Circular Flow of Income & National Income Accounting

Group Members
Sneha Desai Kunal Garad Madhuri Thakur Mangesh Talankar Milind Wadkar Ranjit George Mayuri Khedekar Anamika Vispute Pratik Liye Nisha Ahide

National Income
Most important concept of macroeconomic is national income National income represent total the income of nation Measures of national income enables to know the economic growth, business cycle & so on

Circular flow of income

It explains the process that determines national income & national output Functioning of the economy consist of the production of goods and services by production unit The cost of the production is expenditure to the firm and income the factor owner

Economic activities perform by economy are: Production Distribution Consumption Exchange Above activities are based on decision of economics agent i.e. firms and households.

Circular flow in a two sector economy without saving

Assumptions: Economy consists of two sectorsHousehold and firms Production takes place only in firms No inventory maintained by firms No government operations No international economic relations

TWO SECTOR ECONOMY WITH SAVING

Households

FACTOR INCOMES

Financial markets

PAYMENT FOR GOODS AND SERVICES

Firms

Households

FACTORS OF PRODUCTION

Financial markets

FLOW OF GOODS AND SERVICES

Firms

Households

FP

FI

Financial markets

PGS

I FGS
Firms

TERMS
Y= NATIONAL INCOME C = CONSUMPTION EXPENDITURE I = INVESTMENT SPENDING S = SAVINGS

Y = C + I Y = C + S C + I = Y = C + S I = Y C= S I = S

Circular Flow In Three Sector Economy

Government plays a major role in the functioning & governing of the economic system of a country Government receives income in the form of tax from households & firms Government expenditure comprises spending on goods & services & transfer payments. Money spent by government received by firms & households. hence circular flow. Thus leakages in the form of saving & taxes

Contd.
Introduction of government affects the overall economic activity. Total expenditure = consumption + investment + government expenditure (E) = C + I + G Total income received is allocated to consumption , savings & taxes. Y= C + S + T

Contd.
The economy is in equilibrium when the expenditure is equal to income C+I+G=C+S+T I+G=S+T GT=SI

Government

Households

Financial Market s

Firms

Government

Circular Flow In An Open Economy Or Four Sector Economy

X-M Households Savings Taxation Factor Income Govt. spend Consumption

World Economy

Government

Financial Markets

Taxation

Govt. spend

Investment Business X M

Importance of Circular Flow of Income

Shows smooth functioning of Economy. Helps to know problem of disequilibrium. Helps to find out leakages in the circular flow. Highlights the importance of Monetary and Fiscal policies.

NATIONAL INCOME
National Income
Sum of values of final goods and services produced in the economy in a year. Sum of all the incomes accruing to factors of production in the economy in a year. Sum of all the expenditures on final goods and services produced in an economy.

National Income

National Income

MEASURMENT

Product(Output) or Value Added Method

Income Method

Expenditure Method

Product (Output) or Value Added Method

Problem of double counting can be avoided by adding only the value added by each firm at different stages of production.

Add the value of all final goods and services produced in a given year

Income Method

National Income = Sum of all the incomes (Wages, Salaries, Rent, Interest, Profits and Dividends)

Only income earned for productive services are included. (pensions, unemployment benefits are not included)

Expenditure Method
National income =C+I+G+(X-M)
Where, C=consumption expenditure I=Total investment expenditure G=Government expenditure Net receipts from foreign trade(i.e. export(X) - import(M))

Problems in the Measurement of National income

1. Capital Depreciation. Replace the equipment worn out during the process of production i.e. Depreciation 2.Market prices and Factor cost. Factor cost= Market price indirect taxes + subsidies Or Market prices = Factor cost indirect taxes + subsidies

3.Net factor incomes from abroad =R-P Where, R=Income received by domestic factors for their contribution to production abroad. P= Income paid to the foreign factors for their contribution to production in the domestic economy

Concept of National Income

Gross Domestic Product (GDP)

Gross Domestic Product is the money value of final goods and services produced within domestic territory of the country during a given period of time, a quarter or a year

In an open economy GDP = C + I + G + (X M) In an closed economy GDP = C + I + G Where, C=Consumption expenditure on domestically produced goods I=Investment Expenditure G=Government Expenditure (X-M)=Net receipts from foreign trade or net exports

Gross National Product (GNP)

GNP is the money value of final goods and services produced by the countrys factor of production wherever they are located during a given period of time, a quarter or a year.

GNP = GDP + Net Factor Incomes from abroad Therefore, GNP = C + I + G + (X-M) + (R-P)

Net National Product (NNP) & Net Domestic Product (NDP)

NNP = GNP Depreciation NDP = GDP Depreciation

GNP, GDP, NNP and NDP at Market Price and at Factor Cost

Market Prices=Factor Cost + Indirect Taxes Subsidies Factor Cost=Market Prices Indirect Taxes + Subsidies

National income at current or constant prices

Current prices refer to price of goods prevailing in market at any given point of time i.e. market price of good and services Constant prices e.g. GNP, GDP

Real Vs Nominal GNP

GNP deflector
Nominal GNP Real GNP GNP at current prices GNP at constant prices

GNP deflector

GNP at current prices GNP at constant prices

GNP deflector 2005-06

3363505 3239296 1.04156

Personal Income (PI)

PI = National Income +Transfer Payment Undistributed Profits Of Corporate Sectorcorporate Income Taxes Social Security Contribution

Disposable Income (DI)

DI=Personal Income Direct Taxes Paid By Individuals

Per capita income

National income Population

Difficulties in measurement of national income

1. Treatment of non monetary transactions: w.r.t goods & services which are difficult to be assessed or are not transacted in terms of money. 2. Transfer incomes: income is received without any output of goods & services 3. Government income: received by government for any property or service rendered

Contd.
4. Income from illegal activities 5. Capital gains: gains or losses due to changes in market price 6. Imputed values: valuing of some goods & services that are not sold or bought 7. Inventories

Contd.
5. Depreciation 6. Problems of estimation in developing countries due to lack of Organization Accounting practices Occupational specialization Statistical data