Contents of Unit- I

Introduction to Macroeconomics The Keynesian revolution Objectives and instruments of Macroeconomics The tools of Macroeconomic policy Aggregate supply and demand Capitalism-Socialism-Mixed economies Concept and measurement of national income Understanding macroeconomic data for India and rest of the world

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Introduction
The modern economic science has two branches Microeconomics and macroeconomics Compared to micro economics macroeconomics is a younger branch of economics. Until Great Depression 1930s the subject of economic science was broadly micro economics. It emerged as a separate branch in 1936 with the publication of John Maynard Keynes's revolutionary book, The general theory of employment, Interest, and Money Some terms were coined by Ragner Frisch, in 1933 in his paper preposition problems and impulse problems in dynamic economics
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A reading on Great Depression

Historical Importance of the Great Depression: The Great Depression, an immense tragedy that placed millions of Americans out of work, was the beginning of government involvement in the economy and in society as a whole. Dates: 1929 -- early 1940s Overview of the Great Depression: Just to read The Stock Market Crash After nearly a decade of optimism and prosperity, the United States was thrown into despair on Black Tuesday, October 29, 1929, the day the stock market crashed and the official beginning of the Great Depression. As stock prices plummeted with no hope of recovery, panic struck. Masses and masses of people tried to sell their stock, but no one was buying. The stock market, which had appeared to be the surest way to become rich, quickly became the path to bankruptcy.

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A Reading on Great Depression

And yet, the Stock Market Crash was just the beginning. Since many banks had also invested large portions of their clients' savings in the stock market, these banks were forced to close when the stock market crashed. Seeing a few banks close caused another panic across the country. Afraid they would lose their own savings, people rushed to banks that were still open to withdraw their money. This massive withdrawal of cash caused additional banks to close. Since there was no way for a bank's clients to recover any of their savings once the bank had closed, those who didn't reach the bank in time also became bankrupt. Businesses and industry were also affected. Having lost much of their own capital in either the Stock Market Crash or the bank closures, many businesses started cutting back their workers' hours or wages. In turn, consumers began to curb their spending, refraining from purchasing such things as luxury goods. This lack of consumer spending caused additional businesses to cut back wages or, more drastically, to lay off some of their workers. Some businesses couldn't stay open even with these cuts and soon closed their doors, leaving all their workers unemployed.
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A Reading On Great Depression The Dust Bowl

In previous depressions, farmers were usually safe from the severe effects of a depression because they could at least feed themselves. Unfortunately, during the Great Depression, the Great Plains were hit hard with both a drought and horrendous dust storms. Years and years of overgrazing combined with the effects of a drought caused the grass to disappear. With just topsoil exposed, high winds picked up the loose dirt and whirled it for miles. The dust storms destroyed everything in their paths, leaving farmers without their crops. Small farmers were hit especially hard. Even before the dust storms hit, the invention of the tractor drastically cut the need for manpower on farms. These small farmers were usually already in debt, borrowing money for seed and paying it back when their crops came in. When the dust storms damaged the crops, not only could the small farmer not feed himself and his family, he could not pay back his debt. Banks would then foreclose on the small farms and the farmer's family would be both homeless and unemployed.
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A Reading On Great Depression

Roosevelt and the New Deal
The U.S. economy broke down and entered the Great Depression during the presidency of Herbert Hoover. Although President Hoover repeatedly spoke of optimism, the people blamed him for the Great Depression. Just as the shantytowns were named Hoovervilles after him, newspapers became known as "Hoover blankets," pockets of pants turned inside out (to show they were empty) were called "Hoover flags," and broken-down cars pulled by horses were known as "Hoover wagons. During the 1932 presidential election, Hoover did not stand a chance at reelection and Franklin D. Roosevelt won in a landslide. People of the United States had high hopes that President Roosevelt would be able to solve all their woes. As soon as Roosevelt took office, he closed all the banks and only let them reopen once they were stabilized. Next, Roosevelt began to establish programs that became known as the New Deal.

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A Reading On Great Depression

These New Deal programs were most commonly known by their initials, which reminded some people of alphabet soup. Some of these programs were aimed at helping farmers, like the AAA (Agricultural Adjustment Administration). While other programs, such as the CCC (Civilian Conservation Corps) and the WPA (Works Progress Administration), attempted to help curb unemployment by hiring people for various projects. The End of the Great Depression To many at the time, President Roosevelt was a hero. They believed that he cared deeply for the common man and that he was doing his best to end the Great Depression. Looking back, however, it is uncertain as to how much Roosevelt's New Deal programs helped to end the Great Depression. By all accounts, the New Deal programs eased the hardships of the Great Depression; however, the U.S. economy was still extremely bad by the end of the 1930s.
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A Reading On Great Depression

The major turn-around for the U.S. economy occurred after the bombing of Pearl Harbor and the entrance of the United States into World War II. Once the U.S. was involved in the war, both people and industry became essential to the war effort. Weapons, artillery, ships, and airplanes were needed quickly. Men were trained to become soldiers and the women were kept on the homefront to keep the factories going. Food needed to be grown for both the homefront and to send overseas. It was ultimately the entrance of the U.S. into World War II that ended the Great Depression in the United States.

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What is Economics & why do people economize?

Adam Smith, Economics is a science of wealth Alfred Marshall, Economics is a study of mankind in the ordinary business of life; it examines that part of individual and social action which is most closely associated with the attainment, and with the use of material requisites of well being. Why do people Economize? Human wants desires and aspirations are endless Resources are limited and scarce People are of optimizing nature

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What is Macroeconomics
Gardner Ackley, concerns the over-all dimensions of economic life. .. More specifically, macroeconomics concerns itself with such variables as aggregate volume of an economy, with the extent to which its resources are employed, with size of the national income, with the general price level. J.M. Culbertson, Macroeconomic theory is the theory of income, employment, prices and money. P.A. Samuelson, Macroeconomics is the study of the behavior of the economy as a whole. It examines the overall level of a nations output, employment, prices, and foreign trade. More importantly, it studies the relationship and interaction between the factors or forces that determine the level and growth of national output and employment, general price level, and the balance of payments positions of an economy.

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What is Macroeconomics
Look at the questions that macroeconomics seeks to answer: What determines the levels of economic activities, total output, the general price level, and the overall employment in a country? How is the equilibrium level of national income determined? What causes fluctuations in the national output and employment? What determines the general level of prices in a country? What determines the level of foreign trade and trade balance? What causes disequilibrium in the balance of payments of a country? How do the monetary and fiscal policies of the government affect the economy? What economic policies can steer the economy on the path of growth?

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Macroeconomic model
Macroeconomic model is the representation of the economic phenomenon in terms of a set of behavioral assumptions, definitions, simultaneous equation and identities. Model building is the process of dividing the entire system under different sectors with common features and characteristics in order to develop a simplified model to study the selected macroeconomic phenomenon. Macroeconomic variables are generally classified as:
I. Endogenous variable II. Exogenous variable

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Endogenous variable
Endogenous variable are those whose value is determined within the model. Some typical endogenous variable are National income Consumption Savings Investment Market interest rate Price level and Employment

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Exogenous variable
Exogenous variable are those whose value is determined outside the model. They are: Money supply Tax rates Government expenditure Exchange rates and so on

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Relevance of models
The relevance and applicability of an economic model to the real world depends on: a) How realistic are the assumptions of the model b) How consistent are the assumptions with one another, c) How accurate and relevant are the data to validate assumptions, and d) How logical and realistic are equations of the model. The purpose of economic models is not to replicate the real world or to produce exact economic laws but to develop and use a framework to understand better the economic system and its working.

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Concept: Stocks and flows

Stock is a quantity, which is measured at a point in time. Macro stock variables are the money supply, the total number of people employed in an economy, the total stock of capital, the total labor force etc. Macro flow variables are the savings, investment, change in inventories, change in money supply, etc. Imports and exports, taxes, wages and salaries, and dividend are flows.

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Concept: Equilibrium and disequilibrium

Equilibrium is a state of balance or a state where there is no change. Disequilibrium is a state of imbalance.

Price level P*

AS

AD Y*
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Quality (of all goods and service)

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Concept: Statics, dynamics and comparative statics

In static models, the relations between different variables relate to the same period in time. These models are unable to explain the process of change. They apply to models which are in a state of equilibrium. Dynamic models trace the changes that occur in the values of the different variables over time. They apply to models that are in a state of disequilibrium. Comparative statics compares two or more such equilibrium states.

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Origin and growth of macroeconomics

The foundation was laid by British economist, John Maynard Keynes (1883- 1946) in his revolutionary book The general Theory of Employment, Interest and Money (1936). In fact the use of macroeconomics dates back to the writings of the 16th century economists called mercantilits. Thus the growth of ME is divided into 3 subsections: Classical ME Keynesian revolution and ME Post- keynesian developments

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The Classical Macroeconomics

The classical economists had not developed any coherent theory. The summary their thought: According to classical school of thought, if market forces of demand and supply are allowed to work freely, then There will always be full employment in the long run, and unemployment, if any, will be a short-run phenomenon; There will be neither over-production nor under- production at the aggregated level; and The economy will always be in equilibrium in the long run. The great depression of 1930s however, proved all the classical assumptions wrong. During that period there was large scale unemployment in the most free market industrial economies and their GNP declined heavily.

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The Keynesian Revolution

Keynes departure from the classical school was caused by his realization that the classical economics was not capable of predicting , explaining and providing solution to economic problems. The Keynesian theories are associated mainly with employment growth and stability

The central theme of Keynesian theory are :

The level of output and employment in an economy is determined by the aggregate demand given the resources The unemployment in any country is caused by lack of aggregate demand and economic fluctuations are caused by demand deficiency. The demand deficiency can be removed through compensatory government spending. Indias development plans are largely based on the Keynesian theory of growth and employment.
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The Post Keynesian Developments

Monetarism (1970)
A group of economists led my Milton Friedman. The role of money is central to the growth and stability of national output, not the role of aggregate demand for real output, as Keynesians believe. At the theoretical level, the emphasis shifted from the analysis of the role of aggregate demand for real output to the aggregate demand for and supply of money, and at the policy level, the emphasis shifted from demand management to monetary management.

Neo classical macroeconomics (1980)

A group called radicalists led by Robert Lucas, the Nobel laureate of 1995 The emphasis was on individuals rational expectations about future Peoples rational expectations about government monetary and fiscal policies determine the behavior of aggregate supply and aggregate demand curves in such a way that real output remains unaffected, though prices and wages go up.
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The Post Keynesian Developments

Supply-side economics The team led by Arthur Laffer, emphasized the role of the factors operating on the supply side of the market. Cut in tax rate shifts aggregate supply curve rightward and leads to a rise in output and employment. Neo-Keynesianism Market does not clear always, in spite of individuals working for their own interest. They give reason that information problem and cost of changing prices lead to some price rigidities which cause fluctuations in output and employment.

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Importance/Limitations Of Macroeconomics
Importance: Growing importance of macroeconomics issues Persistence of macroeconomic problems Growing complexity of Economic system Need for government intervention with the market system Use of macroeconomics in business management Limitations: It ignores the structural changes in the constituent elements of the aggregate. Aggregates are not a reality but a picture or approximation of reality People consider it only as a intellectual attraction without much practical use
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Objectives And Instruments Of Macroeconomics

OBJECTIVES Output: High level and rapid growth of output Employment: High level of employment with low involuntary unemployment Stable prices INSTRUMENTS Monetary Policy: Buying and selling bonds, regulating financial institutions Fiscal Policy:
Government expenditures Taxation

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Aggregate Supply And Demand

Aggregate supply refers to the total quantity of goods and services that the nations businesses willingly produce and sell in a given period. Aggregate supply depends upon the price level, the productive capacity of the economy, and the level of costs. Business would like to sell everything they can produce at high price. AS also depends on the price level that businesses can charge as well as on the economys capacity or potential output. Potential output in turn is determined by the availability of productive inputs(land, labour, capital, managerial efficiency with which inputs are combined) Aggregate Demand: refers to the total amount that different sectors in the economy willingly spend in a given period. AD equals spending on goods and services. It depends on the level of prices, as well on monetary policy, fiscal policy and other factors. AD = consumption + investment+ government purchase+ net exports AD is also affected by the prices exogenous forces like wars and weather, and by government policies
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Web references
www.access.gpo.gov/ www.cbo.gov www. aei.org. Macro economic data for the US (www.fedstatgs.gov) www.bea.gov www.bls.gov India: www.rbi.org http://finmin.nic.in/ (http://planningcommission.gov.in/) www.dgciskol.nic.in/ CMIE data base-prowess available in your lab
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The Central Tasks Of A Society

The major considerations of any society in the economic field, irrespective of the way in which it is organized, are: What to produce (necessities v/s luxury, present v/s future, perishable v/s non perishable, capital/ consumer) How to produce (technique of production- capital and labour intensive) For whom to produce (how to share the goods and services) The ultimate goal of economic science is to improve the living conditions of people in their everyday lives.

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Market / Capitalism and the central tasks

The private ownership of resources or means of production. How does such a system solve the main tasks of what, how, and for whom to produce?------- market mechanism Society consists of two classes of people: Producers and consumers. The producers in market economy are motivated by the desire to make profits. Their decision to produce a commodity will be determined by the costs incurred and the price at which it can be sold. The consumers desire goods and services. However, their ability to fulfill their wants is conditioned by their income.

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Market / Capitalism and the central tasks

The market provides link between producers and consumers. Thus capitalism is individualistic with self-interest being the primary driving force. It is a decentralized, decision-making system. The extreme case of a market economy, in which the government keeps its hands off economic decisions, is called a laissez-faire economy. Command economy is one in which the government makes all important decisions about production and distribution. In a command economy, such as the one which operated in the Soviet Union during most of the 20th century, the government owns most of the means of production; it also owns and directs the operations of enterprises in most industries; it is the employer of most workers and tells them how to do their jobs; and it decides how the output of the society is to be divided among different goods and services. The government answers the major economic questions through its ownership of resources and its power to enforce decisions The basic problems of the economy are decided on the basis of need votes rather than money votes.
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Mixed Economies And The Central Tasks

No contemporary societies falls completely into either of these polar categories. Rather, all societies are mixed economies, with elements of market and command. Economic life is organized either through hierarchical command or decentralized voluntary markets. Today most decisions in the United States and other high- income economies are made in the market place. But the government plays and important role in overseeing the functioning of the market; governments pass laws that regulate economic life, product educational and police services, and control pollution. Most societies today operate mixed economies.

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Introduction
An economic system is a way of answering these basic questions what, how and for whom to produce The most general economic systems are Capitalist Economy Socialist Economy Mixed Economy

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Capitalist Economy
A capitalist economy is an economic system in which the production and distribution of commodities take place through the mechanism of free markets An individual has the freedom to buy and sell any number of goods and services Examples: The United States of America. Brazil Japan

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Features Of Capitalism
Right to Private Property Individuals have the right to buy and own property Profit-Motive Profit is the only motive for the functioning of capitalism. Freedom of Choice The question what to produce? will be determined by the producers Minimal role of Government Regulation of market, defence, foreign policy, currency, etc.

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Merits
Economic Growth: Rapid and consistent economic growth is the proven out come of this Capitalism. As there is less government intervention so many evil like corruption, nepotism, poor management did not hurt the growth rate. These are the common evils comes with authority. Another reason of this growth is when people invest their own money the make best effort to make profit out of it. Efficient Allocation of Resources: The means of production utilizes at the optimum level because the individual interest is involved. Resource used to produce the products needed and in demand of market. Efficient production: A competitive environment is there as every individual can takes any profit making activity. Competition push producer to take productive steps like cost cutting, new technology and use of best supply chain for make good profit. Financial incentives: Better financial gains are proven pushing force, for people to being involved in productive activities.
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Demerits
Inequality: The biggest argument against capitalism is inequality, in the free economies system the more talented and innovative people build strong financial position as compare to less skilled individuals. So this trend leads to inequality of distribution of wealth. Money makes money it is true in capitalism people who have the money invests their capital to different businesses and earn more money. Those who do not have the money cannot avail such opportunities and remain being deprived. Lack of Welfare: Capitalism has no feelings it is all about the materialistic efforts. This is the most popular reason vocal against capitalism when compare to communism. In communism the whole philosophy is human welfare in common, this aspect is totally missing in capitalism. Capitalism talks about reward of effort to individuals and advocate for it but do not discuss the interest of society and other stake holders.
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Socialism

a) b) c) d)

Characterized as follows:
much property held by the public through government, including major industries, utilities, and transportation systems; a limit on the accumulation of private property; government regulation of the economy; extensive publicly financed assistance and pension programs;

a) b)

social costs added to financial considerations as measure of efficiency. Centrally planned economy

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Features
Public Ownership - The economy of socialists is characterised by the means of production and distribution. There is a collective ownership whereby all mines, farms, factories, financial institutions, distributing agencies etc are regulated by government departments and state corporations. Central Planning - A socialist economy is centrally planned with functions under the direction of a central planning authority. It lays down the various objectives and targets to be achieved. Freedom of consumption - Under socialism, the consumers are at sovereignty that production in state owned industries is generally governed by the preferences of consumers and the available commodities distributed to the consumers at fixed prices through the state run department stores. Equality of Income Distribution - In a socialist economy, there is great equality of income distribution as compared with free market economy. The elimination of private ownership in the means of production, private capital accumulation and profit motive under socialism prevent the amassing of large wealth in the hands of a few rich persons.

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Merits
Socialisms advantages are related to overall well being of community and easy to understand for general public. Historically we have seen where the countries are deprived or governed by the intruders, after liberty they adopt the socialist infrastructure for their country, examples of French and British colonies can be studied for more details. Full employment level is another merit of socialism. All the means of productions are under government control so its responsibility of the state to provide job for every citizen. Economic conditions are more stable and there is no boom or recession in economy. Socialism work for collective good and also take care of financially and physically handicap people. Every citizen of society has equal rights and excess to the states resources. This is not true in capitalism, where talented and rich people secure well financial and social position and other could not get the equal status.
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Demerits
This system has low economic growth as talented and idle people enjoy the same status. This leads to low morale level which makes even capable people inactive, as they feel no reward of their extra effort. The theory of socialism sounds very attractive where basic rights of every individual is secured by government, but in actual the corruption and nepotism are very high and common person enjoys far less rights then the people in authority. Allocation of resources is poor government doesnt take advance and creative measures to increase productivity. As there is no profitability factor so government doesnt follow market demand. There are rigid policies and difficult to change until or unless change in total administration. Socialism emphasis more to society and less to the basic unit of society that is individual, so as long as the basic element is not satisfy with the reward the total outcome cannot be the satisfactory.
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Mixed Economy
Both public and private institutions exercise economic control. The public sector functions as a socialistic economy The private sector as a free enterprise economy freedom to hold private property, to earn profit, to consume, produce and distribute if these freedoms affect public welfare adversely, they are regulated and controlled by the State

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Features Of Mixed Economy

Public Sector - The state controls the public sector organisations and is operated for the welfare of the public instead of profit maximisation. But they earn profits like private industries which are utilised for capita formation. Private sector - The production and distribution of goods are done by private enterprises. This sector functions under state regulations in the interest of consumer goods and some capital goods. Public and private sector operate in competitive spirit in the interest of the society. Joint Sector - A mixed economy has semi sector which comprises both of public and private sectors and their majority of holdings are with the state. Cooperative Sector - A sector is formed on the cooperative principles. The state takes care of monetary assistance and runs on the interest of the public. Freedom and Control - Mixed economy has the liberty to hold private properties to earn profit, to consume and manufacture and distribute. The control is in the hands of the state. Economic Planning - The central planning authority is there in a mixed economy and it operates few of the economic plans. All sectors of the economy function according to the objectives, priorities and targets laid down in the plan.
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Merits
ECONOMIC STABILITY AND PROPER ALLOCATION OF RESOURCES A mixed economy remedies this through state regulation of the economy, and planning. Through economic plan-ning the resources of the economy are utilized in the more efficient and optimal manner. Production is rationally organized. Possibilities of overproduction or underproduction are eliminated. The rigours of un-employment and inequalities are minimized. This enables a mixed economy to enjoy the basic advantages of a socialist economy. ADVANTAGES OF FREE INITIATIVE AND ENTERPRISE In a mixed economy the various capitalistic institutions such as private property, competition, profit motive and freedom of enterprise, etc., have an adequate scope. There is adequate incentive for hard work and increased productive effi-ciency and efforts. The operation of price mechanism provides an element of dynamism to the economy. FOUNDATION OF INTERNATIONAL COEXISTENCE A mixed economy is based on an amalgam of private enterprise and public enterprise. There is coexistence of the private sector with the public sector. Such peaceful economic coexistence of the two rival sectors at home paves the way for political coexistence abroad. It makes our attitude tolerant towards others.

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Demerits
CONFLICT BETWEEN THE TWO SECTORS Mixed economy represents a compromise between capitalism and socialism and thereby it aims at availing the advantages of both the worlds. But in reality there may take place frequent collusions between them. This would only give rise to further bitterness and non-co- operation. In course of time the private sector may feel suffocated because of the step-motherly treatment meted out to it. INEFFICIENT PUBLIC SECTOR In a mixed economy the public sector usually has a record of poor performance. It suffers from inefficiency, redtapism, corruption and waste. Consequently the public sector has failed either to increase the volume of production or reduce costs. FAILURE TO ERADICATE ECONOMIC FLUCTUATIONS : The principle of mixed economy had become popular in the capitalist countries as it was considered to be a suitable method to eradicate economic fluctuations. But somehow the problem still persists. Economic fluctuations can be removed only when the entire economy is fully covered by the central plan. But the type of regulation that is imposed on the private sector in a mixed economy leaves much to be desired.
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National Income

CONCEPTS & MEASUREMENT OF NATIONAL INCOME

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Measuring Economic Activity through National Income When you can measure what you are speaking about, and express it in numbers, you know something about it; when you cannot measure it, when you cannot express it in numbers, your knowledge is of a meager and unsatisfactory kind; it may be the beginning of knowledge, but you have scarcely, in your thoughts, advanced to the stage of science. -Lord Kelvin

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Measuring Economic Activity through National Income

The single most important concept in macroeconomics is the gross domestic product (GDP), which measures the total value of goods and services produced in a country during a year. When economists/policy makers want to determine the level of economic development of a country, they look at its GDP per capita. What is GDP? GDP is the total market value of the final goods and services produced within a nation during a given year measured in monetary units. It is sum of the dollar values of consumption (C), gross investment ( I), government purchases of goods and services (G), and net exports (X) produced within a nation during a given year. GDP = C+I+ G+ X X = Exports - imports
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Contents
Circular flow of Income Approaches to measurement of National Income Measures of Aggregate Income Problems in National Income Accounting Comparison of NI over time Estimation of National Income in India Methodology of Estimation

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Circular Flow Of Income

The mechanism of income and expenditure flows is extremely complex in reality. To present the flows of income and expenditure, the economy is divided into four sectors: Household, business, government and foreign These 4 sectors are combined to make the following 3 models: Two-sector model including the household and business sectors Three-sector model including the household, business and government sectors Four-sector model including the household, business, government and the foreign sectors.

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The Circular-Flow Diagram

Revenue Goods & Services sold

Market for Goods and Services

Spending Goods & Services bought

Firms

Households

Inputs for production Wages, rent, and profit

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Market for Factors of Production

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Labor, land, and capital Income

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The Circular-Flow Diagram

Tax By House Hold, Income Tax ,Wealth Factor Payment (wages, Salary, interest, P/l) NRI Income Money Internal Borrowing Transfer Payment Corporate tax
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Government

ABROAD

House Hold

Savings

Capital Market

Investment

Business

Final Goods and Services (Land, Labor, Capital, Entrepreneur) Factors of Production Export & Import
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Circular Flow Of Income In A Two Sector Economy

Factor Services Factors Income

House Hold Income

Firms

Expenditure on goods and service Flow of Good of Services

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Circular Flow Of Income In A Three Sector Economy

Government expenditure on Services & Transfer Payment Government expenditure on goods and subsidies

Government Taxes Firms

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Factor Services Factors Income

House Holds

Savings

Capital Market

Investment

Expenditure on goods and service

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Flow of Good of Services

Circular Flow Of Income In A Four Sector Economy

Government expenditure on Services & Transfer Payment Government expenditure on goods and subsidies

Government Taxes Firms

Payment for imports Payment for exports

Factor Services Factors Income

House Holds

Savings

Capital Market

Investment

Expenditure on goods and service

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Flow of Good of Services

Foreign Sector
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Approaches to measurement of National Income Net product method or value added method Factor Income method Expenditure method

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Net product method / value added method

This method consists of 3 stages Estimating the gross value of domestic output in the various branches of production; Determining the cost of material and services used and also the depreciation of physical assets; Deducting these costs and depreciation from gross value to obtain the net value of domestic output

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Net product method / value added method Estimating the gross value of domestic output in the various branches of production For measuring gross value of domestic product, output is classified under various categories. The classification of products varies form country to country depending on The nature of domestic industries Their significance in aggregate economic activities Availability of requisite data 71 divisions are used in the US, a dozen in Netherlands half a dozen in Russia, and 21-24 in India in CSO

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Cont
After classifying the output in categories, the gross value of output of each category is computed by any of the following two alternative methods Multiplying the output of each sector or category by their respective prices and adding them together Collecting the data on gross sales and inventories from the records of the companies and adding them up.

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Net product method / value added method

Determining the cost of material and services used and also the depreciation of physical assets The next step in estimating the net national product is to estimate the intermediate cost of production including depreciation. Conventionally depreciation is estimated as some percentage of original cost of capital, permissible under the taxation laws. In some countries dep is estimated as some percentage of total output rather than cost of capital

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Net product method / value added method

Deducting these costs and depreciation from gross value to obtain the net value of domestic output (Value added)
Product 1 Wheat Flour Bread Sandwich Total
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Value of Inputs Value of Final Output 2 Nil 1000 1500 2000 4500 3 1000 1500 2000 3000 7500
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Gross Value Added 4 1000 500 500 1000 3000

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Factor Income Method

National Income (GDP) = Rent + Wages + Interest + Profit + Depreciation Labor Income: wages and salaries, supplementary income, employers contribution , transfer payments Capital income: dividends, undistributed before tax profits, interest on bonds, mortgages and saving deposits, interest earned by insurance companies, net rents from land building, royalties, profit of govt. enterprises Mixed Income: farming enterprises, sole proprietorship, medical, legal practice, consultancy, trade , transportation

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Expenditure Method

This is also known as final product method- 2 methods are used Income disposal method- money expenditures at market prices are added up together to obtain the total final expenditure ( private consumption expen. Direct tax payments, payments made to the non-profit organizations, charitable institutions, private savings) Product disposal method- the value of the products finally disposed of are computed are added together ( private consumer goods and services, private investment goods, public goods and services, net investment abroad)

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Measurement of National Income in India The history of measurement of NI can be divided under 2 phases: Pre independence phase- The first attempt was made by Dadabhai Naroroji in 1867-68. Subsequently, several attempts were made by economists and government officials to estimate Indias NI. Then Prof. V. K.R. V. Rao estimated NI in the year 1925- 29 and1931-32. Though it was considered to be superior it had serious limitations. Post independence phase- The first official estimate of Indias NI was made in 1949 by the Ministry of Commerce, Government of India.

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Cont.. National Income Commission (NIC) was set up in 1949 my MOC with P. C. Mahalanobis, D. R. Gadgil and V.K.R.V. Rao as its members. NIC estimated NI for 1948-49, and for 195152. The methodology developed by NIC was followed till 1967. After 1967, the job went to Central Statistical Organization (CSO) and it adopted improved methodology to estimate NI.

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Measurement of National Income in India Sectors of an economy: An economy comprises of a variety of economic activities resulting in different sources and nature of income. To make the NI data easy and comprehensive we classify different activities into sectors. This is called sectoral accounting of National Income. CSO uses following sectors for classification: Primary sector Secondary sector Tertiary or service sector

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Measurement of National Income in India PRIMARY SECTOR Agriculture Forestry and logging Fishing Mining and Quarrying SECONDARY SECTOR Manufacturing Registered manufacturing Unregistered manufacturing Construction Electricity, water and gas supply
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Measurement of National Income in India

TERTIARY SECTOR Transport, Trade and Communication Transport, storage and communication Railways Other means of transport Communication Trade hotels and restaurants Finance and Real Estate Banking and insurance Real estate for residential and business purpose Community and Personal Services Public administration and defense Other services
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Methods of measuring NI in India

Production method or value added method: This is also called net output method or value added method is used to estimate income or domestic product of the following production sectors: Agriculture Forestry and logging Fishing Mining and Quarrying Registered manufacturing

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Methods of measuring NI in India

Income method is used for estimating domestic income of the following sectors: Unregistered manufacturing Electricity, water and gas supply Banking and insurance Transport, storage and communication Real estate and business services Trade hotels and restaurants Public administration and defense Other services -For the sake of comparison of estimates and to check their reliability, CSO estimates national income also on the basis expenditure method. In India, the sectoral accounting of GDP, based on the expenditure method, follows the following classification of the NI given below.
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Methods of measuring NI in India

1. Private final consumption expenditure including expenditure on i. Durable goods ii. Semi durable goods iii. Non-durable goods iv. Services 2. Government final consumption expenditure 3. Gross fixed capital formation including construction, machinery and equipments 4. Change in stocks, and 5. Net export of goods and services
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Some concepts related to NI Economic and Non-Economic Production Economic Production Marketable and non- marketable production Non Economic Production Services rendered to self, family and neighbor Intermediate and Final Products Transfer Payments Consumer and Producer Goods

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Economic Production
It refers to the production of goods and services which are meant for sale and have market value. It also includes those goods and services which are produced and provided jointly to the public by the government and public organizations, for which people pay indirectly through tax payment. Thus it includes both marketable and non-marketable production. Goods produced by farmers, firms, factories, shops, hoteliers etc fall under marketable production. Goods and services produced and supplied by the government, public institutions, social organizations, NGOs etc fall in non marketable production.
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Non-Economic Production
It includes production and services of goods that are not meant to be sold, nor there is any market for them, nor do they have a market price. Some of the services which come under this are: I. Services rendered to self, e.g., eating, shaving, exercising, washing ones own clothes, cooking for self, etc II.Services to provide to the family members, e.g., housewives cooking for the family, parents teaching their own children, doctors treating their own family members, etc III.Services provided by the neighbors to each other, e.g., helping each other on festival and marriage occasions etc, While calculating national income we will include only economic production and not non- economic production.
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Intermediate Goods
Goods that flow from one stage to another in the process of production of a good, with their form changing are called intermediate products. A product sold by one firm to another for further processing or value addition in the process of production is called intermediate products. The need for distinction between intermediate and final products arises because of the problem of double counting. Double counting leads to overestimation of the national income.

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Final Goods
The goods that reach the final stage of the production and flow to their ultimate users are called final products. Product that is sold finally to the consumer is the final product. Final goods can be classified into I. Final consumer goods goods that flow to the ultimate consumer II.Final producer or capital goods machinery, plant and equipments which are used by the firms in the process of production.

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Transfer Payments
These are payments made by people to the people, and by people to the government, without corresponding transfer of goods and services or addition to the total output. For example, when a person gifts some money to a relative or friend or when he/she donates an amount to a poor person without receiving anything in return then it is a transfer payment. When people pay taxes to the government and government pays old age pension to the people, these are treated as transfer payments.

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National Income Measures

Gross and net concepts National and domestic concepts Market prices and factor costs GNP--- Gross national product NNP--- Net national product GDP---gross domestic product NDP---net domestic product Personal income Disposable income

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Gross Domestic Product (GDP)

It can be defined as the sum of market value of all final goods and services produced in a country during a specific period of time, generally one year. The market value of domestic product is obtained at both constant and current prices. GDP= consumption + investment + government expenditure + net exports. GDP = market value of goods and services produced by the residents in the country + incomes earned in the country by foreigners incomes received by residents of a country from abroad.

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Gross national product(GNP)

It includes the income of the resident nationals which they receive abroad, and excludes the income generated locally but accruing to the non-nationals. GNP = market value of domestically produced goods and services + incomes earned by the residents of a country in foreign country incomes earned by the foreigners in the country.

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Net national product(NNP)

NNP = GNP depreciation or capital consumption A part of capital goods is used up or consumed in the process of production of these goods. This is called depreciation or capital consumption. NNP is in fact, the actual measure of national income.

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Personal income(PI)

It can be defined as the sum of all kinds of incomes received by the individuals from all sources of incomes. It includes wages, salaries, fees and commission, bonus, dividends, interest earnings. It includes transfer incomes like pensions, family allowances, old age benefits. It also includes the income through illegal means

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National Income Measures

Personal income PI= NNP at factor cost-undistributed profits-corporate taxes + transfer payments Disposable income D I= personal income personal taxes PI = DI +T DI =C+ S Thus PI = C+S+T C= Consumption spending S = personal saving
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National Income Measures NOMINAL and REAL GNP The GNP/GDP are estimated at both current and constant prices. The GNP estimated at current prices is called nominal GNP and the one estimated at constant prices in a chosen year (base year) is called real GNP. The need for estimating GNP at constant prices arises because GNP at the current prices produces a misleading picture of economic performance when prices are continuously rising or decreasing.

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National Income Measures GNP valued at current prices shows rise in GNP under the following conditions: Actual production is decreasing but prices are rising Actual production remains constant and prices are rising Estimating GNP at the prices of the base year is not an easy task. Therefore we use GNP deflator or National Income Deflator to eliminate the effect of rising prices on the GNP and to work out real GNP at the base year prices.

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National Income Measures

The GNP Deflator and its Application The GNP deflator is essentially an adjustment factor used to convert nominal GNP into real GNP. The GNP deflator is the ratio of price index number (PIN) of a chosen year to the price index number (PIN) of the base year. GNP Deflator = PIN of the chosen year/ 100 The formula for converting nominal GNP of a year into real GNP: Real GNP = Nominal GNP/ GNP Deflator Real GNP = Nominal GNP/ PIN (cy)/100
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National Income Measures

Given the data: Nominal GNP of India/ GNP estimated at current prices in year 2000 = Rs 500 billion Price of Index number (PIN) , base year 2000 = 100 Nominal GNP at year 2005 = 600 billion PIN rises = 110 GNP deflator = PIN (2005) = 110 = 1.10 100 100 Given the GNP Deflator at 1.10, the real GNP for the year 2005 can be : Real GNP = Nominal GNP/ GNP Deflator = Rs. 600 billion / 1.10 = Rs. 545.45 billion
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National Income Measures

Note that the Nominal GNP increases from Rs.500 billion to Rs 600 billion that is by 20 percent over a period of 5 years or at an annual average rate of 4 percent. Since PIN increases from 100 to 110, i.e., by 10 percent over 5 years, real GNP increases at a lower rate, i.e., at 9.12 percent or at an annual average rate of 1.8 percent.

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National Income Measures

GNP Implicit Deflator Another variant of GNP deflator is GNP implicit deflator, also called implicit price deflator. It is the ratio of nominal GNP to real GNP, i.e., GNP Implicit Deflator = Nominal GNP/ Real GNP The GNP implicit deflator can be used for the following: To construct price index To measure the rate of change in prices or to measure inflation Nominal GNP in the year 2005 = Rs 600 billion Real GNP in the year 2005 = Rs 545.45 billion GNP Implicit Deflator = 600/ 545.45 = 1.10 The GNP implicit deflator multiplied by 100 give the Price Index Number (PIN) PIN (2005) = GNP Implicit Deflator * 100 = 1.10 * 100 = 110
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National Income Measures

Thus, 110 is the price index number for the year 2005. The same procedure can be adopted to calculate PIN for other years. Once PINs for different years are calculated, the same can be used to calculate the rate of change in price, i.e., the rate of inflation. Rate of Inflation = PIN 2005 PIN 2000 * 100 PIN 2000 = 110 100 * 100 = 10 percent 100 This means that inflation over a period of 5 years was 10 percent or at an annual average rate of 2 percent.

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Some problems in National Income Accounting

Demarcation of productive activity Treatment of non marketed output Distinction between final and intermediate goods Avoiding double counting and the concept of value added Value added = Total sales + Closing stock of finished and semi finished goods- total expenditure on raw materials and intermediate products purchased from other firms- opening stock of finished and semi finished goods.

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Is national income true measure of economic welfare? Can national income be dependable measure of economic welfare? Does its increase bring about a corresponding increases in economic welfare? NI cannot be reliable as it takes into consideration tractions done in terms of money. Barter system doesnt get into account. Again, the NI may increase or decrease according to an increase or decrease in the general price level, because it is expressed on the basis of current money value even when the actual NI has not changed at all. Increase in NI may not mean rise in welfare as the more than proportionate increase in population may decrease the per capita income, people may spend the increased income on harmful goods and activities.
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