Unit - 5

National Income:
National income means the value of goods and services produced by a country during a financial year. Thus, it
is the net result of all economic activities of any country during a period of one year and is valued in terms of
money. National income is an uncertain term and is often used interchangeably with the national dividend,
national output, and national expenditure. We can understand this concept by understanding the national
income definition.

National income is the sum total of the value of all the goods and services manufactured by the residents of
the country, in a year. within its domestic boundaries or outside. It is the net amount of income of the
citizens by production in a year. To be more precise, national income is the accumulated money value of all
final goods and services produced in a country during one financial year. Computation of National Income is
very vital as it indicates the overall health of our economy for that particular year.The aggregate economic
performance of a nation is calculated with the help of National income data. The basic purpose of national
income is to throw light on aggregate output and income and provide a basis for the government to
formulate its policy, programs, to maximize the national welfare of the people. Central Statistical
Organization calculates the national income in India.

It is represented by the following formula:

National Income = Consumption + Government Expenditure
+ Investments + Net Exports + Foreign Production by Nation’s Residents
– Domestic Production of the Country’s Non Residents

The definition of National Income if of two types-

 Traditional Definition of National Income: According to Marshall: “The labor 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.”
 Modern Definition: This definition has two subparts
o GDP
o GNP

Gross Domestic Product

Gross Domestic Product, abbreviated as GDP, is the aggregate value of goods and services produced in a
country. GDP is calculated over regular time intervals, such as a quarter or a year. GDP as an economic
indicator is used worldwide to measure the growth of countries economy. Goods are valued at their market
prices, so: All goods measured in the same units (e.g., dollars in the U.S.)Things without exact market value
are excluded.

 Constituents of GDP
 o Wages and salaries
o Rent Interest
o Undistributed profits
o Mixed-income
o Direct taxes
o Dividend
o Depreciation

The Formula for Calculation of GDP

GDP = consumption + investment + government spending + exports - imports.

Gross National Product

Gross National Product (GNP) is an estimated value of all goods and services produced by a country’s
residents and businesses. GNP does not include the services used to produce manufactured goods
because its value is included in the price of the finished product. It also includes net income arising in a
country from abroad.

 Components of GNP
o Consumer goods and services
o Gross private domestic income
o Goods produced or services rendered
o Income arising from abroad

Formula to Calculate GNP

GNP = GDP + NR (Net income from assets abroad or Net Income Receipts) - NP (Net payment outflow to
foreign assets).

Importance of National Income

Setting Economic Policy

National Income indicates the status of the economy and can give a clear picture of the country’s economic
growth. National Income statistics can help economists in formulating economic policies for economic
development.

Inflation and Deflationary Gaps

For timely anti-inflationary and deflationary policies, we need aggregate data of national income. If
expenditure increases from the total output, it shows inflammatory gaps and vice versa.

Budget Preparation
The budget of the country is highly dependent on the net national income and its concepts. The
Government formulates the yearly budget with the help of national income statistics in order to avoid any
cynical policies.

Standard of Living

National income data assists the government in comparing the standard of living amongst countries and
people living in the same country at different times.

Defense and Development

National income estimates help us to bifurcate the national product between defense and development
purposes of the country. From such figures, we can easily know, how much can be set aside for the defense
budget.

Aggregates of National Income

#1 – Gross Domestic Product at Market Price (GDPMP)
GDPMP is the total value of a nation’s goods and services produced locally—during a given accounting year. It
is evaluated as follows:

GDPMP = Net Domestic Product at FC (NDPFC) + Depreciation + Net Indirect Tax

#2 – Gross Domestic Product at Factor Cost (GDPFC)

It is the total value of domestic production minus net indirect taxes. It is represented as follows:

GDPFC = GDPMP – Net Indirect Tax

#3 – Net Domestic Product at Market Price (NDPMP)

The NDP MP is the value of total goods and services produced within the nation minus depreciation. It is
computed as follows:

NDPMP = GDPMP – Depreciation

#4 – Net Domestic Product at Factor Cost (NDPFC)

The net domestic product at factor cost is the value acquired by deducting the net indirect tax and
depreciation from the gross market value of domestic goods and services. It is denoted by the following
formula:

NDPFC = GDPMP – Net Indirect tax – Depreciation

#5 – Gross National Product at Market Price (GNPMP)
The GNPMP is the value of overall goods or services manufactured by a nation’s residents. It is represented by:

GNPMP = NNPFC + Net Indirect Taxes + Depreciation

#6 – Gross National Product at Factor Cost (GDPFC)

It is computed by deducting net indirect tax from the aggregate value of all commodities produced by the
residents of a country—during an accounting year. It is represented by:

GNPFC = GNPMP – Net Indirect Taxes

#7 – Net National Product at Market Price (PMP)

The NNPMP is the net value of the goods and services generated by production capacities that are owned by
residents. It is computed by subtracting depreciation from the gross value. It is computed as follows:

NNPMP = GNPMP – Depreciation

#8 – Net National Product at Factor Cost (NNPFC)

The net national product at factor cost is the value of overall goods or services manufactured by a nation’s
residents, excluding indirect taxes and depreciation. It is computed as follows:

NNPFC = GNPMP – Net Indirect Taxes – Depreciation

 What is a Business Cycle?
A business cycle is a cycle of fluctuations in the Gross Domestic Product (GDP) around its
long-term natural growth rate. It explains the expansion and contraction in economic
activity that an economy experiences over time.

A business cycle is completed when it goes through a single boom and a single contraction
in sequence. The time period to complete this sequence is called the length of the business
cycle.

A boom is characterized by a period of rapid economic growth, whereas a period of relatively

stagnated economic growth is a recession. These are measured in terms of the growth of
the real GDP, which is inflation-adjusted.
Stages of the Business Cycle

In the diagram above, the straight line in the middle is the steady growth line. The business
cycle moves about the line. Below is a more detailed description of each stage in the
business cycle:

1. Expansion

The first stage in the business cycle is expansion. In this stage, there is an increase in
positive economic indicators such as employment, income, output, wages, profits, demand,
and supply of goods and services. Debtors are generally paying their debts on time, the
velocity of the money supply is high, and investment is high. This process continues as long
as economic conditions are favorable for expansion.

2. Peak

The economy then reaches a saturation point, or peak, which is the second stage of the
business cycle. The maximum limit of growth is attained. The economic indicators do not
grow further and are at their highest. Prices are at their peak. This stage marks the reversal
point in the trend of economic growth. Consumers tend to restructure their budgets at this
point.

3. Recession

The recession is the stage that follows the peak phase. The demand for goods and services
starts declining rapidly and steadily in this phase. Producers do not notice the decrease in
demand instantly and go on producing, which creates a situation of excess supply in the
market. Prices tend to fall. All positive economic indicators such as income, output, wages,
etc., consequently start to fall.

4. Depression

There is a commensurate rise in unemployment. The growth in the economy continues to

decline, and as this falls below the steady growth line, the stage is called a depression.

5. Trough

In the depression stage, the economy’s growth rate becomes negative. There is further
decline until the prices of factors, as well as the demand and supply of goods and
services, contract to reach their lowest point. The economy eventually reaches the trough. It
is the negative saturation point for an economy. There is extensive depletion of national
income and expenditure.

6. Recovery

After the trough, the economy moves to the stage of recovery. In this phase, there is a
turnaround in the economy, and it begins to recover from the negative growth rate. Demand
starts to pick up due to low prices and, consequently, supply begins to increase. The
population develops a positive attitude towards investment and employment and production
starts increasing.

Employment begins to rise and, due to accumulated cash balances with the bankers,
lending also shows positive signals. In this phase, depreciated capital is replaced, leading to
new investments in the production process. Recovery continues until the economy returns to
steady growth levels.

This completes one full business cycle of boom and contraction. The extreme points are the
peak and the trough.

Inflation
Inflation is when the prices of goods and services keep increasing over a certain period. It
results in a decline in the purchasing power of customers. It aims to gauge the effect of
increasing prices on the economy in a financial year.

A low rate increases or rather balances the employment rate. Also, the rate of investment growth rises and,
thus, the gross domestic product increase. However, it can invite deflation (or recession) in the economy
without the necessary precautions deflation (or recession).

Inflation Types
#1 – Demand Pull Inflation
It occurs when the demand exceeds supply. Thus, forcing the firms to increase the prices. For instance, the
Lawson boom of the late 1980s. At that moment, the United Kingdom saw a huge rise in the prices of
houses. Also, household consumption increased massively. Therefore, as a result of increasing prices, the
demand surpassed supply.

#2 – Creeping Inflation
In the initial stage, the inflation rate is around 2%, 3%, or 5%. At this point, the prices rise at a very minimal
rate gradually. However, ignoring them can cause prices to rise.

#3 – Cost-Pull Inflation
This situation appears when the cost of production forces firms to increase their prices. For example,
the factors of production like labor, raw material, and technology are getting expensive.

#4 – Walking Inflation
The hike is said to be walking when the rate rises by 3% to 10% yearly. In September 2022, Sweden’s central
bank announced an inflation report of 9%, probably the highest since 1990. Later, the western countries
had inflation news of 7-8%.

#5 – Galloping Inflation
Galloping inflation occurs when the rate is between 20-1000%. In such situations, there is too much
instability within the economy. As a result, the governing bodies fail to bring situations within control. For
example, in the 1990s, Russia faced a galloping situation where the prices of food and goods increased
severely. In 1993, the rate in Russia was 839.21 %.

#6 – Hyperinflation
Hyperinflation occurs when the rate is above 1000%. At this stage, the value of money depreciates faster.

Inflation Causes
#1 – Increased Money Supply
The money supply is one of the prime reasons for causing inflation. It occurs when the government prints
more currency than the prevailing growth rate. For example, in 2009, Zimbabwe printed excess currency to
normalize the economic situation. Similarly, other African nations also print money to increase their supply.
#2 – Government Policies
At times, government plans and policies can also cause inflation. For example, restrictions on imports cause
the cost of production to rise. As a result, the firms try to adjust that extra cost by increasing the prices of
their products.

#3 – Changes In Exchange Rates

If the dollar’s value fluctuates, consumers have less purchasing power. As a result, the prices of products rise,
causing this situation.

#4 – Rising Wage Rates

The rising wage rate is one of the vital factors for inflation. As the government increases the money supply,
the salaries of individuals also increase. Thus, consumers tend to buy products causing prices to rise.