Unit-5
National income
The total income of the nation is called National
Income. In real terms, national income is the
flow of goods and services produced in the
economy in a particular period- a year.
Concept of national income
 Gross National Product (GNP)- GNP has been
defined as the total market value of all final goods and
services produced within or outside the territorial limits of a
country in a year.
Factors to be taken into consideration while studying GNP
(i)
As GNP is a measure of money, so all kinds of goods and
services produced in a country during one year are
measured in terms of money at current prices and then
added together.
(i)
In estimating GNP of the economy, the market price of only
final products should be taken into account.
(iii) Goods and Services rendered free of charge are not included
in the GNP, because it is not possible to have a correct
estimate of their market prices.
(iv) The transactions which do not arise from the produce of
current year or which do not contribute in any way to
production are not included in the GNP.
(v) The income earned through illegal activities is not included
in the GNP.
GNP = GDP + NFIA
 Net National Product (NNP)-NNP refers to the
total market value of all final goods and services produced by
residents in a country during a given time period
minus depreciation.
NNP = GNP – Depreciation or NDP + NFIA
 Gross Domestic Product (GDP)- Gross domestic
product (GDP) is the market value of all officially recognized
final goods and services produced in the domestic territory of
a country in a given period of time.
Domestic territory includes(i) Terittory lying within the political frontiers, including
territorial waters of the country,
(ii) Ships and aircrafts operated by the residents of the country
between two or more countries,
(iii) Fishing vessels, oil and natural gas rigs, operated by the
residents of the country,
(iv) Embassies, consulates and military establishments of the
country located abroad.
 NDP-While calculating GDP no provision is made for
depreciation allowance.when depriciation is substracted from
GDP ,we get NDP.
NDP = GDP- Depriciation
 Per Capita Income- It denotes the income received by an
individual during a certain year in a country.
Per Capita Income = National income of India in 2011
Population of India in 2011
 Personal Income- It refers to an individual's total
earnings from wages, investment enterprises, and other
ventures. It is the sum of all the incomes actually received by
all the individuals or household during a given period.
 Disposable Income- It is the actual income which can
be spend on consumption.
Disposable Income = Personal Income – Direct Taxes
But it should be remembered while calculating this income that
the whole of the disposable income is not spend on
consumption and a part of it is saved.
Disposable Income = Consumption Expenditure + Savings
Methods of measurement of
national income
 The Census of Products Method or Output
Method- This method measures the output of the country.
It is also called ‘Inventory Method’ and involves the
assessment through census, of the gross value of production
of goods and services produced in different economic sectors
by all the productive enterprises in the economy.
Y= (P-D) + (S-T) + (X-M) + (R-P)
Where,
Y = Total income of the nation
P = Domestic output of all production sectors
D = Depreciation allowance
S = Subsidies
T = Indirect Taxes
X = Exports
M = Imports
R = Receipts from Abroad
P = Payments made abroad.
Precautions Final Product should be used in order to avoid double
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counting.
Goods for self-consumption by the producer should be
excluded, they have not marketed, so it is difficult to ascertain
their true market value.
When, we are calculating the output, changes in the price
level between the years must be taken into account.
Indirect taxes, included in prices, are to be deducted for
getting the exact market value of the products. Similarly,
subsidies given by the govt. to certain products should be
added in evaluating the product.
Add the value of exports, and deduct the value of imports.
This method is widely used in under-developed countries, but it
is less reliable because the margin of error in this method is
large.
 Census of Incomes Method- This method is also
called the factor cost Method. According to this method, the
net income payments received by all the citizens of a country
in a particular year are added up. The data pertaining to
income are obtained from various sources.
 Census of Expenditure Outlay Method- According
to this method the total expenditure incurred by the society
in a particular year are added up. This includes- (i) Personal
Consumption Expenditure of Households, (ii) Gross private
domestic investment i.e. buss. Spending on capital goods, (iii)
Net foreign investments, (iv) Govt. purchases of goods and
services.
This concept is based on the assumption that national income
equals national expenditure.
 Value added method and Final goods approachHere, it has been assumed that the difference between the
value of material outputs and inputs is the value added. If all
such differences are added up for all industries in the
economy, we arrive at the GDP.
 Social Accounting Method- In the social accounts, the
transactions among various sectors such as firms, households,
govt. etc. are recorded . From the total value of these
transactions recorded, the national value is known.
Difficulties in the
measurement of national
income
 Prevalence of Non-monetised transactions
 Illeteracy
 Occupational Specialization is still incomplete and lacking
 Lack of availability of adequate statistical data
 Value of Inventory changes
 Calculation of depreciation
 Difficulty in avoiding double counting system
BUSINESS CYCLE
 The term business cycle refers to the
fluctuations in economic activity that occurs in
a more or less regular time sequence in all
capitalist societies. The volume of economic
activity in a community is shown by various
indicators viz., the volume of employment,
price level, output and income. When these
indicators are plotted on a chart, the graph
looks like a wave. This shows that economic
activity rises and falls in a regular manner. Each
movement the rise and fall taken together, is
called a Trade cycle or a Business cycle.
characterstics
 Recurring Fluctuations- Fluctuations occurs
periodically in a free rhythm. This implies that the recurrence
of expansion and contraction has no fixed period.
 Period of Business Cycle- A typical Buss. Cycle
completes itself in a period of 3 to 4 years. In some cases, it
can be shorter or longer but is not shorter that 1 year.
 Presence of the alternating forces of expansion
and contraction- A buss. Cycle is characterized by
alternating an economy to prosperity and depression. These
forces are in-built in the system.
 Phenomenon of the crisis- According to Keynes, an
important characteristic of the buss. Cycle is the phenomenon
of crisis. This implies that the peak and the trough are
asymmetrical. Normally the prosperity phase comes to an end
abruptly, whereas recovery after depression is gradual and
slow.
Phases of buss. cycle
 Prosperity or Expansion- This stage is
characterized by increase production, high
capital investment in basic industries, and
expansion of bank credit, high prices, high
profits and full employment.
 Recession- It is characterized by liquidation in
stock market, strains in the banking system and
some liquidation of bank loans, fall in prices,
sharp reduction in demand.
inflation
Inflation is normally associated with high prices,
which causes decline in the purchasing power
or the value of money. Inflation refers to the
rapid increase in the general price level. It is a
monetary phenomenon. Prices keeps on rising
due to excess supply of money and lower
production of goods.
Stages of inflation
 Pre-Full Employment stage- Inflation before full
employment is beneficial to the economic development of a
country. Rate of increase is not more that 3% p.a. the supply of
money causes inc. in national income, consequently more
employment is available.
 Full employment stage- upto this stage all resources of
production are fully employed. Production is optimum at this
stage. Production is unable to expand because all the unused
factors are fully employed. There does not exist any chance of
further employment. The rate of increase in prices is not more
than 10% per annum.
 Post-full employment stage- Prices rise without rise
in production and employment. Inflation after full
employment is not due to monetary phenomenon but due to
full employment. The rate of increase in price level is more
than 10%. It is called true inflation.
Theories of inflation
 Market Power Theory- When one seller or a group of
sellers in the market combine to establish a price different
from a competitive level, we call it market-power price. This
group or groups can raise prices to any level they think
profitable to themselves.
 Conventional-pull demand theory- According to
conventional demand pull theorists, excess in aggregate
demand over aggregate supply is the only cause of inflation.
 Structural Theory- According to this group, market
power can be only one force, but not the exclusive force of
inflation.
Several explanations of inflation are put forward by these
economists such as:
(i)
Mark-up Theory- Prof. Gardner Ackley says that inflation is
caused both by demand-pull and cost-pull factors. The
demand pull inflation is caused by excessive demand for
goods, so it is natural to go their prices up. But the increase
in prices stimulates production and causes excess demand
for factors of production and, as a result cost rises and price
also rises.
(ii) Bottle-neck inflation- Prof. Otto Eckstein, found that prices
of manufacturers rose generally but one or two particular
industries had a very sharp increase in price. He calls these
‘bottle-neck industries’ and it was his opinion that general
price rises due to such industries. Out of these steel was a
chief bottle-neck industry.
(iii) Demand- composition inflation- Acc. To Prof. Charles L.
schultez, neither demand pull nor cost push theories can offer
an adequate explanation of inflation. He points out that if
demand decreases prices and wages do not go down quickly,
but if demand increases the increase in prices and wages is
almost simultaneous.
Measures to check inflation
 Monetary Measures- These aims at reducing money
incomes.
(i) Credit Control
(ii) Demonetization of currency
(iii) Issue of new currency
 Fiscal Measures- Fiscal measures are highly effective for
controlling Govt. expenditure, personal consumption
expenditure and private and public investment.
(i) Reduction in unnecessary expenditure
(ii) Increase in Savings
(iii) Increase in taxes
(iv) Public debt
 Other Measures- The other types of measures are those
which aim at increasing aggregate supply and reducing
aggregate demand directly.
(i) To increase production.
(ii) Rational wage policy.
(iii) Price control
(iv) Rationing
Concept of profit
Profit is the difference between the total saleproceeds obtained by a businessman and his
total expenses of production.
In other words, we can say that profit is the
surplus of income over expenses of production.
Profit = Gross Profit – (Rent + Wages + Interest)
Important definitions
 Profit is earning of management- Prof.
Marshall
 Profit is rent of ability- Walker
 Profit is reward of uninsured risks- Croome
 Profit is a surplus over and above the expenses
of production- Ely
Characterstics of profit
 Profit is a residual reward
 It is not a pre-determined payment
 It is the end result of business
 Profit is a dynamic concept
 It is not determined through a formal factors of
market
 Profit is not fixed income, it is uncertain and
fluctuating
 Accounting Profit- It is the revenue obtained
during the period minus the cost and expenses
incurred to produce the goods responsible for
getting the revenue.
Accounting Profit = Total revenue – The cost
involved in producing and selling
 Economic Profit- It refers to those items that
take into consideration both explicit costs and
implicit costs.
 Economic profit is more imp. That accounting
profit as it reflects the true profitability
position of the business enterprise.
Theories of profit
 Walker’s Theory of Profit.
 Clark’s Dynamic theory of Profit.
 Hawley’s Risk theory of Profit.
 Knight’s theory of Profit.
 Schumpeter’s theory of Profit.
 Monopoly power as source of Profit.
 Walker’s Theory of Profit: Profit as a rent of abilityAccording to F.A. Walker, profit is the rent of “exceptional
abilities that an entrepreneur may possess” over others. Just as
land rent is the difference between the yields of the least and
most fertile lands, profit is the difference between the
earnings of the least and most efficient entrepreneurs.
 Clark’s Dynamic theory of Profit- According to J.B. Clark ,
profits arise in a dynamic economy, not in a static one.
A static economy is one in which things do not change
significantly; population and capital are stationary;
production process remains unchanged over time; goods
continue to remain homogeneous; there is no uncertainty and
hence no risk; and if there is any risk, it is insurable.
A dynamic economy is- characterized by following generic
changes: (i) increase in population, (ii) increase in capital,
(iii) improvement in production technique, (iv) changes in
firms of business organization, and (v) increase and
multiplication of consumer wants.
The major functions of entrepreneurs or managers in a dynamic
world are to take advantage of the generic changes and
promote their business, expand their sales and reduce their
costs.
 Hawley’s Risk theory of Profit- According to F.B. Hawley,
Risk in business may arise for such a reasons as obsolescence
of a product, sudden fall in prices, non-availability of certain
crucial materials, introduction of a better substitute by a
competitor, and risk due to fire, war etc. Profit is the price
paid by society for assuming business risks.
 Knight’s theory of Profit- Frank H. Knight treated profit as
a residual return to uncertainty bearing, not to risk bearing.
Risk is divided into calculable and non-calculable risk.
 Schumpeter’s Innovation theory of Profit- According to
Joseph A. Schumpeter, the total receipts from the business are
exactly equal to the total outlay and there is no profit.
Profit in excess can be made only by introducing innovations in
manufacturing technique and method of supplying the goods.
Innovations may include:
(i) Introduction of a new commodity or a new quality of goods.
(ii) The introduction of a new method of production.
(iii) The emergence of opening of a new market.
(iv) Finding new sources of raw material
(v) Organizing the industry in an innovative manner with new
techniques.
 Monopoly power as source of Profit- Monopoly may arise
due to such factors as:
(i) Sole ownership of certain crucial raw material
(ii) Legal sanction and protection
(iii) Mergers and takeovers.
A monopolist can earn profit by using its monopoly powers.
Monopoly power includes:
(i) Powers to control supply and price.
(ii) Powers to prevent the entry of competitors by price cutting.