Finished Ppt. Unit 1

8/3/2019 Finished Ppt. Unit 1

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Introduction

The modern economic science has two branches

Microeconomics and macroeconomics

Compared to micro economics macroeconomics is a younger

branch of economics. Until Great Depression 1930s the subject of economic science

was broadly micro economics.

It emerged as a separate branch in 1936 with the publication ofJohn Maynard Keynes's revolutionary book, The general theory

of employment, Interest, and Money

Some terms were coined by Ragner Frisch, in 1933 in his paper

preposition problems and impulse problems in dynamic

economics

December 9, 2011 2Vidya Suresh


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A reading on Great Depression

Historical Importance of the Great Depression: The Great Depression, animmense tragedy that placed millions of Americans out of work, was the

beginning of government involvement in the economy and in society as a

whole.

Dates: 1929 -- early 1940s Overview of the Great Depression: Just to read

The Stock Market Crash

,

thrown into despair on Black Tuesday, October 29, 1929, the day the

stock market crashed and the official beginning of the Great Depression.

As stock prices plummeted with no hope of recovery, panic struck.

Masses and masses of people tried to sell their stock, but no one was

buying. The stock market, which had appeared to be the surest way tobecome rich, quickly became the path to bankruptcy.



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A Reading on Great Depression

And yet, the Stock Market Crash was just the beginning. Since many banks hadalso invested large portions of their clients' savings in the stock market, these

banks were forced to close when the stock market crashed. Seeing a few banks

close caused another panic across the country. Afraid they would lose their

own savings, people rushed to banks that were still open to withdraw theirmoney. This massive withdrawal of cash caused additional banks to close.

Since there was no way for a bank's clients to recover any of their savings once

the bank had closed, those who didn't reach the bank in time also became

an rup .

Businesses and industry were also affected. Having lost much of their own

capital in either the Stock Market Crash or the bank closures, many businesses

started cutting back their workers' hours or wages. In turn, consumers began to

curb their spending, refraining from purchasing such things as luxury goods.

This lack of consumer spending caused additional businesses to cut back wages

or, more drastically, to lay off some of their workers. Some businesses couldn't

stay open even with these cuts and soon closed their doors, leaving all their

workers unemployed.



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A Reading On Great Depression

The Dust Bowl

In previous depressions, farmers were usually safe from the severe effects of a

depression because they could at least feed themselves. Unfortunately, during

the Great Depression, the Great Plains were hit hard with both a drought and

horrendous dust storms.

Years and years of overgrazing combined with the effects of a drought caused

the grass to disappear. With just topsoil exposed, high winds picked up the

.

their paths, leaving farmers without their crops.

Small farmers were hit especially hard. Even before the dust storms hit, the

invention of the tractor drastically cut the need for manpower on farms. These

small farmers were usually already in debt, borrowing money for seed and

paying it back when their crops came in. When the dust storms damaged thecrops, not only could the small farmer not feed himself and his family, he could

not pay back his debt. Banks would then foreclose on the small farms and the

farmer's family would be both homeless and unemployed.



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Roosevelt and the New Deal

The U.S. economy broke down and entered the Great Depression during

the presidency of Herbert Hoover. Although President Hoover repeatedly

spoke of optimism, the people blamed him for the Great Depression. Just

as the shantytowns were named Hoovervilles after him, newspapersbecame known as "Hoover blankets," pockets of pants turned inside out

(to show they were empty) were called "Hoover flags," and broken-down

cars pulled by horses were known as "Hoover wagons.

During the 1932 presidential election, Hoover did not stand a chance atreelection and Franklin D. Roosevelt won in a landslide. People of the

United States had high hopes that President Roosevelt would be able to

solve all their woes. As soon as Roosevelt took office, he closed all the

banks and only let them reopen once they were stabilized. Next,Roosevelt began to establish programs that became known as the New

Deal.



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These New Deal programs were most commonly known by their initials,which reminded some people of alphabet soup. Some of these programs were

aimed at helping farmers, like the AAA (Agricultural Adjustment

Administration). While other programs, such as the CCC (Civilian

Conservation Corps) and the WPA (Works Progress Administration),attempted to help curb unemployment by hiring people for various projects.

The End of the Great Depression


To many at the time, President Roosevelt was a hero. They believed that he

cared deeply for the common man and that he was doing his best to end the

Great Depression. Looking back, however, it is uncertain as to how much

Roosevelt's New Deal programs helped to end the Great Depression. By allaccounts, the New Deal programs eased the hardships of the Great

Depression; however, the U.S. economy was still extremely bad by the end of

the 1930s.


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The major turn-around for the U.S. economy occurred after the bombing ofPearl Harbor and the entrance of the United States into World War II. Once

the U.S. was involved in the war, both people and industry became essential to

the war effort. Weapons, artillery, ships, and airplanes were needed quickly.

Men were trained to become soldiers and the women were kept on the home-front to keep the factories going. Food needed to be grown for both the home-

front and to send overseas.

It was ultimately the entrance of the U.S. into World War II that ended the


Great Depression in the United States.


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What is Economics & why do people economize?

Adam Smith, Economics is a science of wealth

Alfred Marshall, Economics is a study of mankind in the

ordinary business of life; it examines that part of individual

and social action which is most closely associated with theattainment, and with the use of material requisites of well

being.

Human wants desires and aspirations are endless

Resources are limited and scarce

People are of optimizing nature



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What is Macroeconomics

Gardner Ackley, concerns the over-all dimensions of economic life. ..More specifically, macroeconomics concerns itself with such variables

as aggregate volume of an economy, with the extent to which its

resources are employed, with size of the national income, with the

general price level.

J.M. Culbertson, Macroeconomic theory is the theory of income,

employment, prices and money.

P.A. Samuelson, Macroeconomics is he study of he behavior of heeconomy as a whole. It examines the overall level of a nations output,

employment, prices, and foreign trade. More importantly, it studies the

relationship and interaction between the factors or forces that determine

the level and growth of national output and employment, general pricelevel, and the balance of payments positions of an economy.



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What is Macroeconomics

Look at the questions that macroeconomics seeks to answer:

What determines the levels of economic activities, total output, the

general price level, and the overall employment in a country? How is the equilibrium level of national income determined?

What causes fluctuations in the national output and employment?

a e erm nes e genera eve o pr ces n a coun ry

What determines the level of foreign trade and trade balance?

What causes disequilibrium in the balance of payments of a country?

How do the monetary and fiscal policies of the government affect the

economy?

What economic policies can steer the economy on the path of growth?



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Macroeconomic model is the representation of the economic

phenomenon in terms of a set of behavioral assumptions,

definitions, simultaneous equation and identities.

Model building is the process of dividing the entire systemunder different sectors with common features and

characteristics in order to develop a simplified model to study

Macroeconomic model

t e se ecte macroeconom c p enomenon.

Macroeconomic variables are generally classified as:

I. Endogenous variable

II. Exogenous variable



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Endogenous variable are those whose value is determined

within the model.

Some typical endogenous variable are

National income

Consumption

Endogenous variable

Investment

Market interest rate

Price level and

Employment



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Exogenous variable are those whose value is determined

outside the model.

They are:

Money supply

Tax rates

Exogenous variable

Exchange rates and so on



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The relevance and applicability of an economic model to the

real world depends on:

a) How realistic are the assumptions of the model

b)How consistent are the assumptions with one another,

c) How accurate and relevant are the data to validate

assum tions, and

Relevance of models

d)How logical and realistic are equations of the model.

The purpose of economic models is not to replicate the real

world or to produce exact economic laws but to develop and

use a framework to understand better the economic system andits working.



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Stock is a quantity, which is measured at a point in time.

Macro stock variables are the money supply, the total number

of people employed in an economy, the total stock of capital,

the total labor force etc.

Macro flow variables are the savings, investment, change in

inventories, change in money supply, etc.

Concept: Stocks and flows

Imports and exports, taxes, wages and salaries, and dividendare flows.



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Equilibrium is a state of balance or a state where there is no

change.

Disequilibrium is a state of imbalance.

Concept: Equilibrium and disequilibrium

Price


AD

Y*

P*

level

Quality (of all goods and service)


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In static models, the relations between different variables relate

to the same period in time.

These models are unable to explain the process of change.

They apply to models which are in a state of equilibrium.

Dynamic models trace the changes that occur in the values of

Concept: Statics, dynamics and comparative statics

.

They apply to models that are in a state of disequilibrium.

Comparative statics compares two or more such equilibrium

states.



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Origin and growth of macroeconomics

The foundation was laid by British economist, John Maynard

Keynes (1883- 1946) in his revolutionary book The general

Theory of Employment, Interest and Money (1936).

In fact the use of macroeconomics dates back to the writings ofthe 16th century economists called mercantilits.

Thus the growth of ME is divided into 3 subsections:

Classical ME Keynesian revolution and ME

Post- keynesian developments



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The Classical Macroeconomics

The classical economists had not developed any coherent theory.

The summary their thought:

According to classical school of thought, if market forces of demand and

supply are allowed to work freely, then

There will always be full employment in the long run, and

unemployment, if any, will be a short-run phenomenon;

There will be neither over- roduction nor under- roduction at he

aggregated level; and The economy will always be in equilibrium in the long run.

The great depression of 1930s however, proved all the classical

assumptions wrong. During that period there was large scale

unemployment in the most free market industrial economies and

their GNP declined heavily.



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The Keynesian Revolution

Keynes departure from the classical school was caused by his realization

that the classical economics was not capable of predicting , explaining

and providing solution to economic problems.

The Keynesian theories are associated mainly with employment growth

and stability

The central theme of Keynesian theory are :

aggregate demand given the resources

The unemployment in any country is caused by lack of aggregate

demand and economic fluctuations are caused by demand deficiency.

The demand deficiency can be removed through compensatory

government spending.

Indias development plans are largely based on the Keynesian theory of

growth and employment.



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The Post Keynesian Developments

Monetarism (1970) A group of economists led my Milton Friedman.

The role of money is central to the growth and stability of national output,

not the role of aggregate demand for real output, as Keynesians believe.

At the theoretical level, the emphasis shifted from the analysis of the role

of aggregate demand for real output to the aggregate demand for and

supply of money, and at the policy level, the emphasis shifted from

.

Neo classical macroeconomics (1980)

A group called radicalists led by Robert Lucas, the Nobel laureate of

1995

The emphasis was on individuals rational expectations about future

Peoples rational expectations about government monetary and fiscal

policies determine the behavior of aggregate supply and aggregate demand

curves in such a way that real output remains unaffected, though prices and

wages go up.



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The Post Keynesian Developments

Supply-side economics

The team led by Arthur Laffer, emphasized the role of the factors

operating on the supply side of the market.

Cut in tax rate shifts aggregate supply curve rightward and leads toa rise in output and employment.

Neo-Keynesianism


ar e oes no c ear a ways, n sp e o n v ua s wor ng or

their own interest. They give reason that information problem and

cost of changing prices lead to some price rigidities which cause

fluctuations in output and employment.


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Importance/Limitations Of Macroeconomics

Importance:

Growing importance of macroeconomics issues

Persistence of macroeconomic problems

Growing complexity of Economic system

Need for government intervention with the market system

Use of macroeconomics in business mana ement

Limitations: It ignores the structural changes in the constituent elements of

the aggregate.

Aggregates are not a reality but a picture or approximation of

reality

People consider it only as a intellectual attraction without much

practical use



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Objectives And Instruments Of Macroeconomics

OBJECTIVES

Output: High level and rapid growth of output

Employment: High level of employment with low involuntary

unemployment Stable prices

INSTRUMENTS

Monetary Po cy: Buy ng an se ng on s, regu at ng nanc a

institutions

Fiscal Policy:

Government expenditures

Taxation

December 9, 201125Vidya Suresh


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Aggregate Supply And Demand

Aggregate supply refers to the total quantity of goods and services that thenations businesses willingly 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.

Business would like to sell everything they can produce at high price. AS also depends on the price level that businesses can charge as well as on

the economys capacity or potential output. Potential output in turn is

determined by the availability of productive inputs(land, labour, capital,

managerial efficiency with which inputs are combined) Aggregate Demand: refers to the total amount that different sectors in the

economy willingly spend in a given period. AD equals spending on goods

and services. It depends on the level of prices, as well on monetary policy,

fiscal policy and other factors.

AD = consumption + investment+ government purchase+ net exports

AD is also affected by the prices exogenous forces like wars and weather,

and by government policies



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Web references

www.access.gpo.gov/

www.cbo.gov

www. aei.org.

Macro economic data for the US (www.fedstatgs.gov)

www.bea.gov

. .

India: www.rbi.org

http://finmin.nic.in/

(http://planningcommission.gov.in/)

www.dgciskol.nic.in/

CMIE data base-prowess available in your lab



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The Central Tasks Of A Society

The major considerations of any society in the economicfield, irrespective of the way in which it is organized, are:

What to produce (necessities v/s luxury, present v/s

future, perishable v/s non perishable, capital/ consumer) How to produce (technique of production- capital and

labour intensive)

For whom to produce (how to share the goods andservices)

The ultimate goal of economic science is to improve the

living conditions of people in their everyday lives.



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Market / Capitalism and the central tasks

The private ownership of resources or means of production.

How does such a system solve the main tasks of what, how, and for

whom to produce?------- market mechanism

Society consists of two classes of people: Producers andconsumers.

The roducers in market econom are motivated b the desire to

make profits. Their decision to produce a commodity will bedetermined by the costs incurred and the price at which it can be

sold.

The consumers desire goods and services. However, their ability to

fulfill their wants is conditioned by their income.



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Market / Capitalism and the central tasks

The market provides link between producers and consumers.

Thus capitalism is individualistic with self-interest being the primary driving force.

It is a decentralized, decision-making system.

The extreme case of a market economy, in which the government keeps its hands off

economic decisions, is called a laissez-faire economy. Command economy is one in which the government makes all important decisions

about production and distribution. In a command economy, such as the one which

o erated in the Soviet Union durin most of the 20th centur , the overnment owns

most of the means of production; it also owns and directs the operations ofenterprises in most industries; it is the employer of most workers and tells them how

to do their jobs; and it decides how the output of the society is to be divided among

different goods and services.

The government answers the major economic questions through its ownership of

resources and its power to enforce decisions

The basic problems of the economy are decided on the basis of need votes rather

than money votes.



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Mixed Economies And The Central Tasks

No contemporary societies falls completely into either ofthese polar categories. Rather, all societies are mixed

economies, with elements of market and command.

Economic life is organized either through hierarchicalcommand or decentralized voluntary markets. Today most

decisions in the United States and other high- income

plays and important role in overseeing the functioning of themarket; governments pass laws that regulate economic life,

product educational and police services, and control

pollution. Most societies today operate mixed economies.



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An economic system is a way of answering these basic

questions

what, how and for whom to produce

The most general economic systems are

Capitalist Economy

Introduction

Mixed Economy



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A capitalist economy is an economic system in which the

production and distribution of commodities take place through

the mechanism of free markets

An individual has the freedom to buy and sell any number ofgoods and services

Examples:

Capitalist Economy

The United States of America.Brazil

Japan



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Right to Private Property

Individuals have the right to buy and own property

Profit-Motive

Profit is the only motive for the functioning of capitalism.

Freedom of Choice

Features Of Capitalism

the producers

Minimal role of Government

Regulation of market, defence, foreign policy, currency,

etc.


M i


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Economic Growth: Rapid and consistent economic growth is theproven out come of this Capitalism. As there is less government

intervention so many evil like corruption, nepotism, poor management

did not hurt the growth rate. These are the common evils comes with

authority. Another reason of this growth is when people invest theirown money the make best effort to make profit out of it.

Efficient Allocation of Resources: The means of production utilizes at

Merits

.

used to produce the products needed and in demand of market. Efficient production: A competitive environment is there as every

individual can takes any profit making activity. Competition push

producer to take productive steps like cost cutting, new technology and

use of best supply chain for make good profit. Financial incentives: Better financial gains are proven pushing force,

for people to being involved in productive activities.


D it


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Demerits

Inequality: The biggest argument against capitalism is inequality, inthe free economies system the more talented and innovative people

build strong financial position as compare to less skilled individuals. So

this trend leads to inequality of distribution of wealth. Money makes

money it is true in capitalism people who have the money invests theircapital to different businesses and earn more money. Those who do not

have the money cannot avail such opportunities and remain being


.

Lack of Welfare: Capitalism has no feelings it is all about thematerialistic efforts. This is the most popular reason vocal against

capitalism when compare to communism. In communism the whole

philosophy is human welfare in common, this aspect is totally missing

in capitalism. Capitalism talks about reward of effort to individuals andadvocate for it but do not discuss the interest of society and other stake

holders.

S i li


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Characterized as follows:

a) much property held by the public through government, including

major industries, utilities, and transportation systems;

b) a limit on the accumulation of private property;c) government regulation of the economy;

d) extensive publicly financed assistance and pension programs;

Socialism

a) social costs added to financial considerations as measure ofefficiency.

b) Centrally planned economy


F t


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Public Ownership - The economy of socialists is characterised by the means of

production and distribution. There is a collective ownership whereby all mines, farms,

factories, financial institutions, distributing agencies etc are regulated by government

departments and state corporations.

Central Planning - A socialist economy is centrally planned with functions under thedirection of a central planning authority. It lays down the various objectives and targets

to be achieved.

Freedom of consum tion - Under socialism the consumers are at soverei nt that

Features

production in state owned industries is generally governed by the preferences of

consumers and the available commodities distributed to the consumers at fixed prices

through the state run department stores.

Equality of Income Distribution - In a socialist economy, there is great equality of

income distribution as compared with free market economy. The elimination of private

ownership in the means of production, private capital accumulation and profit motiveunder socialism prevent the amassing of large wealth in the hands of a few rich persons.


Merits


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Merits

Socialisms advantages are related to overall well being of community andeasy to understand for general public. Historically we have seen where the

countries are deprived or governed by the intruders, after liberty they adopt

the socialist infrastructure for their country, examples of French and British

colonies can be studied for more details.

Full employment level is another merit of socialism. All the means of

productions are under government control so its responsibility of the state


o provide job for every citizen. Economic conditions are more stable and

there is no boom or recession in economy.

Socialism work for collective good and also take care of financially and

physically handicap people. Every citizen of society has equal rights and

excess to the states resources. This is not true in capitalism, where talentedand rich people secure well financial and social position and other could

not get the equal status.

Demerits


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This system has low economic growth as talented and idle people enjoy the

same status. This leads to low morale level which makes even capable

people inactive, as they feel no reward of their extra effort.

The theory of socialism sounds very attractive where basic rights of everyindividual is secured by government, but in actual the corruption and

nepotism are very high and common person enjoys far less rights then the

Demerits

peop e n aut or ty.

Allocation of resources is poor government doesnt take advance and

creative measures to increase productivity. As there is no profitability factor

so government doesnt follow market demand. There are rigid policies and

difficult to change until or unless change in total administration.

Socialism emphasis more to society and less to the basic unit of society that

is individual, so as long as the basic element is not satisfy with the reward

the total outcome cannot be the satisfactory.


Mixed Economy


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Both public and private institutions exercise economic control.

The public sector functions as a socialistic economy

The private sector as a free enterprise economy freedom to hold private property, to earn profit, to consume,

produce and distribute

Mixed Economy

if these freedoms affect public welfare adversely, they areregulated and controlled by the State


Features Of Mixed Economy


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Public Sector - The state controls the public sector organisations and is operated for thewelfare of the public instead of profit maximisation. But they earn profits like private

industries which are utilised for capita formation.

Private sector - The production and distribution of goods are done by private

enterprises. This sector functions under state regulations in the interest of consumer

goods and some capital goods. Public and private sector operate in competitive spirit in

the interest of the society.

Joint Sector - A mixed economy has semi sector which comprises both of public and

Features Of Mixed Economy

pr va e sec ors an e r ma or y o o ngs are w e s a e.

Cooperative Sector - A sector is formed on the cooperative principles. The state takescare of monetary assistance and runs on the interest of the public.

Freedom and Control - Mixed economy has the liberty to hold private properties to

earn profit, to consume and manufacture and distribute. The control is in the hands of the

state. Economic Planning - The central planning authority is there in a mixed economy and it

operates few of the economic plans. All sectors of the economy function according to the

objectives, priorities and targets laid down in the plan.


Merits


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ECONOMIC STABILITY AND PROPER ALLOCATION OF RESOURCES

A mixed economy remedies this through state regulation of the economy, and

planning. Through economic plan-ning the resources of the economy are utilized in the more

efficient and optimal manner. Production is rationally organized. Possibilities of

overproduction or underproduction are eliminated. The rigours of un-employment and

inequalities are minimized. This enables a mixed economy to enjoy the basic advantages of asocialist economy.

ADVANTAGES OF FREE INITIATIVE AND ENTERPRISE

In a mixed econom the various ca italistic institutions such as rivate ro ert ,

Merits

competition, profit motive and freedom of enterprise, etc., have an adequate scope. There is

adequate incentive for hard work and increased productive effi-ciency and efforts. The

operation of price mechanism provides an element of dynamism to the economy.

FOUNDATION OF INTERNATIONAL COEXISTENCE

A mixed economy is based on an amalgam of private enterprise and public enterprise.

There is coexistence of the private sector with the public sector. Such peaceful economiccoexistence of the two rival sectors at home paves the way for political coexistence abroad. It

makes our attitude tolerant towards others.


Demerits


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CONFLICT BETWEEN THE TWO SECTORSMixed economy represents a compromise between capitalism and socialism

and thereby it aims at availing the advantages of both the worlds. But in reality

there may take place frequent collusions between them. This would only give rise

to further bitterness and non-co- operation. In course of time the private sector may

feel suffocated because of the step-motherly treatment meted out to it. INEFFICIENT PUBLIC SECTOR

In a mixed economy the public sector usually has a record of poor performance. It

suffers from inefficienc redta ism corru tion and waste. Conse uentl the ublic

Demerits

sector has failed either to increase the volume of production or reduce costs.

FAILURE TO ERADICATE ECONOMIC FLUCTUATIONS :

The principle of mixed economy had become popular in the capitalist

countries as it was considered to be a suitable method to eradicate economic

fluctuations. But somehow the problem still persists. Economic fluctuations can be

removed only when the entire economy is fully covered by the central plan. But thetype of regulation that is imposed on the private sector in a mixed economy leaves

much to be desired.

December 9, 2011 Vidya Suresh 44

National Income


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CONCEPTS

&MEASUREMENT

Vidya Suresh 45

NATIONAL INCOME


Measuring Economic Activity through National Income


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g y g

When you can measure what you are speaking about, and

express it in numbers, you know something about it; when you

cannot measure it, when you cannot express it in numbers, your

knowledge is of a meager and unsatisfactory kind; it may be thebeginning of knowledge, but you have scarcely, in your

thoughts, advanced to the stage of science.

Vidya Suresh 46

- or e v n


Measuring Economic Activity through National Income


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g y g

The single most important concept in macroeconomics is the grossdomestic product (GDP), which measures the total value of goods and

services produced in a country during a year.

When economists/policy makers want to determine the level of

economic development of a country, they look at its GDP per capita.

What is GDP? GDP is the total market value of the final goods and

services produced within a nation during a given year measured in

Vidya Suresh 47

monetary units.

It is sum of the dollar values of consumption (C), gross investment ( I),

government purchases of goods and services (G), and net exports (X)

produced within a nation during a given year.

GDP = C+I+ G+ X X = Exports - imports


Contents


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Circular flow of Income

Approaches to measurement of National Income

Measures of Aggregate Income Problems in National Income Accounting

Comparison of NI over time

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Estimation of National Income in India Methodology of Estimation


Circular Flow Of Income


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The mechanism of income and expenditure flows is extremelycomplex in reality.

To present the flows of income and expenditure, the economy

is divided into four sectors: Household, business, government and foreign

These 4 sectors are combined to make the following 3 models:

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Two-sector model including the household and business sectors Three-sector model including the household, business and

government sectors

Four-sector model including the household, business,

government and the foreign sectors.


The Circular-Flow Diagram


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Market for

Goods

and Services

SpendingRevenue

Goods &Services sold Goods &Services

bought

Firms Households

Market for

Factors

of ProductionWages, rent,and profit

Income

Labor, land,and capital

Inputs forproduction

December 9, 2011

50Vidya Suresh

The Circular-Flow Diagram


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Ca italROAD

Government

Tax By House Hold, Income Tax ,Wealth

Factor Payment (wages, Salary, interest, P/l)

Money

Savin s Investment

Internal

Borrowing Corpo

ratetax

NRI

Income

Market

us nessA

Final Goods and Services

(Land, Labor, Capital, Entrepreneur)

Factors of Production

Export & Import

Transfer

Payment


Circular Flow Of Income In A Two Sector Economy


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House HoldFirms

Factor Services

Factors Income

ncome

Expenditure on goods and service

Flow of Good of Services


Circular Flow Of Income In A Three Sector Economy


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Government

Factor Services

Factors IncomeTa

xes

Government expenditure on

goods and subsidies


Services & Transfer Payment

House HoldsCapital

MarketFirms



Savings Investment

December 9, 2011 53

Circular Flow Of Income In A Four Sector Economy


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Government

Factor Services

Factors IncomeTa

xes


goods and subsidies


Services & Transfer Payment

House HoldsCapital

MarketFirms



Savings Investment

Foreign

Sector

P

aymentfor

im

ports

P

aymentfor

exports

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54

Approaches to measurement of National Income


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Net product method or value added method

Factor Income method

Expenditure method

Vidya Suresh 55December 9, 2011 55Vidya Suresh

Net product method / value added method


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This method consists of 3 stages

Estimating the gross value of domestic output in

the various branches of production;

Determining the cost of material and services used

and also the depreciation of physical assets;

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Deducting these costs and depreciation from gross

value to obtain the net value of domestic output




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Estimating the gross value of domestic output in the various

branches of production

For measuring gross value of domestic product, output is

classified under various categories. The classification of

products varies form country to country depending on The nature of domestic industries

Their significance in aggregate economic activities

Vidya Suresh 57

Availability of requisite data 71 divisions are used in the US, a dozen in Netherlands half

a dozen in Russia, and 21-24 in India in CSO


Cont


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After classifying the output in categories, the gross value of

output of each category is computed by any of the following

two alternative methods

Multiplying the output of each sector or category by their

respective prices and adding them together

Vidya Suresh 58December 9, 2011 58Vidya Suresh

Collecting the data on gross sales and inventories from therecords of the companies and adding them up.



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Determining the cost of material and services used and also the

depreciation of physical assets

The next step in estimating the net national product is toestimate the intermediate cost of production including

depreciation.

Vidya Suresh 59

Conventionally depreciation is estimated as some

percentage of original cost of capital, permissible under the

taxation laws.

In some countries dep is estimated as some percentage of

total output rather than cost of capital




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Deducting these costs and depreciation from gross value to

obtain the net value of domestic output (Value added)

Product Value of Inputs Value of Final

Output

Gross Value

Added

1 2 3 4

Vidya Suresh 60

eat

Flour 1000 1500 500

Bread 1500 2000 500

Sandwich 2000 3000 1000

Total 4500 7500 3000


Factor Income Method


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National Income (GDP) = Rent + Wages + Interest + Profit +

Depreciation

Labor Income: wages and salaries, supplementary income,employers contribution , transfer payments

Capital income: dividends, undistributed before tax profits,

Vidya Suresh 61

interest on bonds, mortgages and saving deposits, interest

earned by insurance companies, net rents from land

building, royalties, profit of govt. enterprises

Mixed Income: farming enterprises, sole proprietorship,

medical, legal practice, consultancy, trade , transportation


Expenditure Method


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This is also known as final product method- 2 methods are used

Income disposal method- money expenditures at market

prices are added up together to obtain the total finalexpenditure ( private consumption expen. Direct tax

payments, payments made to the non-profit organizations,

Vidya Suresh 62

charitable institutions, private savings)

Product disposal method- the value of the products finally

disposed of are computed are added together ( private

consumer goods and services, private investment goods,

public goods and services, net investment abroad)


Measurement of National Income in India


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The history of measurement of NI can be divided under 2

phases:

Pre independence phase- The first attempt was made by

Dadabhai Naroroji in 1867-68. Subsequently, severalattempts were made by economists and government

officials to estimate Indias NI. Then Prof. V. K.R. V. Rao

Vidya Suresh 63

estimated I in the year 1925- 29 and1931-32. Though it

was considered to be superior it had serious limitations.

Post independence phase- The first official estimate of

Indias NI was made in 1949 by the Ministry of

Commerce, Government of India.


Cont..


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National Income Commission (NIC) was set up in 1949 my

MOC with P. C. Mahalanobis, D. R. Gadgil and V.K.R.V. Rao

as its members. NIC estimated NI for 1948-49, and for 1951-

52. The methodology developed by NIC was followed till1967.

After 1967, the job went to Central Statistical Organization

Vidya Suresh 64

(CSO) and it adopted improved methodology to estimate

NI.




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Sectors of an economy: An economy comprises of a variety of

economic activities resulting in different sources and nature of

income. To make the NI data easy and comprehensive we

classify different activities into sectors. This is called sectoralaccounting of National Income.

CSO uses followin sectors for classification:

Vidya Suresh 65

Primary sector Secondary sector

Tertiary or service sector

December 9, 201165Vidya Suresh



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PRIMARY SECTOR Agriculture

Forestry and logging

Fishing Mining and Quarrying

Vidya Suresh 66

SECONDARY SECTOR Manufacturing

Registered manufacturing

Unregistered manufacturing Construction

Electricity, water and gas supply




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TERTIARY SECTOR

Transport, Trade and Communication

Transport, storage and communication

Railways

Other means of transport

Communication

Vidya Suresh 67

Finance and Real Estate Banking and insurance

Real estate for residential and business purpose

Community and Personal Services Public administration and defense

Other services


Methods of measuring NI in India


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Production method or value added method: This is also

called net output method or value added method is used to

estimate income or domestic product of the following

production sectors:

Agriculture

Vidya Suresh 68

Fishing Mining and Quarrying

Registered manufacturing



I th d i d f ti ti d ti i f th


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Income method is used for estimating domestic income of the

following sectors:

Unregistered manufacturing

Electricity, water and gas supply

Banking and insurance Transport, storage and communication

Real estate and business services

Vidya Suresh 69

Trade hotels and restaurants

Public administration and defense

Other services

-For the sake of comparison of estimates and to check their

reliability, CSO estimates national income also on the basisexpenditure method. In India, the sectoral accounting of GDP, based on

the expenditure method, follows the following classification of the NI

given below.




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1. Private final consumption expenditure including

expenditure on

i. Durable goods

ii. Semi durable goods

iii. Non-durable goods

Vidya Suresh 70

iv. Services

2. Government final consumption expenditure

3. Gross fixed capital formation including construction,

machinery and equipments

4. Change in stocks, and

5. Net export of goods and services


Some concepts related to NI


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Economic and Non-Economic Production

Economic Production

Marketable and non- marketable production

Non Economic Production

Services rendered to self, family and neighbor

Vidya Suresh 71

nterme ate an na ro ucts

Transfer Payments

Consumer and Producer Goods


Economic Production


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It refers to the production of goods and services which are meantfor sale and have market value.

It also includes those goods and services which are produced

and provided jointly to the public by the government and publicorganizations, for which people pay indirectly through tax

payment.

Thus it includes both marketable and non-marketable

production.

Goods produced by farmers, firms, factories, shops, hoteliers etc

fall under marketable production.

Goods and services produced and supplied by the government,public institutions, social organizations, NGOs etc fall in non

marketable production.


Non-Economic Production


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It includes production and services of goods that are not meantto be sold, nor there is any market for them, nor do they have a

market price. Some of the services which come under this are:

I. Services rendered to self, e.g., eating, shaving, exercising,washing ones own clothes, cooking for self, etc

II.Services to provide to the family members, e.g.,

housewives cooking for the family, parents teaching their

own children, doctors treating their own family members,etc

III.Services provided by the neighbors to each other, e.g.,

helping each other on festival and marriage occasions etc, While calculating national income we will include only

economic production and not non- economic production.


Intermediate Goods


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Goods that flow from one stage to another in the process of production of a good, with their form changing are called

intermediate products.

A product sold by one firm to another for further processing orvalue addition in the process of production is called

intermediate products.

The need for distinction between intermediate and final

products arises because of the problem of double counting.

Double counting leads to overestimation of the national

income.


Final Goods


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The goods that reach the final stage of the production and flowto their ultimate users are called final products.

Product that is sold finally to the consumer is the final product.

Final goods can be classified intoI. Final consumer goods goods that flow to the ultimate

II.Final producer or capital goods machinery, plant andequipments which are used by the firms in the process of

production.


Transfer Payments


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These are payments made by people to the people, and by

people to the government, without corresponding transfer of

goods and services or addition to the total output.

For example, when a person gifts some money to a relative or

friend or when he/she donates an amount to a poor person

payment. When people pay taxes to the government and government pays

old age pension to the people, these are treated as transfer

payments.


National Income Measures


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Gross and net concepts

National and domestic concepts

Market prices and factor costs GNP--- Gross national product

Vidya Suresh 77

---

GDP---gross domestic product NDP---net domestic product

Personal income

Disposable income


Gross Domestic Product (GDP)


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It can be defined as the sum of market value of all final goodsand services produced in a country during a specific period of

time, generally one year.

The market value of domestic product is obtained at bothconstant and current prices.

GDP= consum tion + investment + overnment ex enditure +

net exports.

GDP = market value of goods and services produced by the

residents in the country + incomes earned in the country by

foreigners incomes received by residents of a country from

abroad.


Gross national product(GNP)


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It includes the income of the resident nationals which they

receive abroad, and excludes the income generated locally but

accruing to the non-nationals.

GNP = market value of domestically produced goods and

services + incomes earned by the residents of a country in

country.


Net national product(NNP)


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NNP = GNP depreciation or capital consumption

A part of capital goods is used up or consumed in the process

of production of these goods.

This is called depreciation or capital consumption.

NP s n act, t e actua measure o nat ona ncome.


Personal income(PI)


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It can be defined as the sum of all kinds of incomes received

by the individuals from all sources of incomes.

It includes wages, salaries, fees and commission, bonus,dividends, interest earnings.

, ,

old age benefits. It also includes the income through illegal means




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Personal income

PI= NNP at factor cost-undistributed profits-corporate taxes

+ transfer payments Disposable income

D I= ersonal income ersonal taxes

Vidya Suresh 82

PI = DI +T DI =C+ S

Thus PI = C+S+T

C= Consumption spending S = personal saving




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NOMINAL and REAL GNP

The GNP/GDP are estimated at both current and constant

prices. The GNP estimated at current prices is callednominal GNP and the one estimated at constant prices in a

Vidya Suresh 83

.

The need for estimating GNP at constant prices arisesbecause GNP at the current prices produces a misleading

picture of economic performance when prices are

continuously rising or decreasing.




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GNP valued at current prices shows rise in GNP under thefollowing conditions:

Actual production is decreasing but prices are rising

Actual production remains constant and prices are rising

Estimating GNP at the prices of the base year is not an easy task.

Therefore we use GNP deflator or National Income Deflator to

Vidya Suresh 84

eliminate the effect of rising prices on the GNP and to work out

real GNP at the base year prices.




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The GNP Deflator and its Application

The GNP deflator is essentially an adjustment factor used to

convert nominal GNP into real GNP.

The GNP deflator is the ratio of price index number (PIN) of achosen year to the price index number (PIN) of the base year.

Vidya Suresh 85

The formula for converting nominal GNP of a year into realGNP:

Real GNP = Nominal GNP/ GNP Deflator

Real GNP = Nominal GNP/ PIN (cy)/100



Given the data:


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Nominal GNP of India/ GNP estimated at current prices in year 2000 =

Rs 500 billion

Price of Index number (PIN) , base year 2000 = 100

Nominal GNP at year 2005 = 600 billion PIN rises = 110

GNP deflator = PIN (2005) = 110 = 1.10

Vidya Suresh 86

100 100

Given the GNP Deflator at 1.10, the real GNP for the year 2005 can be :

Real GNP = Nominal GNP/ GNP Deflator

= Rs. 600 billion / 1.10= Rs. 545.45 billion




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Note that the Nominal GNP increases from Rs.500 billion to Rs

600 billion that is by 20 percent over a period of 5 years or at

an annual average rate of 4 percent.

Since PIN increases from 100 to 110, i.e., by 10 percent over 5

years, real GNP increases at a lower rate, i.e., at 9.12 percent or

12/9/2011 Vidya Suresh 87

at an annual average rate of 1.8 percent.



GNP Implicit Deflator

A th i t f GNP d fl t i GNP i li it d fl t l ll d i li


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Another variant of GNP deflator is GNP implicit deflator, also called implicprice deflator. It is the ratio of nominal GNP to real GNP, i.e.,

GNP Implicit Deflator = Nominal GNP/ Real GNP

The GNP implicit deflator can be used for the following:

To construct price index

To measure the rate of change in prices or to measure inflation

Vidya Suresh 88

om na n e ear = s on

Real GNP in the year 2005 = Rs 545.45 billion GNP Implicit Deflator = 600/ 545.45

= 1.10

The GNP implicit deflator multiplied by 100 give the Price Index Number (PIN)

PIN (2005) = GNP Implicit Deflator * 100

= 1.10 * 100 = 110



Thus, 110 is the price index number for the year 2005. The same

d b d t d t l l t PIN f th


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procedure can be adopted to calculate PIN for other years.

Once PINs for different years are calculated, the same can be used to

calculate the rate of change in price, i.e., the rate of inflation.

Rate of Inflation = PIN 2005 PIN 2000 * 100

PIN 2000

Vidya Suresh 89

= 110 100 * 100 = 10 percent

100

This means that inflation over a period of 5 years was 10 percent or

at an annual average rate of 2 percent.


Some problems in National Income Accounting

D ti f d ti ti it


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Demarcation of productive activity

Treatment of non marketed output

Distinction between final and intermediate goods

Avoiding double counting and the concept of value added

Value added = Total sales + Closing stock of finished and

Vidya Suresh 90

sem n s e goo s- tota expen ture on raw mater a s an

intermediate products purchased from other firms- openingstock of finished and semi finished goods.


Is national income true measure of economic welfare?

Can national income be dependable measure of economic

welfare? Does its increase bring about a corresponding


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welfare? Does its increase bring about a correspondingincreases in economic welfare?

NI cannot be reliable as it takes into consideration tractions

done in terms of money. Barter system doesnt get intoaccount.

gain, the I may increase or decrease according to an

Vidya Suresh 91

increase or decrease in the general price level, because it is

expressed on the basis of current money value even when theactual NI has not changed at all.

Increase in NI may not mean rise in welfare as the more than

proportionate increase in population may decrease the percapita income, people may spend the increased income on

harmful goods and activities.


Documents

Finished Ppt. Unit 1