier
b. Creating adverse situations for businesses
c. Increasing the propensity to save
2. Direct Control on Credit Creation
The central bank directly reduces the credit control capacity of
commercial banks by using the following methods:

(i) Performing Open Market Operations (OMO):

• The central bank issues government securities to commercial
banks and certain private businesses.
• In this way, the cash with commercial banks would be spent on
purchasing government securities.

(ii) Changing Reserve Ratios:

when the central bank needs to reduce the credit creation
capacity of commercial banks, it increases Cash Reserve Ratio
(CRR). As a result, commercial banks need to keep a large amount
of cash as reserve from their total deposits with the central bank.
2. Fiscal Measures:
The two main components of fiscal policy are :
a. government revenue and
b. government expenditure.
In fiscal policy, the government controls inflation
either by reducing private spending or by decreasing
government expenditure, or by using both
• It reduces private spending by increasing taxes on
private businesses.
• The government expenditures are essential for
other areas, such as defence, health, education,
and law and order, so they cannot be reduced.
3. 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.
• Such inflation is termed as suppressed
inflation.
Business Cycle & its phases
Graphical representation of different phases
of a business cycle
1. Expansion:
In the expansion phase, there is an increase in various
economic factors, such as production, employment,
output, wages, profits, demand and supply of products,
and sales.

2. Peak:
In peak phase, the economic factors, such as production,
profit, sales, and employment, are higher, but do not
increase further.

In peak phase, there is a gradual decrease in the demand

of various products due to increase in the prices of input.
3. Recession:
• When the decline in the demand of products becomes rapid
and steady, the recession phase takes place.
• In recession phase, all the economic factors, such as
production, prices, saving and investment, starts decreasing.

4.Trough:
In this phase, the growth rate of an economy becomes
negative. In addition, in trough phase, there is a rapid decline
in national income and expenditure

In trough phase, many weak organizations leave industries or

rather dissolve. At this point, an economy reaches to the
lowest level of shrinking.
5. Recovery:
• Once the economy touches the lowest level, it
happens to be the end of negativism and beginning
of positivism.
• Organizations discontinue laying off individuals and
start hiring but in limited number.
• Consumers increase their rate of consumption, as
they assume that there would be no further
reduction in the prices
• Bankers start utilizing their accumulated cash
balances by declining the lending rate and increasing
investment in various securities and bonds.