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Notes On Economics - ISC Notes

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Published in: Economics
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National income

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  1. NATIONAL INCOME - CHAPTER 1 THREE SECTOR MODEL OF NATIONAL INCOME Of Factor services actor payrnents Capital Market eots for Goods and se /0Lv of Goods and S eoixc.e 1 F i run s Households 1. 2. 3. Three sector model comprises of households, firms and government. The circular flow of income between households and firms comprise of supply of factor services by households (real flow) and factor payments by firms (money flow). The firms supply goods and services to households (real flow) in turn the households make payment for goods and services. (money flow). There is a need to include the activities of the Government in the circular flow of income. a. b. c. The government imposes taxes on both households and firms. It levies taxes on households as personal taxes and indirect taxes like GST. Firms are required to pay corporate taxes. The above results in inflow of taxes from households and firms to the Government. The Government spends the money collected through taxes on various activities which comes as income flows to the households and firms i. Wages and salaries (for factor services used by the Government) and transfer payments (old age pension, unemployment allowance) etc. mainly to households ii. The government buys goods and services from firms and makes payments in turn. Subsidies and transfer payments to firms to encourage production. This is a one-sided flow with no reverse real flow. Taxes (T) constitute leakages from the flows because they reduce income. Government expenditure (G) is an injection in the flows because it adds to the aggregate demand in the form of government purchases of factor services from households and goods from firms.
  2. d. Equilibrium condition of circular flow of income for three sector (closed economy) model is: S + T = I + G i.e. savings plus taxes together must be equal to investment and government expenditure. If S + T > I + G income flow decreases, if S + T < I + G income flow increases. FOUR SECTOR MODEL OF NATIONAL INCOME (OPEN ECONOMY) 1. 2. 3. 4. 5. 6. 7. F actor actor Payments Households Capital Market ents for Goods low of Goods and S Rest of the World An open economy is an economy that engages in international trade in goods and services. A four-sector model comprising of households, firms, government and rest of the world is known as an open economy model. Interaction between the domestic economy and rest of the worlds takes place through international trade — flow of goods and services and factor services. The household sector buys imported goods from abroad and makes payments to the foreign sector. The household sector receives foreign remittances by selling factor services abroad example Indians working abroad remit income to their families in India. The business sector exports goods and services and receives payment in the form of 'receipt from exports. ' Similarly, it makes payment for import of goods and services. Modern governments also export and imports from foreign countries. Imports (M) constitute leakages while exports (X) constitute injections into the circular flow of income. If inflow of income is equal to outflow the circular flow of income remains unaffected. Equilibrium condition S + T+ M = I + G + X; S + T + M are the total withdrawals or leakages from the circular flow while I + G + X are the total injections into the circular
  3. flow of income. This condition implies that total withdrawals must be equal to total injections to ensure equilibrium in the circular flow of income. (two sector model given in hard copy notes) IMPORTANCE OF CIRCULAR FLOW OF INCOME 1. 2. 3. Circular flow of income shows how the different sectors of the economy are interrelated and interdependent. It gives an overview of interaction between different sectors of the economy. The magnitude of these flows determines the size of income. The study of circular flow of income points the conditions of macroeconomic equilibrium. It states the conditions for equilibrium level of income in an economy.
  4. CHAPTER 19 - NATIONAL INCOME AGGREGATES To understand the concept of national income we need to understand the difference between 1. 2. 3. 4. 5. 6. 7. 8. 9. domestic product and national product Domestic roduct It is defined as the value of all final goods and services produced by all the enterprises located within the domestic territory of a countr durin a ear. National roduct National product refers to the amount of final goods and services produced by the normal residents of a country within the domestic territor of a countr or outside. National income is the sum total of factor incomes earned by the normal residents of a country during a year. National product = domestic product + net factor income from abroad NP = DP + NFIA Net factor income from abroad - The difference between the factor income received by the normal residents of a country from the rest of the world for rendering factor services abroad and factor income accruing to rest of the world for the services rendered by it in this country is called net factor income form abroad. National income at factor cost = National income at market price — indirect taxes + subsidies) OR National income at factor cost = National income at market price — net indirect taxes. Indirect taxes minus subsidies is called net indirect taxes Subsidies — Subsidies are cash grants given by the Government to the producers to sell goods at prices lower than the free market price. Depreciation The consumption of fixed capital in the process of production is known as depreciation. It is the loss of value of fixed capital assets during the production process due to normal wear and tear. Net product = Gross product minus depreciation NATIONAL INCOME AGGREGATES S no. A gregate 1 2 Gross domestic product (at market prices) GDP MP Gross national product (at market price) GNPMp Definition It is the market value of all final goods and services at the prevailing market prices produced in the domestic territory of a country during a given year. It is the market value of all final goods and services at the prevailing market prices produced by the normal residents of a country during a year, inclusive of depreciation.
  5. 3 4 5 6 7 8 Net domestic product at market prices (NDPW) Net national product at market prices (NNPW) Gross domestic product at factor cost (GDPFÖ Gross national product at factor cost (GNPFc) Net domestic product at factor cost (NDPFc) Net national product at factor cost NNPFc or NATIONAL INCOME GNPMp = GDP MP + NFIA NFIA may be positive or negative. If NFIA is positive GNPMp would be greater than GDPMp Net domestic product is the market value of all final goods and services at the prevailing market prices produced in the domestic territory of a country during a given year after making allowance for depreciation. NDPMp = GDPMp - Depreciation It is the market value of all final goods and services at the prevailing market prices produced by the normal residents of a country during a year after making allowance for depreciation. NNPMp = GNPMp - Depreciation It is the sum total of earnings received by the various factors of production in the form of wages, interest, rent, profits etc. within the domestic territory of a country in a year, inclusive of depreciation. GDPFc = GDPMp net indirect taxes It is the sum total of earnings received by the various factors of production in the form of wages, interest, rent, profits etc. by the normal residents of a country during a year without making allowance for depreciation. GNPFc = GNPMp net indirect taxes Net domestic product is the estimate of domestic product in terms of earnings of the factors of production within the domestic territory of a country in a year after making allowance for depreciation. NDPFc= GDPFc Depreciation (The incomes included in NDPFc are explained below) National income can be defined as the factor income accruing to the normal residents of a country during a year after making allowance for depreciation. NNPFc = NDP FC + NFIA NNPFc or National income = GNPFc - depreciation Net domestic product at factor cost (NDPFc) includes the following income
  6. Compensation of employees — all payments in the form of wages, salaries in cash or kind Operating surplus — property income + income from entrepreneurship i.e. sum total of rent, interest, profit and similar income. Mixed income — composite of labour income and property income in case of producers where it is difficult to differentiate between labour and capital element. All Formulas or derivations 1. 2. 3. 4. 5. 6. 7. 8. GNPMp = GDP MP + NFIA NDPMp = GDPMp - Depreciation NNPMp = GNPMp - Depreciation GDPFc = GDP MP — net indirect taxes GNPFc - — GNP MP net indirect taxes NDPFc = GDPFc - Depreciation NNPFc = NDP FC + NFIA NNPFc or National income = GNPFc depreciation Net Factor Incorr•te trom Net Factor Income trom Abroad Net Indirect Taxes Mixed Income Net Factor Income from Abroad Mixed Income (3) Operating Surplus (2) Compensation Employees Domestic • Factor Income Net Indirect Taxes Mixed Income (3) Operating Surplus (2) Compensation Employees NDP Net Indirect Taxes (5) Depreciation (4) Mixed Income (3) Operating Surplus (2) Compensation of Employees (1) GDP (6) Net Indirect Taxes Depreciation (4) Mixed Income (3) Operating Surplus (2) Compensation of Employees 0) GNPMP Operating Surplus (2) Compensation of Employees Mixed income Operating Surp\us Compensation oft Employees National \ncome Disposable income aggregates 1. Transfer payment — They are payments received without any contribution to current output. Example — old age pension, unemployment relief, gifts, donations, fines etc. Transfers are of two types a. Current transfer b. Capital transfer
  7. CURRENT TRANSFER A current transfer is the one which is made out of the current income of the payers and adds to the current income of the receivers. Example old age pension, unemployment benefit, scholarship to poor students CAPITAL TRANSFER A capital transfer is one which is paid out of the capital or wealth of the receivers. Example — payment made to meet damages during flood, famines etc and transfer from business firms to Government for capital ains etc. 2. 3. 4. 5. Disposable income = Income + net current transfers National disposable income is defined as the total of national income at market prices and net current transfers received from rest of the world. GNDI = GNPMp + net current transfers received from rest of the world NNDI = NNPMp + net current transfers received from rest of the world Disposable income aggregates of private sector 1. 2. 3. 4. Private income is the total of factor income (including retained profits of the corporations) from all sources and the current transfers from the Government and the rest of the world accruing to the private sector. Private income = National income — income from property and entrepreneurship accruing to the Government commercial enterprises and administrative departments savings of non-departmental enterprises of the Govt + interest on national debt + net current transfers from the Govt + net current transfers from abroad Personal income is the income actually received by persons from all sources in the form of factor incomes and current transfer payments during a year. Personal income = Private income — undistributed profits — corporate profits tax retained earnings of foreign companies — contribution of enterprises towards social security scheme Personal disposable income is that part of personal income which is available to the individuals to be used the way they like. Personal disposable income = Personal income — personal taxes — miscellaneous receipts of the government administrative departments paid by households. Personal disposable income = consumption expenditure of households + household savings Per capital income (PCI) = national income / population
  8. Real GDP and nominal GDP GDP calculated at current prices is nominal GDP. However, GDP may be required to be calculated with reference to a base year known as real GDP or GDP at constant prices. GDP are constant prices reflects the real growth of an economy. GDP at current prices (nominal GDP) It is the market value of all final goods and services at the prevailing market prices produced by the enterprises within the domestic territory of a country during a given year expressed at market prices prevailing in that year. Examples GDP of India in 2019-20 at 2019-20 rices It does not reflect growth in real domestic output. GDP at constant prices (Real GDP) It is the market value of all final goods and services at the prevailing market prices produced by the enterprises within the domestic territory of a country during a given year expressed at market prices prevailing in a particular year, which becomes the base ear. E.g.: GDP of 2019-20 at 2005-06 prices It reflects real growth of an economy. It is a better and reliable index of growth of an econom Why is GDP at constant prices a better and reliable index of growth of an economy? GDP at current prices can change from year to another partly because of a change in physical quantities of final goods and services produced and partly due to change in market prices at which these goods are valued. Therefore, GDP at current prices does not reflect growth in real domestic output. But GDP at constant prices is affected by changes in physical quantities of goods and services only. An increase in GDP at constant prices indicates a real increase in physical quantities of goods and services. So, GDP at constant prices is the real GDP and a better and reliable index of growth of an economy. GDP at current prices GDP at constant prices = x 100 Price index of current year Price index is that number which measures the changes in prices between different years. Price index of base year is 100. Price index of current year is obtained by multiplying the ratio of current prices to the prices of the base year by 100.

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