MANAGERIAL ECONOMICS Shrivastava PDF

Unit 13: Basic National Income Concepts
Unit 13: Basic National Income Concepts Notes
CONTENTS
Objectives
Introduction
13.1 Concept of National Income
13.1.1 Gross and Net Concept
13.1.2 National and Domestic Concepts
13.1.3 Market Prices and Factor Costs
13.1.4 Gross National Product and Gross Domestic Product
13.1.5 Net National Product
13.1.6 Personal Income
13.1.7 Disposable Income
13.2 Some Important Identities
13.3 Summary
13.4 Keywords
13.5 Self Assessment
13.6 Review Questions
13.7 Further Readings
Objectives
After studying this unit, you will be able to:

Explain the concept of national income
Discuss important identities related to national income
Introduction
Macroeconomics is concerned with the determination of the economy's total output, the price
level, the level of employment, interest rates and other variables. A necessary step in
understanding how these variables are determined is "national income accounting". The national
income accounts give us regular estimates of GNP — the basic measure of the economy's
performance in producing goods and services. National income is the most comprehensive
measure of the level of the aggregate economic activity in an economy. It is the total income of
a nation as against the income of an individual but the term national income is not as simple and
self-explanatory as the concept of individual income maybe.
LOVELY PROFESSIONAL UNIVERSITY 203

Managerial Economics
Notes 13.1 Concept of National Income
We may define national income as the aggregate of money value of the annual flow of final
goods and services in the national economy during a given period.
The well-known writer, Paul Studenski, writes: "National income is both a flow of goods and
services and a flow of money incomes. It is therefore called national product as often as national
income". The flow of national income begins when production units combine capital and labour
and turn out goods and services. We call this Gross National Product (GNP), it is the value of all
final goods and services produced by domestically owned factors of production within a given
period. It includes the value of goods produced such as houses and food grains and the value of
services such as broker's services and economist's lectures. The output of each of these is valued
at its market price and the values are added together to give GNP. At the same time, the
production units which produce goods and services distribute money incomes to all who help in
production in the form of wages, rent, interest and profit — we call this as Gross National
Income.
GNI is the sum of the money incomes derived from activities involving current production in an
economy in a given time period.
It may be noted from above that
1. National income is an aggregative value concept: It makes use of the value determined by
the money as the common denominator.
2. National income is a flow concept: It represents a given amount of aggregate production
per unit of time, conventionally represented by one year and relates to a particular year.
3. National income represents the aggregate value of final products rather than the total
value of all kinds of products produced in the economy.
We would not want to include the full price of an automobile producer to put on the car.
The components of the car that are sold to the manufacturers are "intermediate goods" and
their value is not included in GNP.
In practice, double counting is avoided by working with the "value-added".
!
Caution At each stage of manufacture of goods only the "value added" to the good at that
stage of manufacture is counted as part of GNP.
It should be noted that the sum of the value added at each stage of processing will be equal to the
final value of the bread sold. The flour that is directly purchased by households for baking in the
home is counted as the contribution towards GNP since it represents a final sale. It indicates that
national income is an unduplicated total that does not involve any double counting. Obviously
there are three different stages or phases in the flow of output and income in the national
economy.
1. There is production of goods and services by all production units by the use of labour,
capital and enterprise,
2. There is distribution of incomes to all the factors who are suppliers of labour, capital, etc.
this distribution takes the form of wages, interest, rent and profit,
3. There is spending of incomes on the goods and services produced by the economy;
this expenditure is classified into consumption goods (c) and expenditure on investment
goods (I).
204 LOVELY PROFESSIONAL UNIVERSITY

So, we have three kinds of national income estimates: Notes
1. National income as net aggregate output

2. National income as sum of distributive shares
3. National income as aggregate value of final products
13.1.1 Gross and Net Concept
Gross emphasises that no allowance for capital consumption has been made or that depreciation
has yet to be deducted.
Net indicates that provision for capital consumption has already been made or that depreciation
has already been deducted.
Thus the difference between the gross aggregate and the net aggregate is depreciation.
i.e.,
GNP at market price/factor cost = NNP at market price/factor + Depreciation cost.
13.1.2 National and Domestic Concepts
The term national denotes that the aggregate under consideration represents the total income
which accrues to the normal residents of a country due to their participation in world production
during the current year. Thus, the term 'national' is used to emphasise that the aggregate under
consideration covers all types of factor incomes accruing to normal residents of a country
irrespective of whether the factors of production supplied by them are located at home or
abroad.
As against this, it is also possible to measure the value of the total output or income originating
within the specified geographical boundary of a country known as "domestic territory". The
resulting measure is called "domestic product".
In other words, the distinction between "national" and "domestic" aggregates lies in the frame of
reference — the former takes the normal residents of a country, the latter takes a given
"geographical area". Here, national produce differs from domestic product by the amount of net
factor income from abroad.
GNP at market price/factor cost = GDP at market price/factor cost + Net factor income from
abroad
NNP at market price/factor cost = NDP at market price/factor cost + Net factor income from
abroad
Net factor income from abroad = Factor income received from abroad — Factor income paid
abroad.
13.1.3 Market Prices and Factor Costs
The valuation of the national product at market prices indicates the total amount actually paid
by the final buyers while the valuation of national product at factor cost is a measure of the total
amount earned by the factors of production for their contribution to the final output.
GNP at market price = GNP at factor cost + Indirect taxes – Subsidies.
NNP at market price = NNP at factor cost + Indirect taxes – Subsidies.

Notes And vice versa.

Category A Category B
Type 1 GNP at market price GOP at market price
NNP at market price NDP at market price
Type 2 GNP at factor cost GDP at factor cost
NNP at factor cost HDP at factor cost
1. Difference between the aggregates in category A and aggregates in category B is net factor
income from abroad.
2. Difference between the aggregates of type 1 and aggregates of type 2 is indirect taxes less
subsidies.
3. The difference between the two aggregates of each type in each category is depreciation.
13.1.4 Gross National Product and Gross Domestic Product
For some purposes we need to find the total income generated from production within the
territorial boundaries of an economy, irrespective of whether it belongs to the inhabitants of
that nation or not. Such an income is known as Gross Domestic Product (GDP) and found as:
GDP = GNP – Net factor income from abroad
Net factor income from abroad = Factor income received from abroad – Factor income paid
abroad.
Example: If in 1986 the GNP is 8,00,000 million, the income (including tax on such
incomes) received and paid 60,000 million, and 70,000 million respectively, then, the GDP in
1986 would be:
( 8,00,000 – 70,000 + 60,000) million = 7,90,000 million
GNP as a Sum of Expenditures on Final Products
Expenditure on final products in an economy can be classified into the following categories:
1. Personal consumption expenditure (c): The sum of expenditure on both the durable and
non-durable goods as well as services for consumption purposes,
2. Gross Private Investment (I g) is the total expenditure incurred for the replacement of
capital goods and for additional investment,
3. Government expenditure (G) is the sum of expenditure on consumption and capital goods
by the government, and
4. Net Exports (Exports - Imports) (X - M) constitute the difference between the expenditure
or rest of the world on output of the national economy and the expenditure of the national
economy on output of the rest of the world.
GNP is the aggregate of the above mentioned four categories of consumption expenditure.
That is,
GNP = C + Ig + G + (X – M)

GNP as the Total of Factor Incomes Notes
As mentioned above, national product gives a measure of a nation's productive activity,

irrespective of the fact whether this activity takes place at home or abroad. When national
income is calculated after excluding indirect taxes like excise duty, sales tax, etc. and including
subsidies we get GNP at factor cost as this is the amount received by all the factors of production
(indirect taxes being the amount claimed by the government and subsidies becoming a part of
factor income).
GNP at factor cost = GNP at market prices – Indirect taxes + Subsidies
13.1.5 Net National Product
The NNP is an alternative and closely related measure of the national income. It differs from
GNP in only one respect. GNP is the sum of final products. It includes consumption goods plus
gross investment plus government expenditures on goods and services plus net exports. Here
gross investment (GI) is the increase in investment plus fixed assets like buildings and equipment
and thus exceeds net investment (NI) by depreciation.
GNP = NNP + Depreciation
NNP includes net private investment while GNP includes gross private domestic investment.
We know that during the process of production, assets get consumed or depreciated. So, during
a year the net contribution to output is the production of goods and services minus the depreciation
during the year. This is known as NNP at market prices because it is the net money value of final
goods and services produced at current prices during the year after depreciation.
Gross National Product 585.00
Less:
Capital consumption allowances 51.6
Equals:
Net National Product 533.4
Less:
Indirect business taxes 56.6
Other adjustments -1.6
Equals:
National Income 478.4
Equation
NNP = GNP – Depreciation
= C + Ig + G + (X – M) – Depreciation
= C + G + (X – M) + (Ig – Depreciation), where Ig = Government investment
= C + G + (X – M) + In, where In = Net investment, C = Consumption expenditure,
G = Government Expenditure, X = Export, M = Import
= C + G + In + (X – M)
Where I n represents net investment which equals gross investment minus depreciation
(Ig - Depreciation).

Notes NNP at Factor Cost (or National Income)
Goods and services are produced with the help of factors of production. National income or
NNP at factor cost is the sum of all the income payments received by these factors of production.
NI = GNP – Depreciation – Indirect taxes + Subsidies
Since factors receive subsidies, they are added while indirect taxes are subtracted as these do not
form part of the factor income.
NNP at factor cost = NNP at market prices – Indirect taxes + Subsidies
Did u know? What does Genuine Progress Indicator — GPI Mean?
A metric used to measure the economic growth of a country. It is often considered as a

replacement to the more well known gross domestic product (GDP) economic indicator.
The GPI indicator takes everything the GDP uses into account, but also adds other figures
that represent the cost of the negative effects related to economic activity (such as the cost
of crime, cost of ozone depletion and cost of resource depletion, among others). The GPI
nets the positive and negative results of economic growth to examine whether or not it
has benefited people overall.
13.1.6 Personal Income
National income is the total income accruing to the factors of production for their contribution
to current production. It does not represent the total income that individuals actually receive.
Two types of factors account for the difference between national income and personal income.
On the one hand a part of the total income which accrues to the factors of production is not
actually paid out to the individuals who own the factors of production. The obvious instances
are corporate taxes and undistributed or retained profits. On the other hand, the total income
that individuals actually receive generally includes some part that comes to be regarded as
payment for the factor services rendered in the current year, for example, gifts, pensions, relief
payments and other welfare payments. Such payments are known as "transfer payments" because
they do not represent the payments made for any direct contribution to current production.
Thus, personal income is calculated by subtracting from national income those types of incomes
which are earned but not received and adding those types which are received but not currently
earned. So
Personal Income = NNP at factor cost – Undistributed profits – Corporate taxes +

Transfer payments
13.1.7 Disposable Income
Disposable income is the total income that actually remains with individuals to dispose off as
they wish. It differs from personal income by the amount of direct taxes paid by individuals.
Disposable Income = Personal Income – Personal taxes
DI = PI – T
So, PI = DI + T
Usually, people divide their disposable income between consumption spending and personal
saving.

We, therefore, have the following identities Notes
PI = DI + T
DI = C + S
It follows
PI = C + S + T
Notes The concept of value added is a useful device to find out the exact amount that
is added at each stage of production to the value of the final product. Value added can be
defined as the difference between the value of output produced by that firm and the total
expenditure incurred by it on the materials and intermediate products purchased from
other business firms. Thus, value added is obtained by deducting the value of material
inputs or intermediate products from the corresponding value of output.
Value added = Total sales + Closing stock of finished and semi-finished goods – Total
expenditure on raw materials and intermediate products – Opening stock of finished and
semi-finished goods
Caselet Smoking Costs over 6.5% of National Income to

Nations
L
ove for nicotine is weighing heavily on developing nations with top ten smoker
countries losing more than $30 billion annually which is more than 6.5 per cent of
their gross national income (GNI).
The top ten smokers countries, identified by Forbes magazine include Kenya, Turkey,
Namibia, Yemen, Guinea, Bosnia and Herzegovina, Serbia and Montenegro, Mongolia,
Nauru and Sao Tome and Principe.
Thanks to celebrity activism and widespread media attention, the magazine notes, HIV,
malaria and starvation are well-known diseases of the third world. But there's another
resource-draining plague afflicting these countries - smoking.
While the smoking population is half what it was a generation ago in the US and other
industrialised nations, with only one in five using tobacco, it's different in Africa and East
Asia, where time stands still when it comes to cigarettes, it says.
Smoking rates of 40 per cent or more of the population are common in these regions and
medical services are limited.
In Turkey, for example, 44 per cent of its 71.5 million population smokes, draining USD
22.4 billion annually which accounts for 5.8 per cent of its GNI of 384.3 billion dollars.
Around 45 per cent of Yemen's population smokes costing $1 billion to its economy
annually and accounts for 6.2 per cent of GNI.
Societal costs in those countries, Forbes says, can't be calculated the same way they would
be in the US, where most studies measure how much smokers burden taxpayers with extra
medicare and medicaid payments.
For poor countries, there is no medicare-like programme to fund. Nor is there enough
data about the economic impact of other diseases to make real comparisons. Contd...

Notes Tom Glynn, Director of International Care Control for the American Cancer Society has
been quoted as saying. "In Africa, these health care systems don't exist, at least not in the
form we're used to," Only Kenya, he says of Africa's low income nations, has a medical
care system that reasonably resembles that of the western world.
Most studies conclude a cigarette costs 10 minutes of life, so a pack-a-day smoker
(20 cigarettes a day) loses 13.9 per cent of a year to the habit over the long haul, the
magazine notes.
Source: www.articles.economictimes.indiatimes.com
13.2 Some Important Identities
We denote the value of output by 'Y' under the assumption that the simple economy does not
consist of either a government or foreign trade. Consumption is denoted by 'C' and investment
spending by 'I'. The key identity is between output produced and output sold.
Output sold can be written in terms of consumption and investment spending, so identity of
output produced and output sold is
Y C+I (1)
Output produced is identically equal to output sold.
Now, a part of the whole, Y, will be spent on consumption and a part will be saved. So
Y S+C (2)
This tells us that the whole of income is allocated either to consumption or to saving.
Identity (1) and (2) can be combined to read
C+I Y C+S (3)
The left hand side of identity (3) shows the components of demand and the right hand side shows
the allocation of income. The identity emphasises that output produced is equal to output sold.
The value of output produced is equal to income received and income received, in turn, is spent
on goods or saved.
Identity (3) can be rewritten as the relation between saving (S) and investment (I). Subtracting
consumption (C) from each part of identity (3), we have
I Y–C S (4)
Identity (4) is very important. It shows us that in this simple economy, saving is identically
equal to income less consumption and investment is identically equal to saving.
The identity is really only a reflection of our definitions - output less consumption is investment,
output is income and income less consumption is saving.
Reintroducing the Government and Foreign Trade
We now reintroduce government sector and the external sector, G. All taxes denote the purchase
of goods and services by government by I. Transfer to the private sector (including interest) are
denoted by TR. Net exports (X - M) are denoted by X.
We return to the easier identity between output produced and sold, taking into account additional
components of demand G and X. So
Y C+I+G+X (5)

Now we have to recognise that part of income is spent on taxes and that the private sector Notes
receives net transfers (TR) in addition to national income.
Disposable income (YD) is thus equal to income plus transfers less taxes
YD Y + TR – T (6)
Disposable income is allocated to consumption and saving
YD C+S (7)
Combining identity (6) and (7) allows us to write consumption as the difference between income
plus transfers minus taxes and saving.
C + S YD Y + TR – T (8)
Or C YD – S Y + TR – T – S (8a)
Identity (8) states that consumption is disposable income less saving or that consumption is
equal to income plus transfers less taxes and saving. Now we use the right hand side equation
(8a) to substitute for C in identity (5).
Y Y + TR – T – S + I + G +X
Or Y-Y+S–I (G + TR – T) + X
Or S–I (G + TR – T) + X (9)
The term (G + TR - T) in equation (9) is the government budget deficit. (G + TR) equals government
purchases of goods and services (G) and government transfer payments (TR) which is total
government spending. T is the amount of taxes received by the government, the difference
(G + TR – T) is the excess of government. Spending over its receipts or its budget deficit. The
second term on the right hand side is the excess of exports over imports or the net export of
goods and services.
Thus, identity (9) states that the excess of saving over investment (S – I) of the business sector is
equal to the government budget deficit plus the trade surplus.
Task From the following data, find (a) National Income, (b) NNP, (c) GNP, (d)
personal disposable income, (e) personal income, (f) personal saving.
Rupees (crores)
Capital consumption allowance 356.4
Wages and compensation of employees 1866.3
Interest paid by business 264.9
Indirect business of persons 34.1
Corporate profits 164.8
Income of self employed 120.3
Corporate dividends 66.4
P.F. contributions 253.0
Personal taxes 402.1
Interest paid by consumers 64.4
Interest paid by government 105.1
Government and business transfer 374.5
Personal consumption expenditure 1991.9

Notes
Case Study Marking a Significant Shift
O
n May 31, 2010, when the government announced GDP numbers for 2009-10, for
the first time, factories contributed more to the national income than the country's
farmers, marking a significant shift in the structure of the India economy.
That does not, however, diminish the importance of the farm, fisheries and the forest
sector because of the disproportionately high percentage of people still engaged in these
activities. Neither does it take away the fact that the share of manufacturing is still below
desired levels.
As per the advance estimates of GDP growth in 2009-10 released by the Central Statistical
Organisation in February, the manufacturing sector was expected to contribute Rs 7,07,512
crore to the economy, overtaking the 6,49,370 crore from agriculture, forestry, and
fishing.
That would make manufacturing the second biggest contributor to the GDP among the
major sub-sector, but its relative share is well below that of many of India's peers. For
instance, in China, value add by industry has a near 48% share in the national income.
However, a recent CII-BCG report says that India, the 13th largest manufacturing economy
in the world, could emerge as the fourth largest manufacturer if the sector grows by 11%
in the next 15 years. "The share of manufacturing in the GDP has stuck at about 18%. It
should grow up to 30% in the next five to 10 years. Only then can the economy sustain a
growth of 9% to 10%," says Saumitra Chaudhuri, member, Planning Commission.
Experts are, however, unanimous in that the industrial sector needs to generate lot more
employment. "Its (manufacturing) share in GDP is going to be higher by about 15% to that
of agriculture, but dependency is too low compared to agriculture," says P K Joshi, Director,
National Academy of Agricultural Research Management, arguing for a greater
employment generation in manufacturing.
The real structural change in the Indian economy would occur only when lesser people are
employed in agriculture, says Suresh Tendulkar, former chairman of the Prime Minister's
Economic Advisory Council. In fact, India's structural transition has been different from
many other economies, with intermediate manufacturing stage not growing as desired.
"The Indian economy has jumped from an agrarian to a service centric economy. The
services sector has been unable to absorb the vast unskilled population," says Sunil Sinha,
senior economist and head of research at rating agency Crisil.
Question
Is it a real shift in the structure of the Indian economy or is it a temporary event? Give your
views.
Source: www.articles.economictimes.indiatimes.com
13.3 Summary
National income is the aggregate of money value of the annual flow of final goods and
services in the national economy during a given period.
GNP is the value of all final goods and services produced by domestically owned factors
of production within a given period. The production units, which produce goods and

services, distribute money incomes to all who help in production in the form of wages, Notes
rent, interest and profit, is known as Gross National Income.
National produce differs from domestic product by the amount of net factor income from
abroad.
The valuation of the national product at market prices indicates the total amount actually
paid by the final buyers while the valuation of national product at factor cost is a measure
of the total amount earned by the factors of production.
Personal income is calculated by subtracting from national income those types of incomes
which are earned but not received and adding those types which are received but not
currently earned.
13.4 Keywords
Disposable income: The amount of income left to an individual after taxes have been paid,
available for spending and saving.
Gross domestic product: The money value of all final goods and a service produced by normal
residents as well as non-residents in the domestic territory of a country but does not include net
factor income earned from abroad.
Gross national product: Total market value of all finished goods & services produced in a year
by a country's residents
National income: National income is a measure of the total value of the goods and services
(output) produced by an economy over a period of time (normally a year).
Nominal GDP: It is calculated by using the current prices to place value on the economy's
production of goods and services.
Personal income: Income received by persons from all sources. It includes income received from
participation in production as well as from government and business transfer payments
Real GDP: It is calculated by evaluating current production using prices that are fixed at past
levels, it shows the economy's overall production which changes over time.
1. Choose the appropriate answer:

(a) The growth of an economy is indicated by an:
(i) Increase in general prices
(ii) Increase in national income
(iii) Increase in savings
(iv) Increase in investment
(b) The difference between NNP and NDP is:
(i) Depreciation
(ii) Current transfers from rest of the world
(iii) Indirect tax
(iv) Net factor income from abroad

Notes (c) National income as commonly understood by every one refers to:
(i) GNP
(ii) NNP
(iii) GDP
(iv) NDP
2. State true or false for the following statements:
(a) NNP = C+G+X+M.
(b) Disposable income includes personal taxes.
(c) Value added = Total sales + total expenditure on raw materials and intermediate
products - closing stock of finished and semi-finished gods.
(d) GDP = GNP+ Net factor income from abroad.
(e) NNPMP = NNPFC+ Indirect taxes- Subsidies.
3. Fill in the blanks:
(a) The NNP is an .............. measure of the national income.
(b) Government expenditure is the sum of expenditure on consumption and ..............by
the government.
(c) NNP at factor cost is the sum of all the income payments received by ................. .
(d) Gross concept does not include............... .
(e) ................ is the total income that actually remains with individuals to dispose off as
they wish.
(f) Disposable income is allocated to .............. and ............. .
(g) Disposable income equals to income plus transfers less ........... .
1. Suppose that in the country of Nemania, the real gross national product in 1987 was £1483
billion (1972 equals 100). In 1988, real gross national product is £1510 billion (1972 equals
100). By how much the real gross national product would have grown in Nemania?
2. Why is there so much attention given to the national income figures of a country?
Newspapers report the figures, government officials talk about GDP growth, and even
secondary school textbooks mention them.
3. China has overtaken the UK to be the world's fourth largest economy. What this means is
that the GDP of China is larger than UK. But do the Chinese people have a higher standard
of living than the British or the French? Why/ why not?
4. Refer to the data ( in billion dollars) below and answer the questions that follow:
Consumption of Fixed capital 25.00
Government purchases 315.00
U.S. imports 260.00
Personal payments 45.00
Transfer payments 247.00

U.S. exports 249.00 Notes

Personal consumption expenditures 475.00
Net foreign factor income earned 5.00
Gross private domestic investment 300.00
Indirect business taxes 245.00
Undistributed corporate profits 60.00
Social security contributions 240.00
Corporate income taxes 65.00
(a) What is the Personal income?
(b) What are the gross and net domestic products?
(c) Calculate the disposable income.
5. In the national income and product accounts (NIPAs), growth in real imports of services
has been slowing since 2000, and 2003 showed no growth. Yet, we know that outsourcing
has been growing dramatically. Does this imply that the NIPAs are failing to capture the
effects of outsourcing?
6. Given the following data about the economy:
Consumption 7000
Investment 5000
Proprietor’s income 2500
Corporate income taxes 2150
Govt expenditure 3000
Profits 2500
Wages 7000
Net exports 2750
Rents 250
Depreciation 250
Indirect business taxes 1000
Undistributed corporate profits 600
Net foreign factor income 30
Interest 1500
Social security contribution 0
Transfer payments 0
Personal taxes 1650
(a) Calculate GDP and GNP.

(b) Calculate NDP, NNP, NI and domestic income.
7. Suppose capital stock of an economy is worth 200 million and it depreciates at the rate of
10 per cent per annum. Indirect taxes amount to 30 million, subsidies amount to 15
million. Its GNP at market prices is 1200 million. Calculate the national income. (NNP at
factor cost is termed national income).

Notes 8. What is the impact (if any) on the national income of India in each of the following cases?
(a) Shyam receives 5000 as a gift from his father who is also a resident of India.
(b) Aggregate inventories in Indian companies go down by 20,000.
(c) A receives 100 dollars as dividend from a company based in the USA.
(d) A sells shares and reaps capital gains worth 1,000.
Give reasons for your answers.
9. Calculate national income from the following figures (in crores):
Consumption 200
Depreciation 20
Retained earning 12
Gross investment 30
Import 40
Provident fund contributions 25
Exports 50
Indirect business taxes 15
Government purchases 60
Personal income taxes 40
(a) If there were 10 crores people in this country.
(b) If all prices were to double overnight, what would happen to the value of real and
nominal GDP per capita?
10. Discuss the National Income identities with reference to India.
Answers: Self Assessment
1. (a) ii (b) iv (c) iii

2. (a) True (b) False (c) False (d) False
(e) True
3. (a) alternative (b) capital goods (c) Factors of production
(d) depreciation (e) disposable income
(f) consumption, savings (g) taxes.
Books Bibek Debroy, Managerial Economics, Global Business Press, Delhi.

Dr. Atmanand, Managerial Economics, Excel Books, Delhi.
H.L. Ahuja, Macroeconomics Theory and Policy, S. Chand Publication.
Shapiro, Bensen, The Psychology of Pricing, Harvard Business Review.

Notes
Online links http://www.tradechakra.com/indian-economy/national-income.html

http://www.economywatch.com/world-country/national-income.html
http://www.wisegeek.com/what-is-a-circular-flow-of-income.htm
http://tutor2u.net/economics/content/topics/macroeconomy/circular_flow.htm

Notes Unit 14: Calculation of National Income
CONTENTS
Objectives
Introduction
14.1 Product Approach
14.2 Income Approach
14.3 Expenditure Approach
14.4 Problems in Measuring National Income
14.5 Circular Flow of Income
14.5.1 Circular Flow of Income in a 2 Sector Model
14.6 Summary
14.7 Keywords
Objectives
After studying this unit, you will be able to:

Discuss the methods of measuring national income
Identify problems in measuring national income
Describe the circular flow of income in 2 sector and 4 sector model
Introduction
We can measure national income either at the production stage by measuring the value of
output or at the income accrual stage by measuring the amount of factor income earned or at the
expenditure stage by measuring the size of total expenditure incurred in the economy. The
Following are the three different methods of measuring national income.
1. Product Approach
2. Income Approach
3. Expenditure Approach

Unit 14: Calculation of National Income
14.1 Product Approach Notes
According to this method, the sum of net value of goods and services produced at market prices
is found. Three steps are involved in calculation of national income through this method:
1. Gross product is calculated by sensing up the money value of output in the different
sectors of the economy.
2. Money value of raw material and services used and the amount of depreciation of physical
assets involved in the production process are summed up.
3. The net output or value added is found by subtracting the aggregate of the cost of raw
material, services and depreciation from the gross product found in first step.
Let us denote the amounts of each of the three different types of final outputs in a given year as
Q1, Q2, Q3………… Qn and their respective market prices as P 1, P2, P3………… Pn where n stands
for the total number of final goods and service produced in the economy. Then according to the
product approach, the size of the national income (NI) will be equal to the sum of the annual
flow of final goods and services valued at their respective market prices
i.e., NI = P1Q1 + P2Q2 + P3Q3 + ………… + PnQn
Production approach involves estimation of gross value of products, by-products and ancillary
activities of a production unit and deducting from it the value of inputs of raw materials and
other intermediates including services to obtain gross value added.
Broadly speaking the steps involved are:

1. Obtain estimates of quantities of all outputs and all inputs.
2. Obtain estimates of average price for each output and input from market sources.
3. Compute gross value of outputs and inputs using price-quantity data and subtract the
latter from the former to get gross value added.
4. Obtain estimates of value of stocks of fixed assets and apply predetermined depreciation
rates to get capital consumption.
This approach is used to estimate gross and net value added in the following sectors of the
Indian economy:
1. Agriculture and allied activities (e.g., animal husbandry)
2. Forestry and Logging
3. Fishing
4. Mining and Quarrying
5. Registered Manufacturing
For the first three of these sectors, obtaining reliable data on quantities and average prices is a
difficult task particularly for minor products and by-products as also for unorganised part of
fishing activity. CSO uses estimates obtained from a variety of sources such as union ministry of
agriculture, state statistical bureaus, directorate of market intelligence, etc. For registered
manufacturing the Annual Survey of Industries (ASI) gives data on inputs and outputs on a
census basis for larger units and sample basis for smaller units. However, ASI data are often out
of date and several adjustments are required. Corrections for non-response to ASI questionnaires
also have to be incorporated. For mining and quarrying the Indian Bureau of Mines supplies
quantity and value data for inputs and outputs which are supplemented by data from state
governments.

Notes For constant price estimation, the same procedure can be used with prices of the base year being
employed for valuation of quantities.
14.2 Income Approach
This approach is also known as the income-distributed method. According to this method, the
incomes received by all the basic factors of production used in the production process are
summed up. The basic factors for the purposes of national income are categorised as labour and
capital. We have three incomes.
1. Labour income which includes wages, salaries, bonus, social security and welfare
contributions.
2. Capital income which includes dividends, pre-tax retained earnings, interest on saving
and bonus, rent, royalties and profits of government enterprises.
3. Mixed income, i.e., earnings from professions, farming enterprises, etc.
These three components of income are added together to get national income.
Following the income approach, national income can be measured by aggregating the annual
flows of factor earnings generated by the production of the final output. Thus the value of
output, say good I (Pi Qi) is also reflected in the sum of the corresponding factor incomes
generated, i.e., PiQi = Ri + Wi + Ii + Pi.
Where Ri, Wi, Ii, Pi denote flow of rent, wages, interest, and profits generated by the production
of good i. It follows, therefore, that national income can be measured as the sum of annual flow
of different types of factor incomes in the economy.
In this approach, payments for factor, viz. wages, salaries, rents, interest and profits are directly
aggregated together to obtain estimates of value added. Output or input valuation is not necessary.
This approach is particularly suitable for those activities whose output are difficult to value.
The prime example is services. However, reliable data on factor incomes are available only for
those units which keep proper annual accounts. For others, some indirect method has to be
followed. One such method involves estimation of number of workers employed and of value
added per worker. The product of the two gives an estimate of total value added in the relevant
activity. Number of workers is estimated by extrapolation-interpolation of decennial case figures;
per worker value added is taken from surveys conducted at various times with appropriate
adjustments to bring up the estimates to date.
The approach is used for following activities:
1. Railways
2. Electricity, gas and water supply
3. Transport, storage and communication
4. Banking, finance and insurance
5. Real estate
6. Public administration and defence
For the first three groups almost complete data are available from annual accounts. Such data
are also available for parts of latter three - the part that is in the organised sector. For the rest the
indirect approach has to be employed.

Database is the weakest for unorganised sectors of the economy such as unregistered Notes
manufacturing, trade, hotels and restaurants and a variety of personal services. For these sectors
rough and ready estimates based sometimes on production approach, sometimes on income
approach are used. Most often estimates are obtained for a benchmark year during which a
major survey had been conducted and then these benchmark estimates are brought up to date
using a variety of indicators.
Constant price estimates using the income approach are obtained by updating the base year
estimates using some physical indices such as amount of electricity sold, tonne-kilometres of
freight transport, etc.
Did u know? What is transaction in the parallel economy?
The unaccounted flows of money give rise to black money which takes the form of push
money, hush money, hiss money, speed money and so on. Such money either circulates
very fast or gets converted into black property or assets like farm houses, gold ornaments
and benami share certificates. These are the forms in which black money is held, if not
circulated by way of black income to finance black expenditure.
14.3 Expenditure Approach
This method is known as the final product method. According to this method, the total national
expenditure is the sum of the expenditure incurred by the society in a particular year. The
expenditures are classified as personal consumption expenditure, net domestic investment,
government expenditure on goods and services and net foreign investment (imports-exports).
The flow of total expenditure can be measured by aggregating the flows of expenditure on final
goods and services incurred by the three main sectors involved, viz., the household sector, the
business sector, the government sector. Thus from the viewpoint of the expenditure approach,
national income can be measured by
NI = Eh + Eb + Eg
Where Eh, Eb, Eg denote the annual flow of expenditure on final goods and services incurred by
the household sector, the business sector, and the government sector.
These three approaches to the measurement of national income yield identical results. They
provide three alternative methods of measuring essentially the same magnitude. If we follow
the product approach or the expenditure approach, we are in effect trying to measure national
income by the size of the income flow in the upper half of the circle. As against this if we follow
income approach, we are actually trying to measure the flow in the lower half of the circle.
Notes Estimates of national product can also be obtained by adding together

expenditure flows, viz., C, I, G, E and subtracting M. To obtain these, CSO uses the commodity
flow approach. For instance, in case of private consumption expenditures, over 160 goods
and services are identified and quantities of these entering private consumption are
estimated by deducting from quantities produced, quantities used up in intermediate
uses, purchased by government, etc. Market prices are then applied to the quantities to get
expenditures. For organised construction, value of output is estimated by estimating the
quantities of major construction materials, cement, steel, bricks, etc., used up in construction.
Similarly, several items of machinery and equipment are identified and market value of
their outputs are added together to estimate capital formation in the form of machinery
and equipment.

Notes
Task Given the following data about the economy, calculate national income, personal
income and disposable personal income with both the expenditure and income approach.
( crores)
Wages and salaries 7,500
Interest received 450
Rent 900
Dividends 2,100
Undistributed Profits 400
Social security contribution of business sector 600
Mixed incomes 800
Corporate profit taxes 600
Pensions paid by the government 200
Net interest paid by government 300
Personal income tax 1,500
Case Study Rich Getting Richer
Y
ear 2009 may have been a cruel year for much of the country with slow growth and
double-digit food inflation, but India’s High Net Worth Individuals (HNWIs)
prospered — just over 120,000 in number, or 0.01% of the population, their
combined worth is close to one-third of India’s Gross National Income (GNI).
HNWIs, in this context, are defined as those having investable assets of $1 million or
more, excluding primary residence, collectibles, consumables, and consumer durables.
According to the 2009 Asia-Pacific Wealth Report, brought out by financial services firms
Capgemini and Merrill Lynch Wealth Management, at the peak of the recession in 2008,
India had 84,000 HNWIs with a combined net worth of $310 billion. To put that figure in
perspective, it was just under a third of India’s market capitalization, that is, the total value
of all companies listed on the Bombay Stock Exchange — as of end-March 2008. The
average worth of each HNWI was 16.6 crore.
To get a fix on just how rarefied a level it puts them in, we did some simple calculations that
threw up stunning numbers. It would take an average urban Indian, 2,238 years, based on
the monthly per capita expenditure estimates in the 2007-08 National Sample Survey, to
achieve a net worth equal to that of the average HNWI. And that’s assuming that this
average urban Indian just accumulates all his income without consuming anything. A similar
calculation shows that an average rural Indian would have to wait a fair bit longer — 3,814
years!
According to the firms’ 2010 World Wealth Report, India now has 126,700 HNWIs, an
increase of more than 50% over the 2008 number. While the figure for combined net worth
is not available, it seems safe to assume that as a class not only have India’s super-rich
recouped their 2008 losses, they have even made gains over their pre-crisis (2007) positions.
In 2007, 123,000 HNWIs were worth a combined $437 million. Meanwhile, in 2009 alone,
an estimated 13.6 million more people in India became poor or remained in poverty than
would have been the case had the 2008 growth rates continued, according to the United
Contd...

million more people in India became poor or remained in poverty over 2008 and 2009 Notes
than would have been poor had the pre-crisis (2004-07) growth rates been maintained
over these two years.
The 2009 Asia-Pacific Wealth Report notes that the HNWI population in India is also expected
to be more than three times its 2008 size by the year 2018, with emergent wealth playing a
key role. Like China, relatively few among the current HNWI population (13%, compared
to 22% in Japan) have inherited their wealth and even fewer (9%) are over the age of 66.
Question
What does the case say about distribution of income in India?
Source: timesofindia.indiatimes.com
14.4 Problems in Measuring National Income
The major problems that hinder the calculation of national income using a particular method
have already been discussed before along with the methods. Now let’s discuss the problems that
occur, in general.
The difficulties in measurement of national income are:
1. National income measures domestic economic performance and not social welfare. For
real economic growth, there should be strong positive correlation between the two.
2. National Income understates social welfare-non-market transactions like home-makers
service and do-it-yourself projects are not counted.
3. National Income does not measure an increase in leisure or work satisfaction or changes
in product quality.
4. National Income does not accurately reflect changes in environment like oil spills cleanup
is measured as positive output but increased in pollution is not measured as negative.
5. Per capital income is a more meaningful measure of living standards than total national
income.
6. There is a problem of double counting. However, problem of double counting could be
avoided by utilizing the value added approach. For example, the wheat that is used to
make bread is an “intermediate good”. The value of the bread only is counted as part of
GNP and we do not count the value of wheat sold to the miller and the value of flour sold
to the baker.
7. Problems of depreciation estimation as there are different methods of calculating or
estimating depreciation.
8. Inclusion or exclusion of certain items in national income accounting can cause confusion.
(a) Imputed rent of owner occupied houses is also included in calculation of national
income.
(b) Imputed value of goods and services produced for self consumption are included.
(c) Sale and purchase of second hand goods are excluded.
(d) Imputed rent of owner occupied houses and production for self-consumption are
included.
(e) Incomes from illegal activities are not included.
(f) Direct taxes such as Income tax are paid by employees from their salaries are included.

Notes (g) Expenditure on purchase of old share is excluded.

(h) Government expenditure on all transfer payment is excluded.
9. Challenges like difficulties in getting information especially those related to underground
economy (illegal activities).
14.5 Circular Flow of Income
Circular flow of income model shows the flow of income between the producers and the
households who buy their goods or services. Income moves from households to producers as
the households purchase goods or services and income moves from producers to households in
the form of wages or profits. Let’s discuss the circular flow of income in a simple 2 sector model
and in a 4 sector model.
One of the most important insights about the aggregate economy is that it is a circular flow in
which output and input are interrelated (Figure 11.1). Household’s expenditures (consumption
and saving) and firm’s expenditures (wages, rents, etc.) are household’s income.
Figure 14.1
Source: www.medlibrary.org/medwiki/Circular_flow
The circular flow of income model is a model used to show the flow of income through an
economy. Through showing the leakages in the economy and the injections, the different factors
affecting the economic activities are apparent. Just like a leakage in a bucket leads to decrease in
the level of water, a leakage in the economy leads to a decrease in economic activity. And just
like an injection into the bucket where the water level rises, an injection in an economy leads to
an increase in economic activity.
Basic Assumptions of a Simple Circular Flow of Income Model
1. The economy consists of two sectors: households and firms.

2. Households spend all of their income (Y) on goods and services or consumption (C). There
is no saving (S).

3. All output (O) produced by firms is purchased by households through their Notes
expenditure (E).
4. There is no financial sector.
5. There is no government sector.
6. There is no overseas sector.
In the simple two sector circular flow of income model the state of equilibrium is defined as a
situation in which there is no tendency for the levels of income (Y), expenditure (E) and output
(O) to change, that is: Y = E = O.
This means that all household income (Y) is spent (E) on the output (O) of firms, which is equal
in value to the payments for productive resources purchased by firms from households.
Example: This can be shown in an example where John earns 100.00, he doesn’t save it
and spends it all on the goods and services (O) provided by the firms.
2 Sector Model with Financial Market
Financial institutions act as intermediaries between savers and investors. All the lending and
borrowings are carried on in the financial or capital market. All that is earned by the households
is not spent on consumption; a part of it is saved. This saving is deposited in the financial market
leading to a money flow from the household to the financial market. On the other hand, the firm
saves to meet its depreciation expenses and expansion. The savings of the firm going into the
financial market and borrowings made by the firm from the financial market also create money
flows.
Figure 14.2: Circular Flow of Income in 2 Sector Model with Financial System
Therefore, we can say that the savings by households and firms are leakages and borrowings by
the firms act as injections into the circular flow of income.
In this model, we introduce the government sector as well that purchases goods from firms and
factors services from households. Between households and the government money flows from
government to the household when the government makes transfer payments. Like old age
pension, scholarship and factors payments o the households. Money flows back to the government
when it collects direct taxes from the households.
Similarly, there are flows of money between the government sector and firm sector. Money
flows from firms to government when the government realises corporate taxes from the firms.
Money flows from the government to the firms in form of subsidies and payment made for the
goods purchased.

Notes Figure 14.3: The Circular Flow of Income in a Three-sector Economy
In a 4 sector model, an economy moves from being a closed economy to an open economy. In an
open economy imports and exports are made. You must understand that one country’s exports
are other country’s imports. In case of a country imports, money flows to the rest of the world
and in case of exports, money flows in from the rest of the world. An economy experiences a
trade surplus if its exports exceed its imports. On the other hand, there is a trade deficit if imports
exceed exports. Imports act as leakages and exports as injection into the circular flow of income
in an economy.
In a 4 sector model, we have,
Y = C + I + G + (X-M)
Where,
Y = Income or Output
C = Household consumption expenditure
I = Investment expenditure
G = Government expenditure
X – M = Exports minus Imports

Figure 14.4: Circular Flow of Income in a Four Sector Model Notes
Source: www.maeconomics.web.com
Caselet India — Seeking a Second Generation of Reform
T
en years ago the Indian government embarked upon reform, liberalizing the
economy to open it to global markets. Today, this liberalization effort is showing
mixed results.
Despite strong GDP growth (averaging 5 to 6 percent annually), a reasonably low current
account deficit (less than 2 percent of GDP), and ample foreign reserves (over $30 billion),
an analysis of India's economy shows indications of distortions in three areas: the real
economy, the financial sector, and macroeconomic policy. India is considering a "second
generation" of reforms to further liberalize the economy and correct these market
distortions, but if distortions remain unchecked, a financial crisis could emerge.
In the real economy, steady value destruction has been evident over the past eight years.
This value destruction has been sustained since 80 percent of available capital is directed
at non profitable sectors, a trend that is unlikely to change in the near future due to
Contd...

Notes government-directed lending regulations, high transaction costs, and depressed market
conditions. The financial sector also appears weak - as of 1998, 46 percent of financial
institutions had returns on assets (ROA) of less than 1 percent, and the banking average
ROA was 0.55 percent in 2001.
Both the real and the financial sectors are impeded by poor macroeconomic policies. The
Indian government exercises significant ownership and control over the economy, directly
owning 60 percent of assets in the real sector and 75 percent of assets in the financial sector.
In addition to a strong presence in the economy, the Indian government has been
intervening in the economy through fiscal policy and monetary measures to maintain
liquidity and the exchange rate, and to support weak institutions.
Despite weakness in these three areas, the outlook for India is not all gloom. The economy
has low foreign debt exposure and has been able to avoid a credit boom in the real sector.
But government and macroeconomic reforms are needed - more privatization and
liberalization in the real sector, a reduced presence of the government in the real and
financial sectors, fewer requirements on government-directed lending, and a greater
reliance on market decisions to allocate savings. Whether these reforms will occur in time
to prevent a crisis remains to be seen.
14.6 Summary
There are three different methods of measuring national income. These are product
approach, income approach and expenditure approach.
Under product approach, the sum of net value of goods and services produced at market
prices is found.
Income approach is also known as the income-distributed method. According to this
method, the incomes received by all the basic factors of production used in the production
process are summed up.
Expenditure method is known as the final product method. Under this method, the total
national expenditure is the sum of the expenditure incurred by the society in a particular
year.
In India, the national income estimates are prepared by the Central Statistical Organisation.
14.7 Keywords
Expenditure approach: The total national expenditure is the sum of the expenditure incurred by
the society in a particular year.
Government expenditure: The sum of expenditure on consumption and capital goods by the
government.
Income approach: The incomes received by all the basic factors of production used in the
production process.
Product approach: The sum of net value of goods and services produced at market prices.

14.8 Self Assessment Notes
1. State true or false for the following statements:

(a) Under product approach, the factors of production used in the production of a product
are added up.
(b) The three approaches to national income will all lead to different results.
(c) Under expenditure approach net foreign investment is (exports-imports).
(d) Expenditure approach is also known as the income-distributed method.
(e) Product method is known as the final product method.
2. Fill in the blanks:
(a) In India the national income estimates are prepared by the ............................ .
(b) The three approaches to the measurement of national income yield ............................
results.
(c) According to product method, the sum of net value of goods and services produced
at ............................ is found.
(d) Expenditure approach is known as the .............. method.
(e) Personal income = NNP at factor cost - .................. - corporate taxes + transfer payments.
(f) According to product approach, the sum of net value of goods and services produced
at............ is found.
(g) The greatest difficulty in counting the national income is of .............
(h) All inventory changes whether negative or positive are included in the ................... .
(i) The government account is concerned with the.................... of the government sector.
(j) Database is the weakest for .................. sector of the economy.
1. Discuss one method of computing national income. Is this measurement precise? Why?
2. Examine all standard method of computing national income and social accounting in
India with particular reference to both conceptual statistical difficulties of measurement.
3. Find out what is a national income and product account (NIPA) benchmark or
comprehensive revision.
4. Think and enlist the problems that you might face when comparing national income with
other countries.
5. The data in the table below represent the selling price of the intermediate good. After
converting the tree to paper the paper manufacturer sells the paper to the textbook publisher
for $3.
textbook production:
tree $01
paper $03
book $7

Notes bookstore $75

sum of factor payments $86
How much is added to GDP?
6. Suggest how the discrepancy between output can be calculated by the expenditure approach.
7. ‘The national income over the past five decades has shown erratic growth’. Discuss the
statement.
8. The national income growth rate fluctuates with fluctuations in agriculture. Give your
opinion.
9. Discuss the three methods of national income measurement with a hypothetical example.
10. Explain the circular flow of income in two, three and four sector economy.
Answers: Self Assessment
1. (a) True (b) False (c) False (d) False

(e) False
2. (a) Central Statistical Organisation (b) identical
(c) market prices (d) final product (e) undistributed profit
(f) market price (g) double counting (h) GDP
(i) outflow and inflow (j) unorganized
Books Bibek Debroy, Managerial Economics, Global Business Press, Delhi.

Dr. Atmanand, Managerial Economics, Excel Books, Delhi.
H.L. Ahuja, Macroeconomics Theory and Policy, S. Chand Publication.
Shapiro, Bensen, The Psychology of Pricing, Harvard Business Review.
Online links http://www.tradechakra.com/indian-economy/national-income.html

http://www.economywatch.com/world-country/national-income.html
http://www.wisegeek.com/what-is-a-circular-flow-of-income.htm
http://tutor2u.net/economics/content/topics/macroeconomy/circular_flow.htm

MANAGERIAL ECONOMICS Shrivastava PDF

Uploaded by

Copyright:

Available Formats

MANAGERIAL ECONOMICS Shrivastava PDF

Uploaded by

Document Information

Original Description:

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

MANAGERIAL ECONOMICS Shrivastava PDF

Uploaded by

Copyright:

Available Formats

Unit 13: Basic National Income Concepts

Unit 13: Basic National Income Concepts Notes

13.1 Concept of National Income

13.1.1 Gross and Net Concept

13.1.2 National and Domestic Concepts

13.1.3 Market Prices and Factor Costs

13.1.4 Gross National Product and Gross Domestic Product

13.1.5 Net National Product

13.1.6 Personal Income

13.1.7 Disposable Income

13.2 Some Important Identities

13.5 Self Assessment

13.6 Review Questions

13.7 Further Readings

After studying this unit, you will be able to:

LOVELY PROFESSIONAL UNIVERSITY 203

Notes 13.1 Concept of National Income

204 LOVELY PROFESSIONAL UNIVERSITY

So, we have three kinds of national income estimates: Notes

1. National income as net aggregate output

13.1.1 Gross and Net Concept

13.1.2 National and Domestic Concepts

13.1.3 Market Prices and Factor Costs

LOVELY PROFESSIONAL UNIVERSITY 205

Notes And vice versa.

13.1.4 Gross National Product and Gross Domestic Product

GNP as a Sum of Expenditures on Final Products

206 LOVELY PROFESSIONAL UNIVERSITY

GNP as the Total of Factor Incomes Notes

As mentioned above, national product gives a measure of a nation's productive activity,

13.1.5 Net National Product

LOVELY PROFESSIONAL UNIVERSITY 207

Notes NNP at Factor Cost (or National Income)

Did u know? What does Genuine Progress Indicator — GPI Mean?

A metric used to measure the economic growth of a country. It is often considered as a

13.1.6 Personal Income

Personal Income = NNP at factor cost – Undistributed profits – Corporate taxes +

13.1.7 Disposable Income

208 LOVELY PROFESSIONAL UNIVERSITY

We, therefore, have the following identities Notes

Caselet Smoking Costs over 6.5% of National Income to

LOVELY PROFESSIONAL UNIVERSITY 209

13.2 Some Important Identities

Reintroducing the Government and Foreign Trade

210 LOVELY PROFESSIONAL UNIVERSITY

LOVELY PROFESSIONAL UNIVERSITY 211

Case Study Marking a Significant Shift

212 LOVELY PROFESSIONAL UNIVERSITY

13.5 Self Assessment

1. Choose the appropriate answer:

LOVELY PROFESSIONAL UNIVERSITY 213

13.6 Review Questions

214 LOVELY PROFESSIONAL UNIVERSITY

U.S. exports 249.00 Notes

(a) Calculate GDP and GNP.

LOVELY PROFESSIONAL UNIVERSITY 215

Answers: Self Assessment

1. (a) ii (b) iv (c) iii