MACRO ECONOMICS

Unit – National Income & Related Aggregates

(1) Final Goods-: Those goods which have crossed the boundary line of production
and ready for use by their final users.
Intermediate Goods-: Those goods which are within the boundary line of
production and yet not ready for use by their final users.
(2) Distinguish between Final Goods & Intermediate Goods
Basis Final Goods Intermediate Goods
Meaning Those goods which are used Those goods which are
either for consumption or used either for resale or
for investment for further production
Demand They have a direct demand They have a derived
as they satisfy the want demand as their demand
directly depends on the demand
for final goods.
Included It is included in both It is neither included in
National & Domestic Income National nor in Domestic
Income
Production Crossed the production Still within production
Boundary boundary boundary
Ready for They are ready for use by They are not ready for
use their final users so, no value use, some value has to be
has to be added to the final added to the intermediate
goods goods.
Example Furniture Wood
Note -: The same good may be a final good or intermediate good. It depends upon
the nature of its economic use. Hence it is not nature of the good rather its nature
of economic use which makes it final good or intermediate good.
(3) Types of Final Goods-: Final good are divided into two types-:
(a)Consumption Goods-: Those goods which are consumed when purchased by
the ultimate consumers are called consumer goods. Example -: Milk, Bread & Food
etc.
(b)Capital Goods-: Those goods which are durable in nature and used in the
production process to make production of other goods possible, but they
themselves do not get transformed in the production process. Example-:
Machines, Tools & Implements etc.
Note -: All goods used by the producer (Produce Goods) are not capital goods, bit
all capital goods are producer goods.
Difference between Consumption Goods & Capital Goods-:
Consumption Goods Capital Goods
These goods satisfy human Such goods satisfy human
wants directly. wants indirectly
These goods have direct These goods have derived
 demand demand
They do not promote They help in rising production
production capacity capacity
Most of the consumption Capital goods generally have
goods (except durable goods) an expected life more than one
have limited expected life. year
(4) Stock -: Those variables which are measured at a point of time are called stock
variables. Example-: The population of India as on 31, March 2017.

Flow -: Those variables which are measured over a period of time are called flow
variables. Example -: The population of India during the year 2017.

Difference between Stock & Flow-:

Stock Flow
It refers to that variable It refers to that variable
which is measured at a which is measured over a
point of time period of time
It does not have time It has a time dimension
dimension
It is a static concept It is a dynamic concept
Example-: Population of Example-: No of birth
India as on 31,March during 2019, National
2020; Money Supply; Income, Expenditure in
National Wealth money.
(5) Circular Flow of Income-: The flow of income and product among various sectors
in the economy is called Circular Flow of Income.
Phases of Circular Flow -:
(A)Generation-: Production of goods and services by the firms
(B)Distribution-: Flow of factor Income from firms to households
(C)Disposition-: Consumption expenditure by household on the goods and
services.
Types of Circular Flow-: (a)Real Flow-: It is the flow of goods and services
between firms and households. It is also known as ‘Physical Flow’.
(b)Money Flow-: It is the flow of money between firms and households. It is also
known as ‘Nominal Flow’.
CIRCULAR FLOW OF INCOME IN TWO SECTOR ECONOMY-:
(OR)
CIRCULAR FLOW OF INCOME IN A SIMPLE ECONOMY-:
(a)There are only two sector in the economy, namely Household and Firm.
(b)Household is the sole consumer and firm is the sole producer in the economy.
(c)There are no leakages and injections in the economy.
(d)In any exchange process the seller or producer receives the same amount that
the buyer or consumer spends.
(e)Goods & Services flow in the direction (Real Flow) and money payment to
acquire these flow in the return direction, thereby causing a circular flow.
This can be explained with the help of diagram-:

Explanation of the above diagram-:

(a)Households provide factor services like land, labour, capital and enterprise to
the firms.
(b)By using these the firm produce goods and services and provides to the
households.
(c)The firm make payment for the factor service to the hsouseholds in the form of
rent, wages, interest and profits.
(d)Households make payment to the firm in the form of consumption expenditure
In this case the flow of goods and services and factor services are called Real Flow
and money payments and expenditures are called Money Flow.
Money Flow = Real Flow

FOUR SECTORS OF THE ECONOMY-: The four major sectors in an economy

according to macroeconomic point of view are-:
(a)Household Sector-: It includes consumers of goods and services and also the
owners of factors of production. They supply factors like land, labour, capital and
entrepreneur and receive income in return in the form of rent, wages, interest
and profit respectively.
(b)Producing Sector (Firms)-: It includes all producing firms in the economy. To
produce goods and services, the firm hires factors of production from the
households.
(c)Government Sector-: It has two elements: As a welfare agency, it is involved in
maintaining law and order, defence and other services of public welfare. As a
producer, it produces goods and services in public sector enterprises.
(d)Foreign Sector (or External Sector or Rest of the world Sector)-: This sector
includes transactions with the rest of the world. It is involved in export and import
 of goods and flow of capital between the domestic economy and other countries
of the world.
(6) Investment-: Investment refers to the increase in the stock of capital. It is also
capital formation.
Gross Investment-: It is the total addition to the capital stock of the economy
including depreciation.
Depreciation-: Depreciation refers to fall in the value of fixed assets due to normal
tear and wear, accidental damages and expected obsolescence.
(a)It is calculated annually
(b)It is pre determined. Hence it is always positive
(c)It is calculated by: Depreciation = Value of the fixed asset
Expected Life in years
(d)The other names are Consumption of Fixed Capital, Replacement Investment,
Capital Consumption Allowances.
Net Investment-: It is the addition to capital stock in an economy during a year
excluding depreciation.
Net Investment = Gross Investment – Depreciation
Example-: Suppose a company has 5 machines and 20% of each machine is
depreciated annually. This year the company has purchased another 3 machines.
So the Gross Investment is 3 machines. But actually 1 machine is meant for
replacing the existing machines. Hence Net Investment is 2 machines.

Net Indirect Tax-: Net Indirect Tax (NIT) is the difference between Indirect tax and
subsidies.
NIT = Indirect Tax – Subsidies
Indirect Tax-: Indirect tax refers to those taxes which are imposed by the
government on production and sale of goods and services. Indirect Tax increase
the price of the product in the market.
Example -: If cost of production of one set of speaker is Rs500 and government
levies GST of 10%, then price of each speakers will increase to Rs550 due to
Indirect taxes.
Subsidies-: Subsidies are the financial assistance (support/help) provided by the
government to producers to fulfil its social welfare objectives. In India LPG
cylinder is sold at subsidized rates.
Subsidies are just opposite to Indirect taxes as they reduce the market price of the
commodity. In the example of speakers, if the government grants a subsidy of
Rs10, then price of speakers will fall to Rs540 due to subsidies.
Subsidies can be called as ‘Economic Assistance’ or ‘Financial assistance’.

Factor Cost(FC) -: It refers to amount paid to factors of production for their

contribution in the production process. In the above example Rs500 is the Factor
Cost.
Market Price (MP) -: It refers to the price at which product is actually sold in the
market. In the above example Rs540 is the market price.
NET FACTOR INCOME FROM ABROAD-:
 Net Factor Income from abroad is the difference between Factor income earned
by our residents from rest of the world and Factor income earned by non –
residents in our domestic territory.
(OR)
NFIA = Factor Income earned from abroad – Factor Income paid to abroad
(7) Concept of domestic (economic) territory -: Domestic territory is a geographical
territory administered by a government within which persons, goods and capital
circulate freely. (Areas of operation generating domestic Income, freedom of
circulation of persons, goods and capital).
Scope Identified as-:
(a)Political frontiers including territorial waters and air space
(b)Embassies, Consulates, military bases etc. Located abroad but including those
locates within the political frontiers.
(c)Ships, aircrafts etc operated by the residents between two or more countries
(d)Fishing vessels, oil and natural gas rigs etc. Operated by the residents in the
international waters or other areas over which the country enjoys the exclusive
rights or jurisdiction.

Normal Residents-: It refers to an individual or an institution who ordinarily

resides in the country and whose centre of economic interest also lies in that
country.
It’s not included-: (a)Foreign tourist and visitors
(b)Foreign staff of embassies, officials, diplomats and members
of the armed forces of a foreign country
(c)International Organizations
(d)Employee of international organization staying less than one year
(e)Crew members of foreign vessels, commercial travellers and seasonal workers
(f)Border workers
(8) Difference between Factor Income & Transfer Income-:

Factor Income Transfer Income

It refers to the income received by It refers to the income received
factors of the production for rendering without rendering any productive
their services in the production services in return.
process.
It is included in both National and It is neither included in National nor in
Domestic Income Domestic Income
It is an earning Concept It is a receipt concept
Received by factors of production It is generally received by household
(Land, Labour, Capital and and government.
Entrepreneur) Example-: Scholarship, Old age
Example -: Rent, wages, Interest and pension, Unemployment allowance
profit etc.
It is earned by factor of production like It is received by normal people,
rent, interest, wages and profit. organization or country like gifts ,
 grants and donations.
It is earned due to some production It is received without any production
process. process
(9) NATIONAL INCOME & RELATED AGGREGATES-: National Income is an important
concept of macroeconomics. The various aggregates of national income are-:
(1)Gross Domestic Product at Market Price (GDP at MP)-: It refers to gross
market value of all final goods and services produced within the domestic territory
of a country during a period of one year.
(2)Gross Domestic Product at Factor Cost (GDP at FC)-: It refers to gross money
value of all final goods and services produced within the domestic territory of a
country during a period of one year.
(3)Net Domestic Product at Market Price(NDP at MP)-:It refers to net market
value of all goods and services produced within domestic territory of a country
during a period of one year.
(4)Net Domestic Product at Factor Cost (NDP at FC)(Domestic Income)-: It refers
to net money value of all final goods and services produced within the domestic
territory of a country during a period of one year.
(5)Gross National Product at Market Price (GNP at MP)-: It refers to gross market
value of all final goods and services produced by the normal residents of a country
during a period of one year.
(6)Gross National Product at Factor Cost (GNP at FC)-:It refers to gross money
value of all the final goods and services produced by the normal residents of a
country during a period of one year.
(7)Net National Product at Market Price (NNP at MP)-: It refers to net market
value of all the final goods and services produced by normal residents of a country
during a period of one year.
(8)Net National Product at Factor Price (NNP at FC)(National Income)-: It refers
to net money value of all final goods and services produced by the normal
residents of a country during a period of one year.

Difference between Domestic Income and National Income-:

Domestic Income National Income
[Link] is the sum total of factor incomes [Link] is the sum total of factor incomes
generated with in domestic territory of generated by residents of a country
a country by residents and non – within the domestic territory and rest
residents (foreigners). of the world.
[Link] does not include NFIA (Net factor [Link] includes NFIA (Net factor income
income from abroad) from abroad)
(10) Nominal GDP and Real GDP-:
Nominal GDP-: Nominal GDP is the market value of the final goods and services
(Q) produced within domestic territory of a country during an accounting year, as
estimated using the current year price (P ).In other words If the GDP is measured
in terms of current market prices, then it is called Nominal GDP.
Nominal GDP = Q X P
Real GDP-: Real GDP is the market value of the final goods and services (Q)
produced within the domestic territory of a country during an accounting year, as
estimated using the Base year price (P ). In other words If the GDP is measured in
terms of constant (Base) market prices, then it is called Real GDP.
Real GDP = Q X P

Example-: Suppose the output of the commodity X during the year 2019 was 500
units. The market price of the commodity during the same year was Rs50 per unit
while the price in the base year was Rs40 per unit so the Nominal GDP and Real
GDP would be-:
Nominal GDP = 500 X 50 = Rs25,000
Real GDP = 500 X 40 = Rs20,000

Difference between Real GDP and Nominal GDP-:

Real GDP Nominal GDP
[Link] is the value of output at base year [Link] is the value of output at current
price. year price.
[Link] will increase only when output [Link] will increase when price or output
increases both increases
[Link] is reliable index of welfare [Link] confirmation of welfare

Which is better: Nominal GDP or Real GDP?

Real GDP is better as compared to Nominal GDP due to the following reasons-:
(a)Real GDP is helpful in finding out the effect of increased production of goods
and services as it is affected by change in physical output only. On the other hand,
Nominal GDP can increase even without any increase in physical output as it is
affected by change in prices also.
(b)Real GDP enables one to make a year to year comparison of the changes in the
growth of output as compared to Nominal GDP.
(c)Real GDP is also used in making international comparisons of economic
performance across the countries.
Therefore, Real GDP is better than Nominal GDP as it truly reflects the growth of
an Economy.

GDP Deflator (Price Index)-: As we had already know that Nominal GDP is affected
by both changes in price and physical output. On the other hand, Real GDP is
affected by change in physical output only. To eliminate the effect of price
changes and to determine the real change in physical output, we can use ‘GDP
Deflator’ (Price Index). GDP deflator measures the average level of prices of all
goods and services that make up GDP.
GDP Deflator (Price Index) = Nominal GDP X 100
Real GDP
Example -: If the Nominal GDP is Rs15,000 crores and Real GDP is Rs12,000 crores
then, GDP Deflator (Price Index) = 15,000 X 100
 12,000 = Rs125
Determination of Nominal GDP and Real GDP by Conversion-:
Real GDP = Nominal GDP X 100
Price Index
Nominal GDP = Real GDP X Price Index
100

Example -: (a)If Real GDP is Rs200 and Price Index (with base = 100) is Rs110.
Calculate Nominal GDP.
Nominal GDP = Real GDP X Price Index
100
= 200 X 110
100 = Rs220
(b)If Nominal GDP is Rs15,000 and GDP Deflator is Rs125, Calculate Real GDP.
Real GDP = Nominal GDP X 100
Price Index
= 15,000 X 100
125 = Rs12,000
(11) GDP and Welfare-:
GDP is considered as an index of welfare of the people. Welfare of the people is
measured in terms of availability of goods and services per person. Higher the
growth of GDP, greater is the flow of goods and services. Greater is the availability
of goods and services per person.
However, this statement is not correct exactly due to some certain reasons-:
(1)Distribution of GDP/Income-: (a)If the GDP of a country is rising, the welfare
may not rise as a result.
(b)This is because the rise in GDP may be focus/help in the hands of very few
individuals.
(c)Due to this, the income effect may have fallen
(d)In such cases, the welfare of the entire country cannot be said to have
increased.

(2)Composition of GDP-: If GDP is composed of more socially undesirable goods

like guns, bombs etc. So it may not be welfare oriented even when the level of
GDP tends to rise due to largely increase in the production of defence goods.

(3)Non Monetary Exchange-(a)Many activities in an economy are not evaluated in

monetary terms.
(b)The value of non – monetary transactions like services of housewife, kitchen
gardening ,leisure time activities are not included while calculating GDP due to
non – availability of data.
(c)These have also certain values and which measures economic welfare.
(d)By ignorance of these values the estimation of GDP is not correct which may
effect economic welfare of the economy.
(3)Externalities-(a)Externalities refers to good and bad impact of an economic
 [Link] refers to the benefits or harms of an activity by a firm or
individual without any price or penalty. Activities which results in benefits to
others are termed as positive externalities and activities which result in harm to
others are termed as negative externalities. Environment pollution related to
production activity is an example of negative externality. If maintains a beautiful
garden is an important example of positive externality. This also lowers the
significance of GDP is an index of welfare.
(b)Externalities do not have any market in which they can be bought and sold.
(c)The value of externalities are not taken into account while estimating National
Income.
(d)Positive externalities under estimate the national income and negative
externalities over estimate the national income.
(4)Rate of Population Growth-:GDP does not consider the changes in the
population of a country. If the rate of population growth is higher than the rate of
growth of GDP, then it will decrease the per capita availability of goods and
services, which will adversely affect the economic welfare.
(12) MEASUREMENT OF NATIONAL INCOME-:

(1)Value added Method /Product Method-:

Value added method measures national income in terms of value addition by each
producing enterprise in the economy during an accounting year.
Value Added-: Value added is the difference between value of output of an
enterprise and the value of its intermediate consumption
Value added (GDP at MP) = Value of Output (Sales + Change in Stock) –
Intermediate consumption (Includes value of raw material used in the process of
production)
(OR)
GDP at MP = Gross value added by all producing enterprises in Primary sector +
Gross value added by all producing enterprises in Secondary sector + Gross value
added by all producing enterprises in Teritary sector.
Value of Output-: Value of output refers to market value of all goods and services
produced during a period of one year.
Change in stock = Closing Stock – Opening stock

PRECAUTIONS REGARDING VALUE ADDED METHOD-:

Precautions-: The following precautions are required while using this method-:
(a)The value of Intermediate goods should not be included-: The value of
intermediate goods should not be included, rather the value of only the final
goods to be included. Otherwise, the problem of double counting may arise.

(b)The value of second hand goods is not to be included-: The value of second
hand goods is not to be included, since the value of these goods have been
already valuated in the National Income of those years when these goods have
been manufactured and sold.
(c)The value of illegal goods to be excluded-: The value of illegal goods to be
 excluded because these goods have no legal sanction or authority to be produced
or sold.
(d)Commission earned-: Commission earned on account of sale and purchase of
second hand goods is included in the estimation of value added, because
commission is a reward for the service rendered.
(e)The value of transfer payments are to be excluded-: The value of transfer
payments are to be excluded because these transactions do not contribute in the
flow of income and good, rather these are transfer of ownerships
(13) (2)Income Method-: it is also called factor payment method. According to this
method, National Income is estimated in term of factor payment.
NDP at FC = COE + OS + MISE
Components of Domestic Income (NDP at FC)-: The components of factor income
or domestic income are as follows-:
(a)Compensation of Employees (COE)-: COE refers to amount paid to employees
by employer for rendering productive services. It consists of three elements-:
(i)Wages and Salaries in cash-: It includes all monetary benefits, like salaries,
wages, bonus, dearness allowances, commission etc.
(ii)Wages and Salaries in kind-: It includes all non – monetary benefits, like rent
free home, free car, free medical and educational facilities etc.
(iii)Employer’s contribution to social security schemes-: It includes contributions
made by employer for the social security of employees. Example-: Contribution to
provident fund, gratuity, labour welfare funds etc.

(b)Operating Surplus-: OS is the sum total of income from property and

entrepreneurship. Its consists of three elements-:
(i)Rent and Royalty-: Rent refers to the rental or hiring charges for the use of
capital assets like land, buildings, machinery and other properties. Where as
Royalty refers to income received for leasing the rights of mining to others and for
granting the rights of using patents, copyrights and trademarks.

(ii)Interest-: Interest refers to the amount received for lending funds to a

production unit.
Profit-: Profit is the reward to the entrepreneur for his contribution to the
production of goods and services. The profit consists of three parts-:
Corporate tax (Other name as profit tax or Business tax)
Dividend (Other name as Distributed profit)
Retained earnings (Other name as Undistributed Profits or savings of private
sector or Reserve & Surplus)
In Short, Profit = Corporate Tax + Dividend + Retained Earnings

PRECAUTIONS REGARDING INCOME METHOD-:

(a)The Transfer Incomes are not to be included-: Transfer incomes like
scholarships, donations, charity, old age pensions, etc are not to be included in the
National Income because such receipts are not connected with any productive
activity.
 (b)Income from sale of second – hand goods will not be included-: Income from
sale of second – hand goods are to be avoided as its value are already included in
the year in which it was produced and sold. But commission on sale of these
goods to be included in the estimation of National Income as it is a part of
production activity and commission is a reward for the service rendered.

(c)Financial transactions are to be avoided-: Financial transactions like sale of

shares, bonds, debentures are not to be included as these transactions involves a
change of title only. It cannot be included in the estimation of National Income as
there is no flow of any productive activity.
(d)Income generate from Illegal sources are not to be included-: Income derived
from illegal sources such as gambling, smuggling, theft & loot are not to be
included in the estimation of National Income.
(e)Windfalls gains are not included-: Windfalls gains like income from lotteries,
horse race etc are not to be included in the estimation of National Income as they
are not connected with any productive activity.
(14) (3)Expenditure Method-:According to the expenditure method, National Income
is estimated in term of expenditure on the purchase of goods and services in the
economy. This method is also known as ‘Income Disposal Method’.
Components of Final Expenditure (OR) Classification of Final Expenditure-:

(a)Private Final Consumption Expenditure-: It refers to expenditure on the

purchase of goods and services by households and private non – profit institutions
serving households in an economy.
(b)Government Final Consumption Expenditure-: It is the expenditure incurred by
the government on various administrative services.
(c)Gross Domestic Capital Formation-: GDCF refers to the addition to the capital
stock of the economy.
(d)Net Exports-: Net exports is the difference between exports and imports of a
country, during a period of one year.
In Short -: GDP at MP = PFCE + GFCE + GDCF + NX

PRECAUTIONS REGARDING EXPENDITURE METHOD-:

(a)The expenditure on intermediate goods are not to be included-: Expenditure

on intermediate goods will not be included in the National Income as it is already
included in the value of final expenditure. We must make sure that we are not
including the intermediate expenditure and if it is included again, it will lead to
double counting of expenditures.
(b)The expenditure on transfer payments is not to be included-: Expenditure on
transfer payments is not to be included because this expenditure does not lead to
production of goods & services in the economy.
(c)The expenditure on second – hand goods is not to be included-: Expenditure
on second – hand goods is not to be included because it is already been included
in the year when these goods have been manufactured, but the expenditure made
 on broker’s service as commission is to be included.
(d)Expenditure on transfer payments are not to be included-: Expenditure on
transfer payments are not to be included as this expenditure does not lead to
production of goods and services.
(e)Expenditure on Shares and Bonds-: It is not included in the estimation of
National Income as these are paper claims and not related to production of final
goods and services. However any commission or brokerage on such financial
assets is included as it is a productive service.
(15) PROBLEM OF DOUBLE COUNTING-:

Double Counting-: It refers to the situation when the value of a good is estimated
more than once. It is a problem which leads to overestimation of National Income.
The problem of double counting arises when the value of Intermediate goods is
included or the value of second – hand goods is estimated.
Stages of Production Value of Inputs Value of Output Value Added
Farmer – Wheat 500 500
Flour Mill – Flour 500 700 200
Bakery – Bread 700 1,000 300
Distributer 1,000 1,200 200
Total 2,200 3.400 1,200

Two ways to avoid it-:

(a)Final Output Method-: According to this method, only final goods and services
(in terms of their end use) are to be considered in the estimation of GDP. It means
that value of only final goods should be added to determine the National Income.
In the above example, value of bread of Rs1,000 sold to final consumers should be
taken in the National Income.
(b)Value Added Method-: According to this method, sum total of the value added
by each producing unit should be taken in the National Income. In the above
example, value added by farmer (Rs500); miller (Rs200) and baker (Rs300) total of
Rs1000 should be included in the National Income.