By Prof K.

Bhargavi

The labour and capital of a country acting on its natural resources produce annually a certain amount of goods and services which is called the National income of the country .
It is a monetary measure includes only final goods

National income has three interpretations : It represents total value of production and hence represents a receipts total and an expenditure total.
Every

expenditure is at the same time a receipt , therefore the amount spent is equal to the amount received

 But

as goods and services are valued at their market prices we have a three fold identity. a. The sum of value of all final goods and services produced . b. Sum of all incomes in cash and kind accruing to the factors of production in a year. c. Sum of consumption expenditure, net investment expenditure and government expenditure on goods and services .

Sum of all income, sum of values of all final production and sum of all expenditures will be the same reflecting the three basic activities of the nations economy that is production , distribution and expenditure

Total demand for domestic output is made up of four components : Consumption spending by households Investment spending by Businesses Government Foreign demand

These four categories account for all spending. The fundamental national income accounting identity is Y= C+I+ G+ NX

Consumption Spending It includes anything from food to golf lessons , investment , consumer spending on durable goods such as automobiles Higher consumption or lower saving means either less investment or larger trade deficits Government Purchases It includes items such as national Defence expenditures, road paving by state and local governments and salaries of government employees

Government spending Government spending on goods and services as purchases of goods and services

Government makes transfer payments , that are made to people without they providing a current service in exchange

Transfer payments include social security benefits and unemployment benefits.

Transfer payments are not counted as part of GDP because transfers are not part of current production.

Transfers + Purchases = Government Expenditure

Investment Spending Investment means additions to the physical stock of capital Investment includes housing construction building of machinery etc Net investment is gross investment Depreciation Domestic means investment spent by domestic residents but not necessarily spending on goods produced within this country Consumption and government spending may also be for imported goods

Net Exports Domestic spending on foreign goods and foreign spending on domestic goods constitute Net exports.

Difference between exports and imports is called net exports .

Across a simple economy Across a three sector economy Across a four sector model with Government and foreign trade.

The first key identity is that output produced equals output sold. The Output unsold is treated as accumulation of inventories and a part of investment(as if the firms sold the goods to themselves to add to their inventories.) Output sold can be expressed as : Y= C+I (1) Income is also partly allocated between saving and consumption.

Y= S+ C. (2) Identities (1) &(2) can be combined to read C+I =Y= C+ S (3) The left hand side of the identity shows the components of demand and the R.H.S shows the allocation of income. The identity emhasizes that output produced is equal to output sold

The value of output produced is equal to income received ,and income received, in turn is spent on goods or saved. Subtracting consumption from each of the identity we have I=Y-C=S In a simple economy investment is identically equal to saving.

We start with the fundamental identity: Y=C+I+ G+ NX (1) We now establish the relation between Output and disposable income A Part of the income is spent on taxes and the private sector receives net transfers(TR) in addition to national income. Disposable income (YD) is thus equal to income plus transfer less taxes: YD = Y+ TR-TA (2)

Disposable income, in turn is allocated to consumption and saving: YD= C + S (3) Rearranging identity (2) and inserting for Y in identity (1) we have YD-TR +TA = C+I+G+NX (4) Putting identity (3) in (4) yields C+S-TR+ TA = C+I+ G+NX (5) By rearranging we get S-I = (G +TR TA)+ NX (6)

Identity (6) states that excess of saving over investment in the private sector (S-I) is equal to the government budget deficit plus the trade surplus. (G+TR-TA) is the government budget deficit. G+ TR is equal to total government expenditure, consisting of government purchases of goods and services(G) +government transfer payments (TR). TA is the amount of taxes received by the government. The difference (G+TR-TA) is the excess of the governments spending over its receipts ,or its budget deficit

(The budget deficit is a negative budget surplus,BS= TA-(G+TR).) NX is called the trade surplus . When Net exports are negative, we have a trade deficit.

GNP GDP NNPMP NNPFC Personal Income Disposable Income

GDP is the value of all final goods and services produced in the country
It is the value of only final goods and services produced to make sure we do not double count Double counting is avoided by working with value added . At each stage of the manufacture of the good only the value added to the good at that stage of manufacture is counted as part of GDP

GDP consists of Value of output currently produced GDP values goods at market prices

The market price of many goods include indirect taxes and thus the market price of goods is not that same as the price the seller of the goods receives

GDP is valued at market prices and not at factor cost Valuation of market principle is not uniformly applied as some components of GDP are difficult to value e.g Services of home makers

Gross National Product it is defined as the total market value of all final goods and services produced in a year in a country It includes only final goods and transactions involving intermediate goods ignores

GNP includes only currently produced goods in a year . It is a flow measure of output of goods and services per time period

GNP is the value of final goods and services produced by domestically owned factors of production within a given period

The difference between GDP and GNP arises because the sum of the output produced within a given country is made by factors of production owned abroad

Sale of assets such as stocks and bonds excluded from GNP of the year
GNP refers to the value of goods and services currently produced by normal residents of a country which include national or non national companies Market transactions involving goods produced in previous periods not included in GNP of the current year

Value of output of government which is taken to be equal to the value of purchases of goods and services denoted by (G)
Net exports (X) Value of goods imported (M) Net factor income from abroad ( is the difference between the factor income received from abroad from normal residents in India for rendering factor services in other countries on the one hand and the factor incomes paid to the foreign residents for the factor services rendered by them in the domestic territory in India

Value of consumer goods and services Value of final consumer goods and services produced in a year and consumed by households denoted by consumption (C)

Value of new capital goods produced and addition to the inventory of goods such as raw materials , unfinished goods and consumer goods produced but not sold during a year called the gross private investment (I)

GNP at mp =GDP at mp + Net factor income from abroad GDP at mp =GNP at mp Net factor income from abroad GDP = C + I +G +XN NNP at mp = GNP depreciation( the consumption of fixed capital or fall in the value of fixed capital due to wear and tear is called depreciation ) NNP at fc It is called national income . It means the sum of all incomes earned by resource suppliers for their contribution of land , labour ,capital and entrepreneurial ability which goes into the year`s net production NNP at fc = NNP at mp indirect taxes + subsidies

Net of indirect taxes and subsidies is called net indirect taxes National income = Net national product-net indirect taxes Personal income = National income Social security contributions corporate income taxes- undistributed corporate profits + transfer payments Disposable income = personal income personal taxes

GDP and Personal Disposable Income GDP is a measure of the output of goods being produced in an economy Personal disposable income is the level of income available for spending and saving by households in the economy

Nominal GDP measures the value of Output in a given period in the prices of that period (current $) Nominal GDP changes from year to year for two reasons the physical output of goods changes and secondly the market prices also changes
Real GDP measures changes in physical output in the economy between different time periods by valuing all goods produced in the two periods at the same price or in constant dollars

Changes in Nominal GDP that result from price changes do not tell us anything about the performance of the economy in producing god and services that is why we use Real rather than Nominal GDP as the basic measure for comparing output in different years

GDP data are far from perfect measures of either economic output or either welfare There are specifically four problems , some outputs are poorly measured because they are not traded in the market Eg Government services and Non market activities such as volunteer work It is difficult to account correctly for improvements in the quality of goods especially when new products and new models are being invented

Some activities measured as adding to real GDP infact represent the use of resources to avoid or contain`` bads`` such as crime or risks to National security

The accounts do not take environmental pollution and degradation into account

The GDP Deflator The calculation of real GDP gives us a useful measure of inflation known as the GDP deflator GDP Deflator is the ratio of Nominal GDP in a given year to real GDP of the year The deflator measures the change in prices that has occurred between the base year and current year

Since the GDP deflator is based on calculation involving all goods produced in the economy , it is a widely based price index that is frequently used to measure inflation

The Consumer and Producer Price Index The consumer price index (CPI) measures the cost of buying a fixed basket of goods and services representative of the purchases of urban consumers The CPI differs from the GDP deflator in 3 main ways : Deflator measures the prices of a much iwder group of goods than the CPI CPI measures the cost of a given basket of goods which is the same form year to year

CPI includes prices of imports , whereas the deflator includes only prices of goods produced in the United States The two main indexes used to compute inflation , the GDP deflator and the CPI, accordingly differ from time to time The producer price index is the third price index that is widely used PPI is constructed from prices at the level of first significant commercial transaction

PPI differs from CPI in terms of coverage as it includes raw materials and semi finished goods This makes the PPI a relatively flexible price index and one that generally signals changes in the general price levels PPI and one of its sub indexes such as the index of ``sensitive materials, serve as one of the business cycle indicators that are closely watched by policy makers