National Income

National income is the total income earned by a nation’s residents in the production of goods and services.

National income of a country can be defined as the total market value of all final goods and services produced in the economy in a year.

In simply national income means ‘the sum of the incomes earned during the period from the supplying of factor units for the use of production’.

Computation/calculation of NI

There are three methods of computation of National Income

Census /product method Income method Expenditure method

Census /product method This is also called output method or production

method. In this method the contribution of each enterprise to the generation of flow of goods and services is measured. Economy is divided into different industrial sectors such as agriculture,fishing,mining,construction,manufacturing, Trade and commerce, transport and other services.

Income method This method national income is obtained by summing

up of the incomes of all individuals of a country.

Expenditure method Under this method income can be spent either on

consumer goods or capital goods. Expenditure can be made by private individuals and households or by govt. and business enterprises.

National Income Concepts Gross national product-GNP

This is the nations total production of goods and services, for one year, evaluated in terms of the market prices.

Net national product(NNP) This is refers to net production of goods and services

in a country during the year. It is GNP minus the value of capital consumed or depreciated.(NNP=GNP-Depreciation)

Personal Income(PI) PI is the actual income received by the individuals or

households in the country.

Difficulties of computation of NI

Conceptual Difficulties

Statistical Difficulties

The error of double counting

Factors Determining National Income

There are a number of influences which determine the size of the national income in a country. Three main influences are as follows;

Quantity and quality if factors of production The state of technical know how Political stability

Quantity and quality if factors of production Quantity and quality of land, the climate, the

rainfall etc., determine the quantity and quality of agriculture production. This determine the size of the NI. And also labour has a double influence factor for the production.

The state of technical know how Some country with poor technical knowledge

cannot have a large-size national income, as it will be incapable of exploiting its resources efficiently.

Political stability Political stability is essential part to decide the

economy growth level. And also is an essential pre-requisite for mainting production at the highest level.

Aggregate Demand AD is total planned or desired spending in the economy

during a given period. AD “which refers to the total amount that different

sectors in the economy willingly spend in a given period". Aggregate demand is the sum of spending by consumers, businesses, and governments, and it depends on the level of prices, as well as on monetary policy, fiscal policy, and other factors. It determined by the aggregate price level and influenced by domestic investment, net exports, government spending, the consumption and the money supply.AD we mean how much expenditure the people and the entrepreneurs are undertaking on consumption and investment. Therefore,

AD = Consumption demand + Investment demand.

Aggregate Supply

Aggregate supply “which refers to the total quantity of goods and services that the nation’s business are willing to produce and sell in a given period”. Aggregate supply depends upon the price level , the productive capacity of the economy, and the level of costs.AS is the total value of goods and services that firms would willingly produce in a given time period.

AS Means the total money value of goods and services produced in an economy in a year.

Y = (N,K,T)

Y is national output, K is the constant amount of capital stock,T is the constant state of technology and N is the labour employed which is a variable factor.

Macro Economic equilibrium

Macro economic equilibrium is a combination of overall price and quantity at which neither buyers nor sellers wish to change their purchases,sales,or prices.

Multiplier F.A. Kahn developed the concept of multiplier with

reference to the increase in employment, direct as well as indirect, as a result of initial increase in investment.

In the words of Hansen, Keynes investment multiplier is the coefficient relating to an increment of investment to an increment of income.Multiplier analysis we are concerned with changes in income induced by changes in investment

∆Y = ∆C + ∆I …….(1) Keynesian model of income determination, change in

investment is considered to be autonomous or independent of changes in income while changes in consumption are function of changes in income.

Consumption function C = a + bY

where a is constant term, b is marginal propensity to consume which is also assumed to remain constant. Therefore, change in consumption can occur only if there is change in income.

∆C = b∆Y ……….(2)

Substituting (2) into (1) we have

∆Y = b ∆Y + ∆I

∆Y - b ∆Y = ∆I

∆Y(1-b) = ∆I

∆Y= 1/1-b ∆I

∆Y/∆I =1/1-b

As b stands for marginal propensity to consume

∆Y/∆I =1/1-MPC

Multiplier, K = 1/1-MPC

Multiplier Effect

It is a macroeconomic theory used to explain how output is determined in the short run. The name ‘multiplier’ comes from the finding that each dollar change in exogenous expenditures leads to more than a dollar change in GDP. The multiplier model explains how stocks to investment, foreign trade, and government tax and spending policies can affect output and employment in an economy.

The expansion of a country's money supply that results from banks being able to lend. The size of the multiplier effect depends on the percentage of deposits that banks are required to hold as reserves. In other words, it is money used to create more money and is calculated by dividing total bank deposits by the reserve requirement.

Importance of Multiplier

Investment Trade cycle Saving-investment equality Formulation of economic policies

To achieve full employment To control trade cycles Deficit financing Public investment

Acceleration

Whenever autonomous investments take place leading to increased expenditure, the increased demand for consumptions goods will induce the optimistic entrepreneurs to read just their planned investment to cater to the demand created.

Fiscal policy Fiscal programs are instrumental in deciding how the

nation’s output should be divided between collective and private consumption and how the burden of payment for collective goods should be divided among the population.

Fiscal policy also called budgetary policy, refers to the govt. tax , expenditure and dept policies including deficit financing.

In other words ‘a policy under which the govt. uses its revenue and expenditure programmes to produce desirable effects and avoid undesirable effects on national income, production and employment.

Objective of fiscal policy

Objectives is divided into three objectives is that allocation, distribution and stabilization.

Allocation means provision of social goods, or the process by which total resource use is divided between private and social goods.

Distribution means adjustment of income and wealth to ensure ‘fair’ state of distribution. Distribution factor such as wages,interest,etc.

Stabilization means maintaining high employment, a reasonable degree of price-level stability and an appropriate rate of economic growth.

Tools of fiscal policyThree important tools or instruments of fiscal policy as follows. Public Expenditure

For e.g., Purchase of defense goods, construction of roads, salaries for govt. servants, etc.

Taxation

Public dept

Monetary policy

Monetary policy is another important instrument with which objectives of macroeconomic policy can be achieved.

Monetary policy is nothing but controlling the supply of money. Monetary policy regulates the supply of money and the cost and availability of credit in the economy. It deals with both the lending and borrowing rates of interest for commercial banks.

Main objective of monetary policy To ensue economic stability at full-

employment or potential level of output To achieve price stability by controlling

inflation and deflation Ensure adequate flow of credit to the

productive sectors To promote and encourage economic growth

in the economy

Instruments of Monetary policy

Quantitative measures• open market operations• Bank rate policy• Cash reserve ratio Qualitative measures• Credit rationing• Change in lending margin

Instrument or tools of monetary Policy

Central bank of a country has the responsibility of controlling the volume and direction of credit in the country. The volume and direction of bank credit has, an important bearing on the level of economic activity. Excessive credit will tend to generate inflationary pressure in the economy, while deficiency of credit supply may tend to cause depression or deflation.

Open market operations

The term open market operations means the purchase and sale of securities by the central bank of the country.

Bank rate policy

Bank rate is the minimum rate at which the central bank of a country provides loans to the commercial bank of country. Bank credit these days is an important component of the supply of money in the economy. Changes in money supply affect aggregate demand and thereby output and prices.

Cash reserve ratio

Another important method to vary the quantity of credit is to change the cash reserve ratio. By law, banks have to keep a certain amount of cash money with themselves as reserves against the deposit. The minimum cash reserve ratio is 20%.The central bank of a country has the authority to vary the cash reserve ratio.

Credit rationing: -- when there is a shortage of institutional credit available for the business sector, the highly developed and financially strong sectors and industries tend to capture the lion’s share in the total institutional credit. As a result priority sectors and essential industries are served of necessary funds, while the bank resorts to credit rationing measures.

Change in lending margins: -- The banks advance money more often than not against the mortgage of some asset or property-land building jewelry, share stock of goods, and so on. The banks provide loans only up to a certain percentage of the value of the mortgaged property. The gap between the values of the mortgaged property. The gap between the value of the mortgaged property and amount advanced is called lending margin.