UNIT- 1 NATIONAL INCOME AND RELATED AGGREGATES

 1. Basic Concepts of Macroeconomics

Macroeconomic

 Macroeconomics is the branch of economics that deals with the behaviour and performance 

of an economy as a whole.

Difference between Microeconomics and  Macroeconomics

Microeconomics studies the behaviour of individual economic units. 

Example - demand of a consumer, price determination of a commodity

It's main tools are demand and supply. 

It is also called price theory

Macroeconomics studies the behaviour of the economy as a whole. 

Example - income and employment in the economy, money supply in the economy

It's main tools are aggregate demand (AD) and aggregate supply (AS). 

It is also called Income and Employment Theory. 

Final Goods 

Final goods refer to those goods which are either used for consumption purpose 

or for investment purpose by the end user. For example - Milk, machine etc

*Expenditure made on them is called final expenditure

Intermediate Goods 

Intermediate goods are those goods which are either used for resale or further production 

purposes in the same year. For example - copper used for making utensils 

*Expenditure on the intermediate goods is called intermediate cost or intermediate consumption or replacement cost.

* Raw Materials or non-factor inputs purchased for producing goods are called intermediate goods

Intermediate goods are also called single use producer goods

YOU KNOW?

FINAL EXPENDITURE AND INTERMEDIATE EXPENDITURE

Final Expenditure refers to the expenditure on final goods and services, ]

which are meant for final consumption and investment.

EXAMPLES

Expenditure on purchase of a car/furniture/sewing machine/refrigerator by a household is a final expenditure on consumption. Expenditure on purchase of a car/furniture/machine/refrigerator for use by a firm is a final investment expenditure.

Intermediate Expenditure (also called Intermediate Consumption or Intermediate Cost) refers to the expenditure incurred by a production unit on purchasing those goods and services from other production units, which are meant for resale or for using up completely during the same year.

EXAMPLES

• Payment of electricity bill by a school

Purchase of uniforms for nurses by a hospital

Expenditure by a firm on payment of fees to a chartered accountant

Expenditure on maintenance of factory building by a firm

Consumption goods

The final goods which are consumed for satisfaction of wants by the consumer are called consumption goods or consumer goods.

* those consumes goods like TV sets, automobiles home computers etc are called consumes durable goods

.* Those consumer goods like food, clothing, etc; which are extinguished by immediate ar short period

Consumption are known as consumer non-durable goods.

Goods Capital (or Investment goods or Durable-use producer goods)

Some final goods of durable character which are used in the production process for 

producing other goods and services, are called capital goods (or investment goods).

Examples - Machines, tools, implement, equipment, buildings, vehicles, computers etc. 

Inventory and Change in Inventories

Inventory (Stock) 

In economics, the stock of unsold finished goods, or semi-finished goods, or raw materials 

which a firm carries from one year to the next is called inventory

Changs in Inventories (Stocks)

Value of inventory at the beginning of the year is called 'opening inventory. 

And a value of inventory at the end of the year is called "closing inventory. 

Thus, change in inventories equals closing inventory minus opening inventory.

Change in inventories = Closing inventory -  Opening inventory

If  the value of closing inventory is more than the value of opening inventory, inventories have increased (accumulared) 

If the value of closing inventory is less than the value of opening inventory, inventories have decreased (decumulated).

Planned and unplanned change in inventories

Planned change in inventories

Change in the stock of inventories which has occurred in a planned way is called "Planned change in inventories".

Suppose the firm wants to raise the inventories from 100 shirts to 200 shirts during the year. Expecting sales of 1,000 shirs during the year (as before), the firm produces 1000 100 1,100 shirts. If the sales an actually 1,000 shirts, then the firm indeed ends up with a rise in inventories. The new stock of invest 200 shirts, which was indeed planned by the firm. This rise is an example of a planned accumulation of tries On the other hand, if the firm had wanted to reduce the inventories from 100 to 25 (ay), chen it would produce 1,000-75-925 shirts. This is because it plans to sell 75 shirts out of the inventory of 100 shirts it started with (so that the inventory at the end of the year becomes 100-75-25 dis which the firm wann) If the sales indeed turn out to be 1,000 as expected by the firm, the firm will be left with the a planned decumulation of inventories of 25 shirts. 

Unplanned Change in Inventories

Change in the stock of inventories which has occurred in an unexpected way is called 'unplanned change in inventories'. In case of an unexpected fall in sales, the firm will have an unsold stock of goods which it had not anticipated. Hence, there will be an unplanned accumulation of inventories. In the opposite case where there is an unexpected rise in the sales there will be an unplanned decumulation of inventories.

EXAMPLE

Suppose a firm produces shirts. It starts the year with an inventory of 100 shirts. 

During the coming year it expects to sell 1,000 shirts. Hence, it produces 1,000 shirts,

 expecting to keep an inventory of 100 at the end of the year. However, during the year,

 the sales of shirts turn out to be unexpectedly low. The firm is able to sell only 600 shirts. 

This means that the firm is left with 400 unsold shirts. The firm ends the year with 

400+ 100-500 shirts. The unexpected rise in inventories by 400 will be an example

 of an unplanned accumulation of inventories. If, on the other hand, the sales had been 

more than 1,000 we would have an unplanned decumulation of inventories. For example,

 if the sales had been 1,050, then not only the production of 1,000 shirts will be sold, 

the firm will have to sell 50 shirts out of the inventory. This 50 unexpected reduction 

in inventories is an example of an unplanned (unexpected) decumulation of inventories.

Gross Investment and Depreciation

HOW DO ECONOMISTS DEFINE INVESTMENT? 'Investment' is always capital 

formation, a gross or net addition to capital stock and change in inventories during 

an accounting year.

Gross Investment (or Gross Domestic Capital Formation)

Gross Investment (or Gross Domestic Capital Formation)

Gross investment refers to addition to the stock of fixed capital (machinery, 

factory buildings, equipment, etc.) and addition to the stock of inventory

 (unsold finished goods, or semi-finished goods, or raw materials) 

in the hands of producers during an accounting year.

Gross Investment = Fixed Investment + Inventory Investment

■Fixed investment (or Gross domestic fixed capital formation) refers to addition 

to the stock of fixed capital in the hands of producers during an accounting year.

 Note that: 

Fixed investment = Fixed business investment Residential investment 

■Inventory investment is addition to the stock of inventory (unsold finished goods, 

or semi-finished goods, or raw materials) with the producers during an accounting year.

 In other words, change in inventories during an accounting year is called inventory investment. 

(Change in inventories = Closing inventory - Opening inventory)

Inventory investment can be positive as well as negative. If there is a rise in inventory 

in a given time period it is called a positive inventory investment; whereas a decrease 

in inventory is called a negative inventory investment.

Top Tip

Inventory investment can take place due to two reasons:

1. The firm decides to keep some stocks for various reasons. This is called a planned 

inventory investment

2. The actual sales differ from the planned level of sales in which case the firm has 

to add to/run down existing inventories. This is called an unplanned inventory investment.

There can be three major categories of investment 

(i) Inventory investment 

(ii) Fixed business investment investment.

(iii) Residential Investment

MEANING

Depreciation is the continuous fall in the value of fixed capital assets due to normal 

wear and tear, passage of time or expected obsolescence (change in technology) over a period of time.

Top Tip

The new addition to capital stock in an economy is called net investment (or new capital formation).

Net Investment = Gross investment - Depreciation

Depreciation is the continuous fall in the value of fixed capital assets due to normal wear and tear, passage of time or expected obsolescence (change in technology) over a period of time.

Top Tip

The new addition to capital stock in an economy is called net investment (or new capital formation).

Net Investment = Gross investment - Depreciation

Depreciation 

Depreciation is the continuous fall in the value of fixed capital assets due to normal wear and tear, passage of time or expected obsolescence over a period of time

Depreciation = Gross Investment - Net Investment

accidents, natural calamities or other such unforeseen/exceptional circumstances. This is called 'capital loss.

Did you Know?

Depreciation

DIFFERENCE BETWEEN DEPRECIATION AND CAPITAL LOSS

Depreciation is the continuous fall in the value of fixed capital assets due to normal wear and tear, passage of time or expected obsolescence over a period of time.

Capital loss

Capital loss refers to the loss in value of the fixed capital assets due to unexpected or unforeseen obsolescence, natural calamities, thefts, accidents, etc.

Value of output, Intermediate consumption, Value added and Problem of Double counting

Value of output

Value of output is the estimated money value of all final goods and services produced during a given period of time, inclusive of change in stock and production for self-consumption.

Top Tip

Value of output also includes the procurement of final output by the government from the production units.

Final Value of output =  Output produced (in units) xMarket price per unit

(a) If a firm had no unsold stock at the beginning of the year:

Value of output produced = Sales + Value of unsold stock

Note: Sales Output sold (in units) x Market price 

Sales =  Sale of goods and services to domestic buyers +  Exports of goods and services.

Intermediate consumption (or Intermediate Cost)

Intermediate consumption refers to the expenditure incurred by a production unit on purchasing material inputs from ot production units, which are used up completely during the production process in the same year.

Top Tips

• Intermediate consumption includes purchase of raw materials and other non-factor inputs from the domestic market an imports of raw materials and other non-factor inputs.

Intermediate consumption does not include purchase of factor inputs such as machinery, tools, equipment, etc.

Value Added (or Value Addition)

Value Added (VA) refers to the excess of 'Value of Output' over the 'Value of Intermediate Consumption'.

Value Added = Value of output - Value of intermediate goods used

Value added of a firm is the net contribution made by the firm in the process of production.

FACTORS OF PRODUCTION FACTOR PAYMENTS 

Human labour           - Wages and Salaries 

Capital          - Interest 

Natural resources (called 'land')- Rent 

Entrepreneurship - Profit

Market Prices

Market Price is the price at which a commodity is sold in the market. It is the sum total of factor cost and net indirect

Factor Cist 

The term 'factor cost' refers to the prices of products as received by the factors of production.

MARKET PRICES

Market prices are the prices of products as paid by the consumers.

Factor Cost (FC) =  Market Prices (MP) - Indirect Taxes + Subsidies

OR

Factor Cost (FC) =  Market Prices (MP) - Net Indirect Taxes

Example 

Calculate Gross Value Added at Factor cost by a firm X

S. No.  Particulars 

(i) Domestic sales   3000

(ii) Change in stock  (-) 100

(iii) Depreciation 300

(iv) Intermediate consumption 2000

(v) Exports  500

(vi) Indirect tax 250

Domestic Territory

Economic territory is the geographical territory administered by a government within which persons, goods and capital circulate freely.

Scope of economic territory: Based on 'freedom' criterion, the scope of economic territory is defined to cover.

■Political frontiers including territorial waters and air space.

■Embassies, consulates, military bases, etc located abroad, but excluding those located within the political frontiers.

-Ships, aircrafts etc, operated by the residents between two or more countries

■Fishing vessels, oil and natural gas rigs, etc operated by the residents in the international waters or other areas over which the country enjoys the exclusive rights or jurisdiction.

Resident (or Normal Resident)

A normal resident is defined as follows:

A resident, whether a person or an institution, is one whose centre of economic interest lies in the economic territory of the country in which s/he lives.

The 'centre of economic interest' implies two things:

■The resident lives or is located within the economic territory and

■The resident carries out the basic economic activities of earnings, spending and accumulation from that location.

Domestic Income

Domestic Income is the money value of all the final goods and services produced within the domestic territory by residence non-residents of a country during an accounting year.

National Income

National Income refers to money value of all the final goods and services produced by the normal residents residing within outside the domestic territory of a country, during an accounting year.

National Income (NI) = Domestic Income + NFIA (Factor income received from abroad - Factor income paid to abroad

Factor income received from abroad' is added to domestic income because this contribution of residents is in addition their contribution to domestic income.

■ 'Factor income paid to abroad' is subtracted because this part of domestic income, does not belong to the residents.

1.2 Circular Flow of Income and Methods of Calculating National Income 

The circular flow of income is an economic model that shows how money, goods, and services flow between households, businesses, and the government.

Households

Provide factors of production, like land, labor, and capital, to businesses. In return, households receive income from businesses. 

Firms 

Use factors of production to produce goods and services. They then sell these goods and services to households.

Three phases in the circular flow of income

1. Generation Phase

The first phase of the circular flow of income is Generation Phase. In this phase, the firms produce goods and services by taking the help of the factor services. 

2. Distribution Phase

The second phase of the circular flow of income is the Distribution Phase. In this phase, factor incomes such as wages, rent, interest, and profit flow from firms to the households.

3. Disposition Phase

The last phase of the circular flow of income is the Disposition Phase. In this phase, the income received by the factors of production is spent on the goods and services produced by the firms. 

Product Method/ Output Method? Value Added Method

Product method or value added method is that method which measure domestic income by estimating the contribution of each producing enterprise to production in the domestic territory of the country in an accounting year.

Intermediate Consumption – It refers to the value of non-factor inputs.

GVO_MP = Sales + ∆ in Stock

GVO_MP = PRICE X OUTPUT + ∆ IN STOCK

GVA_MP/GDP_MP = GVO_MP – Intermediate Consumption

NVA_FC = GVA_MP – Depreciation – Net Indirect Taxes

Value of Output = Sales + Change in stock

(GVA_MP)Value Added = Value of output – Value of intermediate goods

NVA_MP = GVA_{MP –} Depreciation

Value Addition is the difference between value of output of an enterprise and the value of its intermediate consumption.

Value of Output = sales + Change in Stock

1 . Calculate Net Value added at factor cost (NVAFC)

S.No.                                       Items ` Crores

1                 Goods and Services Tax    25

2               Consumption of Fixed Capital 5

3                Closing Stock                               10

4                 Corporate Tax                       15

5                Opening Stock                      20

6                Sales                                    540

7              Purchase of raw Materials 140

GVAMP = SALES – INTERMEDIATE CONSUMPTION + CHANGE IN STOCK

                             =  540  -   140  +  (10 – 20)

                  = 540  - 140 + (-) 10

                   =  390

    NVAMP = GVAMP – DEPRECIATION

                   = 390 – 5  = 385

    NVAFC  = NVAMP – NIT = 385 – 25

         = 360 CRORES

Problem of Double Counting – It is the problem of estimating the value of goods and services more than once. If certain items are counted for more than once resulting in over estimation of national product to the extent of the value of intermediate goods included, this will cause the problem of double counting.

Precautions in the Estimation of National Income by Product Method

The following precautions should be taken while estimating national income by product method - 

(i)                 The sale and purchase of old goods and property should not be included in national income.

(ii)               The output of intermediate goods should not be included in national income.

(iii)             The value of goods retained for self-consumption should be included in national income.

(iv)              Imputed rent of owner-occupied buildings should be included in national income.

(v)                Only the value of final goods should be included in national income.

Income Method

It is also called distributed share method or factor payment method. According to this method, national income is measured in terms of factor payments to the owners of factors of production during an accounting year.

Classification of Factor Incomes

It is also called distributed share method or factor payment method. According to this method, national income is measured in terms of factor payments to the owners of factors of production during an accounting year.

Classification of Factor Incomes

Compensation of Employees                                                                                                                 

     (i)            Wages and salaries in cash – Remuneration in cash includes wages & salaries, DA, bonus, city compensatory allowance, HRA, leave travelling allowance etc.

   (ii)             Payment in kind – includes rent free quarter, free water and electricity, free uniform, free services of vehicles, amount of interest on interest-free loans etc.                                                              

 (iii)             Employers’ contribution to social security schemes – consists of contribution to life insurance, casualty insurance, provident fund etc.

 (iv)            pension on retirement

Operating Surplus –

1. Rent and Royalty – Rent is a factor income earned from lending the services of land, building whereas royalty is the income earned by landlord for granting leasing rights of subsoil assets.

·         Imputed Rent – The rent of owner-occupied houses is called imputed rent.

·         Royalty – subsoil (deposits of coal, iron, natural gas etc.) and use of patents, copyrights etc.

 2.  Interest – Interest is the price for the funds borrowed.

 3.  Profit                                                                                     

Profit – Dividends, Corporate profit tax and undistributed profit

Profit – Profit is the residual factor payment to owners of production units. Thus, profits are the income of the factor input called entrepreneurship for organizing production and undertaking attendant risks. It is reward that owners of firms get being in business and taking risk involved therein.

Corporate (Profit) Tax – The net profit of a corporate enterprise is used mainly for three purposes –

(i)                 corporate tax,

(ii)                dividend and

(iii)              Reserve fund (undistributed profit).

Profit tax is a direct tax levied by the Government on the profit of a company. The company pays it out of its total profit. Profit tax, thus, is a part of domestic income since it is actually earned by the company. Profit tax is also called corporate tax.

Dividend – It is that part of profit of a corporate enterprise which it pays to its shareholders in accordance with number of shares held by the letter. By the virtue of owing shares, the shareholders become owners of the company.

Undistributed Profit – A company, after paying profit tax and distributing dividend out of its total profit, keeps the balance as reserve fund which is known as undistributed profit (or corporate savings or retained income). The reserve fund is maintained and augmented to meet unexpected contingencies, to expand the size of production and to provide social security benefits to the employees.

Mixed Income from self-employed (MISE) – Income of own account workers like farmers, doctors, barbers etc. and unincorporated enterprises like small shopkeepers, repair shops, retail traders etc is known as mixed income.

Net Factor Income from Abroad (NFIA)

NDP at FC = COE + OS + MISE

2. Calculate national income by income method

S.NO iTEMS                             CRORES

I     Wages and Salaries         500

Ii  Royalty                                20

Iii Interest                                40

Iv Change in Stock                10

V Indirect Tax                      100

Vi Rent                              50

vii Profit after tax            100

Viii Corporate tax             20

Ix Subsidies                   30

x Net Factor Income from Abroad (-) 5

Sol. NDPFC = COE + OS + MI

    COE =  500

     OS = Royalty + Interest +Rent + Profit

      Profit = Profit after tax + Corporate Tax =100 + 20 = 120

      OS = 20 + 40 + 50 + 120 = 230

      NDPFC = 500 + 230 + 0 = 730

      NNPFC = NDPFC + NFIA = 730 + (-) 5 = 725 Crores

                     NNPFC is National Income

Precautions of income method

1. Transfer earnings like old-age pensions, unemployment allowance etc. should not be included in national income.
2. Income from illegal activities like theft and gambling is not included in national income.
3. Commission paid on the sale and purchase of second hand goods are to be included in national income.
4. Brokerage on the sale/purchase of shares and bonds is to be included in national income.
5. Income in terms of windfall gains should not be included in national income.

    Expenditure Method

According to this method, national income is measured in terms of expenditure on the purchase of final goods and services produced in the economy during an accounting year. It is also called consumption and investment method or income disposal method.

Classification of Final Expenditure

a.      Private final consumption expenditure (PFCE)

b.      Government final consumption expenditure (GFCE)

c.       Gross domestic capital formation (GDCF)

d.      Net exports

e.      Net factor income from abroad (NFIA)

f.        Depreciation (-)

g.      Net indirect taxes (-) [Indirect Taxes – Subsidies]

3. 

Pr3. Calculate Gross National Product at Factor Cost from the following data.

S.NO              ITEMS                                             CRORES

i Net Domestic Fixed Capital Formation                  350

ii Closing Stock                                                   100

iii Government Final Consumption Expenditure        200

iv Net Indirect Tax                                                 50

v Opening Stock                                                60

vi Consumption of Fixed Capital                              50

viii Net Exports                                                       (-) 10

ix Private Final Consumption Expenditure             1500

x Net factor Income from Abroad            (-) 10

     Sol. GDPMP = PFCE + GFCE + GDKF + Net Exports

     PFCE = 1500

     GFCE =   200

     GDKF = NDFKF + Change in Stock + Depreciation

                = 350 + (100 – 60) + 50 = 440

      Net Exports = (-) 10

      GDPMP = 1500 + 200 + 440 + (-) 10

                   = 2130

     GDPFC = GDPMP – NIT  = 2130 – 50 = 2080

     GNPFC = GDPFC + NFIA = 2080 + (-) 10

                 = 2070

 

S

Following five items of expenditure should not be included –

1. To avoid double counting, expenditure on all intermediate goods and services is excluded. For example, purchase of eatable items by a restaurant, expenses on electricity by a factory are not included as they are intermediate consumption.
2. Government expenditure on all transfer payments such as scholarship, unemployment allowance, old-age pension etc. is excluded because no productive services are rendered by the recipients in exchange.
3. Expenditure on second-hand goods is excluded.
4. Expenditure on purchase of old shares/bonds or new shares/bonds etc. are excluded because it is not payment for goods or services currently produced.
5. Imputed expenditure on own account output should be included.

The GDP deflator, also known as the implicit price deflator, is a measure of inflation, calculated by dividing nominal GDP by real GDP and multiplying by 100, reflecting changes in the price level of all goods and services produced in an economy.

• Nominal GDP: The monetary value of all final goods and services produced in an economy at current prices. 
• Real GDP: The monetary value of all final goods and services produced in an economy at constant (base year) prices.
• GDP Deflator Formula= (Nominal GDP / Real GDP) * 100

Example. If Real GDP = 600 and Nominal GDP = 660, find GDP Deflator (Price Index).

Sol 

GDP Deflator = Nominal GDP/ Real GDP x 100

660/600x100

= 100