UNIT – I: NATIONAL INCOME AND RELATED

AGGREGATES

CHAPTER-1
NATIONAL INCOME AND RELATED
AGGREGATES
Macroeconomics refers to that branch of economics that deals with economic problems or
economic issues at the level of an economy as a whole, e.g. it deals with aggregates like
national income, general price level, etc.
Consumption Goods: Goods which are used by the consumers to satisfy human wants
directly are called consumption goods.
Capital Goods: All goods which are used in the production of other goods either as fixed assets
or as inventory/ stock are called Capital Goods.
Final Goods: Those goods which are purchased either for final consumption by consumers
(consumer goods) or for investment by producers (capital goods) are final goods.
Intermediate Goods: Those goods and services which are purchased as raw material for further
production or for resale in the same year.
Stock: Stock is a quantity measurable at a particular “point of time”, e.g. wealth, assets,
money, inventory, etc. A stock variable is nothing but an accumulated sum of flows.
Flow: Flow is a quantity that can be measured over a specific “period of time”, e.g. national
income, change in stock, etc.
Gross Investment: Total addition made to physical stock of capital during a period of time. It
includes depreciation.
It is also known as Gross Capital Formation.
Net Investment: Net addition made to the real stock of capital during a period of time.
Depreciation: It means fall in value of fixed capital goods due to normal wear and tear, expected
obsolescence and efflux of time.
Circular flow of income: Circular flow of income refers to the flow of activities of production,
income generation and expenditure involving different sectors of the economy.
2-Sector Model of Circular Flow: It is assumed that:
(i) Domestic economy comprises only 2 sectors, the producers and the households.
(ii) The households spend their entire income, so that there is no savings.
(iii) Domestic economy is a closed economy (no exports and imports).
(iv) There is no government in the economy.
Production in the producing sector generates income for the households who are owners of
the factors of production. Expenditure by the households generates demand for further
production. These movements keep chasing each other continuously moving in a circle.
 Significance of Circular Flow of Income: (i) It reflects structure of an economy, (ii) It shows
interdependence among different sectors, (iii) It shows injections and leakages from flow of
money, (iv) It helps in estimation of national income and related aggregates.

Topic 2: National Income Accounting

National Income: National Income is the sum total of factor incomes earned by normal
residents of a country. Measurement of National Income: In every economy, the circular
flow of production, income and expenditure remains in operation continuously due to economic
activities. Production generates income which creates demand and hence, expenditure. In this
way, the national income of a country may be measured by three alternative methods.
These are: (a) In the form of flow of goods and services, (b) In the form of income flow, (c) In
the form of expenditure flow.
Value Added Method or Production Method: Product Method or Valued Added Method is
the method which measures the national income by estimating the contribution of each
producing enterprise to produce in the domestic territory of the country in an
accounting year. For measuring national income by this method, we have to estimate the
following components:
Net Domestic Product at Market Price (NDPMP): Gross Valued Added by [Primary Sector +
Secondary Sector + Tertiary Sector] - Depreciation
Net National Product at Factor Cost (NNPFC) or NI: NDPMP – Net Indirect Tax + Net Income
from Abroad.
Value Added Method (Product Method): Gross Value Added at Market Price (GVAMP) =
Sales + Change in Stock – Intermediate Consumption.
GDPMP =GVAMP of all sectors + Depreciation + Net Indirect Taxes
OR
Value of output – Intermediate consumption
NVAFC = GVAMP – Depreciation – Net Indirect Taxes (NIT)
Precautions while using Value Added Method:
(i) The value of intermediate goods should not be included.
(ii) Purchase and sale of second hand goods should not be included.
(iii)Imputed or estimated value of self-consumed goods should be included but self-consumed
services should not be included.
(iv) Own account production should be included.
(v) Commission earned on account of sale and purchase of second hand goods is included.
Income Method: It measures national income in term of payments made in the form of wages,
rent, interest and profit to the primary factors of production, i.e., labour, land, capital and
enterprise respectively for their productive services in an accounting year.
Net Domestic Income or Net Domestic Product at Factor Cost: Compensation to Employees +
Operating Surplus
+ Mixed Income from Self Employment.
National Income = Net Domestic Income + Net Income from Abroad.
Precautions while using Income Method:
(i) Income from illegal activities like smuggling, theft, gambling, etc., should not be included.
(ii) Imputed rent of owner occupied structure and value of production for self-consumption is
included but value of self-consumed services like those of housewife is not included.
(iii)Brokerage on the sale/purchase of shares and bonds is to be included.
(iv) Income in terms of windfall gains should not be included.
(v) Transfer earning like old age pensions, unemployment allowances, scholarships, pocket
expenses, etc. should not be included.
Expenditure Method: By this method, the total sum of expenditures on the purchase of final
goods and services produced during an accounting year within an economy is estimated to
obtain the value of GDP.
Final Expenditure: It is the expenditure on the purchase of final goods and services, during an
accounting year. It is broadly classified into four categories:
(i) Private final consumption expenditure,
(ii) Government final consumption expenditure,
(iii)Investment expenditure,
(iv) Net exports, i.e., difference between exports and imports during an accounting year.
Computation of National Income (by expenditure method) NNPFC = GDPMP – Depreciation +
NFIA – Net Indirect Tax. Where, GDPMP = Private Final Consumption Expenditure +
Government Final Consumption Expenditure + Gross Domestic Capital Formation + Net
Exports (Exports – Imports). Where, Gross Domestic Capital Formation
= Gross Domestic Fixed Capital Formation + Change in Stock (Closing Stock – Opening Stock)
Precautions while using Expenditure Method:
(i) Only final expenditure is to be taken into account to avoid error of double counting.
(ii) Expenditure on second hand goods is not to be included.
(iii)Expenditure on transfer payments by the government is not to be included.
(iv) Imputed value of expenditure on goods produced for self consumption should be taken into
account.
(v) Expenditure on shares and bonds is not to be included in total expenditure.
Gross Domestic Product (GDP): It is the total value of all the final goods and services by all the
enterprises (both resident and non-resident) within the domestic territory of a country in a
particular year.
Gross Domestic Product at Market Price (GDPMP): Private Final Consumption Expenditure (C)
+ Government Final Consumption Expenditure (G) + Investment Expenditure (I) or Gross
Capital Formation + Net Exports (X – M).
Net Domestic Product at Market Price (NDPMP) = GDPMP – Depreciation
Net Domestic Product at Factor Cost (NDP FC) = GDPMP – Indirect
Taxes + Subsidies National Income = GDPMP – Depreciation – Net
Indirect Taxes + Net Income from Abroad
Nominal Gross Domestic Product: When the goods and services are produced by all
producing units in the domestic territory of a country during an accounting year and valued
at current year ’s prices or current prices, it is called Nominal GDP or GDP at current prices. It
is influenced by change in both physical output and price level. It is not considered a true
indicator of economic development.
Real Gross Domestic Product: When the goods and services are produced by all producing
units in the domestic territory of a country during an accounting year and valued at base year
’s prices or constant price, it is called real GDP or GDP at constant prices. It changes only by
change in physical output and not by change in price level. It is called a true indicator of
economic development.
Gross National Product: It is defined as the total value of all final goods and services produced in
a country in a particular year, plus the income which is earned by its citizens who are located
abroad and minus the income of non-residents located within the country.
 GNPMP = GDPMP + Net Factor Income from Abroad
Net National Product at Factor Cost (NNPFC): It is the sum total of factor incomes (rent +
interest + profits + wages) earned by normal residents of a country during the period of an
accounting year. It is also known as the National Income.
NNPFC = GNPFC – Depreciation
OR
NNPFC = NDPFC + NFIA
Net National Product at Market Price (NNPMP): It refers to market value of final goods and
services produced during the year inclusive of Net Factor Income from Abroad but exclusive of
depreciation.
NNPMP = GDPMP – Depreciation + NFIA

Topic 3: GDP and Welfare

GDP and Welfare: In general, Real GDP and Welfare are directly related with each other. A
higher GDP implies more production of goods and services. It means more availability of
goods and services. But more goods and services may not necessarily indicate that the people
were better off during the year. In other words, a higher GDP may not necessarily mean
higher welfare of the people.
Welfare means material well being of the people. It depends on many economic factors like
national income, consumption level, quantity of goods, etc., and non-economic factors like
environmental pollution, law and order, etc. The welfare which depends on economic factors is
called economic welfare and the welfare which depends on non-economic factor is called non-
economic welfare. The sum total of economic and non-economic welfare is called social
welfare.
GDP is not an appropriate indicator for Welfare: GDP may be a good indicator of economic
growth but not of economic welfare or economic development because of:
(a) Externalities: Externalities refer to benefits or harms of an activity caused by a firm or an
individual, for which they are not paid or penalized. For example, environmental pollution
caused by industrial plants is a negative externality and building a flyover is a positive
externality.
(b) Composition of GDP: GDP does not exhibit the structure of the product. If the increase
in GDP is mainly due to increased production of war equipment and ammunitions, then
such an increase cannot improve
welfare in economy.
(c) Distribution of GDP: When GDP is unevenly distributed, increase in GDP does not
increase welfare.
(d) Non-monetary exchanges: Many activities in an economy are not evaluated in monetary
terms, they are not included in GDP, due to non availability of data. However, such activities
influence the economic welfare of people of the economy.