MeasurinMeasuring National g National

IncomeIncomeDr. Shylajan, C.SDr. Shylajan, C.S

Topics of DiscussionTopics of Discussion

Circular Flow of Income and Circular Flow of Income and Expenditure Expenditure

Gross Domestic Product (GDP)Gross Domestic Product (GDP) Measurement of GDPMeasurement of GDP Other Measures of IncomeOther Measures of Income Nominal vs Real GDPNominal vs Real GDP Limitations of using GDP as a Limitations of using GDP as a

measure of well-being measure of well-being HDI & Gross National HappinessHDI & Gross National Happiness

Macroeconomic Policy Macroeconomic Policy ObjectivesObjectives

Macroeconomic Policy Macroeconomic Policy ObjectivesObjectives

Sustained Economic Growth

Price Stability

The Economy’s Income and Expenditure

To judge whether the To judge whether the economy is doing well or economy is doing well or poorly, it is natural to poorly, it is natural to look at the total income look at the total income that everyone in the that everyone in the economy is earning.economy is earning.

The Economy’s Income and Expenditure

For an economy as a whole, For an economy as a whole, income must equal expenditureincome must equal expenditure because:because:

Every transaction has a buyer Every transaction has a buyer and a seller.and a seller.

Every rupee of spending by some Every rupee of spending by some buyer is a rupee of income for buyer is a rupee of income for some seller. some seller.

The Economy’s Income and Expenditure-Simple economy (2 sector model)

This process can be seen using This process can be seen using a Circular Flow Diagram.a Circular Flow Diagram.

Two sector model where Two sector model where all all income is consumedincome is consumed

The Circular-Flow of The Circular-Flow of Income and Expenditure Income and Expenditure

(2 sector )(2 sector )

Business Sector or Productive

Sector

Household Sector or Consumer

Sector

Market for Factors

of Production

Market for Goods

and Services

SpendingRevenue

Wages, rent, and interest,

profit

Income

Goods & Services

sold

Goods & Services bought

Labor, land, and capital

Inputs for production

Measurement of Gross Measurement of Gross Domestic Product (GDP)Domestic Product (GDP)

The market value of final The market value of final goods and services goods and services produced in an economy in produced in an economy in a given period of time (say a given period of time (say 2013-2014)2013-2014)

Measurement of Gross Measurement of Gross Domestic Product (GDP)Domestic Product (GDP)

Change in GDP over time due to Change in GDP over time due to

1.change in Price 1.change in Price

2.change in volume of goods and 2.change in volume of goods and servicesservices

Calculation of Nominal Vs Calculation of Nominal Vs Real GDPReal GDPExample # 1Example # 1

GoodsGoods Year 2004Year 2004 Year Year 20132013

P P QQ PP QQ X1X1 22 4040 33 6060 X2X2 88 9090 1010 150150 X3X3 8080 100100 9090 110110 X4X4 7070 120120 8080 130130

Calculation of Real Calculation of Real GDPGDPExample # 1….Example # 1…. Nominal GDP of Year 2004 (Base Year)Nominal GDP of Year 2004 (Base Year)

40*2+90*8+100*80+120*70 =1720040*2+90*8+100*80+120*70 =17200

Nominal GDP of Year 2013Nominal GDP of Year 201360*3+150*10+110*90+130*80=2198060*3+150*10+110*90+130*80=21980

What is Real GDP of 2013?What is Real GDP of 2013?Hold the prices constant at the base yearHold the prices constant at the base yearThen, Then,

Real GDP=60*2+150*8+110*80+130*70Real GDP=60*2+150*8+110*80+130*70=19220=19220

What Is Counted and Not Counted in GDP?

GDP excludes services that GDP excludes services that are produced and are produced and consumed at home and consumed at home and that never enter the market that never enter the market place.place.

What Is Counted and Not Counted in GDP?

– Services of housewivesServices of housewives

– Because GDP does not count it, Because GDP does not count it, it diminishes its importance.it diminishes its importance.

– GDP also excludes black market GDP also excludes black market items, such as illegal drugs.items, such as illegal drugs.

GDP vs GNPGDP vs GNP

GNP = GDP + NFIAGNP = GDP + NFIA

Net Factor Income from Abroad Net Factor Income from Abroad (NFIA) = Factor Income received (NFIA) = Factor Income received from Abroad – Factor Income from Abroad – Factor Income paid Abroadpaid Abroad

That is, inflow of factor incomes That is, inflow of factor incomes from abroad minus the from abroad minus the corresponding outflowcorresponding outflow

GDP vs GNPGDP vs GNP

That is, That is, Factor incomes earned by our residents Factor incomes earned by our residents

from the rest of the world (Indian working from the rest of the world (Indian working in US for instance) minus factor incomes in US for instance) minus factor incomes earned by the non-residents from our earned by the non-residents from our country(Japanese working in India for country(Japanese working in India for instance)instance)

Factor IncomesFactor Incomes: incomes accrued to : incomes accrued to various factors of production, rent for land, various factors of production, rent for land, wages for labour, interest for capital and wages for labour, interest for capital and profit for organisationprofit for organisation

GDP Measurement: Three GDP Measurement: Three WaysWays

Expenditure Method: Expenditure Method: by measuring by measuring the size of total expenditure the size of total expenditure

incurred in the economyincurred in the economy

Output Method: Output Method: by measuring the by measuring the value of output at production stagevalue of output at production stage

Income Method: Income Method: by measuring the by measuring the amount of factor income earnedamount of factor income earned

The circular flow of national income and expenditureThe circular flow of national income and expenditure

(1) Production (1) Production

(2) Incomes (2) Incomes (3) Expenditure(3) Expenditure

Expenditure method of Expenditure method of estimating GDPestimating GDP

By measuring the annual By measuring the annual flow of expenditure on final flow of expenditure on final goods and services incurred goods and services incurred by the household sector by the household sector (C) , business sector (I) and (C) , business sector (I) and government sector (G)and government sector (G)and external sector (X-M)external sector (X-M)

The components of The components of GDP (Expenditure GDP (Expenditure method)method)

GDP (GDP (Y Y ) is the sum of the following:) is the sum of the following:

Consumption spending Consumption spending ((CC)) Investment spendingInvestment spending((II)) Government Purchases Government Purchases ((GG)) Exports minus Import (X-M)Exports minus Import (X-M)

Y = C + I + G + X-MY = C + I + G + X-M

The components of The components of GDP at market price GDP at market price for 2013-14 for India for 2013-14 for India (INR Billion)(INR Billion)Visit RBI website Visit RBI website www.rbi.org and find out and find out the value for each the value for each components.components.

Y = C + I + G + X-MY = C + I + G + X-M

Factorpayments

Factorpayments

Consumption ofdomestically

produced goodsand services (Cd)

Consumption ofdomestically

produced goodsand services (Cd)

Investment (I)Investment (I)

Governmentexpenditure (G)

Governmentexpenditure (G)

Exportexpenditure (X)

Exportexpenditure (X)

BANKS, etc

saving (S)saving (S)

GOV.

taxes (T)taxes (T)

ABROAD

Importexpenditure (M)

Importexpenditure (M)

The circular flow of incomeThe circular flow of income

WITHDRAWALS

INJECTIONS

Consumption expenditure of households (C)

Government final consumption (G)

Gross capital formation (I)

Exports of goods and services (X)

less Imports of goods and services (M)

=

Gross Domestic Product (GDP)

plus Net income from abroad

=Gross National Product (GNP)

less Depreciation

=Net National Product (NNP)

GDP by category of expenditure, GNP and NNP GDP by category of expenditure, GNP and NNP GDP by category of expenditure, GNP and NNP GDP by category of expenditure, GNP and NNP

Income methodIncome method

– By calculating Factor incomesBy calculating Factor incomes

– Factor incomes means factor Factor incomes means factor payments such as wages, interest, payments such as wages, interest, rent, and profit rent, and profit

The total amount earned by the factors of The total amount earned by the factors of production for their contribution to the final production for their contribution to the final output.output.

Output methodOutput method

By adding up the value added at each By adding up the value added at each stage of productionstage of production

GDP vs NDPGDP vs NDP

GDP – Depreciation = Net GDP – Depreciation = Net Domestic ProductDomestic Product

GNP at market priceGNP at market price

The value of national product at The value of national product at market price indicates the total market price indicates the total amount actually paid by the final amount actually paid by the final buyersbuyers

GNP at market price would include net GNP at market price would include net indirect taxesindirect taxes

Net Indirect Taxes = (Indirect Taxes – Net Indirect Taxes = (Indirect Taxes – Subsidies)Subsidies)

GNP at Factor costGNP at Factor cost

The value of national product at The value of national product at factor cost is the total amount factor cost is the total amount earned by the factors of earned by the factors of production for their contribution production for their contribution to the final outputto the final output

GNP at factor cost = GNP at GNP at factor cost = GNP at market price – Net Indirect Taxes market price – Net Indirect Taxes

Net National Product Net National Product (NNP) or National (NNP) or National IncomeIncome

NNP at factor cost = GNP at NNP at factor cost = GNP at factor cost – Depreciation factor cost – Depreciation

NNP at factor cost is called NNP at factor cost is called National IncomeNational Income

National Income and National Income and Per Capita IncomePer Capita Income

National Income divided by National Income divided by population gives per capita incomepopulation gives per capita income

Per capita income signifies the Per capita income signifies the average standard of living of the average standard of living of the people people

Personal IncomePersonal Income

Factors of production also receive Factors of production also receive incomes that are not earned. incomes that are not earned.

For example, gifts, welfare For example, gifts, welfare payments, pensions, unemployment payments, pensions, unemployment benefits etcbenefits etc

These are called These are called Transfer Transfer PaymentsPayments

Personal IncomePersonal Income

Also all earned income is not received Also all earned income is not received by the factors of production in the by the factors of production in the same yearsame year

Examples: Undistributed profitsExamples: Undistributed profits

Personal Income = National Income Personal Income = National Income minus income earned but not received minus income earned but not received plus income received but not earnedplus income received but not earned

Disposable IncomeDisposable Income

Disposable Income = Personal Disposable Income = Personal Income – Personal TaxesIncome – Personal Taxes

That is, income that goes either That is, income that goes either towards Consumption or Savingtowards Consumption or Saving

ExampleExample

Given GNP at factor cost = 1,14,601; Given GNP at factor cost = 1,14,601; Depreciation = 8062 ; Subsidies = Depreciation = 8062 ; Subsidies = 2822 ; NFIA = +330 and Indirect 2822 ; NFIA = +330 and Indirect taxes = 16,745 , computetaxes = 16,745 , compute

(a) GNP at market price(a) GNP at market price (b) NNP at market price(b) NNP at market price © NDP at market price and © NDP at market price and

Hints:Hints:

(a) GNP at market price=GNP at (a) GNP at market price=GNP at factor cost +Net indirect taxesfactor cost +Net indirect taxes

(b) NNP at market price=GNP at (b) NNP at market price=GNP at market price –Depreciationmarket price –Depreciation

© NDP at market price =GDP at © NDP at market price =GDP at market price –Depreciationmarket price –Depreciation

GDP at market price =GNP at GDP at market price =GNP at market price-Net factor income market price-Net factor income from abroadfrom abroad

Is GDP a Measure of Is GDP a Measure of social welfare?social welfare?

GDP as a measure of social welfareGDP as a measure of social welfare

– benefits of using GDPbenefits of using GDP

– Why GDP is not a perfect measure of Why GDP is not a perfect measure of economic well-being?economic well-being?

The Human Development Index (HDI)The Human Development Index (HDI)

Gross National HappinessGross National Happiness

Calculation of Nominal Calculation of Nominal GDP, Real GDP and GDP, Real GDP and GDP DeflatorGDP Deflator

Nominal GDPNominal GDP values the production of values the production of goods and services at current prices.goods and services at current prices.

Real GDPReal GDP values the production of values the production of goods and services at constant prices goods and services at constant prices (base year price)(base year price)

Real values eliminate the impact of Real values eliminate the impact of changes in the price level.changes in the price level.

Calculation of Real Calculation of Real GDPGDP

Example # 1Example # 1GoodsGoods Year 2004Year 2004 Year Year

20132013

P P QQ PP QQ X1X1 22 4040 33 6060 X2X2 88 9090 1010 150150 X3X3 8080 100100 9090 110110 X4X4 7070 120120 8080 130130

Calculation of Real Calculation of Real GDPGDPExample # 1….Example # 1…. Nominal GDP of Year 2004 (Base Year)Nominal GDP of Year 2004 (Base Year)

40*2+90*8+100*80+120*70 =1720040*2+90*8+100*80+120*70 =17200

Nominal GDP of Year 2013Nominal GDP of Year 201360*3+150*10+110*90+130*80=2198060*3+150*10+110*90+130*80=21980

What is Real GDP of 2013?What is Real GDP of 2013?Hold the prices constant at the base yearHold the prices constant at the base yearThen, Then,

Real GDP=60*2+150*8+110*80+130*70Real GDP=60*2+150*8+110*80+130*70=19220=19220

Measurement of Measurement of General Price Level-General Price Level-Price IndicesPrice Indices

GDP Deflator:-GDP Deflator:- It is Nominal GDP/Real GDP *100It is Nominal GDP/Real GDP *100 In our example, 21980/19220*100In our example, 21980/19220*100=114.36=114.36 Consumer Price IndexConsumer Price Index Wholesale Price IndexWholesale Price Index

Consumer Price Consumer Price IndexIndex

CPI, WPI and GDP Deflator are CPI, WPI and GDP Deflator are measures of inflation in the measures of inflation in the economyeconomy

CPI covers CPI covers all goods and servicesall goods and services (including imported) that enter the (including imported) that enter the consumption basketconsumption basket

Consumer Price Consumer Price IndexIndex The relevant price is the The relevant price is the retail retail

priceprice

The quantity The quantity weights are weights are constantconstant

How CPI is How CPI is constructed? An constructed? An

ExampleExample We have the cost of the We have the cost of the

consumption basket for 1993-94 consumption basket for 1993-94 and 2007-08.and 2007-08.

Items in consumption basket are Items in consumption basket are rice, wheat, milk, cloth and houserice, wheat, milk, cloth and house

We need to calculate the cost of the We need to calculate the cost of the consumption basket in 2007-08 consumption basket in 2007-08 compared to 1993-94.compared to 1993-94.

Calculation of rate of Calculation of rate of inflation of the CPI/WPIinflation of the CPI/WPI

Rate of inflation is the rate of growth or Rate of inflation is the rate of growth or decline of the price level from one year to decline of the price level from one year to the next yearthe next year

Rate of inflation = CPI (this year) – CPI (last year) * Rate of inflation = CPI (this year) – CPI (last year) * 100100

CPI (last year)CPI (last year)

Consumer Price Index Consumer Price Index – India – India www.rbidocs.rbi.org.in

Also refer Chapter 1, Errol Also refer Chapter 1, Errol d’Souza “Macroeconomics”d’Souza “Macroeconomics”

Ministry of Statistics and Ministry of Statistics and Programme Implementation (Programme Implementation (http://www.mospi.nic.in))

Wholesale Price Wholesale Price IndexIndex It consists of a much larger It consists of a much larger

basketbasket

Wholesale pricesWholesale prices are used for are used for estimationestimation

Wholesale Price Wholesale Price IndexIndex Base year Base year weights are fixedweights are fixed

In India, movements in WPI In India, movements in WPI are used to measure inflationare used to measure inflation

Pls refer the RBI Pls refer the RBI websitewebsite www.www.rbidocs.rbi.org.in.in

Thank youThank you