GNP:

Gross national product or GNP may be defined as the total market value of all-final
goods and services produces by the economy of country within a certain period (generally one
year). It doesn’t include nonproductive transactions (i.e. sale of stock and bond).
Characteristics of GNP:
1. It has monetary value.
2. Flow variable.
3. It has three aspects:
a) Production.
b) Income.
c) Expenditure.
4. It only includes final goods and services.
5. It doesn’t include transfer payments.
Three important macroeconomics concepts are output, income and expenditure. Firms
produce goods and services, which in total are the nation’s output. Productions require factors of
production whose owners are paid for their services and properties. It thus generates income.
Expenditure is the amount required to purchase goods and services.
There are tree methods of measuring GNP corresponding to these three concepts and they
are:
1. Product method.
2. Income method.
3. Expenditure method.
Product method: According to this method the value of the output of each firm is
added up to get the total value of nation’s output. The output can be grouped into more or less
aggregated categories corresponding to industries, to sectors or to any desired categories. It
includes only the final goods and services. Symbolically this method can be expressed as:
GNP = P1Q1 + P2Q2 +………..+ PnQn
= PiQi
Here, P => Price Q => Quantity i = number of sectors in the economy.
The advantage of this method is that it reveals the importance of different sectors of the
economy by showing their contribution to national income.
Income method: This method approaches the nation’s GNP from the distribution side.
According to this method GNP is obtained by summing up the incomes of the individuals in the
country who contribute their services and properties in the production process. It can indicate the
distribution of national income among the factors of production. Symbolically this method can
be expressed as:
GNP = TR + TW + TI + TP
Where TR = Total rent.
TW = Total wage.
TI = Total interest.
TP = Total profit.
Expenditure method: This method arrives at the GNP by adding up the expenditure
made by the individuals on goods and services. Hence GNP is found by adding up
1. Personal consumption expenditure (i.e. household expenses)
2. Gross private domestic investment (i.e. Purchases of new capital by business
firms.
3. Net foreign investment. (i.e. Excess export over import)
4. Govt. expenditure (i.e. Purchases by the govt.)
Symbolically this method can be expressed as:
GNP = C + I + G + (X – M)
Where C = Consumption.
I = Investment.
G = Govt. expenditure.
X = Total export and M = Total import
So far, three alternative methods of calculating GNP have been explained, the best way to
arrive at GNP will be to employ all these three methods so as to permit them cross checking
inquiry and to have greater accuracy.
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Why ‘Real GNP’ is superior to ‘Money GNP’?
A serious difficulty arises in comparing GNP of several years because of inflation. Say
for example over one year all prices remain unchanged, the quantity of the output increases by
10% and as result GNP will increase by 10%. Again in the following year the quantity remains
unchanged but the price level increase by 10% and as result GNP will increase by 10%. But
these two cases are different. To avoid this confusion we use ‘Real GNP’.
Nominal GNP: Money GNP / nominal GNP / GNP at market price / GNP at current
price is the market value of a nation’s aggregate production of final output based on current price
of the corresponding year. Nominal GNP is of only limited use in measuring changes in
aggregate production over the time. This is because nominal GNP can rise from one year to the
next as result of increase in market price level of goods even when the nation’s aggregate
production of final products doesn’t increase. If market prices were to fall substantially during a
year, nominal GNP might fall even if the nation’s aggregate production goes up.
Real GNP: Real GNP / GNP at constant price / base year GNP is the measure of value
of the nation’s aggregated output of final product obtained by using the market price prevailing
for product during a certain single year called base year. For example it the base year is 1972,
output in each year will be valued at the 1972’s price level and results will be referred to as GNP
valued at 1972’s price.
Because the price used to valued all product remain unchanged from year to year, changes in
GNP must be due to the changes in quantity of output.

How to convert Money GNP into Real GNP:

To convert Money GNP into Real GNP we must follow the following procedure:
1. First we have to select a base year.
2. Then we will have to construct a price index.
Price index = (Present year price level / Base year price level) X 100
3. Then Real GNP will be
(Money GNP / Price index) X 100

Potential GNP: Potential output or full employment output or expected GNP refers to
what the economy could produce over a given time period if all resources are fully employed.
When the economy is producing its potential output the actual output is then equal to potential
GNP and will remain on the production possibility boundary.
Actual GNP: Actual GNP refers to what is actually produced by a nation over a given
period. When there are some unemployed resources so that the actual GNP is less than the
potential GNP, the output point is somewhere inside the transformation curve.

What items are included / excluded in / from GNP:

1. Only final goods and services are included and intermediate goods are excluded.
2. Services free of charges are excluded from GNP.
3. Transfer payments are excluded from GNP.
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 4. Subsidies will be excluded.
5. Illegal transactions are excluded.
6. Only the goods services of the concern year are included.
7. Reselling of goods are excluded.
8. Transactions, which are not related with productive effort, are excluded.
9. Capital gains and loses are excluded.
GNP deflator:
GNP deflator = Money GNP / Real GNP = Rate of inflation.
GNP gap:
GNP gap = Potential GNP – Actual GNP.
Personal income (PI): personal income is a measure of income available to household in a
given period of time. To obtain the PI the subtraction from and addition to national income are
required: –
1. Subtract all net interest and corporate profit from national income because these
accrue to business rather than to households.
2. Subtract social security taxes, as they are not available for households to spend.
3. Add all personal interest income in national income.
4. Add personal dividend payment, the portion of corporate profits paid to individuals.
5. Add all govt. transfer payment to individual.
Thus PI can be written as:
PI = NI – Corporate profit – Social security + Transfer payment + Interest
adjustment + Dividend.
Personal income is useful to measure of the ability of the households to make purchases,
save and pay taxes.
Disposable income (DI): The income that individuals have to spend or to save after
the payment of personal taxes is called disposable income. It is obtained by simply deducting
personal tax and non-tax payment to the govt. from personal income. Thus DI can be written as:
DI = PI – Ti.
GDP: Gross domestic product measures the market value of final product produced
within the boundary of the country by deducting citizens earning living abroad from GNP while
adding the earning of foreign corporation with operation in the state. Thus GDP is a measure of
income resulting from the use of all resources within the border of the nation. To accurately
reflect on domestic production, international comparisons of output of nations are sometimes
based on GDP rather than GNP.
NNP (National income at market price): GNP includes investment purchases
reflecting replacement of existing capital goods that have worn out or become obsolete. To
account a net new addition to capital stock these capital expenditure must be deducted from
GNP. Net national product or NNP is a measure of national production that only includes net
addition to capital while excluding any purchases for the replacement of worn out or obsolete
capital goods. Symbolically
NNP = GNP – Capital consumption allowance.
Because capital consumption allowances are only very rough estimates of actual
depreciation most economists believe that NNP is not a very reliable indicator of net production.
National income (NNP at factor cost): National income is a measure of
household and business earnings from the use of productive resources over a period of one year.
It can be calculated by subtracting Capital consumption allowance (CCA), Indirect business
taxes (Ti), transfer payments (Tr), Surplus of govt. enterprises (Sg) and adding Subsidies (Sb) to
GNP. Thus National income can be written as:
National income = GNP – CCA – Ti – Tr – Sg + Sb
National income can also be measured by summing up the compensation of employees,
rental income, net interest income earned by those who make loans to finance production process
and profit.
Significance of national income:
There are several important uses of national income statistics. National income estimates
provide not only a single figure showing the national income, but also supply the detailed figure
in regard to the various components of the national income. Thus it throw light on the
functioning and performance of the economy.
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The following are some of the important uses of the national income estimates:
 First, national income estimates reveal the overall production performance of the
economy. Beside this per capita income, which is found by dividing the total national
income by the population gives us an idea about the average standard of living of the
people.
 Secondly, by comparing national income of different years, we can know whether the
economy is growing, stagnant or declining.
 Thirdly, the national income estimates show the contribution made by the various
sectors of the economy.
 Fourthly, national income estimates throw light on the distribution of national income
among different categories of income such as wages, profits, rents and interest.
 Fifthly, the national income estimates also contain the figures of consumption, saving
and investment in the economy.
 Sixthly, by the figures of the real national income per capita, we can compare the
standard of living or levels of welfare in different countries of the world.
 Finally, national income estimates are valuable guide to economic policy. By looking
at national income statistics, the govt. can decide if the economy or its various sectors
need any stimulus or regulation.

Output determination in two sector economy / Private economy

Consumption expenditure C = f (Y)
= C + cY ; C = Autonomous Consumption
Y = National Income
cY = Induced Consumption
c = MPC (Marginal propensity to consume)c /  Y

Savings function S = f (Y)

= – C + (1 – c) Y ; C = Autonomous Consumption
Y = National Income
(1 – c) = MPS (Marginal propensity to save) =  S /  Y
c = MPC = c /  Y

Average propensity to consume (APC)

APC = C / Y ; C = Consumption expenditure, Y = National Income.
= C / Y + cY / Y
=C/Y+C
Average propensity to save (APS)
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APS = S / Y ; S = Savings, Y = National Income.
= – C / Y + (1 – c)Y / Y
= – C / Y + (1 – c)

Consumption function:
Assumptions:
1. Consumption expenditure varies directly with disposable income.
2. As income increases consumer will spend part of it but not all and rest will be saved.
3. All other influences on consumption remain constant except income.

The relationship between consumption and income that emerge from the above assumptions
is referred to as consumption function. Thus consumption function may be described as the
relationship between disposable income and consumption expenditure with all other influences
kept constant. The consumption function here employed holds that the aggregated consumption
varies directly but not proportionately with income. Symbolically:
C = f (Y) ; C = consumption expenditure, Y = Disposable income.
More specifically consumption function can be written as
C = C + cY ; C = autonomous consumption, c = marginal propensity to consume, Y
disposable income.

Consumption equation:
A consumption equation is the specific version of consumption function. A consumption
function shows that there is a relation between consumption expenditure and income. But
consumption equation shows how proportionately they are related. A simple specimen of
consumption equation is as follows:
C = C + cY C = autonomous consumption, c = marginal propensity to
consume, Y disposable income C = consumption expenditure
In the above consumption equation ‘C’ implies the aggregated consumption expenditure.
‘C’ is autonomous consumption expenditure. That is the consumption purchases that are not
affected by the income (i.e. necessary for existence). ‘cY’ is the induced consumption that is
dependent on income. Here ‘c’ represent the marginal propensity to consume that is the rate at
which the consumer will increase the consumption for per unit increase in income.
Let C = 100 and mpc = 0.8
. . C = 100 + .8Y

Consumption schedule:
A consumption schedule is a table that shows how consumption expenditure increases as
income increases or vice versa.
Let the consumption equation of an economy is as below
C = C + cY; C = autonomous consumption = 400, c = marginal propensity to consume =
0.8, Y disposable income C = consumption expenditure

Yd C Savings (S)
0 400 -400
1000 1200 -200
2000 2000 0
3000 2800 200
4000 3600 400
Above we have drawn a hypothetical consumption schedule of an economy. The table shows the
relationship between possible levels of annual disposable income and aggregated consumer
purchases for the hypothetical economy. The first column shows the possible level of disposable
income (yd) and the second column show the consumer purchases (C) associated with the
possible income level. It is assumed that $400 billion consumption expenditure is independent of
income (autonomous consumption) and occurs during the year even if the disposable income is
zero. The rest of the data in column 2 is obtained by assuming MPC = 0.8
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Consumption curve:
A consumption curve is a graphical representation of a consumption function. It shows
graphically how consumption varies with change in income. We know
Consumption expenditure C = C + cY ; C = autonomous consumption, c = marginal propensity
to consume, Y disposable income.
Now let C = 400 and c = .8
. . Consumption equation C = 400 + .8Y

Determining the value of C with change in Y

Y 0 1000 2000 3000 4000
C 400 1200 2000 2800 3600

The consumption function based on the data is plotted on the graph above. The line
labeled C in the figure shows the relationship between income level and corresponding
consumption expenditure. The other line is 45o guideline; any point on this line is equidistant
from the vertical and horizontal axis. We know by definition that any portion of disposable
income that is not consumed must be saved. The guideline and the hypothetical ‘C’ line show
how people plan to allocate any given level of disposable income between spending and savings.
For example: when income is 3000 then consumption is 2800. So savings must be equal the
balance of income – consumption = 3000 – 2800 = 200.
When income level is 2000 at that time the planned consumption is exactly equal to
income (point E). This is referred as break even level of income. Any level above it will
encourage people to save. At any level below ‘E’ people spend more that their income.
MPC: The marginal propensity to consume is the fraction of each additional unit of annual
disposable income that is allocated to the consumer purchases. In other ward MPC is the rate by
which consumer will increase the consumption for per unit increase in disposable income. MPC
can be calculated from the following formula.
MCP = change in consumption/change in disposable income = C / Yd
For example: Let the income of the consumers of an economy is 1000 and they spend 800. Now
if the income goes up by 1000 unit and as result expenditure goes by 800 unit then MPC will be
C/ Y = (1600 – 800) / (2000 – 1000) = 0.8.
MPS: The marginal propensity to save is the fraction of each additional unit of annual
disposable income that is saved. In other ward MPC is the rate by which consumer will increase
the consumption for per unit increase in disposable income. MPC can be calculated from the
following formula.
MCP = change in savings / change in disposable income = S / Yd
For example: Let the income of the consumers of an economy is 1000 and they save 200. Now if
the income goes up by 1000 and as result savings goes by 200 then MPC will be
S/ Y = (400 – 200) / (2000 – 1000) = 0.2
APC: Average propensity to consume is the average amount of all income spent on
consumption. It obtained by dividing the total consumption by total income. Symbolically:
APC = C / Y
For example: Let the total income of the consumers of an economy is 1000 unit and they spend
800 unit for consumption then the average propensity to consume will be 800 / 1000 = 0.8
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APS: Average propensity to save is the average amount of all income spent on savings. It
obtained by dividing the total savings by total income. Symbolically:
APS = S / Y
For example: Let the income of the consumers of an economy is 1000 and they save 200 then
average propensity to save will be 200 /1000 = 0.2

Savings function:
Assumption:
1. A portion of income is saved.
2. All other influences on savings are kept constant
3. Autonomous consumption of a consumer comes from previous savings or loan and is
considered as dis-savings.
The theory:
A savings function is counterpart of consumption function. Savings function may be
defined as the relationship between total saving and total income. Symbolically
S = f(Yd). Here S = Total savings, Yd = Disposable income.
The amount of savings at any level of income is the difference between consumption
expenditure and total income and autonomous consumption of a consumer is considered as dis-
savings. Thus more specifically savings function can be written as
S = - C + (1 – c) Yd ;
Let autonomous consumption is 400 and mpc = .8 then
S = - 400 + (1 - .8) Yd

Savings equation:
A savings equation is the specific version of savings function. A savings function shows
that there is a relation between savings and income. But savings equation shows how
proportionately they are related. A simple specimen of savings equation is as follows:
S = - C + (1 – c) Yd
In the above equation S represent the total savings. If disposable income is very low or zero in
any given year, households will reduce their savings and sell some of their assets or will use
previous savings to meet their autonomous consumption. In the equation –C represent that
portion. As we know income that is not consume must be saved, so 1 – MPC = MPS. Here 1 – c
represent MPS.
Let the autonomous consumption of the households of an economy is 100 and MPS = 0.2. So the
savings equation will be S = -100 + 0.2Yd. Now if the annual disposable income is 1000 then
annual savings will be
S = -100 + 0.2 X 1000
= 100
Savings schedule:
A Savings schedule is a table that shows how Savings increases as income increases or vice
versa.
Let the Savings equation of an economy is as below
S = - C + (1 – c)Y; C = dis-saving = 400, (1 – c) = marginal propensity to save = 0.2, Y
disposable income S = Total savings

Yd Savings (S)
0 -400
1000 -200
2000 0
3000 200
4000 400
Above we have drawn a hypothetical Savings schedule of an economy. The table shows the
relationship between possible levels of annual disposable income and aggregated savings for the
hypothetical economy. The first column shows the possible level of disposable income (yd) and
the second column shows the savings (S) associated with the possible income level. It is assumed
that 400 unit Savings dis-savings or autonomous consumption expenditure. The rest of the data
in column 2 is obtained by assuming MPS = 0.2
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Savings curve:
A Savings curve is a graphical representation of a Savings schedule. It shows graphically
how Savings varies with change in income. We know
Savings S = - C + (1 – c)Y ; C = dis-Savings, (1 – c) = marginal propensity to save, Y disposable
income.
Now let C = 400 and 1 - c = 0.2
. . Savings equation S = - 400 + 0.2Y

Determining the value of S with change in Y

Y 0 1000 2000 3000 4000
S - 400 - 200 0 200 400

The savings schedule has been plotted on the graph above with disposable income on horizontal
axis and savings on vertical axis. The graph shows that savings in the economy is negative if
disposable income is less than 2000. Negative savings means people consume more than their
present income by converting some of savings from years past into cash. Again savings is zero
when the disposable income is2000 unit for the year. The graph also shows that for each 1000
unit increase in disposable income savings goes up 200 unit.

Multiplier
A multiplier is a number that indicates the increase in real GNP results from increase in
consumption. For example a multiplier of 5 indicates that each 1 unit increase in consumption
will increase the GNP by 5 units. Multiplier can be expressed as the ratio of change in GNP to
change in autonomous purchases. Thus
Multiplier = Change in GNP / Change in autonomous purchases
To see how multiplier works let assume in a two sector economy (Y= C+S) MPC = 0.8 and
initial level of equilibrium GNP is 4000. Under this circumstance a 200 unit increase in
consumption purchase will increase the income of some people by 200 unit. But the increase in
equilibrium income is much larger than the initial income. Because those who earn 200 will
spend it on their needs @ MPC = 0.8 that is 160 unit will be spend in the second round of
spending. But the process doesn’t end here. The 160 unit will result 128 unit consumer purchases
(160*0.8). The 128 unit will then generate 128 income and the spending process will commence
again. As the process continues, the change in income for the subsequent rounds become smaller
and smaller because MPC is less than 1. We can show the value of multiplier depending on MPC
in the foll0owing way
 Real GNP = 200 + 200*0.8 + (200*0.8) 0.8 + {(200*0.8)0.8}0.8+ ……….
At each stage 0.8 of the previous change in income is represented. The infinite progression of
numbers can be solved with the following formula.
 Real GNP = (Increase in investment purchases)* 1/ 1 - MPC
Thus in case of our hypothetical economy Real GNP = 200 + 1 /1-0.8 = 1000
So multiplier of the economy is
Multiplier = Change in GNP / Change in autonomous purchases

= 1000 / 200 = 5
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Graphical analysis:

The graph above shows how each additional round of re-spending results in more
consumption, more production, and therefore still increase in income. As the process go on and
on, the graph shows that equilibrium GNP eventually grows by 1000 unit.

Money is what money does – Walker.

Anything which is widely accepted in payment for goods or in discharge of other kinds of
obligations – Robertson.
Functions of money
1. A medium of exchange: The most important function of money is to serve as a medium of
exchange. As a medium of exchange money solves all the difficulties of barter system. For
example:
2. A standard value: Money provides a unit of account that serves as a stadard to measure value.
For example we measure our income in Taka. The concept of GNP is useless without a
standard of value.
3. A standard of differed payment: Many contract involves promises to pay sums of money in
future. Lending and borrowing, therefor, must take place in terms of such commodity which
will keep its value stable over time and the value of money can be kept more stable than that
of other articles. By serving as a standard measure of payments overtimes, money makes
borrowing and lending much less risky.
4. A store of value: Money serves as store of value or more correctly, it enables a person to
keep a portion of his assets liquid. That means money can instantaneously be converted to
goods and services without any inconvenience or cost. Other assets like bond, share must be
sold to be converted into a generally accepted medium of exchange. Thus money is best kept
as a store of value.
5. A mean of transferring value: One cannot take his land and other immovable assets to
another place. But he can sell it and with the money so acquired, he can buy them elsewhere.
Value will thus be transferred.

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