Analysis of National Income (2)

8/3/2019 Analysis of National Income (2)

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Copyright PCTI Group 2009

ANALYSIS OF NATIONALINCOME


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PRODUCTIONPRODUCTION

INCOMEINCOME

EXPENDITUREEXPENDITURE


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METHODS OF MEASURING NATIONAL INCOME

Value added method(output method)

(net value added by allproducing units is

measured)

Income method

(sum of all productsincomes is measured)

Expenditure method

(sum of all items offinal expenditure is

Measured)


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Value Added Method Measures The Value AddedValue Added Method Measures The Value Added

(Contribution) By Each Producing Enterprises In The(Contribution) By Each Producing Enterprises In The

Production Process In The Domestic Territory Of AProduction Process In The Domestic Territory Of A

Country In An Accounting Year.Country In An Accounting Year.

In A Simple MeaningIn A Simple Meaning

(Value Added Is Defined As The Difference Between(Value Added Is Defined As The Difference Between

Total Value Of Output Of A Firm And Value Of InputsTotal Value Of Output Of A Firm And Value Of InputsBought From Other Firm)Bought From Other Firm)

VALUE ADDED METHODVALUE ADDED METHOD


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SYMBOLICALLY :-SYMBOLICALLY :-

Net value added at FCNet value added at FC== Gross outputGross outp

ut- intermediate consumption- intermediate consump

tion

(NVAfc)

(NVAfc) --

depreciation-net indirect taxesdep

reciation-net indirect taxes

value of output = sales + change in stock ( it is alwaysvalue of output = sales + change in stock ( it is always

at MP)at MP)

^i.e. gross output^i.e. gross output

Value added = value of output - value of intermediateValue added = value of output - value of intermediategoodsgoods

= gross product = gross value added at MP= gross product = gross value added at MP

NVA at MP = GVA at MP depreciationNVA at MP = GVA at MP depreciation

NVA at FC = NVA at MP net indirect taxesNVA at FC = NVA at MP net indirect taxes


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THE INCOME METHOD:THE INCOME METHOD:

The Income method measures national incomeThe Income method measures national incomefrom the side of payments made to the primaryfrom the side of payments made to the primary

factors of production in the form of rent, wages ,factors of production in the form of rent, wages ,

interest and profit for their productive services ininterest and profit for their productive services in

an accounting year .an accounting year .

Thus if factor incomes generated by all theThus if factor incomes generated by all the

producing units located within the domesticproducing units located within the domestic

economy during a period of account are addedeconomy during a period of account are added

up to, the resulting total will be Domestic incomeup to, the resulting total will be Domestic income

oror

Net Domestic Product at FC (NDP at FC)Net Domestic Product at FC (NDP at FC)


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Income method (NDPat fc)

Compensation ofemployees

Operating SurplusMixed income of

self employed

RENT INTEREST

PROFIT

CORPORATE

TAXDIVIDEND

UNDISTRIBUTED

PROFIT



a) Domestic incomea) Domestic income= rent + wages= rent + wages

+ interest + mixed income +profit+ interest + mixed income +profit

tax + dividendtax + dividend

+ undistributed profit + surplus of govt. sector+ undistributed profit + surplus of govt. sector

(if shown separately)(if shown separately)

oror

= Compensation of employees= Compensation of employees+ operating surplus + mixed income+ operating surplus + mixed income



b)National incomeb)National income == Domestic income + net factorDomestic income + net factor

income fromincome from abroadabroad

1)1) Private incomePrivate income == National income - surplus ofNational income - surplus of

governmentgovernment sectional types ofsectional types of

transfer incometransfer income including nationalincluding national

debt interestdebt interest..

2)Personal income2)Personal income == National income - surplus ofNational income - surplus of

govermentgoverment sector -corporatesector -corporate

tax - undistributed profittax - undistributed profit

+ all types of transfer income+ all types of transfer income

includingincluding national debt interest.national debt interest.

3)3) Personal incomePersonal income == Private income - corporate taxPrivate income - corporate tax

- undistributed profit.- undistributed profit.

..



4)4) Personal Disposable incomePersonal Disposable income == personal income - personalpersonal income - personal

taxes (includingtaxes (including

miscellaneousmiscellaneous receipt of thereceipt of the

government).government).

5)5) Personal Disposable incomePersonal Disposable income == private income-corporateprivate income-corporate

tax-undistributed profit -tax-undistributed profit -

personal taxespersonal taxes

6)6) Personal Disposable incomePersonal Disposable income == National incomeNational income-surplus of govt. sector-surplus of govt. sector

- corporate tax- corporate tax

-undistributed profit-undistributed profit

+ all types of transfer+ all types of transfer

comecome -personal taxes-personal taxes

7)7) Private incomePrivate income == Income from domestic product accruing toIncome from domestic product accruing to

private sector + net factor income fromprivate sector + net factor income from

abroad + all types of transfer incomeabroad + all types of transfer income

including national debt interestincluding national debt interest



EXPENDITURE METHODEXPENDITURE METHOD :-:-Expenditure method measures finalExpenditure method measures finalexpenditure on Gross Domestic Product atexpenditure on Gross Domestic Product at

market price (GDP at MP) during a period ofmarket price (GDP at MP) during a period of

account .By adding up all the items of finalaccount .Byadding up all the items of final

consumptionconsumption expenditure and final investmentand final investment

expenditure within the domestic economy, weexpenditure within the domestic economy, weget the aggregate called GDP at mp.i.e. whyget the aggregate called GDP at mp.i.e. why

expenditure method is also knows as'expenditure method is also knows as'

Consumption and investment method' or'Consumption and investment method' or'

income Disposable method'.income Disposable method'.



MEASURES GDP byMEASURES GDP by

expenditure methodexpenditure method

GDPmp = private final consumptionGDPmp = private final consumption

expenditure+ final investment expenditureexpenditure+ final investment expenditure

( government final consumption( government final consumption

expenditure+ gross fixed capitalexpenditure+ gross fixed capital

formation+change in stock+net export).formation+change in stock+net export).

GDP = C+I+G+(X-M)GDP = C+I+G+(X-M)



GDP at sum of expenditureprivate consumption

Expenditure

by household(c)

InvestmentExpenditure (I) Govt. purchasesof goods and services(G)

Business fixed

investmentInventoryinvestment

ResidentialConstructionInvestmentPublicinvestment



AGGREGATE DEMANDAGGREGATE DEMAND ;-;-Aggregate demand broadly refers to the totalAggregate demand broadly refers to the total

demand for goods and services in the economy. aggregate demand isdemand for goods and services in the economy. aggregate demand is

also defined as " the total amount of money which all Sectionsalso defined as " the total amount of money which all Sections

( households, firms,government) are ready to spend on purchase of( households, firms,government) are ready to spend on purchase of

goods services produced in an economy during a given period .goods services produced in an economy during a given period .

" Aggregate demand is the total expenditure on consumption and" Aggregate demand is the total expenditure on consumption and

investment investment

AD = C+IAD = C+I

AGGREGATE SUPPLYAGGREGATE SUPPLY;-;- Aggregate supply is the value of total outputAggregate supply is the value of total output

available for purchase by the economy during a given period, sum of theavailable for purchase by the economy during a given period, sum of the

factor incomes (rent, wages, interest & profit)factor incomes (rent, wages, interest & profit)

at national level is called NATIONAL INCOME.at national level is called NATIONAL INCOME.

A major portion of income is spent on consumption of goods and servicesA major portion of income is spent on consumption of goods and servicesand the balanced is saved;and the balanced is saved;

AS = C+SAS = C+S



consumption functionconsumption function:- meaning - The relationship:- meaning - The relationship betweenbetween

consumption and income is called consumption function [ or propensity toconsumption and income is called consumption function [ or propensity to

consume ].consume ].

we may bifurcate consumption in two partswe may bifurcate consumption in two parts;;

(i) first part relates to consumption when income is zero(i) first part relates to consumption when income is zero i.e.i.e.when minimum level of consumption has to be maintained for survival. thiswhen minimum level of consumption has to be maintained for survival. this

is called autonomous consumption [denoted by c]is called autonomous consumption [denoted by c]

(ii) second part of consumption is when income(ii) second part of consumption is when income

increases,consumption also increases but by a lesser amountincreases,consumption also increases but by a lesser amount

i.e.additional consumption (c) is less than additional incomei.e.additional consumption (c) is less than additional income (y).this(y).thismay be represented,bymay be represented,by b(i.e.,marginal propensity tob(i.e.,marginal propensity to consume).thusconsume).thus

consumption function may be represented in the following equation.consumption function may be represented in the following equation.

c = c + byc = c + by



measured APC and MPCmeasured APC and MPC

AVERAGE PROPENSITY TO CONSUME ( APC)AVERAGE PROPENSITY TO CONSUME ( APC)

The ratio of total consumption expenditureThe ratio of total consumption expenditure

to total income is called APC.to total income is called APC.

APC = C/YAPC = C/Y

WHEREWHEREC = CONSUMPTION EXPENDITUREC = CONSUMPTION EXPENDITURE

ANDAND

Y = TOTAL INCOMEY = TOTAL INCOME

{ The value of APC may be greater{ The value of APC may be greaterthan 1 when at very lowthan 1 when at verylow

level of income , consumption exceeds incomelevel of income , consumption exceeds income

to meet the very basic necessitiesto meet the verybasic necessities

(then saving becomes negatives).}(then saving becomes negatives).}



MARGINAL PROPENSITY TO CONSUME (MPCMARGINAL PROPENSITY TO CONSUME (MPC))

The ratio of change in consumption(c) to change inThe ratio of change in consumption(c) to change in

income (Y) is called marginal propensity to consume.income (Y) is called marginal propensity to consume.

literally marginal means additional (or incremental) andliterally marginal means additional (or incremental) and

propensity to consume means desire ( or urge) topropensity to consume means desire ( or urge) to consume. thusconsume. thus

MPC is the ratio of additional consumptionMPC is the ratio of additional consumption toto additionaladditionalincome. it indicates the proportion ofincome. it indicates the proportion ofadditional income that isadditional income that is

being spent on additionalbeing spent on additional consumption.consumption.

MPC =C/YMPC =C/Y

Hence, MPC is always greater than zero (MPC > 0)and lessHence, MPC is always greater than zero (MPC > 0)and less

than 1(MPC < 1)because additional consumption (c) is lessthan 1(MPC < 1)because additional consumption (c) is less

than additional income (y). thus value of MPC liesthan additional income (y). thus value of MPC lies betweenbetween

0 and 10 and 1 }}


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Circular Flow ofCircular Flow ofMacroMacroEconomic ActivityEconomic Activity

National income accounting calls for an understanding of the structureNational income accounting calls for an understanding of the structureof the macro economy. A pictorial illustration of this inter-of the macro economy. A pictorial illustration of this inter-independence between the major sectors of economic activity is calledindependence between the major sectors of economic activity is calledthe circular flow of income and product. The circular flow of incomethe circular flow of income and product. The circular flow of incomeinvolves two basic principles:involves two basic principles:

a) In any exchange process, the seller or producer receive the samea) In any exchange process, the seller or producer receive the sameamount that the buyer or consumer spends; andamount that the buyer or consumer spends; and

b) Goods and services flow in one direction and money payments tob) Goods and services flow in one direction and money payments to

acquire these, flow in the return direction, thereby causing a cicularacquire these, flow in the return direction, thereby causing a cicularflow. So, the output or product or real flow from the seller to the buyerflow. So, the output or product or real flow from the seller to the buyernecessarily creates the income or payment or money flow from thenecessarily creates the income or payment or money flow from the

buyer to the seller.buyer to the seller.


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There are two typesThere are two types

of marketof market

First, market for goods and services First, market for goods and services ProductProduct

marketmarket; and; and

second, market for factors of production second, market for factors of production FactorFactor

marketmarket..

Circular flow of income can be depicted in two-sector,Circular flow of income can be depicted in two-sector,three-sector and four-sector models.three-sector and four-sector models.


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FinancialSystem HouseholdsFirms

Analysis of National Income (2)

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