Unit 1: National Income:

National income refers to the aggregate money value of all final goods and services resulting from the economic activities of the people of a country over a period of one year. National income is the most important variable from both the theoretical and the practical points of view. At the theoretical level, a major part of macroeconomic theories seeks to explain the determination of national income, the interrelationship and interaction between its various components and growth of, and fluctuation in, national income. From the practical point of view, a countrys national income data is used for i) ii) iii) measuring the standard of living and economic welfare of its people, formulation of economic policies for the management of the economy, and making international comparisons about the status of the economy.

Meaning: The labour of a country work with capital and natural resources to produce annually a certain amount of goods and services. This is called national income of a country. 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. Two things must be noted in regard to this meaning of national income. First, it measures the market value of annual output. In other words, national income is a monetary measure. Secondly, for calculating national income accurately all goods and services produced in any given year must be counted only once and not more than once. Most of the goods go through a serious of production stages before reaching a market. As a result, parts or components of many goods are bought and sold many times. Hence, in order to avoid counting several times the parts of goods that are sold and resold, national income only includes the market value of all final goods and services and ignores the transactions involving intermediate goods. The above way of explaining national income is only one way of interpreting it. In fact, the concept of national income has three interpretations. It represents a total value of production, it represents total income. It represents a total of expenditure made. It is an obvious fact that every expenditure is at the same time a receipt. In other words, amount spent is equal to amount received. But as goods and services are valued at their market prices, we have three-fold identity, namely, that the value equals the value paid equals the value of goods and services produced and sold. To explain the above idea let us take an economy where there are only two agents: households and firms. Firms are required to produce goods. To produce them, they require services of factors of production. Factors of production are paid rewards for their contribution to the production of goods. Thus incomes of these factors arise in the course of production. The market value of net production must equal the sum total of payments made by the firms to the factors of production in the form of wages, rent, interest and profits. These incomes in terms become the sources of expenditure. Thus income flows from the firms to the households in exchange for productive services. This income gain returns to the firms when expenditure is made by the households on goods and services produced by them. From above it follows that: National Income = National Product = National Expenditure. Thus, there are three measures of national income of a country; a) The sum of values of all final goods and services produced; b) The sum of all incomes, in cash and kind, accruing to factors of production in a year; and c) The sum of consumption expenditure, net investment expenditure and government expenditure on goods and services. Sum of all incomes, sum of values of all final production, and sum of all expenditures will be the same, but the significance of each arises from the fact that they reflect the three basic activities of the nations economy, viz., production, distribution and expenditure.
Circular flow of income:

1.

Definition of circular-flow diagram: a visual model of the economy that shows how dollars flow through markets among households and firms. This diagram is a very simple model of the economy. Note that it ignores the roles of government and international trade. There are two decision makers in the model: households and firms. There are two markets: the market for goods and services and the market of factors of production. Firms are sellers in the market for goods and services and buyers in the market for factors of production. Households are buyers in the market for goods and services and sellers in the market for factors of production. The inner loop represents the flows of inputs and outputs between households and firms. The outer loop represents the flows of dollars between households and firms. Circular Flow of National Income :National income is a flow of money payments resulting from the productive resources of a country during a year. It has the concept of circular flow in this sense that the economic transactions which are made in a country during a particular year appears in different ways. The expenditure of one person is the income of another person, and his expenditure is also equal to value of goods and services. To explain this idea we assume that there is economy where are only two sectors in the economy. 1. Firms. 2. House holds. Firms are required to produce goods. Households own the various factors of production. Firms require the services of households to produce goods. The firms hire the services of households to produce goods. These goods are again supplied to the households. When households sector purchases the goods it makes the payments. Similarly firms make the payment in the shape of rent, wages, and interest to the households against their services. In this way the sum of prices of the goods and services must be equal to the sum of the reward for the services of factors of production. So income flows from firms to households in exchange for these services and again the expenditure flows from households to firms. The goods which are produced by the firms these are purchased by the household. The flow of income flows from firms to household and flow of expenditure from household to firms will be equal. This is called circular flow of national income. We can also explain the circular flow of national income buy the following diagram :

2. a. b. c. d. e. f.

In this diagram two circular flows are shown. 1. People provide the services and firms produce the goods and provide to the people. 2. People received reward against their services from the firms. The payments which are received by the people, these are spent on the purchase of those goods which are produced by the firms

Circular flow of income

In this simplified image, the relationship between the decision-makers in the circular flow model is shown. Larger arrows show primary factors, whilst the red n ,.0p;smaller arrows show subsequent or secondary factors. In economics, the terms circular flow of income or circular flow refer to a simple economic model which describes the reciprocal circulation of income between producers and consumers. In the circular flow model, the inter-dependent entities of producer and consumer are referred to as "firms" and "households" respectively and provide each other with factors in order to facilitate the flow of income. Firms provide consumers with goods and services in exchange for consumer expenditure and "factors of production" from households. More complete and realistic circular flow models are more complex. They would explicitly include the roles of government and financial markets, along with imports and exports. Human wants are unlimited and are of recurring nature therefore, production process remains a continuous and demanding process. In this process, household sector provides various factors of production such as land, labour, capital and enterprise to producers who produce by goods and services by co-ordinating them. Producers or business sector in return makes payments in the form of rent, wages, interest and profits to the household sector. Again household sector spends this income to fulfil its wants in the form of consumption expenditure. Business sector supplies them goods and services produced and gets income in return of it. Thus expenditure of one sector becomes the income of the other and supply of goods and services by one section of the community becomes demand for the other. This process is unending and forms the circular flow of income, expenditure and production. Reference- S.Dinesh Introduction to Macro Economics. A continuous flow of production, income and expenditure is known as circular flow of income. It is circular because it has neither any beginning nor an end. The circular flow of income involves two basic principles:- 1.In any exchange process, the seller or producer receives the same amount what buyer or consumer spends. 2.Goods and services flow in one direction and money payment to get these flow in return direction, causes a circular flow. Circular flows are classified as: Real Flow and Money Flow. Real Flow- In a simple economy, the flow of factor services from households to firms and corresponding flow of goods and services from firms to households s known to be as real flow. Assume a simple two sector economy- household and firm sectors, in which the households provides factor services to firms, which in return provides goods and services to them as a reward. Since there will be an exchange of goods and services between the two sectors in physical form without involving money, therefore, it is known as real flow. Money Flow- In a modern two sector economy, money acts as a medium of exchange between goods and factor services. Money flow of income refers to a monetary payment from firms to households for their factor services and in return monetary payments from households to firms against their goods and services. Household sector gets monetary reward for their services in the form of rent, wages, interest, and profit form firm sector and spends it for obtaining various types of goods to satisfy their wants. Money acts as a helping agent in such an exchange.

Circular Flow of Income

The amount of income generated in a given economy within a period of time (national income) can be viewed from three perspectives. These are:

Income, Product, and Expenditure. The above assertion implies that we can view national income as either the total sum of all income received within a particular period (income); the total good and services produced within a particular period (product) or total expenditure on goods and services within a given period (expenditure). Whichever approach is used, the value we get is the same.

The circular flow of income and product is used to show diagrammatically, the equivalence between the income approach and the product approach in measuring gross national product (GNP). In analysing the circular flow of income, there are three scenarios: 1. A simple and closed economy with no government and external transactions, i.e., two-sector economy; 2. A mixed and open economy with savings, investment and government activity, i.e., three-sector economy; and 3. A mixed and open economy with savings, investment, government activity and external trade, i.e., four-sector economy. 1. Circular Flow of Income in a Two-Sector Economy: According to circular flow of income in a two-sector economy, there are only two sectors of the economy, i.e., household sector and business sector. Government does not exist at all, therefore, there is no public expenditure, no taxes, no subsidies, no social security contribution, etc. The economy is a closed one, having no international trade relations. Now we will discuss each of the two sectors: (i) Household Sector: The household sector is the sole buyer of goods and services, and the sole supplier of factors of production, i.e., land, labour, capital and organisation. It spends its entire income on the purchase of goods and services produced by the business sector. Since the household sector spends the whole income on the purchase of goods and services, therefore, there are no savings and investments. The household sector receives income from business sector by providing the factors of production owned by it.

(ii) Business Sector: The business sector is the sole producer and supplier of goods and services. The business sector generates its revenue by selling goods and services to the household sector. It hires the factors of production, i.e., land, labour, capital and organisation, owned by the household sector. The business sector sells the entire output to households. Therefore, there is no existence of inventories. In a two-sector economy, production and sales are thus equal. So long as the household sector continues spending the entire income in purchasing the goods and services from the business sector, there will be a circular flow of income and production. The circular flow of income and production operates at the same level and tends to perpetuate itself. The basic identities of the two-sector economy are as under: Y=C Where Y is C Income is Consumption

Circular Flow of Income in a Two-Sector Economy (Saving Economy): In a two-sector macro-economy, if there is saving by the household sector out of its income, the goods of the business sector will remain unsold by the amount of savings. Production will be reduced and so the income of the households will fall. In case the savings of the households is loaned to the business sector for capital expansion, then the gap created in income flow will be filled by investment. Through investment, the equilibrium level between income and output is maintained at the original level. It is illustrated in the following figure:

The equilibrium condition for two-sector economy with saving is as follows:

Y=C+S

or

Y=C+I or S=I

or

C+S=C+I

Where Y C S I

is is is is

Income Consumption Saving Investment

When saving and investment are added to the circular flow, there are two paths by which funds can travel on their way from households to product markets. One path is direct, via consumption expenditures. The other is indirect, via saving, financial markets, and investment. Savings: On the average, households spend less each year than they receive in income. The portion of household income that is not used to buy goods and services is termed Saving. Since there is no government in a two-sector economy, therefore, there are no taxes in this economy. The most familiar form of saving is the use of part of a households income to make deposits in bank accounts or to buy stocks, bonds, or other financial instruments, rather than to buy goods and services. However, economists take a broader view of saving. They also consider households to be saving when they repay debts. Debt repayments are a form of saving because they, too, are income that is not devoted to consumption or taxes. Investment: Whereas households, on the average, spend less each year than they receive in income, business firm spend more each year than they receive from the sale of their products. They do so because, in addition to paying for the productive resources they need to carry out production at its current level, they desire to undertake investment. Investment includes all spending that is directed toward increasing the economys stock of capital. Financial Market: As we have seen, households tend to spend less each year than they receive in income, whereas firms tend to spend more than they receive from the sale of their products. The economy contains a special set of institutions whose function is to channel the flow of funds from households, as savers, to firms, as borrowers. These are known as financial markets. Financial markets are pictured in the center of the circular-flow diagram in the above figure. Banks are among the most familiar and important institutions found in financial markets. Banks, together with insurance companies, pension funds, mutual funds, and certain other institutions, are termed financial intermediaries, because their role is to gather funds from savers and channel them to borrowers in the form of loans. 2. Circular Flow of Income in a Three-Sector Economy: We have so far discussed the two-sector economy consisting of household sector and business sectors. Under three-sector economy, the additional sector is the government. Two-sector economy is a hypothetical economy, whereas the three-sector economy is much more realistic. The inclusion of the government sector is very essential in measuring national income. The

government levies taxes on households and on business sector, purchases goods and services from business sector, and attain factors of production from household sector.

The following figure illustrates three-sector economy:

the above diagram, in one direction, the household sector is supplying factors of production to the factor market. Business sector demands the factors of production from factor market. Inputs are used by the business sector, which produces goods and services that are purchased back by the households and the government. Personal income after tax or disposable income that is received by households from business sector and government sector is used to purchase goods and services and makes up consumption expenditure (or C). The money spent in the product market is the market value of final goods and services (or GDP). That money goes to business sector that pays it back in the form of wages, rent, profits and interests. Total spending on goods and services is known as aggregate demand. The total market value of output produced and sold is also known as aggregate supply. To measure aggregate demand in a closed economy, we simply add consumption spending (C), investment spending (I) and government spending (G). Therefore: Y=C+I+G Where Y is Income, I is Investment, and C is Consumption, G is Government Spending.

In

Note that government spending (G) includes its buying of labour from factor market, buying of goods and services from product market, and transfer payments to the household sector. Transfer payments are payments the government makes in return for no service, for example, welfare payments, unemployment compensation, pension, etc. The government collects its money in the form of tax, which makes up most of the government revenue. But the government does not always balance their budgets. The government always tends to spend more than it takes in as taxes. The federal government almost always runs a deficit. The government deficit must be financed by borrowing in financial markets. Usually this borrowing takes the form of sales of government bonds and other securities to the public or to financial intermediaries. Over time, repeated government borrowing adds to the domestic debt. The debt is a stock that reflects the accumulation of annual deficits, which are flows. When the public sector as a whole runs a budget surplus, the direction of the arrow is reversed. Governments pay off old borrowing at a faster rate than the rate at which new borrowing occurs, thereby creating a net flow of funds into financial markets. 3. Circular Flow of Income in a Four-Sector Economy:

Two-sector economy and three-sector economy are briefly discussed in previous sections. These are hypothetical economies. In real life, only four-sector economy exists. The four-sector economy is composed of following sectors, i.e.: (i) Household sector,

(ii) Business sector, (iii) The government, and (iv) Transaction with rest of the world or foreign sector or external sector. The household sector, business sector and the government sector have already been defined in the previous sections. The foreign sector includes everyone and everything (households, businesses, and governments) beyond the boundaries of the domestic economy. There is an export of goods produced by the domestic economy and imports purchased by the domestic economy, which are commonly combined into net exports (exports minus imports). The inclusion of fourth sector, i.e., foreign sector or transaction with rest of the world makes the national income accounting more purposeful and realistic. With the inclusion of this sector, the economy becomes an open economy. The transaction with rest of the world involves import and export of goods and services, and new foreign investment. It is illustrated in the following figure.

In four-sector economy, goods and services available for the economys purchase include those that are produced domestically (Y) and those that are imported (M). Thus, goods and services available for domestic purchase is Y+M. Expenditure for the entire economy include domestic expenditure (C+I+G) and foreign made goods (Export) = X. Thus: Y+M=C+I+G+X Y = C + I + G + (X M) Where, I G X M XM C = Consumption expenditure = Investment spending = Government spending = Total Exports = Total Imports = Net Exports

What is National Income? National income measures the money value of the flow of output of goods and services produced within an economy over a period of time. Measuring the level and rate of growth of national income (Y) is important to economists when they are considering: The rate of economic growth Changes over time to the average living standards of the population Changes over time to the distribution of income between different groups within the population (i.e. measuring the scale of income and wealth inequalities within society) Consumer spending accounts for over two thirds of total spending. Consumer spending has been strong in recent years, a reflection of rising living standards and low unemployment, but this may now be coming to an end because of the mountain of household debt.

Methods of Measuring National Income: Since factor incomes arise from the production of goods and services, and since incomes are spent on goods and services produced, three alternatives methods of measuring national income are possible. 1. Value Added Method or Product Method 2. Income Method 3. Expenditure Method 1. Value Added Method or Product Method: Value added method is used to avoid double counting, i.e., counting the value of a commodity more than once. To understand the problem of double counting, recall the definition of national income (GDP). National income is defined as the money value of all final goods and services produced in a given period of time. The problem of double counting arises because of the conceptual and practical problem of defining what product is final and what is considered intermediate product. In the process of production, some material products pass from one stage to another. But, at each stage of production, it is transformed into a final product. However, the same final product is used as material input at the next stage in the production process of another commodity. Therefore, the value of the same product is likely to be counted twice or more than twice, in estimating national income. For example, wheat is the final product for the farmer, Kisanchand. But wheat is an input (raw material) for a flour mill, say, Shakthi Atta. Wheat flour is the final product for shakti Atta company. But wheat flour is used by the bread manufacturer, Britannia Bread Company, as raw material. For Britannia, bread is the final product. But bread is an input for sandwich-maker, the Tasty food Restaurant. Now, if all these products wheat, wheat flour, bread and sandwich are treated as final products, then the value of wheat will be counted at four stages wheat production, flour production, bread production and sandwich production. This is called double counting in national accounting jargon. Value Addition by Flour Mill (Per quintal) Cost of wheat (intermediate input) Rs. 1000 Transportation cost Rs. 50 Labour charge Rs. 150 Electricity charge Rs. 100 Storage cost Rs. 50 Depreciation Rs. 50 Profit margin Rs. 100 ---------------------------Sales price Rs. 1500 Less cost of wheat (raw material) Rs. 1000 --------------------------Value added Rs. 500 --------------------------Method of Measuring Value Added: ------------------------------------------------------------------------------------------------------(Rs. Per quintal) Product Value of Inputs Value of Final Gross Value Output Added (3 2) 1 2 3 4

Wheat Nil 1000 1000 Flour 1000 1500 500 Bread 1500 2000 500 Sandwich 2000 3000 1000 Total 4500 7500 3000 ----------------------------------------------------------------------------------------------------------

i) ii) iii)

Double counting results in overestimation of national income. Therefore, in order to avoid the problem of double counting, a method called value added method is used to estimate the national income. This method avoids counting value of wheat, a material input, more than once. The same method of value added is followed for each enterprise producing goods and services within the territory of a country. For the purpose of estimating value added, the following steps are generally followed. Identifying the production units and classifying them under different industrial activities. Estimating net value added by each production unit in each industrial sector. Adding up the total value added of each final product to arrive at GDP.

2. Income Method: This method approaches national income from distribution side. In other words, this method measures national income at the phase of distribution and appears as income paid and or received by individuals of the country. Thus, under this method, national income is obtained by asumming up the incomes of all individuals of a country. Individuals earn income by contributing their own services and the services of their property such as land and capital to the national production. Therefore, national income is calculated by adding up the rent of land, wages and salaries of employees, interest on capital, profits of entrepreneurs and incomes of selfemployed people. Measurement of national income through income method involves the following main steps: i) Like the value added method, the first step in income method is also to identify the productive enterprises and then classify them into various industrial sectors such as agriculture, fishing, forestry, manufacturing, transport, trade and commerce, banking etc. ii) The second step is to classify the factor payments. The factor payments are classified into the following groups. a. Compensation of employees which includes wages and salaries, employers contribution to social security schemes. b. Rent and also royalty, if any. c. Interest d. Profits: Profits are divided into three sub-groups: 1. Dividend 2. Undistributed profits 3. Corporate income tax 4. Mixed income of the self-employed: In India as in other developing countries there is fourth category of factor income which is termed as mixed income of self-employed. In India a good number of people are engaged in household industries, in family farms and other unorganised enterprises. Because of self-employment nature of the business it is difficult to separate wages for the work done by the self-employed from the surplus or profits made by them. Therefore, the incomes earned by them are mix of wages, rent, interest and profit and are, therefore, called mixed income of the self-employed. iii) The third step is to measure factor payments: Income paid out by each enterprise can be estimated by gathering information about the number of units of each factor employed and the income paid to each unit of every factor. Price paid out to each factor multiplied by the number of units of each factor employed would give us the factors income. The adding up of factor payments by all enterprises belonging to an industrial sector would give us the incomes paid out to various factors by a particular industrial sector.

By summing up the incomes paid out by all industrial sectors we will obtain domestic factor income which is also called net domestic product at factor cost (NDP fc). iv) Finally, by adding net factor income earned from abroad to domestic factor income or NDP fc we get net national product at factor cost (NNP fc) which is also called national income. 3. Expenditure Method: Expenditure method arrives at national income by adding up all expenditure made on goods and services during a year. Income can be spent either on consumer goods or capital goods. Again, expenditure can be made by private individuals and households or by government and business enterprises. Further, people of foreign countries spend on the goods and services which a country exports to them. Similarly, people of a country spend on imports of goods and services from other countries. We add up the following types of expenditure by households, government and productive enterprises to obtain national income. a) Expenditure on consumer goods and services by individuals and households. This is called final private consumption expenditure, and is denoted by C. b) Governments expenditure on goods and services to satisfy collective wants. This is called governments final consumption expenditure, and is denoted by G. c) The expenditure by productive enterprises on capital goods and inventories or stocks. This is called gross domestic capital formation or gross domestic investment and is denoted by I or GDCF. Gross domestic capital formation is divided into two parts: i) Gross fixed capital formation ii) Addition to the stocks or inventories of goods d) The expenditure made by foreigners on goods and services of a country exported to other countries which are called exports and denoted by X. We deduct from exports (X) the expenditure by people, enterprises and government of a country on imports (M) of goods and services from other countries. That is, we have to estimate net exports (that is, exports imports) or (X-M). The following sectors and subsectors and the method of measuring national income originating in these sectors are as follows: A. Primary Sector: Agriculture, Forestry and Logging, Fishing Mining and Quarrying. B. Secondary Sector: Manufacturing: this is further divided into two sub-sectors. Registered manufacturing and unregistered manufacturing. Construction Electricity Gas and Water Supply Trade, Hotel and Restaurants C. Tertiary Sector: Transport, Storage, Communications and Trade Railways, Transport by other means, Storage and Communication Finance and Real Estate Banking and Insurance, Real estate, Ownership of Dwellings and Business Services. Community Social and Personal Services. Public Administration and Defence and other services.
GDP Definition Gross Domestic Product. The total market value of all final goods and services produced in a country in a given year, equal to total consumer, investment and government spending, plus the value of exports, minus the value of imports. The GDP report is released at 8:30 am EST on the last day of each quarter and reflects the previous quarter. Growth in GDP is what matters, and the U.S. GDP growth has historically averaged about 2.5-3% per year but with substantial deviations. Each initial GDP report will be revised twice before the final figure is settled upon: the "advance" report is followed by the "preliminary" report about a month later and a final report a month after that. Significant revisions to the advance number can cause additional ripples through the markets.

`The GDP numbers are reported in two forms: current dollar and constant dollar. Current dollar GDP is calculated using today's dollars and makes comparisons between time periods difficult because of the effects of inflation. Constant dollar GDP solves this problem by converting the current information into some standard era dollar, such as 1997 dollars. This process factors out the effects of inflation and allows easy comparisons between periods. It is important to differentiate Gross Domestic Product from Gross National Product (GNP). GDP includes only goods and services produced within the geographic boundaries of the U.S., regardless of the producer's nationality. GNP doesn't include goods and services produced by foreign producers, but does include goods and services produced by U.S. firms operating in foreign countries.

GNP
Definition Gross National Product. GNP is the total value of all final goods and services produced within a nation in a particular year, plus income earned by its citizens (including income of those located abroad), minus income of non-residents located in that country. Basically, GNP measures the value of goods and services that the country's citizens produced regardless of their location. GNP is one measure of the economic condition of a country, under the assumption that a higher GNP leads to a higher quality of living, all other things being equal.

The Gross National Product (GNP) is the total dollar value of all final goods and services produced for consumption in society during a particular time period. Its rise or fall measures economic activity based on the labor and production output within a country. The figures used to assemble data include the manufacture of tangible goods such as cars, furniture, and bread, and the provision of services used in daily living such as education, health care, and auto repair. Intermediate services used in the production of the final product are not separated since they are reflected in the final price of the goods or service. The GNP does include allowances for depreciation and indirect business taxes such as those on sales and property.

Gross National Product (GNP)

An estimate of the total money value of all the final goods and services produced in a given one-year period by the factors of production owned by a particular country's residents. ("Final" goods and services means goods and services sold or otherwise provided to their final consumers -- that is, to avoid double counting, the value of steel sold to GM to make a car is not added separately into the GNP or GDP totals because its value is already included when we add in the final sales price of the car to the customer.) GNP and GDP are very closely related concepts in theory, and in actual practice the numbers tend to be pretty close to each other for most large industrialized countries. The differences between the two measures arise from the facts that there may be foreign-owned companies engaged in production within the country's borders and there may be companies owned by the country's residents that are engaged in production in some other country but provide income to residents. So, for example, when Americans receive more income from their overseas investments than foreigners receive from their investments in the United States, American GNP will be somewhat larger than GDP in that year. If Americans receive less income from their overseas investments than foreigners receive from their US investments, on the other hand, American GNP will be somewhat smaller than GDP. Equivalent estimates of GNP (or GDP) produced in a given year may theoretically be arrived at through at least three different accounting approaches, depending upon whether the transactions that determine the prices of final goods and services are looked at and tallied up by focussing on the buying or by focussing on the proceeds from selling or by focussing on the nature of the products themselves. Using the expenditure approach, you can estimate total GNP as the sum of estimates of the amounts of money that are spent on final goods and services by households (Consumption), by business firms (Investment), by government (Government Purchases), and by the world outside the country (Net Exports). Using the incomes approach, you can estimate total GNP by summing up estimates of the different kinds of earnings people receive from producing these same final goods and services:

Total wages and salaries Profits of incorporated and unincorporated businesses Rental incomes Interest incomes (Plus certain adjustments to account for wear and tear on productive assets like plant and machinery -- depreciation -- and what are called indirect business taxes). Using the product or output approach, you can estimate GNP by summing up the output of all the various organizations producing goods and services in the country, subtracting out the costs of their raw materials to avoid double counting and making suitable adjustments for depreciation and for the value of imports and exports.

(In theory, all three approaches should give you the same grand totals -- but of course in actual practice there will be discrepancies, and sometimes sizable discrepancies, between the three estimates.) Why does anyone bother to estimate the GNP or GDP? For the same reasons statistical data is also gathered on unemployment rates, consumer price levels, the international trade balance and so on -- to facilitate economic policy making by government, to assist in planning by decision-makers in private business, and to test economic theories. If government policy makers include among their goals the promotion of economic growth and material prosperity in the national economy as a whole by means of monetary and fiscal policy, they need to have some reasonably precise way of telling how the economy is doing so as to decide whether they should be pushing on the gas or stepping on the brakes. Businessmen responsible for planning new investments in plant and equipment or the introduction of new products can use macroeconomic data and economic theory to forecast the likely levels of demand for their products and the probable trends in their various costs of production. Finally, a historical record of such statistics provides economists with the necessary data to test and refine their theories about how the economy actually works (and, in the process, perhaps to improve the policy makers' understanding of the likely consequences of their policies). GNP and GDP are among the most comprehensive measures of the overall amount of economic production taking place in a national economy. Nevertheless, the available statistics produced by government agencies are always far from perfect estimates of what they purport to measure. They are measured in money value terms to get around the problem of adding up total output of many different goods and services that are normally expressed in many different kinds of incomparable physical units. Microeconomic theory gives us lots of reasons for believing that the relative prices at which products trade on a free market represent reasonably unbiased estimates of the relative values consumers put upon the various kinds of goods and services traded -- at least where there are no large problems with externalities or public goods. But not all the final goods and services produced in a society are traded on the free market, and the relative contributions of these untraded goods and services to the consumers' material living standards are therefore awfully difficult to estimate very well. Most of the services produced by government, to take the largest example, cannot be valued at a free market price because they are not offered for voluntary purchase on a free market -- instead, the presumed beneficiaries of these services (the citizenry) are forced to pay for them through taxes, whether they think the benefits are "worth it" or not. In compiling the national accounts, the government statistical offices simply make the heroic (and self-flattering) assumption that all the goods and services provided by government are "worth" at least what was spent to produce them, however outrageous the costs might have been and however worthless (or harmful) the output might have been in the eyes of the citizenry. A very large category of privately produced goods and services whose production does not register at all in the official GNP or GDP statistics (because they do not trade for money on the market) consists of householders' home production for their own use -- things like backyard vegetable gardening, do-it-yourself home and auto repairs, and the innumerable productive service activities of homemakers in cooking, cleaning, sewing, childcare and so on. Another major omission from the national accounts consists of goods and services that actually are traded for money on markets -- black markets -- but the transactions are deliberately concealed from government information collectors, either to avoid prosecution for trading in illegal demerit goods (for example, drugs and prostitution) or simply to avoid paying taxes or submitting to costly regulations on otherwise potentially legal business transactions (working off the books, unauthorized import/export trade, "moonshine" production of liquor, etc.). Economists' unofficial estimates of the size of the American "underground economy" in recent years range from no less than 5% to as much as 30% of official GDP!) If one wants to use GNP (or GDP) to measure changes in overall levels of economic production from one year to the next, then using money prices as a "common denominator" for adding up all the disparate kinds of goods and services introduces another problem for the accuracy of the estimates -- inflation. Using money valuations to measure output at several points in time is a little like using a rubber tape-measure to measure several different distances. Part of the increase in GNP (or GDP) from one year to the next really is the result of increased output, but part is also likely to be due merely to change in the value of the currency unit used to measure it. Government statistical compilers try to deal with this problem by producing estimates of "real" or "constant dollar" GNP (and GDP), dividing their original ("current dollar") estimates by one or another of many possible "price indexes" constructed to account for and remove the effects of general price inflation -- but the problems of choosing and constructing appropriate price indexes for this purpose are themselves numerous and admit of no single unambiguous "best" answer to the problem. It is also important to keep in mind that GNP and GDP (even when divided by the size of the population to produce "per capita GNP") were never intended even theoretically to be good measures of overall economic welfare: they are at best only measures of recent levels or rates of productive activity. Overall societal welfare is a broader concept than just economic welfare, and GNP (or GDP) is at best only a very incomplete measure even of economic welfare, since levels of current production do not necessarily reflect the levels of accumulated wealth actually at the disposal of the citizenry. Moreover, the greater availability of leisure time made possible by today's higher levels of productivity is pretty clearly an improvement in our economic welfare over the days of the early 19th century 14-hour workday. But this improvement does not show up at all in our long-term GNP growth rates -- except possibly in a backwards way, since our official GNP would no doubt be much

higher than it is today if everyone still worked a 14-hour workday using our modern technology instead of "wasting" all those potential labor hours on "nonproductive" recreation, relaxation, contemplation and socializing. And of course aggregate GNP and GDP do not give any indication as to who gets to consume how much of the goods and services produced, nor do their compilers exercise any "judgment" about what these goods and services are or ought to be (as the advocates of the "equitable distribution" and merit goods and demerit goods concepts would want to insist upon as crucial determinants of societal welfare).

Definition of 'Net National Product (NNP)

The monetary value of finished goods and services produced by a country's citizens, whether overseas or resident, in the time period being measured (i.e., the gross national product, or GNP) minus the amount of GNP required to purchase new goods to maintain existing stock (i.e., depreciation). Alternatively, net national product (NNP) can be calculated as total payroll compensation + net indirect tax on current production + operating surpluses.

Net National Product (NNP) or National Income at Market Prices: The second important concept of national income is that of net national product (NNP). In the production of gross national product of a year, we consume or use up some fixed capital i.e., equipment, machinery, etc. the capital goods, like machinery, wear out or fall in value as a result of its consumption or use in the production process. This consumption of fixed capital or fall in the value of fixed capital due to wear and tear is called depreciation. When charges for depreciation are deducted from the gross national product we get net national product. Clearly, it means the market value of all final goods and services after providing for depreciation. It is also called national income at market prices. Therefore, Net National Product (or) National Income at = Gross National Product ( ) Depreciation Market Prices. Net domestic product (NDP)= NNP at Market Prices ( ) Net Factor Income from abroad. Disposable Income: Disposable income or personal disposable income means the actual income which can be spent on consumption by individuals and families. Thus disposable income = personal income ( ) Direct Taxes. Personal Income: Personal Income is the total income received by the individuals of a country from all sources before payment of direct taxes in one year. Personal income is never equal to the national income, because the former includes the transfer payments whereas they are not included in national income. Private Income: Private Income is income obtained by private individuals from any source, productive or otherwise, and the retained income of corporations. It can be arrived at from NNP at factor cost by making certain additions and deductions. The additions include transfer payments such as pensions, unemployment allowances, sickness and other security benefits, gifts and remittances from abroad, windfall gains from lotteries or from racing, and interest on public debt.