UNIT-I National Income and related aggregates

Chapter1. - Some basic concepts of national income

National income accounting is a branch of macroeconomics of which estimation of national income and
related aggregates is a part. In a closed economy, without a government or external trade, there are only two
sectors, namely households and firms.

A. Classification of Goods:-
i. Final goods:-
 These are those goods which are ready to be used by their final users.
 Final goods are at their final stage which is out of the process of production.
 Final users can be either consumers (final consumer goods) or producers (final producer goods).
 Final consumer goods are those goods which are ready to use by consumers to satisfy their needs.
 Final producer goods are those goods which are used by producers in the form of assets for production.
 The expenditure done by household is known as Consumption expenditure which is done to purchase
consumer goods.
 The expenditure done by producer is known as Investment expenditure which is done to purchase producer
goods.
 The value of final goods will be included in National Income.
ii. Intermediate goods:-
 These are such goods which are not yet ready for their final use.
 They have not reached its final stage and value is yet to be added.
 These are the goods which are purchased by one firm from another firm in the form of raw material or for
reselling purpose.
 Value of intermediate goods ultimately becomes part of the value of final goods.
 Therefore, it is not included in calculation of National Income.
The same goods may be final or intermediate:-
 The same goods may be final or intermediate.
 It depends upon end-use of the goods.
 If the goods are used by producer as raw material then they are classified as intermediate goods.
 If the goods are used by producers as fixed assets they are known as final goods.
 For eg: - Purchase of car. If cars are purchased by consumers, they are final goods and if purchased by retailer
then they are known as intermediate goods.
iii. Consumer goods:-
 These goods are directly used by consumer to satisfy human wants.
 It includes: - Durable goods: - These goods are used for several years and are of high value which remains with
consumer. For eg: - Car, scooter etc.
 Semi-durable goods: - These are those goods which are used for specific time period. For eg: - Clothes, shoes
etc.
 Non-durable goods: - The value of such goods will be finished after single use of goods. For eg: - Milk, etc.
 Services: - The services that directly satisfy human want. For eg: - Doctor, Lawyer etc.
iv. Capital goods:-
 These are the goods which are used as fixed assets by the producers.
 It can be either replacement in existing capital or addition to the new capital assets.
 The fixed assets, which are used as capital goods by the producers are used repeatedly and are of high value.
 Any goods which are of less value and are used by producer will not be considered as capital goods. For eg: -
Nails, screws etc.
 All capital goods are producer goods, but all producer goods are not capital goods.
 Goods which are of high value and used for further production process are known as capital goods.
 But there are certain products which are used by producers such as nails, screws etc. These are producer goods
but cannot be treated as capital goods.
 Similarly, there are certain goods which can be used by producers as well as consumers.
  For eg: - Sewing machines with tailor are capital goods whereas sewing machines for household purpose are
consumer goods.
B. Concept and components of consumption expenditure:-
 Consumption expenditure refers to the expenditure done for the consumption purpose by households,
government and non-profit organization.
 Household: - Household incurs consumption expenditure to satisfy their needs.
 Government: - Government incurs expenditure to purchase the goods which are to be distributed among
defence forces, government schools etc.
 Non-profit organization: - Goods purchased for the purpose to distribute as charity.
 Sum of all these components will result in consumption expenditure.
C. Concept and components of Investment:-
 Investment means addition made in the existing stock of capital. So change in stock of capital is called capital
formation.
i. Fixed Investment:-
 It is increase in the stock of fixed assets, which is used in the process of production for many years.
 It raises the capacity of producers.
 Increased capacity of producers will increase the overall production of the country.
 High level of output implies high GDP.
ii. Inventory Investment:-
 Inventory means stock of unsold goods.
 Any changes made in stock during the year are called inventory investment.
 It ensures regular supply of inputs to the producers.
iii. Gross Investment:-
 It includes expenditure by the producer on the purchase of new assets as well as expenditure on the replacement
of existing assets.
 Replacement of existing assets refers to depreciation.
iv. Net Investment:-
 It includes expenditure by the producers only on the purchase of new assets.
 It does not include expenditure on existing assets.
 It generates employment opportunities, promotes efficiency of labour and accelerates GDP growth.
Concept of Depreciation:-
 Depreciation means wear and tear of assets. When any assets after regular use, have some reduction in their
value or their value is reduced when the assets become obsolete, it is known as depreciation.
 Because of depreciation, fixed assets are replaced.
 To complete their cost of replacement, producer keeps some fund with them which is known as depreciation
reserve fund.
 Net investment= Gross investment – depreciation
 Depreciation= cost of capital asset-scrap value
Estimated life of capital asset
Expected obsolescence Unexpected obsolescence
 It means change in value due to regular use of  It means change in value due to any natural
assets. calamities.
 It is a part of depreciation.  It is a part of capital loss.
 It can be managed by reserve fund.  It can be managed through insurance.

Depreciation is also defined as:-

Consumption of fixed capital
Replacement cost of fixed capital
Part of capital asset used in production process.
 D. Stocks and Flow:-
Stock: - A stock is a quantity measured at a specific time period. It is an economic variable which is measured at
a given point of time. Stock impacts the flow of goods and services. For eg: - wealth, money supply, population,
inventories etc.
Flow: - A flow is a quantity measured over a specified time period. It is an economic variable which is measured
over a period of time. Flow is time dimensional. For eg: - consumption and investment.
Basis Stock Flow
Meaning Any variable measured at a point of time. Any variable measured over a period of time.
Time dimension It has no time dimension. It has time dimension.
Examples Capital, wealth, inventories. Per capita income, inventories speed.
Nature It is a static concept. It is a dynamic concept.

E. Circular flow of Income:-

i. Real flow: - Flow of goods and services among different sectors of the economy.
ii. Money flow: - Flow of income across different sectors of the economy.
Definition:-
 It refers to continuous flow of activities of production & income across different sectors of the country.
 Each activity depends upon another activity which is being flowed in different sectors of the country.
Different sectors:-
i. Household sectors: - They are the consumers of goods and services. These are also known as the owners of
factors of production.
ii. Producer sector: - It includes producing units which produce goods and services and provide it to household
sector. They are also known as hires of factors of production and provide payment of using factor services.
iii. Government sector: - Government receives tax from producer and households whereas government provides
subsidies to the society.
iv. External sector: - It includes rest of the world, which is export and import of goods and services.
Three phases of circular Flow:-
Phase-I Production:-
 Production means producing goods from given raw material.
 It adds value to the raw material. For eg: - Wood is converted into furniture.
 Therefore, it is a process of value addition by producing sector.
 The producer hires factors of production from households and uses these factors of production as factor inputs
for manufacturing goods and services.
Phase-II Income Generation:-
 When consumers render services to the producer they get income in return which is factor income.
 This factor income is in the form of rent, wages, interest, profits etc.
Phase-III Expenditure:-
 By receiving income, consumers will dispose of consumption in the form of consumption expenditure.
 This income is used for consuming goods and services produced by producing sectors.
 When expenditure is made by consumer then it is known as consumption expenditure. And when expenditure is
done by producer then it is known as Investment expenditure.
Assumption of model:-
 Only two sectors prevail in the country: - Household, producer.
 Households spend their entire income for consumption.
 No interference of government.
 All the activities are carried out within the boundaries of a country.
Leakage and Injection:-
Leakages Injections
They have negative impact on the process of They cause an increase in the process of production.
production.
It is a withdrawal of money from the flow. It is an addition to the circular flow of income.
It is that part of income which is not spent on The money that is borrowed from capital market and is
consumption but it is saved in the capital market and re-injected or reinvested into the production process.
is termed as savings.
For eg:- savings, imports and taxes For eg:- investment, export government purchases

Ch-3 National Income and Related Aggregates

A. Concept of National Income:-
 It is the sum total of factor income earned by normal residents of country during a financial year.
 It includes: - Factor income and income earned by normal residents of country.
i. Factor Income:-
 Factor income is the income received by households for rendering their services to producers.
 It includes: - compensation of employees (salaries/wages), Rent (Land used by producer), Interest (Capital used
by producer), Profit (for managing and using skills) etc.
ii. Normal residents:-
 Normal residents are the ones who reside in the country and who carry all their economic activities in that
country.
 A person who resides in a country for more than one year is known as normal resident of that country. The person
may or may not have citizenship of that country.
 The person‘s economic interest (production, consumption, Investment, etc.) should lie in that country.
 For eg: - Indians working in the office of UNO in India are normal residents of India since they live in India.
 Indians going abroad for medical treatment are residents of India as they go abroad for short time period.
 Indian officials working in the Indian embassy in USA are not residents of India as they do not carry out their
economic transactions within India.
Non-residents:- Foreigners working in WHO, IMF located in India. Any foreign citizen working in India for less
than one year.

B. Domestic and National concepts of Income:-

Domestic Income National Income
If domestic concept is used, it will be domestic If national concept is used, it will be national
income. income.
It is sum total of factor income (Compensation of It is sum total of factor income(Compensation of
employees+ rent+ interest+ profit) generated within employees+ rent+ interest+ profit) generated by
country either by residents or non-residents of normal residents either within country or outside the
country. country.
Domestic territory:-
 It is also called economic territory governed by government within which persons, goods and capital circulate
freely.
 It will include the factor income which is part of domestic territory of country.
 For eg: - Foreign embassies located in India are not part of domestic territory whereas Indian Embassy located
abroad is part of domestic territory.
 It covers: - (a) Political frontiers or geographical frontiers. For eg: - Branch of an American Bank in India is
included in domestic territory of India. Office of Tata industries in USA is not included in domestic territory of
India.
 (b) Embassies, consulates, military bases etc. located abroad. For eg: - Indian embassy in Japan is a part of
domestic territory of India. Russian embassy in India is not a part of domestic territory of India.
 (c) Ships, aircrafts etc. operated by the residents between two or more countries. For eg: - aircrafts operated by
Air India between Russia and Japan are treated as a part of the domestic territory of India.
 National Income= Domestic product + Net factor Income from Abroad
 Net factor income from abroad is the excess of factor incomes earned from abroad over factor incomes paid
abroad.
 Positive NFIA:- when factor income from abroad is more than factor income to abroad
 Negative NFIA: - when factor income to abroad is more than factor income from abroad.
C. Gross and Net concepts of domestic product:-
 Domestic product can be measured with the help of gross domestic product and net domestic product.
 We know that a part of capital goods is used up or consumed in the process of production of goods and services in
the economy. This is called depreciation or fixed capital.
 GDP is gross of depreciation whereas NDP is net of depreciation.
 Net Product= Gross product- Depreciation

D. Domestic product at market price and at factor cost:-

 Market price is the price paid by the buyer of a commodity in the market.
 Factor cost is the cost paid by the producer to the factors of production for their contribution in the production of
the commodity.
 Market price includes indirect taxes but does not include subsidies granted by the government.
 For eg: - Suppose, the price of a small bag is 6. In this case market price is 6.
 Let us suppose that sales tax on this bag is 2, which is included in the price of bag that is 6.
 Therefore factors of production will receive only 4(6-2) because the balance goes to government in the
form of tax.
 For eg: - if the market price of khadi is 10, but the producer is giving 12 to factors of production to produce it.
 The difference between Market price and Factor cost is subsidies (12-10=2) which are paid by government to
producer, in order to promote sale of khadi.
 Market price= Factor cost –Net indirect taxes
 Net Indirect taxes=Indirect taxes-Subsidy
E. Aggregates of National Income:-
i. Gross domestic product at market price:- (GDPMP)
= Value of all final goods and services produced within the domestic territory of a country.
ii. Net Domestic Product at Market price:- (NDPMP)
=It is net market value of all the final goods and services produced in the domestic territory. It is equal to
market value of goods minus depreciation.
iii. Gross National Product at Market price:- (GNPMP)
=It is the money value of all final goods and services produced in the domestic territory of a country during a
year plus net factor income from abroad.
iv. Net National Product at Market price:- (NNPMP)
=It is net market value of all final goods and services produced by normal residents of country during a year.
v. Gross Domestic Product at Factor cost:- (GDPFC)
=It is the value of all goods and services at factor cost that is cost paid by producers.
vi. Net Domestic Product at Factor cost:- (NDPFC)
=It is the sum total of factor cost incurred on goods and services excluding depreciation.
vii. Gross National Product at Factor cost:- (GNPFC)
=It is the sum total of gross value added at factor cost by all the normal resident producer enterprises of a
country during a year.
viii. Net National Product at Factor cost:- (NNPFC)
= It is the sum total of net value added at factor cost by all the normal resident producer enterprises of a country
during a year. It is also known as National Income.
F. Nominal and real GDP:-
i. Nominal GDP:-
  The total monetary value of all the goods and services produced in the domestic territory of a country during a
year, counted on the basis of current market price of that particular year, is known as nominal GDP or GDP at
current prices.
 Current year prices are the prices prevailing during the year of estimation.
 Nominal GDP=Q x P
 Nominal GDP can increase when there is either increase in quantity or increase in price.
 When Q increases then flow of goods and services also increases in a country and as a result nominal GDP also
increases.
 When P increases nominal GDP also increases which creates money illusion in the country.
ii. Real GDP:-
 The total monetary value of all the goods and services produced in the domestic territory of a country during a
year, counted on the basis of market price of base year, is known as real GDP or GDP at constant prices.
 Real GDP=Q x P* whereas P*=Prices of base year.
 In this, real GDP always increases with increase in quantity which shows increase in flow of goods and services
in the country.
 Real GDP is more useful in making comparisons of economic development among various other countries.
 Real GDP always changes with change in goods and services. So, it will reveal true picture about economic
growth.
iii. Conversion of nominal GDP into real GDP:-

G.GDP and welfare:-

 Real GDP is regarded as good index of welfare of the people.
 Welfare of the people is measured in terms of goods and services.
 GDP measures the value of goods and services and this value of goods and services will be considered as factor
income.
 Income provides satisfaction and hence becomes the basis of social well-being.
 Therefore, greater the magnitude of GDP, greater the level of welfare.
 But, benefit of increased GDP will be considered as benefit for society if this benefit reaches to everyone in the
society.
Limitations:-
i. Distribution of income:-
 It is possible that a rise in GDP may not contribute to the well-being of the people of a country if it is not
distributed equally.
 If with increase in GDP, rich are getting richer and poor are getting poorer, then this growth in GDP cannot
promote welfare.
 Rather, it may lower down welfare of the people. Therefore, mere increase in GDP cannot be regarded as good
index of welfare unless it is accompanied by equitable distribution of income.
ii. Composition of GDP:-
 The components of GDP may or may not be welfare oriented.
 If the production of tobacco products, liquor etc. increases in the country, GDP will increase since it is counted in
GDP. However, these harmful goods adversely affect the health of people.
 If the government imposes a ban on consumption and production of tobacco then GDP will reduce but it will
provide welfare to society.
iii. Non-monetary exchanges:-
 The non-monetary exchanges are not included in the estimation of GDP.
 For eg: - Services rendered by the housewives to the family members greatly add to their welfare but they are not
counted in GDP.
 This causes underestimation of GDP.
iv. Externalities:-
 It refers to harmful effects or beneficial effects that the production enterprises have on the members of the society
for which they are not penalized or paid.
 For eg:-A steel plant produces steel, value added by steel plant will be included in GDP but the pollution caused
by steel plant is ignored.
 Therefore in such cases, if we are taking GDP as the measure of welfare, we are overestimating the actual
welfare.
 Apart from negative externalities, there can be positive externalities, which have beneficial effects also. For eg: -
construction of dams, colleges etc.
 In this case GDP may underestimate actual welfare.
Ch-4 Methods of calculating National Income
A. Value added method:-
 It is also known as Product method.
 This method measures the contribution of each individual sector at different stage of production.
 This contribution of producing goods and services are always taken at market price.
Steps to calculate National Income:-
i. Gross value added: - It is defined as the contribution of enterprises to the current flow of goods and services by
various sectors. It includes value addition by primary, secondary and tertiary sector. It is also called GDP MP.
So, Gross value added=Value of Gross output-Intermediate consumption
Intermediate consumption: - One firm purchases goods from another firm.
ii. Value of gross output: - It includes market value of all goods and services. If entire goods and services are sold
then it is also equal to sales.
So, value of gross output=output x price
Or
Value of gross output=sales+ change in stock
Change in stock: - closing stock-opening stock
Hence,
GDPMP=Value of output –Intermediate consumption
NNPFC GDPMP (-) Depreciation(-) Net Indirect Taxes(+) Net factor income from abroad
Precautions:-
 Value of second hand goods either purchased or sold will not be included as it leads to double counting because
it is already included earlier when it was produced.
 Commission earned from sale of second hand goods will be included as it is the reward of services rendered.
 Own account production of fixed assets by all producers will be included.
 Production for self-consumption will be included in estimating national income.
 Value of intermediate goods will not be included in estimating national income.
B. Income method:-
 As per this method national income is estimated by taking into account all the factor income received by
rendering factor services.
Factor income:-
i. Compensation of employees: - It is the payment made by producers, to their employees in the form of cash,
kind and social security benefits.
It includes:-
Wages and salaries:- Compensation in kind:- Employers contribution
 Basic pay  Accommodation EPF
 Dearness allowance  Free ration
 Commission to sales staff  Uniforms
 Free travelling arrangements
 Crèches
 Medical facilities
ii. Operating surplus: - It includes income from property and entrepreneurship in the form of rent, interest and
profits. Profits include (Dividend, Undistributed profits, Corporate taxes)
iii. Mixed income: - It is the income of self -employed.
 Hence,
NDPFC compensation of employees+ operating surplus+ mixed income.
NNPFC NDPFC + Net factor income from abroad.
Precautions:-
 Transfer payments like gift, scholarship, old-age pension, taxes, donations etc. will be included.
 Income through illegal activities will not be included.
 Corporation tax and income tax will not be included separately as they are already included in corporation
tax and compensation of employees.
 Income from lotteries will not be included.
 Commission earned from sale of second hand goods will be included as it is the reward of services rendered.
 Payment of interest on loan taken by an employee from the employer will not be included in national
income.
 Imputed rent of self - occupied house will be included in national income.
 Receipts from sale of land will not be included in national income as land is free gift of nature.
 Earnings of shareholders from the sale of shares will not be included in national income.
 Value of bonus shares received by shareholders of the company will not be included in national income.

C. Expenditure method:-
 National income is estimated from the final expenditure of goods and services produced in the country.
Steps:-
i. Private final consumption expenditure: - It is the money value of goods and services purchased by households
and non-profit organization. It includes: - Durable goods, Non-durable goods, services or intangible goods.
ii. Government final consumption expenditure: - It includes final goods and services consumed or purchased by
government.
iii. Investment expenditure: - It is also known as Gross domestic fixed capital formation. It includes:-
 Fixed investment(Business fixed investment, Residential construction investment, Public/government
investment)
 Inventory (change in stock)
iv. Net exports: - It is difference between total exports and total imports.
So,
GDPMP Private final expenditure+ government expenditure + investment expenditure + net exports.
NNPFC GDPMP-Depreciation +NFIA-Net Indirect taxes
Precautions:-
 Purchased of second hand machinery from abroad will not be included in national income.
 Payment of electricity bill by a school will not be included in national income.
 Expenditure on engine oil by car service station will not be included in national income.
 Purchase of goods by foreign tourist will be included in national income.
 Expenditure on advertisement and scientific research by a firm will not be included in national income.
 Purchase of bonds by a domestic firm will not be included in national income.