Basics of Economy

Economy - Basics of Economy

National Income Definition

• National income is the total value of a country’s final output of all new goods and services produced in one year. However, there are practical difficulties in estimating the national income as per this concept; hence we use the Pigouvian definition.
• C. Pigou has in his definition of national income included that income which can be measured in terms of money. In the words of Pigou, “National income is that part of objective income of the community, including the income derived from abroad which can be measured in monetary terms.”

National Income Concepts

Gross Domestic Product at Market Prices (GDPMP )

• GDP is the market value of all final goods and services produced within a domestic territory of a country measured in a year. •
• All production done by the national residents or the non-residents in a country gets included, regardless of whether that production is owned by a local company or a foreign entity.
• Everything is valued at market prices.
• GDP MP = C+ I +G +X –M

GDP at Factor Cost (GDPFC)

• GDP at factor cost is gross domestic product at market prices, less net product taxes.
• Market prices are the prices as paid by the consumers Market prices also include product taxes and subsides. The term factor cost refers to the prices of products as received by the producers. Thus, factor cost is equal to market prices, minus net indirect taxes. GDP at factor cost measures money value of output produced by the firms within the domestic boundaries of a country in a year.
• GDPFC =GDPMP –NIT

Net Domestic Product at Market Prices (NDPMP)

• This measure allows policy-makers to estimate how much the country has to spend just to maintain their current GDP. If the country is not able to replace the capital stock lost through depreciation, then GDP will fall.
• NDP MP =GDP MP –DEP

NDP at Factor Cost (NDPFC)

• NDP at factor cost is the income earned by the factors in the form of wages, profits, rent, interest, etc., within the domestic territory of a country.
• NDPFC =NDPMP -Net ProductTaxes-Net ProductionTaxes

Gross National Product at Market Prices (GNPMP)

• GNPMP is the value of all the final goods and services that are produced by the normal residents of India and is measured at the market prices, in a year.
• GNP refers to all the economic output produced by a nation’s normal residents, whether they are located within the national boundary or abroad.
• Everything is valued at the market prices.
• GNPMP= GDP MP + NFIA

GNP at Factor Cost (GNPFC)

• GNP at factor cost measures value of output received by the factors of production belonging to a country in a year.
• GNP FC =GNP MP -Net ProductTaxes-Net ProductionTaxes

Net National Product at Market Prices (NNPMP)

• This is a measure of how much a country can consume in a given period of time. NNP measures output regardless of where that production has taken place (in domestic territory or abroad).
• NNPMP =GNPMP –Depreciation
• NNPMP= NDPMP+ NFIA

NNP at Factor Cost (NNPFC)

• NNP at factor cost is the sum of income earned by all factors in the production in the form of wages, profits, rent and interest, etc., belonging to a country during a year.
• It is the National Product and is not bound by production in the national boundaries. It is the net domestic factor income added with the net factor income from abroad.
• NI =NNPMP - Net ProductTaxes-Net ProductionTaxes

GVA at basic prices

• GVAMP - Net Product Taxes

GVA at factor cost

• GVA at basic prices - Net Production Taxes

Three Measurements of National Income

National Income calculated by three ways:

Consider the following while calculating National Income through:

Value Added Method (or the Product Method)

• The value added or production method is used by economists to calculate GDP at market prices, which is the total values of outputs produced at different stages of production. It needs to be mentioned that caution should be taken to take final Goods and not Intermediate goods, as it will result in Double Counting.
• Some of the goods and services included in production are:
  • Goods and services actually sold in the market.
  • Goods and services not sold but supplied free of cost. (No Charge/Complementary
• Some of the goods and services not included in production are:
  • Second hand items and purchase and sale of the same. Sale and purchase of second cars, for example, are not a part of GDP calculation as no new production takes place in the economy.
  • Production due to unwarranted/ illegal activities.
  • Non-economic goods or natural goods such as air and water.
  • Transfer Payments such as scholarships, pensions etc. are excluded as there is income received, but no good or service is produced in return.
  • Imputed rental for owner-occupied housing is also excluded

Income Method 

• This method emphasises on aggregating the payments made by firms to households, called factor payments.
• It is defined as total income earned by citizens and businesses of a country. There are four types of factors of production and four types of factor incomes accordingly i.e. Land, Labour, Capital and Entrepreneur/Organization as Factors of Production and Rent, Wages, Interest and Profit as Factor Incomes correspondingly.
• GDP = Wages+ Interest Income + Rental Income +Profit +Indirect Taxes-Subsidies+ Depreciation
• The term Profit can be further sub-divided into: profit tax; dividend to all those shareholders; and retained profit (or retained earnings).
• Such an approach is adopted in India to calculate the contribution of services sector to the economy.
• Any income corresponding to which there is no flow of goods and services or value added, it should not be included in calculation by Income method.

Expenditure Method

• The expenditure method measures the final expenditure on GDP. Amount of Expenditure refers to all spending on currently-produced final goods and services only in an economy. In an economy, there are three main agencies, which buy goods and services. These are: Households, Firms and the Government
• This final expenditure is made up of the sum of four expenditure items, namely:
• Consumption (C): Personal Consumption made by households, the payment of which is paid by households directly to the firms which produced the goods and services desired by the households.
• Investment Expenditure (I): Investment is an addition to capital stock of an economy in a given time period. This includes investments by firms as well as governments sectors
• Government Expenditure (G): This category includes the value of goods and service purchased by Government. Government expenditure on pension schemes, scholarships, unemployment allowances etc. are not included in this as all of them come under transfer payments.
• Net Exports (X-IM): Expenditure on foreign made products (Imports) are expenditure that escapes the system, and must be subtracted from total expenditures. In turn, goods produced by domestic firms which are demanded by foreign economies involve expenditure by other economies on our production (Exports), and are included in total expenditure. The combination of the two gives Net Exports.

GDP= C+I+G+X-IM C = consumption 

I = Investment

G = Government expenditure

X = Export 

IM = Import

What are the factors that affect National Income?

Several factors affect the national income of a country. Some of them have been listed below:

Factors of Production

Normally, the more efficient and richer the resources, higher will be the level of National Income or GNP.

1. Land

Resources like coal, iron and timber are essential for heavy industries so that they must be available and accessible. In other words, the geographical location of these natural resources affects the level of GNP.

2. Capital

Capital is generally determined by investment. Investment in turn depends on other factors like profitability, political stability, etc.

3. Labour

The quality or productivity of human resources is more important than quantity. Manpower planning and education affect the productivity and production capacity of an economy.

4. Entreprise

The size of the national income also greatly depends upon the number and skill of the entrepreneurs. If the captains of the industries! are efficient, they will combine; the various factors of production to the optimum proportion and so the volume of total production will be quite large, if managerial skill is lacking in the country, the size of the national income will be small.

5. Technology

This factor is more important for Nations with fewer natural resources. The development in technology is affected by the level of invention and innovation in production.

6. Government

Government can help to provide a favourable business environment for investment. It provides law and order, regulations.

7. Political Stability

A stable economy and political system helps in appropriate allocation of resources. Wars, strikes and social unrests will discourage investment and business activities.

New Methodology for Calculation of GDP in India

• Earlier domestic GDP was calculated at factor or basic cost, which took into account prices of products received by producers.
• The new formula takes into account market prices paid by consumers. It is calculated by adding GDP at factor price and indirect taxes (minus subsidies). It is in line with international practice and is expected to better capture the changing structure of the Indian economy.
• The government has also changed the base year for estimating GDP from 2004-05 to 2011-12. This has been done to incorporate the changing structure of the economy, especially rural India.
• Data for the new GDP series will now be collected from 5 lakh companies (against 2,500 companies earlier). Under-represented and informal sectors as well as items such as smartphones and LED television sets will now be taken into account to calculate the gross domestic product.

Green GDP

• Green GDP is a term used generally for expressing GDP after adjusting for environmental damage. When information on economy’s use of the natural environment is integrated into the system of national accounts, it becomes green national accounts or environmental accounting.
• The process of environmental accounting involves three steps viz. Physical accounting; monetary valuation; and integration with national Income/wealth Accounts. Physical accounting determines the state of the resources, types, and extent (qualitative and quantitative) in spatial and temporal terms. Monetary valuation is done to determine its tangible and intangible components. Thereafter, the net change in natural resources in monetary terms is integrated into the Gross Domestic Product in order to reach the value of Green GDP.