Engineering_Economics_PPT-UNyfyff5IT-_II.pptx

UNIT- II
Macroeconomic Concepts
Lavanya.K
Assistant Professor
MRIT-MBA

NATIONAL INCOME
INTRODUCTION
 The term National Income is used to refer the money value of the total income of
the economy in a year.
 In common parlance national income means the total value of goods and services
produced annually in a country.
 In other words the total amount of income accruing to a country from economics
activities in a year's time is known as national income.
 Firstly it measures the market value of annual product.
 Secondly National income is a monetary measure.
 Thirdly national income includes the market value of all final goods the value of
intermediate products are not included. A final product is one which is available for
immediate consumption. For example, a shirt or a sewing machine. The example of
intermediate product is raw materials.

DEFINITIONS OF NATIONAL INCOME
The definitions of National income can be grouped into two classes as the traditional
definition advanced by Marshall, Pigou and Fisher and the modern definitions.
 Marshallion Definition:- According to Marshall, the labour and capital of a
country acting on its natural resources produce annually a certain net aggregate of
commodities, material and immaterial, including services of all kinds. This is the
true net annual income or revenue of the country or national dividend.
 Pigovian Definition: - According to Pigou "National income is that part of
objective income of the community, including of course income derived from
abroad which can be measured in money”
National Income

 Fisher's Definition: - Fisher adopted consumption as the criterion of national
certain whereas Marshall and Pigou regarded it to be production. According to
Fisher ‘the national income consists solely of services as received by ultimate
consumers whether from their material or from their human environment'. From the
modern point of view national income is defined as the net output of commodities
and services flowing during the year from country's productive system in the hands
of ultimate consumer.
DEFINITIONS OF NATIONAL INCOME
National Income

NATIONAL INCOME ACCOUNTING
The total income obtained as wages, rent, interest and profits are the national income of
the country. Various households get their income from the firms for the production of
goods and services. The value of all the goods produced is the national product. Thus
the total national product produced by firms in a year is distributed to all factors in the
form of wages, interest rent and profits. The sum of all these factors income will be
equal to the national income. Thus the national product is equal to the national income.
 National Income = Wages + Rent + Interest + profit
 National income = Domestic income + Net income from abroad.
 Personal Income = Domestic income + Net income from abroad + Transfer
Payments + Net interest on borrowings + Unearned income - Taxes on profit -
Undistributed profit - Contribution to social security measures.
National Income

METHODS OF ESTIMATION
There are three methods to calculate the national income of a country. They are:
 Product or inventory method: Under this method national income is computed by
adding the net value of all commodities and services produced during a given
period. Thus national income is equal to the total of final products.
 We first estimate the gross value of domestic output in the various sectors of
production (Agriculture, manufacturing industry, and services including
government).
 The value of gross output is obtained by multiplying the output of each sector by
their respective market prices and adding them together. Then we deduct value of
depreciation from gross value of domestic output.
National Income

 The figure so obtained has to be adjusted with net income from abroad. This is
the national income at factor cost.
 This method is also known as output method or value added method.
 This method is very complicated because of non-availability of adequate and
requisite data. It is also difficult to calculate depreciation.
National Income

 Income Method: Under this method the national income of a country is
obtained by adding the incomes accrue to factors of production within the
national territory. Basic factors of production used producing the national
products are land, labour, capital and organisation.
 The national income is equal to total rent plus total wages and salaries of all
employees including income of self employed persons plus total interest on
capital including dividends of the shareholders plus total profit of all firms
including undistributed corporate profits and earnings of public enterprises.
 In short, the national income represents the total of rent, wages, interest and
profit.
National Income

 Expenditure method: This method is based on the assumption that income is
equal to expenditure plus savings.
 Under this method the personal consumption expenditure, government purchase of
goods and services, gross private domestic investment and net foreign investment
are added together to get the national income of a country.
 This method is also known as consumption- saving method.
 The expenditure method is not generally used because the necessary data
regarding consumption expenditure are not easily available.
 This method includes the total expenditure of a country during a given year.
 The income is spent on consumer goods or on producer goods.
 The consumption expenditure and investment expenditure of all the individuals in
a government during a year is added.
Thus
National Income = Consumption Expenditure + Investment Expenditure +
government expenditure + exports - imports.
Y = C + I + G + X-M
National Income

 Value Added Method
Another method of measuring national income is the value added by industries.
 The difference between the value of material output and input at each stage of
production is the value added.
 If all such differences are added up for all industries in the economy we arrive
at the gross domestic product.
National Income

Various Concepts of National Income
 Gross National Product (GNP)
Gross national product is defined as the total market value of all final goods and
services produced in a year. GNP includes four types of final goods and services, (i)
Consumer goods and services to satisfy the immediate wants of the people (ii) gross
private domestic investment on capital goods consisting of fixed capital formation,
residential constructions and inventories of finished and unfinished goods, (iii)
goods and services produced by government and (iv) net export of goods and
services‘
GNP = government production + private output
National Income

 Net National Product (NNP)
The second concept is Net National Product. The capital goods like machinery wear
out as a result of continuous use. This is called depreciation. This is also called
National income at market prices.
Hence NNP = GNP - depreciation.
 National Income at factor cost
National income at factor cost denotes the sum of all incomes earner by the factors.
GNP at factor cost is the sum of the money value of the income produced by and
accruing to the various factors of production in one year in a country. It includes all
items of GNP less indirect tax. GNP at market price is always more than GNP at
factor cost as GNP at factor cost is the income which the factors of production
receive in return for their service alone.
National income at factor cost = net national product - indirect taxes + subsidies.
National Income

 Personal Income (PI)
Personal income is the sum of all incomes received by all individuals during a given
year. Some incomes such as Social security contribution are not received by
individuals; similarly some incomes such as transfer payments are not currently
earned, for example Old Age Pension. Therefore,
Personal income = national income - social security contribution - Corporate
income taxes - undistributed corporate profit + transfer payment.
 Disposable Income (DI)
Disposable income = personal income - personal taxes
After a part of the income is paid to the Government in the form of taxes, the
remaining income is called disposable income.
National Income

INFLATION
DEFINITION OF INFLATION
Inflation can be defined as the persistent increase in the price level of goods and
services in an economy over a period of time. Some of the important definitions of
inflation are:
 In the words of Samuleson-Nordhaus, “Inflation is a rise in the general level of
prices.”
 According to Coulborn, inflation can be defined as, “too much money chasing too
few goods.”
 According to Parkin and Bade, “Inflation is an upward movement in the average
level of prices. Its opposite is deflation, a downward movement in the average level
of prices. The boundary between inflation and deflation is price stability.”

 In the words of Peterson, “The word inflation in the broadest possible sense
refers to any increase in the general price-level which is sustained and non-
seasonal in character.”
 According to Johnson, “Inflation is an increase in the quantity of money faster
than real national output is expanding.”
Inflation

TYPES OF INFLATION
Generally, inflation is categorised on the basis of its rate. There are three types of
inflation:
 Moderate inflation: This type of inflation takes place when there is a rise in the
prices of goods and services at a single rate annually. Moderate inflation is also
known as creeping inflation. At the time of moderate inflation in an economy, the
prices of goods and services increase only at a moderate rate. However, the rate
of increase in prices differs in different countries. It is easy to anticipate
moderate inflation; therefore, individuals hold money as a store of value.
Inflation

 Galloping inflation: This type of inflation takes place at the time of the rise in
the prices of goods and services at two-digit or three-digit rate per annum.
Another name for galloping inflation is as jumping inflation. In the words of
Baumol and Blinder, “Galloping inflation refers to an inflation that proceeds at
an exceptionally high.” The worst sufferers of galloping information are middle
and lower class individuals. Due to this, people are unable to save money for the
future. This kind of situation requires strict measures to control inflation.
Inflation

 Hyperinflation: This type of inflation takes place when the rate of increase in
prices is extremely high or out of control. In other words, hyperinflation
occurs when the increase in prices is more than three-digit rate annually. The
cause behind hyperinflation is the unrestricted increase in the supply of money
in the market. This results in a situation of imbalance in the supply and
demand for money. Consequently, money loses its real worth at a rapid speed.
Inflation

Causes of Inflation
• Primary Causes
• Increase in Public Spending
• Deficit Financing
of Government Spending
• Increased Velocity of Circulation
• Population Growth
• Hoarding
• Genuine Shortage
• Exports
• Trade Unions
• Tax Reduction
• The imposition of Indirect Taxes
• Price-rise in
the International Markets
Inflation

 Primary Causes
In an economy, when the demand for a commodity exceeds its supply, then the
excess demand pushes the price up. On the other hand, when the factor prices
increase, the cost of production rises too. This leads to an increase in the price level
as well.
 Increase in Public Spending
In any modern economy, Government spending is an important element of the total
spending. It is also an important determinant of aggregate demand.
 Deficit Financing of Government Spending
There are times when the spending of Government increases beyond what taxation
can finance. Therefore, in order to incur the extra expenditure, the Government
resorts to deficit financing.
For example, it prints more money and spends it. This, in turn, adds to inflationary
pressure.
Inflation

 Increased Velocity of Circulation
In an economy, the total use of money = the money supply by the Government x the
velocity of circulation of money.
When an economy is going through a booming phase, people tend to spend money at
a faster rate increasing the velocity of circulation of money.
 Population Growth
As the population grows, it increases the total demand in the market. Further,
excessive demand creates inflation.
 Hoarding
Hoarders are people or entities who stockpile commodities and do not release them to
the market. Therefore, there is an artificially created demand excess in the economy.
This also leads to inflation.
Inflation

 Genuine Shortage
It is possible that at certain times, the factors of production are short in supply. This
affects production. Therefore, supply is less than the demand, leading to an increase
in prices and inflation.
 Exports
In an economy, the total production must fulfill the domestic as well as foreign
demand. If it fails to meet these demands, then exports create inflation in the
domestic economy.
 Trade Unions
Trade Union work in favor of the employees. As the prices increase, these unions
demand an increase in wages for workers. This invariably increases the cost of
production and leads to a further increase in prices.
Inflation

 Tax Reduction
While taxes are known to increase with time, sometimes, Governments reduce taxes to
gain popularity among people. The people are happy because they have more money in
their hands.
However, if the rate of production does not increase with a corresponding rate, then the
excess cash in hand leads to inflation.
 The imposition of Indirect Taxes
Taxes are the primary source of revenue for a Government. Sometimes, Governments
impose indirect taxes like excise duty, VAT, etc. on businesses.
As these indirect taxes increase the total cost for the manufacturers and/or sellers, they
increase the price of the product to have a minimal impact on their profits.
Inflation

 Price-rise in the International Markets
Some products require to import commodities or factors of production from the
international markets like the United States. If these markets raise prices of these
commodities or factors of production, then the overall production cost in India
increases too. This leads to inflation in the domestic market.
 Non-economic Reasons
There are several non-economic factors which can cause inflation in an economy.
For example, if there is a flood, then crops are destroyed. This reduces the supply
of agricultural products leading to an increase in the prices of the commodities.
Investment in Gold, Real estate, stocks, mutual funds, and other assets are some of
the ways to deal with Inflation.
Inflation

Measures to Control Inflation
 Inflation is considered to be a complex situation for an economy. If inflation goes
beyond a moderate rate, it can create disastrous situations for an economy;
therefore is should be under control.
 It is not easy to control inflation by using a particular measure or instrument.
 The main aim of every measure is to reduce the inflow of cash in the economy or
reduce the liquidity in the market.
Inflation

Monetary Measures:
 The government of a country takes several measures and formulates policies to
control economic activities. Monetary policy is one of the most commonly used
measures taken by the government to control inflation.
 In monetary policy, the central bank increases rate of interest on borrowings for
commercial banks. As a result, commercial banks increase their rate of interests
on credit for the public. In such a situation, individuals prefer to save money
instead of investing in new ventures.
 This would reduce money supply in the market, which, in turn, controls
inflation. Apart from this, the central bank reduces the credit creation capacity
of commercial banks to control inflation.

Fiscal Measures:
 Apart from monetary policy, the government also uses fiscal measures to control
inflation. The two main components of fiscal policy are government revenue
and government expenditure. In fiscal policy, the government controls inflation
either by reducing private spending or by decreasing government expenditure,
or by using both.
 It reduces private spending by increasing taxes on private businesses. When
private spending is more, the government reduces its expenditure to control
inflation. However, in present scenario, reducing government expenditure is not
possible because there may be certain on-going projects for social welfare that
cannot be postponed

Besides this, the government expenditures are essential for other areas, such as
defense, health, education, and law and order. In such a case, reducing private
spending is more preferable rather than decreasing government expenditure.
When the government reduces private spending by increasing taxes, individuals
decrease their total expenditure.

Price Control
 Another method for ceasing inflation is preventing any further rise in the
prices of goods and services. In this method, inflation is suppressed by price
control, but cannot be controlled for the long term. In such a case, the basic
inflationary pressure in the economy is not exhibited in the form of rise in
prices for a short time. Such inflation is termed as suppressed inflation

New Economic Policy 1991 impact on Industry
Salient Features of The Industrial Policy 1991
The industrial policy resolution of 1956 emphasized on increasing state involvement
through the public sector. The main objective of achieving economic growth, was by
allowing public sector to grow fast and attain “commanding heights”. The statement on
industrial policy of 1991 appears to be the reversal of the 1956 policy.
The objectives of the industrial policy, 1991 were
 To speed up liberalization measures
 To correct the distortions or weaknesses that might have crept in
 To maintain sustained growth in productivity and gainful employment
 To attain international competitiveness

The main features of NIP-1991
 Doing away with industrial licensing requirements: In a major move to liberalize
the Indian economy, the NIP abolished all kinds of industrial licensing irrespective
on level of investments in all excepts 18 industries related to security and strategic
concerns, safety, environmental issues etc.
In continuation of the 1991 policy with regard to delicensing, there are only six
industries related to health, strategic and security consideration that remain under the
preview of industrial licensing.

 Diminishing role of public sector: The spirit of the 1991 policy is diametrically
opposite to that of 1956 policy with regard to the role of the public sector in
economic growth and development.
The 1956 resolution reserved 17 industries in the public sector where as the 1991
policy reduced this to 8 and by 2001, the number reserved for public sector is just
3. The govt decided to open the arms and ammunition industry also to the private
sector. The govt also made its intentions clear to further reduce the importance of
the public sector by introducing a ‘divestment’ where in private sector participation
is encouraged in the important areas of the economy.

 Incentives and concessions for foreign investment and technology: The
NIP prepared a specified list of high technology and high investments priority
industries where automatic permission was to be made available for foreign
direct investment up to 51% foreign equity. At present, foreign up to 100%
has been permitted in infrastructure industries such as electricity generation,
transmission and distribution, construction and maintenance of roads,
highways, ports and harbors.
The main purpose of announcing these investments is to make the Indian
industries more vibrant, modern and efficient.

 Drastic amendments to MRTP Act : The Monopolies and Restrictive Trade
Practices (MRTP) act has been amended in tune with the spirit of new industrial
policy (NIP 1991). Earlier there were restrictions on the size of assets of MRTP
companies (which are very strong in terms of asset and market hold). Such
restrictions have now been lifted and the companies operate freely. For instance
foreign equity has gone up to a maximum limit of 51% in most industries. In the
case of export oriented units (EOUs) and life saving drugs and equipment
manufacturers, there is provision for 100% foreign equity. Now the amended act
emphasizes prevention of restrictive and unfair trade practices.

Stabilization Measures (LPG)
These measures were undertaken to correct the inherent weakness that has
developed in Balance of Payments and control the inflation. These measures were
short-term in nature. Various Long-Term Structural Reforms were categorized as:
 Liberalization
 Privatization and
 Globalization
Collectively they are known by their acronym LPG. The balance of Payment is the
system of recording the economic transactions of a country with the rest of the
world over a period of one year. When the general prices of goods and services are
increasing in an economy over a period of time, the same situation is
called Inflation. Let’s understand each terminology in detail

 Liberalization
The basic aim of liberalisation was to put an end to those restrictions which became
hindrances in the development and growth of the nation. The loosening of
government control in a country and when private sector companies’ start working
without or with fewer restrictions and government allow private players to expand
for the growth of the country depicts liberalization in a country.
Objectives of Liberalization Policy
 To increase competition amongst domestic industries.
 To encourage foreign trade with other countries with regulated imports and
exports.
 Enhancement of foreign capital and technology.
 To expand global market frontiers of the country.
 To diminish the debt burden of the country.

 Privatization
This is the second of the three policies of LPG. It is the increment of the
dominating role of private sector companies and the reduced role of public sector
companies. In other words, it is the reduction of ownership of the management of
a government-owned enterprise. Government companies can be converted into
private companies in two ways:
 By disinvestment
 By withdrawal of governmental ownership and management of public sector
companies.

Forms of Privatization
 Denationalization or Strategic Sale: When 100% government ownership of
productive assets is transferred to the private sector players, the act is called
denationalization.
 Partial Privatization or Partial Sale: When private sector owns more than 50%
but less than 100% ownership in a previously construed public sector company
by transfer of shares, it is called partial privatization. Here the private sector
owns the majority of shares. Consequently, the private sector possesses
substantial control in the functioning and autonomy of the company.
 Deficit Privatization or Token Privatization: When the government disinvests
its share capital to an extent of 5-10% to meet the deficit in the budget is termed
as deficit privatization.

Objectives of Privatization
 Improve the financial situation of the government.
 Reduce the workload of public sector companies.
 Raise funds from disinvestment.
 Increase the efficiency of government organizations.
 Provide better and improved goods and services to the consumer.
 Create healthy competition in the society.
 Encouraging foreign direct investments (FDI) in India.

 Globalization
It means to integrate the economy of one country with the global economy. During
Globalization the main focus is on foreign trade & private and institutional foreign
investment. It is the last policy of LPG to be implemented.
Globalization as a term has a very complex phenomenon. The main aim is to
transform the world towards independence and integration of the world as a whole
by setting various strategic policies. Globalization is attempting to create a
borderless world, wherein the need of one country can be driven from across the
globe and turning into one large economy.

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