Unit 1: Nature and Scope of Macroeconomics 4 LHR

 Meaning and Concept of macroeconomics

 Basic issues in macroeconomics: unemployment, inflation business cycles, and economic growth
 Scope and importance of macroeconomics
 Distinction and interdependence between microeconomics and macroeconomics
Introduction
Economics is the study of how individuals and societies choose to utilize scarce resources to satisfy unlimited human
wants. Such scarce resources compel us to make choice which is the source of all of the problems we study in
economics. Households have limited incomes for satisfying their desires, so they must choose carefully how they allocate
their spending among different goods and services. Business firms want to make the highest possible profit, but they
must pay for their resources, so they carefully choose what to produce, how much to produce, and how to produce it.
The government also works with limited budget, so it must carefully choose which goals to pursue. In this way,
economics studies these decisions made by households, firms, and government to explain how our economic system
operates, to forecast the future of our economy, and to suggest ways to make that future even better. For the study of
economics, scarcity and the manner in which individuals and society make choice are fundamental issues. To examine
these important issues, modern economists have divided the whole economic theories into two parts:
Microeconomics and Macroeconomics.
These words in economics were first used by Ragnar Frisch in 1933. The terms micro is derived from the Greek word
'MIKROS', which means "small". Microeconomics, therefore, studies the economic behaviour of individual decision
makers, such as a consumer, a worker, a firm, or a manager. It also analyzes the behaviour of individual households,
industries, markets, labour unions, or trade associations. On the contrary, the term macro comes from the Greek word
'MAKROS', which means "large". Macroeconomics, thus, analyzes how entire national economy performs.
A course in macroeconomics would examine aggregate levels of income and employment, the levels of interest rates and
prices, the rate of inflation, and the nature of business cycles in a national economy. In this unit, we will discuss about
meaning, scope, uses, and limitations of macroeconomics. Besides, we will study about macroeconomic concepts like
equilibrium and disequilibrium; and static and dynamic equilibrium analysis.

Macroeconomics
The term “MACRO” which was derived from Greek word “MAKROS” and its meaning is big or large. Macroeconomics is
the branch of economics that studies the behaviour and performance of an economy as a whole. It focuses on the
aggregate changes in the economy such as unemployment, growth rate, gross domestic product and inflation.
Macroeconomics analyzes all aggregate indicators and the microeconomic factors that influence the economy.
Government and corporations use macroeconomic models to help in formulating of economic policies and strategies.
The objective of macroeconomic study is to investigate principles, problems, and policies related to achievement of full
employment and expansion of production capacity. It deals with how different economic sectors such as households,
governments and industry make their decisions. Macroeconomics studies economy-wide phenomena such as inflation,
price levels, rate of economic growth, national income, gross domestic product (GDP), and changes in unemployment.
Macroeconomics is defined as the branch of economics which deals with economy as a whole. In other words,
macroeconomics is the study of very large, economy-wide aggregate variables like national income, money, price level,
unemployment, economic growth rate, etc. Therefore, it is also known as the aggregative economics. Since
macroeconomics was propounded by J.M. Keynes, it is also known as the Keynesian Economics.
In fact, macroeconomics is basically concerned with national aggregate or total values such as national income,
aggregate consumption, aggregate Macroeconomics attempts to explain how the economy's total output of goods and
services and total employment of resources are determined and what explains the fluctuations in the level of output and
employment. In other words, macroeconomics is concerned with the nature, relationship and behaviour of such
aggregate quantities and averages such as national income, total consumption, savings, investment, total employment,
general price level, aggregate expenditure and aggregate supply of goods and services. The unit of study in
macroeconomics is the total of economy variable entire economy rather than a part of it and it deals with the problems
faced by the entire economy. Thus, macroeconomics deals with the functioning of an economy as a whole. According to
Lipsey, "Macroeconomics is the study of the determination of economic aggregate and averages, such as, total output,
total employment, the general price level, the rate of economic growth." According to K.E. Boulding, "Macroeconomics
deals not with individual quantities as such with aggregates of these quantities; not with individual income but with
national income; not with individual prices but with price levels; not with individual outputs but with national output."
According to, P. A. Samuelson “Macroeconomics is the study of behaviour of the economy as a whole. It examines the
overall level of national output, employment, prices and foreign trade.” According to, Grander Ackley “Macroeconomics
concerns the overall dimension of economic life. More specifically, macroeconomics concerns with such variables as
aggregate volume of an economy, with the extent to which its resources are employed, with size of national income and
with the general price level.” From the above definitions, it can be stated that macroeconomics is essentially the study of
behaviour and performance of the economy as a whole. Its studies relationship and interaction between forces that
determine level and growth of national output and employment, price level and balance of payment position of an
economy. Since, macroeconomics splits up the economy into big lumps for the purpose of study; it is also called the
"Lumping Method". It explains how the level of income and employment are determined and analyses the factors that
bring about fluctuations in income and employment. It also explains how national income grows over time. Thus,
macroeconomics deals with the phenomena related to the level and growth of national income and employment and
various factors governing their trends. Therefore, macroeconomics is also known as the "Theory of Income and
Employment". The main objective of macroeconomics is to explain principles, problems and policies related to full
employment and growth of resources. It seeks, not only understand macroeconomic phenomena, but to find policies,
promote maximum output, employment and price stability over time. The subject matter of macroeconomics is to study
process of income and employment determination. In other words, the subject matter of macroeconomics constitutes
the study of current output, long run economic growth, economic fluctuations, unemployment, inflation and the effect
of increasing globalization upon domestic output. It also establishes an important relationship between movements of
income, employment and the general price level and explains the process of income and employment determination.
Therefore, it is called income and employment theory.
Features of Macroeconomics
 It is aggregative economics.
 It is concerned with the behaviour of the economy as a whole.
 It presupposes constant relative prices and given resource allocation.
 It is policy science and more normative.
 Its analytical tools are fiscal policy (taxes, government expenditure and government borrowing) and monetary
policy (interest rate and money supply).
 It is also called income and employment theory.
 Its objectives are to determine aggregate output, employment and general price level and their rate of change.
 It is relatively new and developed after the publication of Keynesian General Theory in 1936 AD.
 Its principal or main variables are national income, total consumption, total expenditure, total saving, total
investment, etc.
SCOPE OF MACROECONOMICS
 Theory of national income
 Theory of employment
 Theory of money and price level
 Theory of economic growth
 Theory of International trade
 Macro Theory of Distribution

Theory of national income

Macroeconomics studies the concept of national income, its different elements, methods of measurement and social
accounting. Social accounting refers to the systematic record and presentation of national income data.
Theory of employment
Macroeconomics also studies problems relating to employment and unemployment. It studies different factors
determining the level of employment, such as effective demand, aggregate demand, aggregate supply, aggregate
consumption, aggregate investment, aggregate saving, multiplier, etc.
Theory of Money and Price Level
Macroeconomics explains nature, cause and effect of inflationary and deflationary tendencies in the economy. Changes
in demand and supply of money affect level of employment. Therefore, under macroeconomics, functions and theories
relating to demand for money and supply of money are studied.
Theory of economic growth
Macroeconomics explains various issues relating to economic growth and development like privatization, economic
liberalization, balanced development, poverty, inequality, etc. In other words, it studies the theory of economic growth
and development.
Theory of international trade
Macroeconomics also studies trade among different countries. Theories of international trade, tariff and protection, etc.
are subjects of great significance to macroeconomics.
Macro Theory of Distribution
Macroeconomics studies about the determinants of income distribution. It also studies about how the comparative
share of different classes of people in national income is determined and distributed.
USES OR IMPORTANCE OF MACROECONOMICS
 Helpful to understand the working of the economy
 Helpful in formulating economic policies
 Helpful in controlling economic fluctuations
 Helpful in international comparisons
 Evaluate performance of the economy
 To develop and expand the microeconomics
 Helpful to understand international trade

USES OR IMPORTANCE OF MACROECONOMICS

Helpful to understand the working of the economy
Macroeconomics is indispensable for understanding the working of the economy. It is concerned with the study of
economy in total or aggregate. It helps to understand how the macroeconomic variables behave in aggregate.
Macroeconomic variables, such as national income, aggregate output, gross saving and investment, national
expenditure, etc. are very essential to understand the working of the economy.

Helpful in formulating economic policies

Macroeconomic analysis provides a sound basis for the formulation of government's economic policies. Economic
policies for the removal of poverty, unemployment and inflation must be based upon reliable statistics of the aggregate
variables. Such aggregate variables are studied in the macroeconomics.

Helpful in controlling economic fluctuations

Economic fluctuations like trade cycle, inflation, deflation, etc. need to be handled appropriately in appropriate period to
correct them. To provide a finite direction to the economy, knowledge of macroeconomics is essential.

Helpful in international comparisons

Only macroeconomic variables like national income, total output, aggregate demand, consumption behaviour and
investment patterns of different countries can be easily compared. Thus, macroeconomics provides the necessary
information for the international comparison.

Evaluate performance of the economy

Macroeconomics is very useful to evaluate performance of the economy. National income is the prime macroeconomic
variable. It is the barometer that scales the growth of a country. It analyses the overall performance of the economy
within a given period of time and allows us to compare that performance with the past. National income, basically, is an
aggregate concept.

To develop and expand the microeconomics

Study of macroeconomics is essential for the development and expansion of microeconomics. For example, the theories
of microeconomics such as law of demand, law of diminishing marginal utility, consumer's surplus, etc. are based on
collection of experience of mass consumers. Likewise, macroeconomics is also useful to understand the behaviour of
individual units. For example, to understand demand for a product, we need to understand aggregate demand of the
economy which is studied under macroeconomics.

Helpful to understand international trade

The entire world is engaged in international trade and macroeconomics helps to understand international trade
structure of a country. Besides, macroeconomics also helps to analyzes benefit of international trade as well as designing
an appropriate trade policy.
Useful in business decision making:
Macroeconomics is very useful in business decision making. The overall economic activity such as national income and
employment, aggregate demand and supply conditions, fiscal and monetary policies of the government, rate of inflation,
etc. affect business firms. These aggregates of the economy make up overall business environment, which affects
business decision making. The forecasting of future demand and investment decisions are also based on the situation of
the economy and its growth process.
Basic Macroeconomic Issues
 Employment and Unemployment
 Inflation or Rising General Price Level
 Business Cycles
 Stagflation and Deflation
 Economic Growth
 Balance of Payments and Exchange Rate

Employment and Unemployment:

The major issue in macroeconomics is to explain what determines the level of employment and national income in an
economy. Unemployment refers to involuntary idleness of resources including labour. If this problem exists the society's
actual output (GNP) will be less than its potential output. So, one of the objectives of the government is to ensure full
employment, which implies absence of involuntary unemployment. Thus, macroeconomic issue is what cause
involuntary unemployment.
Classical economists denied that there could be involuntary unemployment of labour and other resources for a long
time. They thought that with the flexible wage rates and interest rates, unemployment would be automatically removed
and full employment established. But this did not appear to be so at the time of depression in the thirties.
Keynes explained that level of employment and national income are determined by aggregate demand and aggregate
supply. According to him, with the aggregate supply remaining unchanged in the short run, it is deficiency in aggregate
demand that cause unemployment in the economy.

Inflation or Rising General Price Level

Another macroeconomic issue is to explain and analyze the problem of inflation faced by both developed and
developing countries. It refers to a phenomenon of persistent rise in price level. During inflation some people gain but
most people lose. Therefore, one of the objectives of the government is to ensure stability in price level. Classical
economists thought that it is the quantity of money that determines the price level. According to them, the rate of
inflation depends on the growth of money supply in the economy. But Keynes criticized that quantity theory of money
and explained his own theory of inflation. According to him, just as unemployment is caused by the deficiency of
aggregate demand; inflation is due to the excessive aggregate demand over aggregate supply due to either demand
raising factor or cost raising factors.

Business Cycles
Throughout the history of economics, market economies have experienced what are called business cycles. Business
cycles refer to the fluctuations in output and employment with alternating periods of prosperity and depression. The
causes of these business cycles in the market economies are an important market economic issue. So, in
macroeconomics, we study the causes of business cycles and suggest remedial measures.

Stagflation and Deflation

Stagflation refers to a situation when a high rate of inflation occurs simultaneously with a high rate of unemployment.
The existence of a high rate of unemployment means the reduced level of GNP. The term stagflation was coined in the
70s when several developed countries of the world, received a supply shock in terms of rapid hike in oil prices. It is an
important macroeconomic issue of the day perhaps the most complex. This problem could not explain with the
Keynesian theory of effective demand (demand side analysis). Therefore, a new economic thought emerged which is
called supply side economies. Every country in the world is struggling hard to fight this issue.
During the decade of 1930's market economies have experienced a greater economic problem, which has been
described as depression or deflationary pressure. Deflation is a phenomenon of falling prices. In other words, deflation is
the state of the economy where the value of money is rising or the prices are falling.

Economic Growth
Another important macroeconomic issue is to explain what determines economic growth in a country. The problem of
growth is a long run problem, which Keynes did not take into consideration. The expansionary trend in the country's
total output over the long period is known as economic growth. Growth is measured by the annual rate of increase of
per capita income. It refers to a situation when the rate of increase in per capita income exceeds the rate of population
growth. There are many theories and models on economic growth that explain how the steady growth of the economy
can be achieved.
These theories also explain the causes of underemployment and poverty in less developed countries and they also
suggest the policies and strategies for accelerating growth in them.

Balance of Payments and Exchange Rate

Balance of Payments (BOP) is the systematic record of all economic transactions of the residents of a country with the
rest of the world during a period. There may be deficit or surplus in BOP. Both create problems in the economy. The
transactions in the BOP are influenced by the rate of exchange. The exchange rate is the rate at which a country's
currency is exchanged for foreign currencies. The instability in foreign exchange rate is a major problem, which creates
serious BOP problems. The economists are always eager to discover the cause and effect of changes in BOP. Thus, the
equilibrium in BOP position and stability in exchange rate are important macroeconomic issues.

Interdependence between Microeconomics and Macroeconomics

Microeconomics and Macroeconomics are different in their approaches. Microeconomics studies the individual units of
the whole economy whereas Macroeconomics deals with the aggregates and sub-aggregates related to the whole
economy. The objectives, subject matters, assumptions etc. of microeconomics are different from those of
macroeconomics.
But macro and microeconomics are interdependent. The objective of the study of economics cannot be fulfilled by the
study of only one, microeconomics or macroeconomics. Again, they are dependent on each other because the parts
affect the
whole and the whole affects the parts. A general theory of the economy should cover both. It should explain prices,
outputs, incomes, the behaviour of individual firms and industries and the aggregates of the individual variables.

Dependence of Microeconomics on Macroeconomics

Microeconomics analyzes problems and behaviour of small units of the economy. All micro economic variables are
fraction of macroeconomic variables. For example, a particular commodity produced by a firm, price of that commodity,
individual consumption, wages of labour, etc. are analyzed under microeconomics. Macroeconomics plays an important
role in the study of these aspects of microeconomics. It is explained as follows:
 Determination of price of product
 Determination of consumption
 Determination of rate of interest
 Determination of profit
 Determination of wages
Dependence of Macroeconomics on Microeconomics
Macroeconomics studies the economy as a whole. For example, general price level, national income, employment, etc.
form the subject matter of macroeconomics. But the total is made up of parts. It can be proved as follows:
 Determination national income
 Determination of national output and investment
 Determination of price level
 Determination of level of employment
 Determination of tax

Difference between Micro and Macro economics

 Verbal difference
o Micro: Greek word 'MIKROS
o Macro: Greek word 'MAKROS
 Difference in studying unit:
o Micro: Individual units
o Macro: Aggregate units
 Difference in assumption
o Micro: Full employment
o Macro: Below full employment
 Difference in objectives
o Micro: Proper utilization of limited resources
o Macro: Economic stability and growth
Difference between Micro and Macroeconomics
 Difference in method of study
 Micro: Partial Equilibrium
 Macro: General Equilibrium
 Difference in subject matter
 Micro: Individual demand, supply, price, wage, market...
 Macro: Aggregate demand, supply, consumption, saving...
 Difference in force of equilibrium
 Micro: D and S
 Macro: AD and AS
 Development of micro and macro economics
 Micro: Developed by classical and neo classical economists
 Macro: Developed by modern economists J. M. Keynes
 Unit 2
National Income: Concept and Measurement
Meaning of Circular Flow
Circular flow is an economic tool of showing the continuous movement of production, income, and the services of
resources that flow between producers, resource suppliers and consumers. It is the recurring flow of products, factors,
and money among the household, business, government, and foreign sectors through the product, resource, and
financial markets. There are different types of the circular flow model which connect the four sectors: household,
business, government, and foreign and the three markets; product, resource, and financial to describe the economy.
Physical and Monetary Flow in the Circular Flow

Physical Flow
The foundation of the circular flow is the physical movement of goods and services. The physical flow is the movement
of goods and services between household, the business firm, the government and the foreign economy. Two sector
circular flow includes only the household and business, three sector economy includes the household, the business firms
and government, and the four-sector model involves the
household, the business, the government, and foreign sector as the main economic players.

Monetary Flow
The physical flow of goods, services and resources is responded to by the payment flow in monetary terms that moves in
the opposite direction. The payment flow is the movement of money payments from the household to the business
sector in exchange for final goods and services and from the business to the household sector in exchange for the
services of resources (e.g. The security service provided by the household).

Sectors in Macroeconomic Circular Flow

Household Sector
The household sector is one of the key components of circular flow of goods and services in an economy. The household
sector performs three major activities like; consuming goods and services, selling factor services and paying taxes to the
government.
Business Sector
The business sector is another important sector in income and expenditure flow model. This sector involves in
production, exchange and investment activities. It produces goods and services, made payment to the factors of
production and pays direct and indirect taxes to the government.
Government Sector
This sector includes all government units that have right to impose tax and make impact on resources allocation
decisions in the rest of economy. Government sector buys goods and services from business sectors, impose direct and
indirect taxes to household and business sector and provides allowance and subsidies to the household and business
sector.
Foreign Sector
The foreign sector is another important sector of an economy. The primary function of foreign sector is to carry out
external activity. The domestic household, business, and government sectors purchase imports produced in the foreign
sector. The foreign sector also buys exports produced by the domestic business sector. It conducts foreign trade and
involve in import and export activities.

Types of Circular Flow Model

Circular Flow of Income and Expenditure in the Two Sector Economy Model
The two-sector economy consists of only household and business sectors. This is the most simplified economic model in
which product and money flow generated by the government and the foreign sectors are ignored. This is obviously an
unrealistic model. In other words, such kind of economy is not found in the real world. This is also known as two sector
closed economy.
Assumptions
• There are only two sectors in the economy: household and business sectors.
• All income is spent on consumption.
• There is no saving in the economy.
• There is no government and no international trade
• Households are owners of factors of production or factors of production are supplied only by households.
• Producers purchase or hire factors of production from the households.
Features of Household Sectors
• The households are the owners of all factors of production.
• Their total income consists of wages, rent, interest and profits.
• They are the consumers of all final products (i.e. consumer goods and services).
• They save a part of their income in financial institutions.
Features of Business Sectors
• They own no resources of their own.
• They hire and use the factors of production from the households.
• They produce and sell goods and services to the households.
• They do not save, i.e. there is no corporate savings.
• They borrow loan from financial institutions.
Diagrammatic Representation

Explanation
The outer circle represents real flow and the inner circle represents the monetary flow. Real flow indicates the factor
services flow from household sector to the business sector, and goods and services flow from business sector to the
household.
Monetary flow illustrates that, in terms of money, factor rent, wage, interest and profit flows from the business sector to
household sector. On the other hand, the consumption expenditure made by household’s flow to the business sector as
revenue for the firms.
This means that the expenses made by the households become the source of income for the business sector or the firms
and vice versa. The firms provide payment to the factor owners for procuring factors of production. Further, the factor
owners spend this income on goods and services produced by the business sector, which becomes revenue for the
business sector.
Since the households spend their income, the total monetary receipts of business sector will be equal to the income and
consumption expenditure of the household sector. This means, monetary receipts of the producers = income of the
households = consumption expenditure of the households. In this way, an equilibrium state exists in the economy where
total demand equals total supply.
Thus, the circular movement of income and expenditure in the economy continues, leading to equalization in the gross
national product and gross national income.

Circular Flow of Income and Expenditure in the Three Sector Economy Model
Three sector economy consists of household, business and government sectors. It is also known as three sector closed
economy. It is more realistic than two sector economy as it includes government which plays an important role in the
economy. In reality, such kinds of economies rarely exist in the real world. This economic model is formed by adding
government sector in the two-sector economic model. This sector includes the government, which plays an important
role in the economy. It is necessary to include the effect of the fiscal operations of the government. However, only three
fiscal variables (i.e. taxes, government spending on goods and services and transfer payments) are analyzed in this
analysis. Taxes are withdrawals from the flows because they reduce private disposable income and, therefore,
consumption expenditure and savings. On the other hand, government expenditure is an injection into the income
stream. The government expenditure adds to the aggregate demand in the form of government purchases of factor
services from the households and goods and services from the business sector. The transfer payments by the
government (i.e. old age pensions, subsidies, unemployment allowance, etc.) are injections to the circular flows. They
add to the household income which leads to increase in household demand for consumer goods.
Assumptions
• The economy consists of household, business and government sector.
• There is government intervention. Government imposes taxes and grants subsidies.
• There is perfectly competitive market.
• The economy has no international trade, i.e. no export and import.
• Business sector pays both direct and indirect taxes to the government.
• Household sector pays only direct tax to the government.

Diagrammatic Representation

Explanation
•The circular flow between the household sector and the government sector
Household sector pay direct taxes and commodity taxes in terms of building up the leakage from the circular flow. On
the other hand, government sector also purchases the services from household sector and make transfer payments to
the household sector which has low income. All the expenditure is said to be injected into the circular flow.
•The circular flow between the business sector and the government sector
The action of business sector pays taxes to the government also constituting leakage from the circular flow. Government
sector will purchase the final goods from the business sector as well as make transfer payments to firms to induce
production from the other sectors.
•The circular flow among the household sector, business sector and government sector
Taxation is a leakage from the circular firm. Taxation reduces savings and consumption of the households. The reduction
in consumption will reduce the sale and the income of firms. The government offsets these leakages by making
purchases from the business sector and the household sector. It equal to the amount of taxes and total sales again equal
production of firms. The equilibrium will show in the circular flows of income and the expenditure too.

Circular Flow of Income and Expenditure in the Four Sector Economy Model
Four sector economy consists of household, business, government and foreign sectors. It is also known as the open
economy. This model is formed by adding, foreign sector to the three-sector model. The model studies all sectors of the
economy dropping all simplifying assumptions made for the two and three sector models. The foreign sector has an
important role in the economy. When the domestic business firms export goods and services to the foreign markets,
injections are made into the circular flow model. On the other hand, when the domestic households, firms or the
government imports something from the foreign sector, leakage occurs in the circular flow model.
Assumptions
• The whole economic activities are organized under four distinct economic sectors: household, business,
government, and foreign sector.
• Household supply resources to domestic and foreign firms, they obviously supply resources of production to the
homeland government.
• It is an open economy.
• The abroad sector includes exports and imports of goods and services produced by the firms.
• Household sector exports labour and capital only.
• There is minimal government intervention.
• There is perfect competition in both internal and external markets.
• There is a well-managed financial market.
• Business firms export and import only goods and services.
Diagrammatic Representation

Explanation
•Household Sector
The household sector of an economy provides factor services to the firms, government, and the foreign sector for which
it received factor payments in return. Besides factor payments, the households also receive transfer payments like old
age pensions, scholarships, etc., from the government and foreign sector. The household sector spends its earned
income on Payments for goods and services purchased from firms, payments for imports, and tax payments to the
government.
•Firms
The firms receive revenue for the sale of goods and services from the government, households, and foreign sectors. They
also receive subsidies from the government to produce goods and services. Besides, the firms make payments for taxes
to the government, factor services to the households, and imports to the foreign sector.
•Government
The government receives revenue for the sale of goods and services, fees, taxes, etc., from the firms, households, and
the foreign sector. It also makes factor payments to households and spends its revenue on transfer payments and
subsidies.
•Foreign Sector
The foreign sector receives revenue for the export of goods and services from firms, households, and the government. It
also makes payments to firms and the government for the import of goods and services, and households for the factor
services.
The financial market also plays an important role in a four-sector economy as the savings made by the households, firms,
and the government gets accumulated here and this money is invested by the financial market in the form of loans to
firms, households, and the government. The inflows of money in the financial market in a four-sector economy are equal
to the outflows of money, which makes the circular flow of income continuous and complete.

National Income
National income refers to the sum of income earned by all individuals in a country in a particular period of time. In other
words, it is the total income of to know how well its economy is performing. National account statistics, i.e. national
income tells us about the health of an economy. National income represents receipts total, expenditure total and the
value of production. Since one man's income is another man's expenditure and each commodity are bought and sold at
its market price, national income, national expenditure and national product are equal. It represents as a receipt total,
an expenditure total and the total value of production. National income accounting is defined as a system used to
estimate national income and its components, an approach to measuring an economy's aggregate performance. "The
labour and capital of a country acting on its natural resources produce annually a certain net aggregate of commodities,
material and immaterial, including services of all kinds. This is the true net annual income or revenue of the country or
national dividend." -Alfred Marshall "National income is that part of the objective income of the community, including
of course income derived from abroad, which can be measured in money."- A.C Pigou
“The national dividend or income consists solely of services as received by ultimate consumers, whether from their
material or from their human environment. Thus, a piano or an overcoat made for me this year is not a part of this year’s
income, but an addition to capital. Only the services rendered to use during this year by these things are income.”-
Irriving Fisher
“the net output of commodities and services flowing during the year from the country’s productive system in the hands
of the ultimate consumers.” - Simon Kuznets
Features of National Income
• National Income is the net amount of income accruing from all economic activities (or sectors) like primary.
(agriculture), secondary (industry) and territory (trade, transport, services, etc.) sectors during a specific period
of time, usually a year.
• It is a result of combine contribution of all economic resources like natural resources, human resources and
physical resources.
• It is a flow of final goods and services produced from all economic sectors in a country for a specified period of
time.
• Net factor income from abroad should be added to national income.
• There is a triple identity; National output = National Income = National Expenditure (NO =NI=NE).
Thus, national income is the monetary value of all final goods and services produced in a country during a specific period
of time.

Various Concepts of National Income

Gross Domestic Product (GDP)

Gross domestic product (GDP) is the monetary value of all the finished goods and services produced within a country's
borders in a specific time period. Though GDP is usually calculated on an annual basis, it can be calculated on a quarterly
basis as well. The market value of all final goods and services produced within the domestic territory of a country during
a year is called GDP.
It includes:
• Currently produced goods and services
• Final products
• Goods and services produced with in the economy
• Market value of output

The Significance of GDP

GDP is commonly used as an indicator of the economic health of a country, as well as a gauge of a country's standard of
living. Since the mode of measuring GDP is uniform from country to country, GDP can be used to compare the
productivity of various countries with a high degree of accuracy. Adjusting for inflation from year to year allows for the
seamless comparison of current GDP measurements with measurements from previous years or quarters. In this way, a
nation's GDP from any period can be measured as a percentage relative to previous periods. An important statistic that
indicates whether an economy is expanding or contracting, GDP can be tracked over long spans of time and used in
measuring a nation's economic growth or decline, as well as in determining if an economy is in recession (generally
defined as two consecutive quarters of negative GDP growth).
Features of GDP
• GDP is the money value of all final goods and services produced within a country. In other words, GDP is the
monetary measure. There are no other ways of adding up the different types of goods and services except with
their money prices.
• GDP includes the value of only final goods and services produced in a year. The intermediate goods are excluded
to avoid double counting. For accurate measurement of GDP, the goods and service must be counted only once,
i.e. it takes into account only final goods and service.
• The value of final goods and services is calculated at the current market prices.
• We must take into account only current production. That is, the sale or purchase of previously produced goods is
not a part of current GDP. They are already taken into account in the period of production Thus, the GDP is a
flow and not a stock variable.
• GDP includes only those goods which have market value and brought in the market for sale.
• Transfer payments like pension, unemployment allowance, etc. are not included in GDP because these payments
do not contribute any way to production
• GDP does not include capital gains.
• Whether the resources are domestically-owned or foreign-owned does not matter.

Calculation of GDP
Product method
1 1 2 2
GDP=P x Q + P Q ±−−−+ P n × Qn+( X −M )
Where,
P = Per. unit price
Q = Quantity produced
X −M =Net Export ; X =Export , M =Import

Income Method
GDP=w+i+r + π +(X −M )
Where,
W = Wage
i = Rate of Interest
r = rent
π =Profit
X-M = Net Export; X = Export, M = Import

Expenditure Method
GDP=C+ I +G+( X−M )
Where,
C= Consumption Expenditure
= Investment Expenditure
G = Government Expenditure
X-M = Net Export; X = Export, M = Import
National output = National Income = National expenditure
(NO =NI=NE).
Thus, national income is the monetary value of all final goods and services produced in a country during a specific period
of time.

GDP at Market Price and GDP at Factor Cost

GDP at market price measures total domestic output inclusive of indirect taxes on goods and services. It is the value of
final goods and services produced within domestic territory during an accounting year. It can be calculated as,
GDP at MP = P1×Q1+P2×Q2+ P3×Q3 + ----------------------+Pn× Qn

If GDP measured as the sum of price paid to the all factors of production in the form of wages, profit, interest and rent
for their contribution in production, it is known as GDP at factor cost. In order to calculate GDP at factor cost, we have to
deduct the net indirect taxes from GDP at MP. Net indirect tax is equal to indirect tax and subsidies. It can be expressed
as,
GDP at FC = GDP at MP- Net indirect taxes

Nominal GDP and Real GDP

The GDP which is calculated at current market price is known as nominal GDP. Inflation and deflation are adjusted in
nominal GDP.
The GDP which is calculated by taking a certain year as a base year is known as real GDP. If the GDP of 2022 is calculating
by taking the price of base year 2018 then it is said to be real GDP.
GDP Deflator and Rate of Inflation
GDP deflator measures relative changes in current level prices in comparison to the level of prices in the base year. In
other words, it is the ratio of nominal GDP in a given year to real GDP of that year. The formula for calculating the GDP
deflator is relatively simple. The calculation requires information regarding the real GDP and the nominal GDP. It is
calculated by dividing nominal GDP by real GDP and multiplying it by 100. The following formula shows how GDP
deflator is calculated:
Nominal GDP
GDP deflator= × 100
Real GDP
Based on GDP deflator, we can calculate real GDP from the nominal GDP. It can help to provide a more accurate picture
of the gross domestic product in the country. The GDP deflator is also used as a measure of change in the prices of goods
and services produced or the rate of inflation in the country. In other words, on the basis of GDP deflator, we can
calculate rate of inflation between any two periods. The formula to calculate rate of inflation by GDP deflator is as
follows:
Change ∈GDP Deflator
Rate of Inflation= ×100
GDP Deflator of the Previous Year

Net Domestic Product (NDP)

Gross domestic product minus depreciation is called net domestic product When a charge for depreciation is deducted
from GDP, we get net domestic product. Depreciation means wear and tear of fixed capital assets decrease in value of
fixed capital assets. It is also known as the capital consumption allowance.
NDP= GDP – Depreciation.

NDP at Market Price and Factor Cost

NDP measured at actual market price is called NDP at market price where as NDP measured as the sum of price paid to
the all factors of production the form of wages and salaries, profit, interest and rent for their contribution in the
production of goods and services is called NDP at factor cost.
NDP at FC (NDPFC) = NDP at MP - Net indirect taxes
Where,
Net indirect taxes = Indirect taxes – Subsidies

Gross National Product (GNP)

Gross national product is the market value of all final goods and service produced during a year by domestically owned
resource or factors production. In other words, it is the market value of all final goods are services produced within a
country in a year plus net factor income from aboard. It is broader concept than GDP because GNP is equal to GDP plus
net factor income from abroad. Net factor income from abroad is the difference between the factor income earned by
our residents from foreign countries and the factor income earned by foreigners from our country.
GNP = GDP+ Net factor income from abroad
Features of GNP
• It is calculated in monetary terms.
• It includes only final goods and services.
• The intermediate goods are excluded to avoid double counting
• It includes income earned by the residents of a country within a country and abroad.
• It does not include capital gains and transfer payments.
• It includes only those goods which have market value and brought in the market for sale.

Net national product (NNP)

Net national product (NNP) is a term that is often used to represent the difference between gross national product and
depreciation. In numerical terms, the NNP is the total market value of the goods and services produced by a nation
during a specified period (generally a year) with depreciation subtracted from it. Gross national product minus
depreciation is called net national product. In other words, net national product is the market value of all final goods and
services after allowing for depreciation. It is also called national income at market price. When charges for depreciation
are deducted from the gross national product, we get it. While producing goods and services, the machineries and other
fixed capitals wear and tear. It is known as depreciation. By deducting the value of depreciation from the value of gross
national product in a year, we get the value of net national product.
Thus,
NNP=GNP – Depreciation

NNP at Market Price and Factor Cost

NNP measured at the actual market price is called NNP at market price whereas NNP measured as the sum of price paid
to the all factors of production in form of wages, profits, interest and rent for their contribution in production is called
NNP at factor cost. In order to calculate NNP at factor cost, we deduct net indirect taxes from NNP at market price. Net
indirect tax is equal to indirect taxes minus subsidies.
NNP at FC (NNP) = NNP at MP-Net indirect taxes
Where,
Net indirect taxes = Indirect taxes- Subsidies
National Income
The monetary value of all final goods and services which is produced in a country in a specific period of time is known as
national income. National income is the sum of earnings of all factors of production in the form of wages, profit, rent and
interest plus net factor income from abroad. Under expenditure method it can be calculated as;
NI = NNP+C+I+G+ (X-M)-Net indirect tax
Where,
NI = National Income
C = Consumption Expenditure
I = Investment Expenditure
G = Government Expenditure
X-M = Net Export
Net Indirect taxes = Indirect Taxes – Subsidies

Personal Income (PI)

The total income received by all individuals and households of a country from all possible sources before payment of
direct taxes during a year is called personal income. While calculating personal income, social security contribution (SSC),
corporate income tax (CIT), and undistributed corporate profit is deducted from national income(Nl) and transfer
payment is added in Pl. It can be calculated as;
PI = NI-UCP-SSC-CIT+TP

Disposable Income (DI)

Whatever be the income remains after the payment of direct taxes from personal income is known as disposable
income. Personal disposable income refers to those parts of personal income, which is actually available to individuals to
consumption. All personal income may not be available for being spent in satisfying needs. Individual have to pay certain
direct taxes such as income tax, wealth tax, estate tax etc. Hence the personal disposable income is personal income
minus personal direct taxes, fee and fines etc.
DI = PI-DT
Where,
DI = Disposable Income
Pl= Personal Income
DT= Direct Taxes

Per Capita Income

The average income of the people of a country in a particular year is called per capita income. It is expressed at the
current prices. In order to find the per capita income, national income of the country in a particular year is divided by
population of the country in that year.
National Income for 2021
Per Capita Income for 2021=
Total Population for 2021

The per capita income concept enables us to know average income and living standard of the people. It is one of the
important indicators of economic development of the country. But it is not very reliable, because in every country due to
unequal distribution of national income, a major part of it goes to the richer sections of the society and thus income
received by common people is lower than the per capita income.

Measurement of National Income

Product Method
The product method is also known as the output method or inventory method. In this method, the sum total of the
gross value of the final goods and services in different sectors of the economy like industry, service, agriculture, etc. is
acquired for the current year by determining the total production that was made during the specific time period. The
value obtained is the gross domestic product. Thus, according to this method,
GDP = Total product of (industry + service + agriculture) sector
Symbolically,
GDP= (P x Q)
Where,
P= Market price of goods and services
Q= Total volume of Output
Components

a. Primary sector: It includes agro-products (food crops, cash crops, animal husbandry, horticulture, etc.), fishery,
forestry, mining, querying and so on.
b. Secondary sector: It includes manufacturing, construction, electricity, gas, water supply and others.
c. Tertiary sector: It includes banking and insurance, transport and communication, trade and commerce, health and
education and other services.
d. Net factor income from abroad: It is the difference between receipts from foreign countries and payments to foreign
countries.
Sometimes goods produced by one sector are further processed by another sector. These goods are termed as
intermediate goods and are already included while determining the value of final goods. So, in order to avoid the
problem of double counting of value of goods, the product method if further categorized into two approaches:
a. Final Product Method
Under this method, the output is calculated by taking the monetary value of all final goods and services. The value of
intermediate goods is not included in final product method for avoiding the double counting.
GDPMP = Value of output- Value of intermediate goods
b. Value Added Method
Value added method estimates national income and product by considering the values of both intermediate and final
output simultaneously. Output is the transformation of inputs from one form to another. So, a final output should pass
through different stages of production before being transformed into ultimately consumable/usable form. At each stage
of production, a particular value is added or created by the producer. Value added means the addition to the value of
raw materials and other inputs during the process of production. In other words, value added is the value that a
producing unit/firm adds to the intermediate inputs to get the final output. Therefore, in order to calculate the value
added at a particular stage of production, the cost of intermediate product is deducted from the total value of the
output. Hence,
Gross Value added = value of output – Cost of intermediate goods.

Hypothetical Example
Producer Stage of Production Value of Output Cost of Intermediate Gross Value Added
Goods
Farmer Wheat 3000 - 3000
Miller Flour 3500 3000 500
Baker Bread 4000 3500 500
Total 10500 6500 4000

Income Method
The income method calculates the National Income based on factor incomes. The incomes received by every resident of
a country for the productive services provided by them during a year are added together to determine the National
Income of an economy. In other words, under the Income Method of calculating National Income, all incomes of a
country accruing to the factors of production through rent, wages, profits, interest, etc., are added up together for the
determination of National Income. This method is also widely known as the Factor Payment Method or Distributive
Share Method.

Components Of Factor Income

1. Compensation of Employees (COE)
COE refers to the amount paid to employees directly or indirectly by the employer in exchange for their services. It
includes all kinds of payments and benefits received by the employee, directly or indirectly.
COE consists of three elements:
• Wages and Salaries in Cash: It consists of all monetary benefits like salaries, wages, bonuses, commissions,
dearness allowance, etc.
• Wages and Salaries in Kind: It includes all non-monetary benefits like health & education facilities, rent-free
accommodation, free car, etc. An imputed value of such benefits should be calculated in National Income.
• Employer’s Contribution to Social Security Schemes: It consists of the employer’s contribution to the employee’s
security. For example, contribution in gratuity, provident fund, labour welfare fund, etc. The main aim of these
contributions is to ensure employee security.
2. Rent and Royalty
Rent is that part of the factor income that arises from ownership of a land and building. Rental income includes both
actual rents obtained from let-out land and imputed rent obtained from self-occupied land. The Imputed rent of a self-
occupied house is calculated at the market value of that house.
Royalty refers to the income earned from granting leasing rights for self-owned assets. For example, the mineral deposits
(coal, natural gas, iron ore, etc.) owners can earn more through royalty, by giving mining rights to the contractors.
3. Interest
Interest refers to the income earned from lending funds to production units. It includes both actual & imputed interest
provided by entrepreneurs. Interest income consists of the interest on loans taken for productive services. It doesn’t
include interest paid by one firm to another, interest paid for loans by a consumer taken for consumption, and interest
paid by the government on public debt.
4. Profit
Profit is the income or reward of the entrepreneur for his contribution to manufacturing of goods & services. In other
words, it is the residual income that an entrepreneur earns after paying off all other factors of production.
The profit earned is used for three purposes:
• Corporate Tax: It is the tax paid by a firm to the government for the profits earned by them in a particular period.
It is also known as business tax or profit tax.
• Dividend: Dividend is the part of profit given to shareholders in their shareholding ratio. It is also known as
distributed profits.
• Retained Earnings: It is that part of the profit that is kept aside as a reserve to handle the uncertain situations
that may arise in a business. It is also known as reserves and surplus or undistributed profits or savings of private
sector.
Profit = Corporate Tax + Dividend + Retained Earnings
5.Operating Surplus
Operating surplus is another term used in factor payments. It is the sum total of income from property, i.e., rent, royalty,
and interest, and income from entrepreneurship, i.e., profit.
Operating Surplus = Rent + Royalty + Interest + Profit
6. Net indirect taxes
Net indirect tax is equal to indirect taxes less subsidies. This indirect tax consists primarily of sales or value added tax
(VAT), excise and real property taxes incurred by businesses. It is considered as a business expense the same as wages
and other costs. Though final burden of such taxes is borne by final consumer in the form of higher prices, it is included
in GDP. This is because the indirect taxes cause the expenditure side of GDP to be greater than the income side. On the
other hand, subsidies cause expenditure side to be lower than income side. Therefore, indirect taxes are deducted and
subsidies are added to get GDP at factor cost.
Net indirect taxes = Indirect taxes - Subsidies
7. Net factor income from abroad
The net factor income from abroad is included in the national income. Net factor income from abroad is equal to income
received by citizens of a country from abroad less income paid to the foreigners. It is added to GDP to get GNP.
8. Depreciation
The depreciation amount is deducted from gross income to get net income i.e., net national product (NNP).
Depreciation is the wear and tear of fixed assets and machineries. It is also known as the capital consumption allowance.

Precautions of Income Method

1. Transfer Income will not be included: Transfer incomes such as donations, charity, scholarships, old age pensions,
etc., are not counted in the National Income, as these activities are not connected to any production activity and no
value addition takes place.
2. Income from Sale of Second Hand Goods will not be included: Income received from the sale of second hand goods
also known as capital gains is not calculated in National Income, as their original sale has already been included at the
time of purchase. If these goods are calculated again, then it will lead to the problem of double counting. However, any
kind of commission or brokerage received by agents on the sale of these goods will be included, as it is an income
received for rendering productive services.
3. Income from Sale of Securities will not be included: Income from the sale of bonds, shares, and debentures will not
be calculated, as these transactions do not contribute to the current flow of goods & services. These financial assets are
just paper claims and include the transfer of title only. However, any kind of commission or brokerage on such assets is
included in National Income, as it is a productive service.
4. Windfall Gains will not be included: Income that arises from windfall gains like horse racing, lotteries, etc., are not
calculated in the determination of National Income, as they are not connected with any kind of production activity.
5. Imputed Value of Services by Owners of Production Units will be included: The imputed value of self-occupied houses,
production for self-consumption, interest on own capital, etc., are included under National Income, as these are
productive activities and add to the current flow of goods & services of the economy.
6. Payment out of Past Savings will not be included: Payment out of past savings such as interest tax, gift tax, death
duties, etc., is not calculated in National Income, as they are paid out of past savings or wealth and do not contribute to
the current flow of goods & services of the economy.

Expenditure Method
In this method, the income is calculated as the aggregate of all expenditures incurred by households, firms, government,
and foreigners. It is assumed that all the factor income earned is spent in the form of expenditure incurred in the
production of the goods and services, and circulated by the businesses in an economy. Therefore, the total final
expenditure incurred is the Gross Domestic Product at Market Price. It is often known as the Income Disposable Method.
Expenditure method measures national income as the total of all final expenditure on gross domestic product in an
economy during a year. Final expenditure means expenditure on final product. The total income generated in the
economy is spent either on consumer goods or capital goods. According to expenditure method, the sum of private
consumption expenditure, private investment expenditure, government expenditure and net export gives the GDP
account at market price.

Components of national income

1. Personal consumption expenditures (C)
It is frequently referred to as consumption expenditures or simply consumption. This component consists of
expenditures on consumer goods and services. Some examples are personal consumption expenditures are food,
clothing, appliances, automobiles, medical care, recreation, etc.
2. Government expenditure (G)
The items in this component are purchased by all levels of government. They include government expenditures on
security, administration, infrastructure development, etc. However, the transfer payments which are a significant part of
government expenditures are omitted because they do not represent part of current output of goods and services.
3. Gross private domestic investment(I)
This component includes total investment spending by business firms. Investment has a special meaning in economics.
In everyday language, a person makes an investment when buying stocks, bonds or other assets with the intention of
receiving an income or making a profit. In economics, investment means additions to or replacement of physical
productive assets. Thus, investment represents spending by business goods. Because such expenditures contribute
significantly to GDP, they are of major concern in economics.
Gross private domestic investment (I)= Net fixed capital formation +Gross investment + Depreciation + Change in
stock+ Gross fixed investment (Gross capital formation) +Change in stock

Gross private domestic investment (I) = Net investment (Net capital formation) +Depreciation
Where,
Change in stock (Change in Inventories) = Closing stock - Opening stock
4. Net exports of goods and services
Some domestic expenditure is made to purchase foreign goods and services which is known as the import. On the other
hand, some foreign expenditure is made to purchase domestic goods and services which is known as the import. On the
other hand, some foreign expenditure is made to purchase domestic goods and services which is known as the export.
To measure GDP at MP in terms of total expenditures, we must include the value of exported goods and services
(because the value of exported represents the amount that foreign buyers spend on purchasing some of our total
output). Then, we subtract the value of imported goods and services from our total expenditures (because the part of
our consumption was for imported goods, and we are interested only in measuring the value of domestic output).
Hence, net exports equal to total exports minus total imports.
Net export= Export - Import
5. Net indirect taxes
Net indirect tax is equal to indirect taxes less subsidies. Indirect tax consists primarily of sales or value added tax (VAT),
excise and real property taxes incurred by businesses. It is considered as a business expense - the same as wages and
other costs. Though final burden of such taxes is borne by final consumer in the form of higher prices, it is included in
GDP. This is because the indirect taxes cause the expenditure side of GDP to be greater than the income side. On the
other hand, subsidies cause expenditure side to be lower than income side. Therefore, indirect taxes are deducted and
subsidies are added to get GDP at factor cost.
Net indirect taxes = Indirect taxes - Subsidies
6. Net factor income from abroad
The net factor income from abroad is included in the national income. Net income from abroad is equal to income
received by citizens of a country from abroad less income paid to the foreigners. It is added to GDP to get GNP.
7. Depreciation
The depreciation amount is deducted from gross national product (GNP) to get net national product (NNP). Depreciation
is the wear and tear of fixed assets and machineries. It is also known as the capital consumption allowances.

Precautions of Expenditure Method

1. Expenditure on Intermediate Goods will not be included: To avoid double-counting, expenditure on intermediate
goods and purchase of second-hand goods are not taken into account in the calculation of National Income using this
method, as they do not contribute to the current circular flow of goods and services.
2. Purchase of Financial Assets will not be included: Procurement of financial assets like debts, bonds, etc., will not be
included as they are a mere tool and not an actual physical good; therefore, they not contributing in any way to the flow
of goods and services. However, any brokerage or commission on the sale or purchase of such kinds of financial
statements is included in the National Income, as it is a productive service.
3. Transfer Payments are not included: Since transfer payments do not create any value addition in the economy, nor is
it connected to any production activity, it is not included in the National Income calculation.
4. Purchase of second-hand goods will not be included: Expenditure on the second-hand goods has already been
included in the National Income at the time of their initial purchase. Therefore, purchase of these types of goods does
not affect the circular flow of goods and services of an economy, and hence is not included in the National Income.
However, any type of brokerage or commission, even on the purchase of second-hand goods and financial assets, will be
included in the expenditure method.
5. Expenditure on own account production will be included: Expenditure on productive services, like the imputed value
of owner-occupied houses, production of goods or services for self-consumption, free services from the general
government, and private non-profit institutions serving households will be included in the calculation of National Income
of an economy.

Difficulties in the Measurement of National Income

1. Problems of double counting
While calculating national income, only final goods and services should be included, but some goods may be final for
one sector and intermediate for another sector. For example, sugarcane is final goods for the agricultural sector but it
may be intermediate goods in the industrial sector for producing sugar. Thus, there is a very high possibility of double
counting.
2. Existence of non-monetized sector
In a developing country, there is still a barter system in backward areas. Thus, all agricultural outputs do not reach to the
market. Either it is consumed at home or exchange for other goods in the village. Hence, it is difficult to calculate the
national income accurately.
3. Illegal income
Different people can earn income through illegal activities, such as black marketing, dacoits, gambling, smuggling, etc.
But these incomes are not included in national incomes which make national income less than the actual amount.
4. Calculation of depreciation
The depreciation is deducted from gross national product to calculate net national product and national income. But it is
difficult to estimate accurate depreciation. The depreciation charge differs from product to product. Sometimes similar
capital goods are treated differently by the different firms. It becomes further complicated if the value of capital assets
changes every year.
5. Transfer payment
Transfer payment like pension, unemployment allowances, disable allowances, etc. are a part of individual income but
these are also a part of government expenditure. So, it creates problem whether it should be included in N.I. or not.
6. Frequently change in price
National income is measured in monetary terms. The value of money keeps on changing with time because of changes in
the price level. This creates a problem to calculate national income because national income changes even without a
change in output.
7. Inadequate and unreliable statistics
Due to lack of required data on various economic activities, national income accounting has become quite a difficult task
in developing countries. Even the available has become quite a reliable due to various factors such as geographical
condition, etc.
8. Illiteracy and Ignorance
If the majority of people are illiterate and ignorant, they cannot keep the records of production activities accurately.
Hence, it is difficult to get the correct information about the production.
9. Choice of method
It is also difficult to decide which method is to be used in the calculation of national income. The general view is to use
product, income, and expenditure methods simultaneously depending upon the availability of statistical data.
10. Environmental damage: Production activities cause the reduction of miner resources, the erosion of soil, the
pollution of air and water. These activities damage natural environment. National income accounting neither prepares
account of natural resources depletion nor measures the impact of environmental damage on human health and adjusts
them in the value of GDP or national income.
Importance or Uses of National Income
1. To compare standard of living
Since income is a flow of wealth. Changes in the national income give some indication of economic welfare. The total
figure, however, can be misleading, since account must be taken of the changes in the value of money, and changes in
the total production. Per capita income is the best indicator of development. Other things being equal, economic per
head is used to compare standards of living in different countries.
2. To measure growth rate
Economic growth is measured in terms of per capita national income and the national income figures (in real terms) are
used to measure the rate of growth of a country.
3. To examine the behaviour of economic sectors
The national income accounts make possible an analysis of the behaviour of the different sectors of the economy. They
provide the details of the changes. in consumption and investment spending, in the level of savings, in the output of
different branches of industry, in the expenditure of public authorities, and to the distribution of income among the
different income groups. These details are essential in planning development of various sectors.
4. To forecast business activities
National income statistics can be used to forecast the level of business activity at later dates and to find out trends in
other annual data.
5. To evaluate structure of the economy
The national income figures are useful in providing a correct sense of proportion about the structure of the economy.
6. To examine production possibilities
In war time the study of the components of national income is of great importance because they show the maximum
possible production possibilities of the country.
7. Basis of economic planning
Above all, the national income statistics are used for planned economic development of a country. In the absence of
such data, planning will be a leap in the dark.
8. Importance in economics analysis
National income estimates help us in analyzing the functioning, growth, d anatomy of the economy. They are important
in analyzing (a) the growth of the economy, (b) the trend of various sectors, (c) the trends of factor shares, and (d) the
trend of various macro variables, such as aggregate consumption, aggregate investment, and aggregate saving, etc.
9. Inflationary and deflationary gaps
National income estimates provide information about the existence of inflationary and deflationary gaps in the
economy. They are also helpful in formulating anti-inflationary and anti-deflationary policies.