Unit 5

UNIT –V
NATIONAL INCOME;
CONCEPTS AND VARIOUS METHODS OF ITS MEASUREMENT,
INFLATION,
TYPES AND CAUSES,
BUSINESS CYCLE.
7/5/2016Deepak Srivastava 1

BASIC NATIONAL INCOME
CONCEPTS
• 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.
Objectives
After studying this unit, you will be able
to:
• Explain the concept of national income
• Discuss important identities related to
national income

CONCEPT OF NATIONAL INCOME
• "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".
• :Paul Studenski.
• 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.
• 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).

GROSS NATIONAL INCOME (GNI)
• 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".

NATIONAL INCOME ESTIMATES
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).
• So, we have three kinds of national income estimates:
• National income as net aggregate output
• National income as sum of distributive shares
• National income as aggregate value of final products

GROSS AND NET CONCEPT
• Gross emphasizes 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.

NATIONAL AND DOMESTIC CONCEPTS
• 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.

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.
• And vice versa.

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 (Is) 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) 7/5/2016Deepak Srivastava 12

GNP AS THE TOTAL OF FACTOR INCOMES
• 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

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.

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

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.
• 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

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
PI = DI + T
DI = C + S
It follows
PI = C + S + T

THE CONCEPT OF VALUE ADDED
• 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

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, 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.

CALCULATION OF NATIONAL INCOME
Methods
Product
Approach
Income
Approach
Expenditure
Approach

PRODUCT APPROACH
• 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.

BROADLY SPEAKING THE STEPS INVOLVED ARE:
Obtain estimates of quantities
of all outputs and all inputs.
Obtain estimates of average
price for each output and
input from market sources.
Compute gross value of
outputs and inputs using
price-quantity data and
subtract the latter from the
former to get gross value
added.
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

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.

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 defense

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).

EXPENDITURE APPROACH
• 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.

PROBLEMS IN MEASURING NATIONAL INCOME
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.

1. 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.
2. Problems of depreciation estimation as there are different
methods of calculating or estimating depreciation.

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.
g) Expenditure on purchase of old share is excluded.
h) Government expenditure on all transfer payment is excluded. 7/5/2016Deepak Srivastava 34

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.

CIRCULAR FLOW OF INCOME IN A 2 SECTOR MODEL

CIRCULAR FLOW OF INCOME IN A 3 SECTOR MODEL

CIRCULAR FLOW OF
INCOME IN A FOUR SECTOR
MODEL

INFLATION
TYPES AND CAUSES

INFLATION
• It arises when price level of an economy goes on rising continuously.
• It is open inflation.
• An economy may also suffer from inflation without any apparent rise in prices.
• This is repressed inflation.
• According to classical writers inflation is a situation when too much money chases too few
goods.
• It is an imbalance between money supply and Gross Domestic Product.
• As per Keynes inflation is an imbalance between aggregate demand and aggregate supply.
• In an economy, if the aggregate demand for goods and services exceeds aggregate supply,
then prices will go on rising.

: PRIMARY: PRIMARY CAUSES
• When demand for a commodity in the market exceeds its supply,
the excess demand will push up the price (‘demand-pull
inflation’).
• When factor prices rise, costs of production rise (‘cost-push
inflation’)

LET US NOW DISCUSS IN DETAIL THE VARIOUS CAUSES
THAT MAY BRING ABOUT INFLATION

FORMS OF INFLATION
Demand Pull Inflation:
When in an economy aggregate
demand exceeds aggregate supply.
Aggregate demand may increase due
to an increase in money supply, or
money income or public expenditure.
The idea of demand inflation is
associated with full employment
when supply cannot be altered.

COST PUSH INFLATION
Inflation may originate from supply side
also.
Aggregate demand remaining unchanged,
a fall in aggregate supply due to
exogenous cause, may lead to increase in
price level.

• Open inflation
• The continuous rise in price level is visible in the
naked eye.
• One can see the annual rate of increase in the
price level.
• Repressed inflation
• There is excess demand.
• The excess demand is prevented from increasing
price level by some repressive measures.
• The measures taken by the government like price
control, rationing etc.
• Hyper inflation
• The price level goes on rising at a very fast rate.
• Often there happens hourly increase in price level.
• It often leads to demonetization.
• Creeping inflation
• The price level increases very slowly over a period
of time.
• Moderate inflation
• The rise in price level is neither too fast nor too
slow.

PRICING METHODS
Do you know !!!
In a bundle pricing, companies
sell a package or set of goods
or services for a lower price
than they would charge if the
customer bought all of them
separately. Common examples
include option packages on
new cars, value meals at
restaurants and cable TV
channel plans.

COST-BASED PRICING:
• Cost-based pricing refers to a pricing method in which some
percentage of desired profit margins is added to the cost of the
product to obtain the final price. In other words, cost-based
pricing can be defined as a pricing method in which a certain
percentage of the total cost of production is added to the cost of
the product to determine its selling price. Cost-based pricing can
be of two types, namely, cost-plus pricing and markup pricing.

COST-PLUS PRICING:
• Refers to the simplest method of determining the price of a
product. In cost-plus pricing method, a fixed percentage, also
called mark-up percentage, of the total cost (as a profit) is added
to the total cost to set the price. For example, XYZ organization
bears the total cost of Rs. 100 per unit for producing a product. It
adds Rs. 50 per unit to the price of product as’ profit. In such a
case, the final price of a product of the organization would be Rs.
150.

COST-PLUS PRICING:
• In economics, the general formula given for setting price in case of cost-plus pricing is as follows:
• P = AVC + AVC (M)
• AVC= Average Variable Cost
• M = Mark-up percentage
• AVC (m) = Gross profit margin
• Mark-up percentage (M) is fixed in which AFC and net profit margin (NPM) are covered.
• AVC (m) = AFC+ NPM

MARKUP PRICING:
• Refers to a pricing method in which the fixed amount or the percentage of cost of the product
is added to product’s price to get the selling price of the product. Markup pricing is more
common in retailing in which a retailer sells the product to earn profit. For example, if a
retailer has taken a product from the wholesaler for Rs. 100, then he/she might add up a
markup of Rs. 20 to gain profit.
• It is mostly expressed by the following formulae:
• a. Markup as the percentage of cost= (Markup/Cost) *100
• b. Markup as the percentage of selling price= (Markup/ Selling Price)*100
• c. For example, the product is sold for Rs. 500 whose cost was Rs. 400. The mark up as a
percentage to cost is equal to (100/400)*100 =25. The mark up as a percentage of the selling
price equals (100/500)*100= 20.

DEMAND-BASED PRICING
• Demand-based pricing refers to a pricing method in which the price of a
product is finalized according to its demand. If the demand of a product is
more, an organization prefers to set high prices for products to gain profit;
whereas, if the demand of a product is less, the low prices are charged to
attract the customers.
• The success of demand-based pricing depends on the ability of marketers to
analyze the demand. This type of pricing can be seen in the hospitality and
travel industries. For instance, airlines during the period of low demand
charge less rates as compared to the period of high demand. Demand-based
pricing helps the organization to earn more profit if the customers accept the
product at the price more than its cost.

COMPETITION-BASED PRICING
• Competition-based pricing refers to a method in which an organization
considers the prices of competitors’ products to set the prices of its own
products. The organization may charge higher, lower, or equal prices as
compared to the prices of its competitors.
• The aviation industry is the best example of competition-based pricing where
airlines charge the same or fewer prices for same routes as charged by their
competitors. In addition, the introductory prices charged by publishing
organizations for textbooks are determined according to the competitors’
prices.

OTHER PRICING METHODS:
IN ADDITION TO THE PRICING METHODS, THERE ARE OTHER METHODS THAT ARE DISCUSSED AS
FOLLOWS:
• i. Value Pricing:
• Implies a method in which an organization tries to win loyal customers by
charging low prices for their high- quality products. The organization aims to
become a low cost producer without sacrificing the quality. It can deliver high-
quality products at low prices by improving its research and development
process. Value pricing is also called value-optimized pricing.
• ii. Target Return Pricing:
• Helps in achieving the required rate of return on investment done for a
product. In other words, the price of a product is fixed on the basis of
expected profit.

OTHER PRICING METHODS:
IN ADDITION TO THE PRICING METHODS, THERE ARE OTHER METHODS THAT ARE DISCUSSED AS
FOLLOWS:
• iii. Going Rate Pricing:
• Implies a method in which an organization sets the price of a product according to the prevailing price
trends in the market. Thus, the pricing strategy adopted by the organization can be same or similar to
other organizations. However, in this type of pricing, the prices set by the market leaders are followed
by all the organizations in the industry.
• iv. Transfer Pricing:
• Involves selling of goods and services within the departments of the organization. It is done to manage
the profit and loss ratios of different departments within the organization. One department of an
organization can sell its products to other departments at low prices. Sometimes, transfer pricing is
used to show higher profits in the organization by showing fake sales of products within departments.

Peak
Recession
Depression
Trough
Recovery
Boom
PHASES OF
BUSINESS CYCLE

SCHEME OF PRESENTATION
• Introduction
• Different Phases of Business Cycle
o Expansion
• Recovery
• Boom
• Peak
o Contraction
• Recession
• Depression
• Trough
• Factors That Shape Business Cycle

FACTORS THAT SHAPE BUSINESS CYCLE
• Volatility of investment spending
• Momentum
• Technological Innovations

INTRODUCTION
Definition:- The business cycle is the periodic but irregular up-and-
down movement in economic activity, measured by fluctuations in real gross domestic
product (GDP) and other macroeconomic variables.
 How do we measure “up-and-down movement in business activity ?
 Percent change in real GDP

GDP-REAL GROWTH RATE OF INDIA

DIFFERENT PHASES OF BUSINESS CYCLE
• Expansion :-increased consumer confidence, which translates into higher levels of business activity.
It consists of three small stages :
1.Recovery
2.Boom
3.Peak

1.RECOVERY
• The turning point from depression to expansion is termed as Recovery or Revival Phase.
• Consumer’s confidence starts to increase.
• Rise in economic activities.

2.BOOM
 Consumer’s confidence starts to increase at a faster pace.
 Unemployment levels fall.
 Business starts increase their construction levels.
 Rise in National Income.
 Rapid increase in economy.
 Inflation increase at very high rates.

3.PEAK
• The economy has reached its peak.
• Output starts to standstill and level off.
• Consumer’s confidence starts to decline.
• People start to stop their buying.
• GDP begins to decline(bust).

• CONTRACTION
 It is a period of decrease in consumer confidence and economic activity.
 It consists of three smaller stages:
• Recession
• Depression
• Trough

1.RECESSION
• is a period of reduced economic activity in which levels of buying, selling, production, and
employment typically diminish.
• Consumer’s confidence starts to decrease a little.
• Unemployment is increasing while inflation is dropping.

2.DEPRESSION
• Depression is the most fearful stage of a trade cycle.
• The phase of depression (also called slump) is characterized by low economic activities.
• Rapid decline in general output
and employment.

3.TROUGH
• Contraction reaches a minimum, or
• Economy hits bottom.
• Output starts to standstill and level off.
• Consumer’s confidence starts to level off.
• End of recession, growth resumes.

Unit 5

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