MACRO ECONOMICS AND NATIONAL INCOME-UNIT 5

Introduction
Economics at its core is concerned with the production, distribution, trade and consumption of
goods and services. It is the science that arises out of the interplay between limited resources and
unlimited human wants and needs.
Meaning :
Macroeconomics is the broad and distant view, which attempts to view things in aggregate for
a society at large. Macroeconomics is concerned with the study of the economy as a whole. It
studies not individual economic units like a household, a firm or an industry but the whole
economic system. Macroeconomics is the study of aggregates of the entire economy. Such
aggregates are national income, total employment, aggregate savings and investment, aggregate
demand, aggregate supply general price level, etc.
This view is helpful because it is only by this kind of analysis that we can see the general trends
which a society or nation is following. Macroeconomic theory and analysis is employed most
often by governments and institutions, which have a responsibility to make policies and
decisions which affect the economy as a whole.
Here, we study how these aggregates of the economy as a whole are determined and what causes
fluctuations in them. The aim is how to ensure the maximum level of income and employment in
a country. Therefore, it is also known as Theory of Income "
The scope of macroeconomics includes the following :

Importance of Macroeconomics:
1. It helps to understand the functioning of a complicated modern economic system. It describes
how the economy as a whole functions and how the level of national income and employment is
determined on the basis of aggregate demand and aggregate supply.
2. It helps to achieve the goal of economic growth, higher level of GDP and higher level of
employment. It analyses the forces which determine economic growth of a country and explains
how to reach the highest state of economic growth and sustain it.
3. It helps to bring stability in price level and analyses fluctuations in business activities. It
suggests policy measures to control Inflation and deflation.
4. It explains factors which determine balance of payment. At the same time, it identifies causes
of deficit in balance of payment and suggests remedial measures.
5. It helps to solve economic problems like poverty, unemployment, business cycles, etc., whose
solution is possible at macro level only, i.e., at the level of whole economy.
6. With detailed knowledge of functioning of an economy at macro level, it has been possible to
formulate correct economic policies and also coordinate international economic policies.
7. It helps in the application of microeconomic theory to the problems of the economy as a
whole.

Micro Economics Vs Micro Economics:

Macroeconomics is a branch of economics dealing with the performance, structure, behavior, and
decision-making of an economy as a whole, as opposed to individual markets. This includes
national, regional, and global economies. Macroeconomics involves the study of aggregated
indicators such as GDP, unemployment rates, and price indices for the purpose of understanding
how the whole economy functions, as well as the relationships between such factors as
national income,

output,

consumption,

unemployment,

inflation, savings, investment,

international trade and international finance.

Microeconomics, on the other hand, is the branch of economics that is primarily focused on the
actions of individual agents, such as firms and consumers, and how their behavior determines
prices and quantities in specific markets. One of the goals of microeconomics is to analyze
market mechanisms that establish relative prices among goods and services and the allocation of
limited resources among many alternative uses. Significant fields of study in microeconomics
include general equilibrium, markets under asymmetric information, choice under uncertainty,
and economic applications of game theory. Macroeconomics encompasses a variety of concepts
and variables related to the economy at large.
The distinction between macro and micro economics is the most usual classification of
economic analysis.
1) Object of Study :
The main difference between microeconomics and macroeconomics is the object of study:
- Microeconomics focuses on the study of individual economic units and particular markets, like
the market of ice cream or why an increase in the price of a product can lead to a lower
consumption of that particular product.
- Macroeconomics studies economic aggregates, like GDP, unemployment, inflation and
economic growth.

2) Variables:
Variables are elements of economic models. Variables can be a characteristic of an economic
agent, a number or quantity.
- Microeconomics: In microeconomic models, the variables are usually individual, like the
production of a business.
- Macroeconomics: In macroeconomic models, the variables are aggregates. For example,
the GDP is the sum of the production of every economic unit inside a country.
3) Relation between micro and macro:
Macroeconomics models can take a lot of elements from microeconomic models. Theoretically,
the behavior of an aggregate variable can be explained by the behavior of the individual
components and the aggregation. Some macroeconomic models have elements that explain the
behavior of large economic units from microeconomic principles. This is called micro foundation
of a macroeconomic model.
Microeconomics can study how macroeconomic changes can affect the behavior of
microeconomic units. For example, how an increase in inflation or a change in the real exchange
rate can affect the production of cars in the city of Detroit.
4) scope of study:
Business

administrators

tend

to

focus

on

microeconomics

and

place

less

focus

on macroeconomics.
Economists and public policy makers focus on both macro and micro. Economist tend to
specialize either on microeconomics or on macroeconomics.

5)Applications:
There are some economic fields that are dominated by microeconomics, while the application of
macroeconomics

is

more

usual

in

other

fields.

For

example:

Microeconomics has more applications in: labor economics, regulation economics, industrial
organization,

urban

economics,

development

economics,

environmental

economics,

Macroeconomics has more applications in: international economics, public finance, study of
particular economic regions.
6) Government Involvement:
In Microeconomics Government intervention in the market is narrow.
In Macroeconomics there is a much wider role for Government

Fiscal Policy

Monetary policy

7) Macro considers the Long-run growth rate of total economy.

Micro focuses on the amount of output the economy is capable of producing

Basic Concepts of Macro Economics

1. Aggregate Demand And Aggregate Supply:
Economic fluctuations, also called business cycles, are movements of GDP away from potential
output. Insufficient demand for goods and services was a key problem of the Great Depression,
identified by British economist John Maynard Keynes in the 1930s.
In our study of GDP accounting, we divided GDP into four components: Consumption
spending ( C), investment spending ( I), government purchases ( G), and net exports (NX).
These four components are also four parts of aggregate demand because the aggregate demand
curve really just describes the demand for total GDP at different price levels.
Why the Aggregate Demand Curve Slopes Downward
The increase in spending that occurs because the real value of money increases when the price
level falls is called the wealth effect.
The interest rate effect: With a given money supply in the economy, a lower price level will
lead to lower interest rates and higher consumption and investment spending.
The impact of foreign trade: A lower price level makes domestic goods cheaper relative to
foreign goods.
The non price determinants for changes in aggregate demand are:

future expectations
foreign income and price levelgovernment policy

AGGREGATE SUPPLY:
It shows the quantity of real GDP produced at different price levels. Short-run AS slopes
upward because an increase in the price level (while production costs and capital are held
constant on the short-run), means higher profit marginsfirms will want to produce more.
Determinants Of Aggregate Supply:

Changes In Short run Aggregate Supply:

Supply Shock: Resource Market

Suppose there is an adverse supply shock, perhaps as the result of a crop failure or a sharp
increase in the world price of a major resource, such as oil. Here we show the impact in the
resource market: prices rise from Pr1 to Pr2 .

AD and SRAS determine the price level, real GDP, and the unemployment rate in the short run.
In instances of both surplus and shortage, economic forces are moving the economy toward the
short-run equilibrium point.

The basic AD-AS model focuses on how the general level of prices influence the choices of
business decision makers. Disequilibrium occurs when the actual price level is either greater
than or less than the anticipated level. The actual price level will also differ from the level
people anticipated when the rate of inflation differs from what is expected. When the inflation
rate is greater than anticipated, this implies a higher than anticipated price level. As a result,
profit margins will be attractive and business firms will respond with an expansion in output.
When the inflation rate is less than anticipated, this implies a lower than anticipated price level.
As a result, profit margins will be unattractive and businesses will reduce their output.
2. Investment:
In simple terms, Investment refers to purchase of financial assets. While Investment Goods are
those goods, which are used for further production.
Investment implies the production of new capital goods, plants and equipments. John
Keynes refers investment as real investment and not financial investment.

Investment is a conscious act of an individual or any entity that involves deployment of money
(cash) in securities or assets issued by any financial institution with a view to obtain the target
returns over a specified period of time. Target returns on an investment include:
1. Increase in the value of the securities or asset, and/or
2. Regular income must be available from the securities or asset.
Types of Investment
Different types or kinds of investment are discussed in the following points.

1. Autonomous Investment
Investment which does not change with the changes in income level, is called as

Autonomous or Government Investment.

Autonomous Investment remains constant irrespective of income level. Which means
even if the income is low, the autonomous, Investment remains the same. It refers to
the investment made on houses, roads, public buildings and other parts of

Infrastructure. The Government normally makes such a type of investment.

2. Induced Investment

Investment which changes with the changes in the income level, is called as Induced

Investment.
Induced Investment is positively related to the income level. That is, at high levels of
income entrepreneurs are induced to invest more and vice-versa. At a high level of
income, Consumption expenditure increases this leads to an increase in investment of

capital goods, in order to produce more consumer goods.

3. Financial Investment
Investment made in buying financial instruments such as new shares, bonds, securities,

etc. is considered as a Financial Investment.

However, the money used for purchasing existing financial instruments such as old
bonds, old shares, etc., cannot be considered as financial investment. It is a mere
transfer of a financial asset from one individual to another. In financial investment,
money invested for buying of new shares and bonds as well as debentures have a

positive impact on employment level, production and economic growth.

4. Real Investment
Investment made in new plant and equipment, construction of public utilities like

schools, roads and railways, etc., is considered as Real Investment.

Real investment in new machine tools, plant and equipments purchased, factory
buildings, etc. increases employment, production and economic growth of the nation.
Thus real investment has a direct impact on employment generation, economic growth,
etc.

5. Planned Investment
Investment made with a plan in several sectors of the economy with specific objectives

is called as Planned or Intended Investment.

Planned Investment can also be called as Intended Investment because an investor

while making investment make a concrete plan of his investment.

6. Unplanned Investment
Investment done without any planning is called as an Unplanned or Unintended

Investment.
In unplanned type of investment, investors make investment randomly without making
any concrete plans. Hence it can also be called as Unintended Investment. Under this
type of investment, the investor may not consider the specific objectives while making

an investment decision.
7. Gross Investment

Gross Investment means the total amount of money spent for creation of new capital
assets like Plant and Machinery, Factory Building, etc. It is the total expenditure made

on new capital assets in a period.

8. Net Investment
Net Investment is Gross Investment less (minus) Capital Consumption (Depreciation)
during a period of time, usually a year. It must be noted that a part of the investment is
meant for depreciation of the capital asset or for replacing a worn-out capital asset.
Hence it must be deducted to arrive at net investment.

THE MULTIPLIER MODEL

The term multiplier refers to the way that an initial increase in aggregate expenditures
(Consumption & Investment) causes a ripple effect that leads to more and more spending and
raises GDP by a multiple of that initial increase in spending. The main reason why this
happens is because when you spend money, the person who receives that money from you as
payment will turn around and spend some of it. And the same thing will happen
when that person spends his money -- the person he paid the money to will turn around and
spend some it, too. The chain of spending continues until there's nothing left to spend.
The size of the multiplier depends upon households marginal decisions to spend, called the
marginal propensity to consume (mpc), or to save, called the marginal propensity to
save (mps). It is important to remember that when income is spent, this spending becomes
someone elses income, and so on. Marginal propensities show the proportion of extra
income allocated to particular activities, such as investment spending by firms, saving by
households, and spending on imports from abroad.

The following general formula to calculate the multiplier uses marginal propensities, as
follows:
1/1-mpc
Hence, if consumers spend 0.8 and save 0.2 of every 1 of extra income, the multiplier will
be:
1/1-0.8
= 1/0.2
=5
Hence, the multiplier is 5, which means that every 1 of new income generates 5 of extra
income.
Applying the multiplier effect
The multiplier concept can be used any situation where there is a new injection into an
economy. Examples of such situations include:
1. When the government funds building of a new motorway
2. When there is an increase in exports abroad
3. When there is a reduction in interest rates or tax rates, or when the exchange rate falls.
3. Inflation
Inflation refers to a continuous rise in general price level which reduces the value of
money or purchasing power over a period of time. Statistically, inflation is measured
in terms of a percentage rise in the price index (i.e. percentage rate per unit time)
usually for an annum (a year) or for 30-31 days (a month).

Economists measure changes in prices with price indexes. Inflation (general price
increase across the entire economy) occurs when an economy becomes overheated and
grows too quickly. Inflation can lead to increased uncertainty and other negative
consequences. Similarly, a declining economy can lead to deflation, or a rapid
decrease in prices. Deflation can lower economic output. Central bankers try to
stabilize prices to protect economies from the negative consequences of price changes.
Raising interest rates or reducing the supply of money in an economy will reduce
inflation.

Definition of Inflation
According to Crowther, "Inflation is a state in which the value of money is failing

i.e. the prices are rising."

According to Coulbourn, "Inflation is too much of money chasing too few goods."

Features of Inflation
The characteristics or features of inflation are as follows : Inflation involves a process of the persistent rise in prices. It involves rising trend in

price level.
Inflation is a state of disequilibrium.
Inflation is scarcity oriented.
Inflation is dynamic in nature.
Inflationary price rise is persistent and irreversible.
Inflation is caused by excess demand in relation to supply of all types of goods and

services.
Inflation is a purely monetary phenomenon.
Inflation is a post full employment phenomenon.
Inflation is a long-term process.

Terms Related to Inflation

The important terms related to inflation are as follows : Deflation : Deflation is a condition of falling prices. It is just the opposite of
inflation. In deflation, the value of money goes up and prices fall down. Deflation

brings a depression phase of business in the economy.

Disinflation : Disinflation refers to lowering of prices through anti-inflationary

measures without causing unemployment and reduction in output.

Reflation : Reflation is a situation of rising prices intentionally adopted to ease the
depression phase of the economy. In reflation, along with rising prices, the
employment, output and income also increase until the economy reaches the stage of

full employment.
Stagflation : Paul Samuelson describes Stagflation as the paradox of rising prices

with increasing rate of unemployment.

Stagnation : Stagnation in the rate of economic growth which may be a slow or no

economic growth at all.

Statflation : The term 'Statflation' was coined by Dr. P.R. Brahmananda to describe
the inflationary situation of India. According to Brahmananda, Rising prices in the
middle of a recession is known as Statflation.

Following is a conceptual graph on Creeping, Walking, Running, Galloping, Hyperinflation,

and Moderate Inflation.

Deflation : Deflation is defined as a decrease in the general price level.

It is a negative inflation rate.
Deflation means the value of money will increase.
Deflation is often associated with periods of negative or stagnant economic growth .
In fact deflation is often used to express a declining economy
Deflation caused by rising AS
However, if deflation is caused by rising productivity, improved technology and lower costs,
the deflation may not be harmful but beneficial.

Causes of deflation:
1. A fall in aggregate demand (AD)

2. A shift to the right of aggregate supply (AS) i.e. lower costs of production through
improved technology.
3. During a deep recession, when there is a sustained fall in demand and output.
4. falling money supply and / or velocity of circulation causing a fall in the price level.
5. In rare circumstances, rapid growth in technology may enable lower prices, whilst at the
same time increasing output.
Problems of Deflation:
People delay spending, hoping prices will be cheaper next year
1. Workers resist nominal wage cuts, therefore, real wages rise causing real wage
unemployment.
2. Real interest rates become too high. Even interest rates of 0% cannot induce people to
spend creating a liquidity trap.
3. Deflation increases the burden of debt.
4. periods of deflation / low inflation can lead to economic stagnation and periods of high
unemployment.
5. The value of money increases rather than decreases.
6. Discourages consumer spending. When there are falling prices, this often encourages
people to delay purchases because they will be cheaper in the future. In particular, it can
discourage consumers from buying luxury goods / non-essential items, e.g. flat screen
TV) because you could save money by waiting for it to be cheaper. Therefore, periods of
deflation often lead to lower consumer spending and lower economic growth;
7. Increase real value of debt. Deflation increases the real value of money and the real
value of debt. Deflation makes it more difficult for debtors to pay off their debts.
Therefore, consumers and firms have to spend a bigger percentage of disposable income
on meeting debt repayments.

4. Marginal Efficiency of Capital MEC

The marginal efficiency of capital displays the expected rate of return from investment, at a particular
given time. The marginal efficiency of capital is compared to the rate of interest.
Keynes described the marginal efficiency of capital as:
The marginal efficiency of capital is equal to that rate of discount which would make the present value
of the series of annuities given by the returns expected from the capital asset during its life just equal to
its supply price. J.M.Keynes, General Theory, Chapter 11

This theory suggests investment will be influenced by:

1. The marginal efficiency of capital
2. The interest rates
Generally, a lower interest rate makes investment relatively more attractive.
If interest rates, were 3%, then firms would need an expected rate of return of at least 3% from their
investment to justify investment.
If the marginal efficiency of capital was lower than the interest rate, the firm would be better off not
investing, but saving the money.
Why are interest rates important for determining the Marginal efficiency of capital?
To finance investment, firms will either borrow or reduce savings. If interest rates are lower, its cheaper
to borrow or their savings give a lower return making investment relatively more attractive.
Marginal Efficiency of Capital

A cut in interest rates from R1 to R2 will increase investment to I2.

1. The alternative to investing is saving money in a bank, this is the opportunity cost of investment.
If the rate of interest is 5% then only projects with a rate of return of greater than 5% will be profitable.
How Responsive is Investment to Interest Rates?
In Keynesian investment theory, interest rates are one important factor. However, in a liquidity trap,
investment may be unresponsive to lower interest rates. In some circumstances,

In a liquidity trap, business confidence may be very low. Therefore, despite low interest rates, firms dont
want to invest because they have low expectations of future profits.

Factors which shift the Marginal Efficiency of Capital

1. The cost of capital. If capital is cheaper, then investment becomes more attractive. For example, the
development of steel rails made railways cheaper and encouraged more investment.
2. Technological change. If there is an improvement in technology, it can make investment more
worthwhile.
3. Expectations and business confidence.

If people are optimistic about the future, they will be willing to invest because they expect higher profits.
In a recession, people may become very pessimistic, so even lower interest rates dont encourage
investment. (e.g. during recession 2008-12, interest rates were zero, but investment low)
4. Supply of finance. If banks are more willing to lend money investment will be easier.
5. Demand for goods. Higher demand will increase profitability of capital investment.
6. Rate of Taxes. Higher taxes will discourage investment. Sometimes, governments offer tax breaks to
encourage investment.
5. Output and Income
National output is the total value of everything a country produces in a given time period. Everything
that is produced and sold generates income. Therefore, output and income are usually considered
equivalent and the two terms are often used interchangeably. Output can be measured as total income,
or, it can be viewed from the production side and measured as the total value of final goods and
services or the sum of all value added in the economy. Macroeconomic output is usually measured by
Gross or one of the other national accounts. Economists interested in long-run increases in output
study economic growth. Advances in technology, accumulation of machinery and other capital, and
better education and human capital all lead to increased economic output over time. However, output
does not always increase consistently. Business cycles can cause short-term drops in output called
recessions. Economists look for macroeconomic policies that prevent economies from slipping into
recessions and lead to faster, long-term growth.
6. Unemployment
The unemployment in an economy is measured by the unemployment rate, the percentage of workers
without jobs in the labor force. The labor force only includes workers actively looking for jobs.
People who are retired, pursuing education, or discouraged from seeking work by a lack of job
prospects are excluded from the labor force. Unemployment can be generally broken down into
several types relating to different causes. Classical unemployment occurs when wages are too high for
employers to be willing to hire more workers. Frictional unemployment occurs when appropriate job
vacancies exist for a worker, but the length of time needed to search for and find the job leads to a
period of unemployment. Structural unemployment covers a variety of possible causes of
unemployment including a mismatch between workers' skills and the skills required for open jobs.
While some types of unemployment may occur regardless of the condition of the economy, cyclical
unemployment occurs when growth stagnates.
Natural rate of unemployment :
The average rate of unemployment around which the economy fluctuates.

In a recession, the actual unemployment rate rises above the natural rate.
In a boom, the actual unemployment rate falls below the natural rate.

Types of Unemployment:
Unemployment is a significant concern within macroeconomics. Unemployment number are several
sub-types of unemployment.

Frictional unemployment results from imperfect information and the difficulties in matching
qualified workers with jobs. A college graduate who is actively looking for work is one example.
Frictional unemployment is almost impossible to avoid, as neither job-seekers nor employers can
have perfect information or act instantaneously, and it is generally not seen as problematic to an

economy.
Cyclical unemployment refers to unemployment that is a product of the business cycle. During
recessions, for instance, there is often inadequate demand for labor and wages are typically slow

to fall to a point where the demand and supply of labor are back in balance.
Structural employment refers to unemployment that occurs when workers are not qualified for the
jobs that are available. Workers in this case are often out of work for much longer periods of time
and often require retraining. Structural unemployment can be a serious problem within an
economy, particularly in cases where entire sectors (manufacturing, for instance) become
obsolete.

While high unemployment is undesirable, full employment (meaning zero unemployment) is neither
practical nor desirable. When economists talk about full employment, frictional unemployment and
some small percentage of structural unemployment are excluded. Economists do not generally believe
it is practical or desirable to have 100% employment in an economy.

Concepts of National Income

There are various concepts of National Income.
The main concepts of NI are: GDP, GNP, NNP, NI, PI, DI, and PCI.
These different concepts explain about the phenomenon of economic activities of the various sectors of
the various sectors of the economy.
National Income (NI)
National Income is also known as National Income at factor cost. National income at factor cost means
the sum of all incomes earned by resources suppliers for their contribution of land, labor, capital and
organizational ability which go into the years net production. Hence, the sum of the income received by
factors of production in the form of rent, wages, interest and profit is called National Income.

Symbolically,
NI=NNP+Subsidies-Interest Taxes (or) GNP-Depreciation+Subsidies-Indirect Taxes (or)
NI=C+G+I+(X-M)+NFIA-Depreciation-Indirect Taxes+Subsidies
Gross Domestic Product (GDP)
The most important concept of national income is Gross Domestic Product. Gross domestic product is the
money value of all final goods and services produced within the domestic territory of a country during a
year.
Algebraic expression under product method is, GDP=(P*Q)
where, GDP=Gross Domestic Product
P=Price of goods and service
Q=Quantity of goods and service
denotes the summation of all values.
According to expenditure approach, GDP is the sum of consumption, investment, government
expenditure, net foreign exports of a country during a year.
Algebraic expression under expenditure approach is, GDP=C+I+G+(X-M)
Where, C=Consumption
I=Investment
G=Government expenditure
(X-M)=Export minus import
GDP includes the following types of final goods and services. They are:
1. Consumer goods and services.
2. Gross private domestic investment in capital goods.
3. Government expenditure.
4. Exports and imports.
Gross National Product (GNP)
Gross National Product is the total market value of all final goods and services produced annually in a
country plus net factor income from abroad. Thus, GNP is the total measure of the flow of goods and
services at market value resulting from current production during a year in a country including net
factor income from abroad. The GNP can be expressed as the following equation:
GNP=GDP+NFIA (Net Factor Income from Abroad) or, GNP=C+I+G+(X-M)+NFIA
Hence, GNP includes the following:
1. Consumer goods and services.
2. Gross private domestic investment in capital goods.
3. Government expenditure.

4. Net exports (exports-imports).

5. Net factor income from abroad.
Net National Product (NNP)
Net National Product is the market value of all final goods and services after allowing
for depreciation. It is also called National Income at market price. When charges for depreciation are
deducted from the gross national product, we get it. Thus,
NNP=GNP-Depreciation
or, NNP=C+I+G+(X-M)+NFIA-Depreciation
Personal Income (PI)
Personal Income i s the total money income received by individuals and households of a country from
all possible sources before direct taxes. Therefore, personal income can be expressed as follows:
PI=NI-Corporate Income Taxes-Undistributed Corporate Profits-Social Security
Contribution+Transfer Payments

Disposable Income (DI)

The income left after the payment of direct taxes from personal income is called Disposable Income.
Disposable income means actual income which can be spent on consumption by individuals and
families. Thus, it can be expressed as:
DI=PI-Direct Taxes
From consumption approach,
DI=Consumption Expenditure+Savings
Per Capita Income (PCI)
Per Capita Income of a country is derived by dividing the national income of the country by the total
population of a country. Thus,
PCI=Total National Income/Total National Population

The important concepts of national income are:

1. Gross Domestic Product (GDP)
2. Gross National Product (GNP)
3. Net National Product (NNP) at Market Prices
4. Net National Product (NNP) at Factor Cost or National Income
5. Personal Income
6. Disposable Income
Let us explain these concepts of National Income in detail.

1. Gross Domestic Product (GDP): Gross Domestic Product (GDP) is the total market
value of all final goods and services currently produced within the domestic territory of a
country in a year.
Four things must be noted regarding this definition.
First, it measures the market value of annual output of goods and services currently
produced. This implies that GDP is a monetary measure.
Secondly, for calculating GDP accurately, all goods and services produced in any given year
must be counted only once so as to avoid double counting. So, GDP should include the value
of only final goods and services and ignores the transactions involving intermediate goods.
Thirdly, GDP includes only currently produced goods and services in a year. Market
transactions involving goods produced in the previous periods such as old houses, old cars,
factories built earlier are not included in GDP of the current year.
Lastly, GDP refers to the value of goods and services produced within the domestic territory
of a country by nationals or non-nationals.
2. Gross National Product (GNP): Gross National Product is the total market value of all
final goods and services produced in a year. GNP includes net factor income from abroad
whereas GDP does not. Therefore,
GNP = GDP + Net factor income from abroad.
Net factor income from abroad = factor income received by Indian nationals from abroad
factor income paid to foreign nationals working in India.
3. Net National Product (NNP) at Market Price: NNP is the market value of all final
goods and services after providing for depreciation. That is, when charges for depreciation
are deducted from the GNP we get NNP at market price. Therefore
NNP = GNP Depreciation
Depreciation is the consumption of fixed capital or fall in the value of fixed capital due to
wear and tear.
4.Net National Product (NNP) at Factor Cost (National Income): NNP at factor cost or
National Income is the sum of wages, rent, interest and profits paid to factors for their
contribution to the production of goods and services in a year. It may be noted that:
NNP at Factor Cost = NNP at Market Price Indirect Taxes + Subsidies.
5. Personal Income: Personal income is the sum of all incomes actually received by all
individuals or households during a given year. In National Income there are some income,
which is earned but not actually received by households such as Social Security
contributions, corporate income taxes and undistributed profits. On the other hand there are
income (transfer payment), which is received but not currently earned such as old age
pensions, unemployment doles, relief payments, etc. Thus, in moving from national income

to personal income we must subtract the incomes earned but not received and add incomes
received but not currently earned. Therefore,
Personal Income = National Income Social Security contributions corporate income
taxes undistributed corporate profits + transfer payments.
6. Disposable Income: From personal income if we deduct personal taxes like income taxes,
personal property taxes etc. what remains is called disposable income. Thus,
Disposable Income = Personal income personal taxes.
Disposable Income can either be consumed or saved. Therefore,
Disposable Income = consumption + saving.
7. Net Domestic Income at factor cost = Wages, Salaries, and Supplementary Labour
Income + Profits of Corporations and Govt. Enterprises before taxes + Interest and
Investment Income + Net Income from Farms and Unincorporated Businesses + Taxes less
subsidies on factors of production
8. Net Domestic Income at market prices = Net Domestic Income at factor cost + Indirect
taxes less subsidies
MEASUREMENT OF NATIONAL INCOME
Production generate incomes which are again spent on goods and services produced.
Therefore, national income can be measured by three methods:
1. Output or Production method
2. Income method, and
3. Expenditure method.
Let us discuss these methods in detail.
1. Output or Production Method: This method is also called the value-added method. This
method approaches national income from the output side. Under this method, the economy is
divided into different sectors such as agriculture, fishing, mining, construction,
manufacturing, trade and commerce, transport, communication and other services. Then, the
gross product is found out by adding up the net values of all the production that has taken
place in these sectors during a given year.
In order to arrive at the net value of production of a given industry, intermediate goods
purchase by the producers of this industry are deducted from the gross value of production of
that industry. The aggregate or net values of production of all the industry and sectors of the
economy plus the net factor income from abroad will give us the GNP. If we deduct
depreciation from the GNP we get NNP at market price. NNP at market price indirect taxes
+ subsidies will give us NNP at factor cost or National Income.

The output method can be used where there exists a census of production for the year. The
advantage of this method is that it reveals the contributions and relative importance and of
the different sectors of the economy.
2. Income Method: This method approaches national income from the distribution side.
According to this method, national income is obtained by summing up of the incomes of all
individuals in the country. Thus, national income is calculated by adding up the rent of land,
wages and salaries of employees, interest on capital, profits of entrepreneurs and income of
self-employed people.
This method of estimating national income has the great advantage of indicating the
distribution of national income among different income groups such as landlords, capitalists,
workers, etc.
3. Expenditure Method: This method arrives at national income by adding up all the
expenditure made on goods and services during a year. Thus, the national income is found by
adding up the following types of expenditure by households, private business enterprises and
the government: (a) Expenditure on consumer goods and services by individuals and households denoted by
C. This is called personal consumption expenditure denoted by C.
(b) Expenditure by private business enterprises on capital goods and on making additions to
inventories or stocks in a year. This is called gross domestic private investment denoted by I.
(c) Governments expenditure on goods and services i.e. government purchases denoted by
G.
(d) Expenditure made by foreigners on goods and services of the national economy over and
above what this economy spends on the output of the foreign countries i.e. exports imports
denoted by
(X M). Thus,
GDP = C + I + G + (X M).
Difficulties in the Measurement of National Income
There are many difficulties in measuring national income of a country accurately. The
difficulties involved are both conceptual and statistical in nature. Some of these difficulties or
problems are discuss below:
1. The first problem relates to the treatment of non-monetary transactions such as the services
of housewives and farm output consumed at home. On this point, the general agreement
seems to be to exclude the services of housewives while including the value of farm output
consumed at home in the estimates of national income.

2. The second difficulty arises with regard to the treatment of the government in national
income accounts. On this point the general viewpoint is that as regards the administrative
functions of the government like justice, administrative and defense are concerned they
should be treated as giving rise to final consumption of such services by the community as a
whole so that contribution of general government activities will be equal to the amount of
wages and salaries paid by the government. Capital formation by the government is treated as
the same as capital formation by any other enterprise.
3. The third major problem arises with regard to the treatment of income arising out of the
foreign firm in a country. On this point, the IMF viewpoint is that production and income
arising from an enterprise should be ascribed to the territory in which production takes place.
However, profits earned by foreign companies are credited to the parent company.