Session 13&14 ME

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Harcourt, Inc. items and derived items copyright 2001 by Harcourt,

Inc.

Session 13&14

Anatomy &Anatomy &

Functioning of theFunctioning of theEconomy:NI aEconomy:NI a

precursorprecursor

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IntroductionIntroduction

ME examines the economic

behaviour of a nation and GDP is one

of the indicators based on which wecan examine the economic health of

a nation.

GDP and its sectoral distribution

also gives us an idea about structural

composition and income distribution.

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Inc.

Contd...

The growth of national income

and its composition gives a fairidea to a firm as what is there in

store for the firm in terms of its

growth prospects and scope ofdiversification if any.

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Inc.

Objectives

To understand circular flow on income and

expenditure.

To understand various concepts of NI To examine measures of national income

accounting.

To understand difficulties in the measurement

of national income.

To distinguish bet real GDP and nominal GDP

and concept of deflator.

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Inc.

When judging whether the

economy is doing well or poorly, it

is natural to look at the total

income that everyone in the

economy is earning.

TThe Economys income andhe Economys income and

expenditureexpenditure

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Inc.

For an economy as a whole, income

must equal expenditure because:

Every transaction has a buyer and a

seller.

Every rupee of spending by some buyer

is a rupee of income for some seller.

The Economys income andThe Economys income and

expenditureexpenditure

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Inc.

Gross domestic product (GDP) is a

measure of the income and expenditures

of an economy.

It is the total market value of all final

goods and services produced within a

country in a given period of time

notwithstanding the ownership of the

FOPs.

Gross Domestic Product

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Inc.

The Circular-Flow Diagram

The equality of income and

expenditure can be illustrated

with the circular-flow diagram.

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Inc.

The Circular-Flow Diagram

Firms Househ

olds

Market for

Factors

ofProduction

Market for

Goods

and Services

SpendingRevenue

Wages, rent,

and profit

Income

Goods &

Services soldGoods &

Services

bought

Labor, land,

and capital

Inputs for

production

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Inc.

The Measurement of GDP

Output is valued at market prices.

It records only the value offinal goods,not intermediate goods (the value is

counted only once).

It includes both tangible goods (food,

clothing, cars) and intangible services

(haircuts, housecleaning, doctor visits).

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It includes goods and services currently

produced, not transactions involving

goods produced in the past.

It measures the value of production

within the geographic confines of acountry.

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It measures the value of production

that takes place within a specific

interval of time, usually a year or a

quarter (three months).


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Inc.

What Is Counted in GDP?

GDP includes all itemsproduced in the economy

and sold legally in markets.

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Harcourt, Inc. items and derived items copyright 2001 by Harcourt,Inc.

What Is Not

Counted in GDP?

GDP excludes most items that are

produced and consumed at home and that

never enter the marketplace such as

services of housewives and various services

we render for our friends and family.

It excludes items produced and soldillicitly, such as illegal drugs.

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OtherMeasures of Income

Gross National Product (GNP)

Net National Product (NNP)

National Income

Personal IncomeDisposable Personal Income

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Gross National Product

Gross national product (GNP) is the total

income earned by a nations permanent

residents (called nationals) irrespective of their

place of work.

It differs from GDP by including income that

our citizens earn abroad and excluding income

that foreigners earn here.

GNP=GDP+NFIA(net factor income from

abroad)

GDP=GNP-NFIA

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Net National Product (NNP)

Net National Product (NNP) is the total

income of the nations residents (GNP)minus losses from depreciation.

Depreciation is the wear and tear on

the economys stock of equipment and

structures(capital).

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National Income

National Income is the total income

earned by a nations residents in the

production of goods and services.

It differs from NNP by excluding indirect

business taxes (such as sales taxes) andincluding business subsidies.

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Personal Income

National income is all earned by the residentFOPs for their contribution to current

years's output.

However all earned income is not received byFOPs.

At the same time FOPs receive income which

are not earned.

Personal income is the income that

households and noncorporate businesses

receive.

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Personal IncomePersonal Income

Unlike national income, it excludes

retained earnings, which is income that

corporations and PSUs have earned but

have not paid out to their owners.

In addition, it includes households

interest income, government transfers and

dividends.

PI =NI income earned but not

received+income received but not earned.

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Disposable Personal Income

Disposable personal income is the income

that household and noncorporate

businesses have left after satisfying all

their obligations to the government.

It equals personal income minus personaltaxes and certain nontax payments.

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The Components of GDP

GDP (Y) is the sum of the following:Consumption (C)

Investment (I)

Government Purchases (G)

Net Exports (NX)

Y= C + I + G + NX

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Consumption (C):

The spending by households on goods and

services, with the exception of purchases of

new housing.

Investment (I):The spending on capital equipment,

inventories, and structures, including new

housing.

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Government Purchases (G):

The spending on goods and services by

central, state, and local governments.

Does not include transfer payments because

they are not made in exchange for currently

produced goods or services.

Net Exports (NX):

Exports minus imports.

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Real versus Nominal GDP

Nominal GDP values the production of

goods and serv

ices at current prices.Real GDP values the production of

goods and services at constant prices.

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Real versus Nominal GDP

An accurate view of the economyrequires adjusting nominal to real

GDP by using the GDP deflator.

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Calculation ofReal GDPCalculation ofReal GDP

G & S Base Yr Current YP Q P Q

X1 2 40 3 60

X2 8 90 10 150

X3 80 100 90 110

X4 70 120 80 130

NY at Base yr- 17200

NY at current yr - 21980

Real=60*2+150*8+110*80+130*70=19220

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GDP Deflator

The GDP deflator measures the current

level of prices relative to the level of

prices in the base year.

It tells us the rise in nominalGDP that is

attributable to a rise in prices rather thana rise in the quantities produced.

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GDP Deflator

100GDPReal

GDPNominal=deflatorGDP

The GDP deflator is calculated as follows:

PIN of the chosen year

100

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100X

)fl t r(

)( i ll

20xx

20xx20xx

Nominal GDP is converted to real

GDP as follows:

Nominal GDP

PIN/100

Cont . . .Cont . . .

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Measurement of GNPMeasurement of GNP

Net Product Method or value added

method

Factor income method

Expenditure method

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National income estimationNational income estimation

CSO through its National Accounts

Statistics brings out the estimates of NI.

It has divided economy into 14 sectors

constituting three broad sectors of the

economy: Primary sector, secondarysector, tertiary sector.

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Contd..Contd..

Primary Sector comprises: agriculture,

forestry and logging, fishing, mining and

quarrying.

Secondary sector comprises:

manufacturing, both registered andunregistered sector, construction,

electricity, gas and water supply.

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Contd..Contd..

Tertiary sector comprises:

transport,storage and communication;

trade,hotels and restaurants; banking

and insurance; real estate, ownership of

dwellings and business services; public

administration and defence; other

services and last foreign sector.

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contd...contd...

In preparing estimates, theCSO follows

the product and income methods.

The product method is used in the

commodity producing sectors like

agriculture, forestry, fishing, mining,etc.,and manufacturing.

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Contd..Contd..

Under thisfrom the gross value of output,

value of inputs such as raw materials,

service inputs and depreciation of assets

are deducted.

The income method is used to estimate the

income from service sector.

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Contd...Contd...

Under this, the prodct of per person

average earnings and the no. of people

working is appliedto computing income

To the combined estimates so arrived at by

using these two methods are added theestimates of net income from abroad.

Depreciated value of assets is added to

NNP to get GDP.

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Difficulties in estimation of NIDifficulties in estimation of NI

Presence of large non-monetised sector:

One third of productive activities

according to RBI are outside the purview

of money. Examples: ag. Output retained

by the farmers for self-consumption,

services rendered by housewives.

Lack of reliable data from vast

unorganised sector

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Contd..Contd..

Unreported illegal income

Difficulties in the classification ofworking population

Black money

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GDP is the best single measure of the

economic well-being of a society.GDP per person tells us the income

and expenditure of the average person

in the economy.

GDP and Economic well-being

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Higher GDP per person indicates a

higher standard of living.

GDP is not a perfect measure of the

happiness or quality of life, however.


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Some things that contribute to well-being are

not included in GDP.

The value of leisure.

The value of a clean environment.

The

value of almost all acti

vity that takes place

outside of markets, such as the value of the time

parents spend with their children and the value of

volunteer work.


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GDP, Life Expectancy, and Literacy

Country Real GDP perPerson (1997)

LifeExpectancy

AdultLiteracy

United States $29,010 77 years 99%

Japan 24,070 80 99

Germany 21,260 77 99

Mexico 8,370 72 90

Brazil 6,480 67 84

Russia 4,370 67 99

Indonesia 3,490 65 85

China 3,130 70 83

India 1,670 63 53

Pakistan 1,560 64 41

Bangladesh 1,050 58 39

Nigeria 920 50 59

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Measuring the Cost of Living

Inflation refers to a situation in which the

economys overall price level is rising.

The inflation rate is the percentage change

in the price level from the previous period.

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The Wholesale Price Index

When theWPI rises, the typical family

has to spend more dollars to maintainthe same standard of living.

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How the Consumer Price Index Is

Calculated

Fix the Basket: Determine what prices are

most important to the typical consumer.

The MOF identifies a market basket of

goods and services the typical consumer

buys.

The NSSO conducts periodic consumer

surveys to set the weights for the prices of

those goods and services.

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Contd..Contd..

Choose a Base Year and Compute the

Index:

Designate one year as the base year, making it

the benchmark against which other years are

compared.

Compute the index by dividing the price of

the basket in one year by the price in the base

year and multiplying by 100.

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Contd..Contd..

Compute the inflation rate: The

inflation rate is the percentage change

in the price index from the preceding

period.

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Contd..Contd..

Compute the inflation rate: The

inflation rate is the percentage change

in the price index from the preceding

period.

Inflation rate:

WPI in Yr.2-WPI in Yr.1 X 100

WPI in Year 1

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What is there in WPIWhat is there in WPI

Manufactured Prodcuts:64%

Food and nonfood articles:22%

Fuel, oil, lubricants: 14%

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Summary

Because every transaction has a buyer and

a seller, the total expenditure in the

economy must equal the total income in

the economy.

Gross Domestic Product (GDP) measures

an economys total expenditure on newly

produced goods and services and the total

income earned from the production of

these goods and serv

ices.

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Summary

GDP is the market value of all final goods

and services produced within a country in

a given period of time.

GDP is divided among four components

of expenditure: consumption, investment,

government purchases, and net exports.

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Summary

Nominal GDP uses current prices to

value the economys production. Real

GDP uses constant base-year prices tovalue the economys production of goods

and services.

The GDP deflator--calculated from the

ratio of nominal to real GDP--measures

the level of prices in the economy.

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Harcourt Inc items and derived items copyright 2001 by Harcourt

Summary

GDP is a good measure of economic well-

being because people prefer higher to

lower incomes.

It is not a perfect measure of well-being

because some things, such as leisure time

and a clean environment, arent

measured by GDP.

Session 13&14 ME

Documents

Transcript of Session 13&14 ME