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Introduction
The modern economic science has two branches
Microeconomics and macroeconomics
Compared to micro economics macroeconomics is a younger
branch of economics. Until Great Depression 1930s the subject of economic science
was broadly micro economics.
It emerged as a separate branch in 1936 with the publication ofJohn Maynard Keynes's revolutionary book, The general theory
of employment, Interest, and Money
Some terms were coined by Ragner Frisch, in 1933 in his paper
preposition problems and impulse problems in dynamic
economics
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A reading on Great Depression
Historical Importance of the Great Depression: The Great Depression, animmense tragedy that placed millions of Americans out of work, was the
beginning of government involvement in the economy and in society as a
whole.
Dates: 1929 -- early 1940s Overview of the Great Depression: Just to read
The Stock Market Crash
,
thrown into despair on Black Tuesday, October 29, 1929, the day the
stock market crashed and the official beginning of the Great Depression.
As stock prices plummeted with no hope of recovery, panic struck.
Masses and masses of people tried to sell their stock, but no one was
buying. The stock market, which had appeared to be the surest way tobecome rich, quickly became the path to bankruptcy.
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A Reading on Great Depression
And yet, the Stock Market Crash was just the beginning. Since many banks hadalso invested large portions of their clients' savings in the stock market, these
banks were forced to close when the stock market crashed. Seeing a few banks
close caused another panic across the country. Afraid they would lose their
own savings, people rushed to banks that were still open to withdraw theirmoney. This massive withdrawal of cash caused additional banks to close.
Since there was no way for a bank's clients to recover any of their savings once
the bank had closed, those who didn't reach the bank in time also became
an rup .
Businesses and industry were also affected. Having lost much of their own
capital in either the Stock Market Crash or the bank closures, many businesses
started cutting back their workers' hours or wages. In turn, consumers began to
curb their spending, refraining from purchasing such things as luxury goods.
This lack of consumer spending caused additional businesses to cut back wages
or, more drastically, to lay off some of their workers. Some businesses couldn't
stay open even with these cuts and soon closed their doors, leaving all their
workers unemployed.
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A Reading On Great Depression
The Dust Bowl
In previous depressions, farmers were usually safe from the severe effects of a
depression because they could at least feed themselves. Unfortunately, during
the Great Depression, the Great Plains were hit hard with both a drought and
horrendous dust storms.
Years and years of overgrazing combined with the effects of a drought caused
the grass to disappear. With just topsoil exposed, high winds picked up the
.
their paths, leaving farmers without their crops.
Small farmers were hit especially hard. Even before the dust storms hit, the
invention of the tractor drastically cut the need for manpower on farms. These
small farmers were usually already in debt, borrowing money for seed and
paying it back when their crops came in. When the dust storms damaged thecrops, not only could the small farmer not feed himself and his family, he could
not pay back his debt. Banks would then foreclose on the small farms and the
farmer's family would be both homeless and unemployed.
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A Reading On Great Depression
Roosevelt and the New Deal
The U.S. economy broke down and entered the Great Depression during
the presidency of Herbert Hoover. Although President Hoover repeatedly
spoke of optimism, the people blamed him for the Great Depression. Just
as the shantytowns were named Hoovervilles after him, newspapersbecame known as "Hoover blankets," pockets of pants turned inside out
(to show they were empty) were called "Hoover flags," and broken-down
cars pulled by horses were known as "Hoover wagons.
During the 1932 presidential election, Hoover did not stand a chance atreelection and Franklin D. Roosevelt won in a landslide. People of the
United States had high hopes that President Roosevelt would be able to
solve all their woes. As soon as Roosevelt took office, he closed all the
banks and only let them reopen once they were stabilized. Next,Roosevelt began to establish programs that became known as the New
Deal.
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A Reading On Great Depression
These New Deal programs were most commonly known by their initials,which reminded some people of alphabet soup. Some of these programs were
aimed at helping farmers, like the AAA (Agricultural Adjustment
Administration). While other programs, such as the CCC (Civilian
Conservation Corps) and the WPA (Works Progress Administration),attempted to help curb unemployment by hiring people for various projects.
The End of the Great Depression
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To many at the time, President Roosevelt was a hero. They believed that he
cared deeply for the common man and that he was doing his best to end the
Great Depression. Looking back, however, it is uncertain as to how much
Roosevelt's New Deal programs helped to end the Great Depression. By allaccounts, the New Deal programs eased the hardships of the Great
Depression; however, the U.S. economy was still extremely bad by the end of
the 1930s.
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A Reading On Great Depression
The major turn-around for the U.S. economy occurred after the bombing ofPearl Harbor and the entrance of the United States into World War II. Once
the U.S. was involved in the war, both people and industry became essential to
the war effort. Weapons, artillery, ships, and airplanes were needed quickly.
Men were trained to become soldiers and the women were kept on the home-front to keep the factories going. Food needed to be grown for both the home-
front and to send overseas.
It was ultimately the entrance of the U.S. into World War II that ended the
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Great Depression in the United States.
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What is Economics & why do people economize?
Adam Smith, Economics is a science of wealth
Alfred Marshall, Economics is a study of mankind in the
ordinary business of life; it examines that part of individual
and social action which is most closely associated with theattainment, and with the use of material requisites of well
being.
Human wants desires and aspirations are endless
Resources are limited and scarce
People are of optimizing nature
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What is Macroeconomics
Gardner Ackley, concerns the over-all dimensions of economic life. ..More specifically, macroeconomics concerns itself with such variables
as aggregate volume of an economy, with the extent to which its
resources are employed, with size of the national income, with the
general price level.
J.M. Culbertson, Macroeconomic theory is the theory of income,
employment, prices and money.
P.A. Samuelson, Macroeconomics is he study of he behavior of heeconomy as a whole. It examines the overall level of a nations output,
employment, prices, and foreign trade. More importantly, it studies the
relationship and interaction between the factors or forces that determine
the level and growth of national output and employment, general pricelevel, and the balance of payments positions of an economy.
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What is Macroeconomics
Look at the questions that macroeconomics seeks to answer:
What determines the levels of economic activities, total output, the
general price level, and the overall employment in a country? How is the equilibrium level of national income determined?
What causes fluctuations in the national output and employment?
a e erm nes e genera eve o pr ces n a coun ry
What determines the level of foreign trade and trade balance?
What causes disequilibrium in the balance of payments of a country?
How do the monetary and fiscal policies of the government affect the
economy?
What economic policies can steer the economy on the path of growth?
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Macroeconomic model is the representation of the economic
phenomenon in terms of a set of behavioral assumptions,
definitions, simultaneous equation and identities.
Model building is the process of dividing the entire systemunder different sectors with common features and
characteristics in order to develop a simplified model to study
Macroeconomic model
t e se ecte macroeconom c p enomenon.
Macroeconomic variables are generally classified as:
I. Endogenous variable
II. Exogenous variable
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Endogenous variable are those whose value is determined
within the model.
Some typical endogenous variable are
National income
Consumption
Endogenous variable
Investment
Market interest rate
Price level and
Employment
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Exogenous variable are those whose value is determined
outside the model.
They are:
Money supply
Tax rates
Exogenous variable
Exchange rates and so on
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The relevance and applicability of an economic model to the
real world depends on:
a) How realistic are the assumptions of the model
b)How consistent are the assumptions with one another,
c) How accurate and relevant are the data to validate
assum tions, and
Relevance of models
d)How logical and realistic are equations of the model.
The purpose of economic models is not to replicate the real
world or to produce exact economic laws but to develop and
use a framework to understand better the economic system andits working.
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Stock is a quantity, which is measured at a point in time.
Macro stock variables are the money supply, the total number
of people employed in an economy, the total stock of capital,
the total labor force etc.
Macro flow variables are the savings, investment, change in
inventories, change in money supply, etc.
Concept: Stocks and flows
Imports and exports, taxes, wages and salaries, and dividendare flows.
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Equilibrium is a state of balance or a state where there is no
change.
Disequilibrium is a state of imbalance.
Concept: Equilibrium and disequilibrium
Price
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AD
Y*
P*
level
Quality (of all goods and service)
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In static models, the relations between different variables relate
to the same period in time.
These models are unable to explain the process of change.
They apply to models which are in a state of equilibrium.
Dynamic models trace the changes that occur in the values of
Concept: Statics, dynamics and comparative statics
.
They apply to models that are in a state of disequilibrium.
Comparative statics compares two or more such equilibrium
states.
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Origin and growth of macroeconomics
The foundation was laid by British economist, John Maynard
Keynes (1883- 1946) in his revolutionary book The general
Theory of Employment, Interest and Money (1936).
In fact the use of macroeconomics dates back to the writings ofthe 16th century economists called mercantilits.
Thus the growth of ME is divided into 3 subsections:
Classical ME Keynesian revolution and ME
Post- keynesian developments
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The Classical Macroeconomics
The classical economists had not developed any coherent theory.
The summary their thought:
According to classical school of thought, if market forces of demand and
supply are allowed to work freely, then
There will always be full employment in the long run, and
unemployment, if any, will be a short-run phenomenon;
There will be neither over- roduction nor under- roduction at he
aggregated level; and The economy will always be in equilibrium in the long run.
The great depression of 1930s however, proved all the classical
assumptions wrong. During that period there was large scale
unemployment in the most free market industrial economies and
their GNP declined heavily.
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The Keynesian Revolution
Keynes departure from the classical school was caused by his realization
that the classical economics was not capable of predicting , explaining
and providing solution to economic problems.
The Keynesian theories are associated mainly with employment growth
and stability
The central theme of Keynesian theory are :
aggregate demand given the resources
The unemployment in any country is caused by lack of aggregate
demand and economic fluctuations are caused by demand deficiency.
The demand deficiency can be removed through compensatory
government spending.
Indias development plans are largely based on the Keynesian theory of
growth and employment.
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The Post Keynesian Developments
Monetarism (1970) A group of economists led my Milton Friedman.
The role of money is central to the growth and stability of national output,
not the role of aggregate demand for real output, as Keynesians believe.
At the theoretical level, the emphasis shifted from the analysis of the role
of aggregate demand for real output to the aggregate demand for and
supply of money, and at the policy level, the emphasis shifted from
.
Neo classical macroeconomics (1980)
A group called radicalists led by Robert Lucas, the Nobel laureate of
1995
The emphasis was on individuals rational expectations about future
Peoples rational expectations about government monetary and fiscal
policies determine the behavior of aggregate supply and aggregate demand
curves in such a way that real output remains unaffected, though prices and
wages go up.
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The Post Keynesian Developments
Supply-side economics
The team led by Arthur Laffer, emphasized the role of the factors
operating on the supply side of the market.
Cut in tax rate shifts aggregate supply curve rightward and leads toa rise in output and employment.
Neo-Keynesianism
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ar e oes no c ear a ways, n sp e o n v ua s wor ng or
their own interest. They give reason that information problem and
cost of changing prices lead to some price rigidities which cause
fluctuations in output and employment.
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Importance/Limitations Of Macroeconomics
Importance:
Growing importance of macroeconomics issues
Persistence of macroeconomic problems
Growing complexity of Economic system
Need for government intervention with the market system
Use of macroeconomics in business mana ement
Limitations: It ignores the structural changes in the constituent elements of
the aggregate.
Aggregates are not a reality but a picture or approximation of
reality
People consider it only as a intellectual attraction without much
practical use
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Objectives And Instruments Of Macroeconomics
OBJECTIVES
Output: High level and rapid growth of output
Employment: High level of employment with low involuntary
unemployment Stable prices
INSTRUMENTS
Monetary Po cy: Buy ng an se ng on s, regu at ng nanc a
institutions
Fiscal Policy:
Government expenditures
Taxation
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Aggregate Supply And Demand
Aggregate supply refers to the total quantity of goods and services that thenations businesses willingly produce and sell in a given period. Aggregate
supply depends upon the price level, the productive capacity of the
economy, and the level of costs.
Business would like to sell everything they can produce at high price. AS also depends on the price level that businesses can charge as well as on
the economys capacity or potential output. Potential output in turn is
determined by the availability of productive inputs(land, labour, capital,
managerial efficiency with which inputs are combined) Aggregate Demand: refers to the total amount that different sectors in the
economy willingly spend in a given period. AD equals spending on goods
and services. It depends on the level of prices, as well on monetary policy,
fiscal policy and other factors.
AD = consumption + investment+ government purchase+ net exports
AD is also affected by the prices exogenous forces like wars and weather,
and by government policies
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Web references
www.access.gpo.gov/
www.cbo.gov
www. aei.org.
Macro economic data for the US (www.fedstatgs.gov)
www.bea.gov
. .
India: www.rbi.org
http://finmin.nic.in/
(http://planningcommission.gov.in/)
www.dgciskol.nic.in/
CMIE data base-prowess available in your lab
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The Central Tasks Of A Society
The major considerations of any society in the economicfield, irrespective of the way in which it is organized, are:
What to produce (necessities v/s luxury, present v/s
future, perishable v/s non perishable, capital/ consumer) How to produce (technique of production- capital and
labour intensive)
For whom to produce (how to share the goods andservices)
The ultimate goal of economic science is to improve the
living conditions of people in their everyday lives.
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Market / Capitalism and the central tasks
The private ownership of resources or means of production.
How does such a system solve the main tasks of what, how, and for
whom to produce?------- market mechanism
Society consists of two classes of people: Producers andconsumers.
The roducers in market econom are motivated b the desire to
make profits. Their decision to produce a commodity will bedetermined by the costs incurred and the price at which it can be
sold.
The consumers desire goods and services. However, their ability to
fulfill their wants is conditioned by their income.
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Market / Capitalism and the central tasks
The market provides link between producers and consumers.
Thus capitalism is individualistic with self-interest being the primary driving force.
It is a decentralized, decision-making system.
The extreme case of a market economy, in which the government keeps its hands off
economic decisions, is called a laissez-faire economy. Command economy is one in which the government makes all important decisions
about production and distribution. In a command economy, such as the one which
o erated in the Soviet Union durin most of the 20th centur , the overnment owns
most of the means of production; it also owns and directs the operations ofenterprises in most industries; it is the employer of most workers and tells them how
to do their jobs; and it decides how the output of the society is to be divided among
different goods and services.
The government answers the major economic questions through its ownership of
resources and its power to enforce decisions
The basic problems of the economy are decided on the basis of need votes rather
than money votes.
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Mixed Economies And The Central Tasks
No contemporary societies falls completely into either ofthese polar categories. Rather, all societies are mixed
economies, with elements of market and command.
Economic life is organized either through hierarchicalcommand or decentralized voluntary markets. Today most
decisions in the United States and other high- income
plays and important role in overseeing the functioning of themarket; governments pass laws that regulate economic life,
product educational and police services, and control
pollution. Most societies today operate mixed economies.
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An economic system is a way of answering these basic
questions
what, how and for whom to produce
The most general economic systems are
Capitalist Economy
Introduction
Mixed Economy
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A capitalist economy is an economic system in which the
production and distribution of commodities take place through
the mechanism of free markets
An individual has the freedom to buy and sell any number ofgoods and services
Examples:
Capitalist Economy
The United States of America.Brazil
Japan
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Right to Private Property
Individuals have the right to buy and own property
Profit-Motive
Profit is the only motive for the functioning of capitalism.
Freedom of Choice
Features Of Capitalism
the producers
Minimal role of Government
Regulation of market, defence, foreign policy, currency,
etc.
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M i
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Economic Growth: Rapid and consistent economic growth is theproven out come of this Capitalism. As there is less government
intervention so many evil like corruption, nepotism, poor management
did not hurt the growth rate. These are the common evils comes with
authority. Another reason of this growth is when people invest theirown money the make best effort to make profit out of it.
Efficient Allocation of Resources: The means of production utilizes at
Merits
.
used to produce the products needed and in demand of market. Efficient production: A competitive environment is there as every
individual can takes any profit making activity. Competition push
producer to take productive steps like cost cutting, new technology and
use of best supply chain for make good profit. Financial incentives: Better financial gains are proven pushing force,
for people to being involved in productive activities.
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D it
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Demerits
Inequality: The biggest argument against capitalism is inequality, inthe free economies system the more talented and innovative people
build strong financial position as compare to less skilled individuals. So
this trend leads to inequality of distribution of wealth. Money makes
money it is true in capitalism people who have the money invests theircapital to different businesses and earn more money. Those who do not
have the money cannot avail such opportunities and remain being
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.
Lack of Welfare: Capitalism has no feelings it is all about thematerialistic efforts. This is the most popular reason vocal against
capitalism when compare to communism. In communism the whole
philosophy is human welfare in common, this aspect is totally missing
in capitalism. Capitalism talks about reward of effort to individuals andadvocate for it but do not discuss the interest of society and other stake
holders.
S i li
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Characterized as follows:
a) much property held by the public through government, including
major industries, utilities, and transportation systems;
b) a limit on the accumulation of private property;c) government regulation of the economy;
d) extensive publicly financed assistance and pension programs;
Socialism
a) social costs added to financial considerations as measure ofefficiency.
b) Centrally planned economy
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F t
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Public Ownership - The economy of socialists is characterised by the means of
production and distribution. There is a collective ownership whereby all mines, farms,
factories, financial institutions, distributing agencies etc are regulated by government
departments and state corporations.
Central Planning - A socialist economy is centrally planned with functions under thedirection of a central planning authority. It lays down the various objectives and targets
to be achieved.
Freedom of consum tion - Under socialism the consumers are at soverei nt that
Features
production in state owned industries is generally governed by the preferences of
consumers and the available commodities distributed to the consumers at fixed prices
through the state run department stores.
Equality of Income Distribution - In a socialist economy, there is great equality of
income distribution as compared with free market economy. The elimination of private
ownership in the means of production, private capital accumulation and profit motiveunder socialism prevent the amassing of large wealth in the hands of a few rich persons.
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Merits
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Merits
Socialisms advantages are related to overall well being of community andeasy to understand for general public. Historically we have seen where the
countries are deprived or governed by the intruders, after liberty they adopt
the socialist infrastructure for their country, examples of French and British
colonies can be studied for more details.
Full employment level is another merit of socialism. All the means of
productions are under government control so its responsibility of the state
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o provide job for every citizen. Economic conditions are more stable and
there is no boom or recession in economy.
Socialism work for collective good and also take care of financially and
physically handicap people. Every citizen of society has equal rights and
excess to the states resources. This is not true in capitalism, where talentedand rich people secure well financial and social position and other could
not get the equal status.
Demerits
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This system has low economic growth as talented and idle people enjoy the
same status. This leads to low morale level which makes even capable
people inactive, as they feel no reward of their extra effort.
The theory of socialism sounds very attractive where basic rights of everyindividual is secured by government, but in actual the corruption and
nepotism are very high and common person enjoys far less rights then the
Demerits
peop e n aut or ty.
Allocation of resources is poor government doesnt take advance and
creative measures to increase productivity. As there is no profitability factor
so government doesnt follow market demand. There are rigid policies and
difficult to change until or unless change in total administration.
Socialism emphasis more to society and less to the basic unit of society that
is individual, so as long as the basic element is not satisfy with the reward
the total outcome cannot be the satisfactory.
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Mixed Economy
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Both public and private institutions exercise economic control.
The public sector functions as a socialistic economy
The private sector as a free enterprise economy freedom to hold private property, to earn profit, to consume,
produce and distribute
Mixed Economy
if these freedoms affect public welfare adversely, they areregulated and controlled by the State
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Features Of Mixed Economy
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Public Sector - The state controls the public sector organisations and is operated for thewelfare of the public instead of profit maximisation. But they earn profits like private
industries which are utilised for capita formation.
Private sector - The production and distribution of goods are done by private
enterprises. This sector functions under state regulations in the interest of consumer
goods and some capital goods. Public and private sector operate in competitive spirit in
the interest of the society.
Joint Sector - A mixed economy has semi sector which comprises both of public and
Features Of Mixed Economy
pr va e sec ors an e r ma or y o o ngs are w e s a e.
Cooperative Sector - A sector is formed on the cooperative principles. The state takescare of monetary assistance and runs on the interest of the public.
Freedom and Control - Mixed economy has the liberty to hold private properties to
earn profit, to consume and manufacture and distribute. The control is in the hands of the
state. Economic Planning - The central planning authority is there in a mixed economy and it
operates few of the economic plans. All sectors of the economy function according to the
objectives, priorities and targets laid down in the plan.
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Merits
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ECONOMIC STABILITY AND PROPER ALLOCATION OF RESOURCES
A mixed economy remedies this through state regulation of the economy, and
planning. Through economic plan-ning the resources of the economy are utilized in the more
efficient and optimal manner. Production is rationally organized. Possibilities of
overproduction or underproduction are eliminated. The rigours of un-employment and
inequalities are minimized. This enables a mixed economy to enjoy the basic advantages of asocialist economy.
ADVANTAGES OF FREE INITIATIVE AND ENTERPRISE
In a mixed econom the various ca italistic institutions such as rivate ro ert ,
Merits
competition, profit motive and freedom of enterprise, etc., have an adequate scope. There is
adequate incentive for hard work and increased productive effi-ciency and efforts. The
operation of price mechanism provides an element of dynamism to the economy.
FOUNDATION OF INTERNATIONAL COEXISTENCE
A mixed economy is based on an amalgam of private enterprise and public enterprise.
There is coexistence of the private sector with the public sector. Such peaceful economiccoexistence of the two rival sectors at home paves the way for political coexistence abroad. It
makes our attitude tolerant towards others.
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Demerits
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CONFLICT BETWEEN THE TWO SECTORSMixed economy represents a compromise between capitalism and socialism
and thereby it aims at availing the advantages of both the worlds. But in reality
there may take place frequent collusions between them. This would only give rise
to further bitterness and non-co- operation. In course of time the private sector may
feel suffocated because of the step-motherly treatment meted out to it. INEFFICIENT PUBLIC SECTOR
In a mixed economy the public sector usually has a record of poor performance. It
suffers from inefficienc redta ism corru tion and waste. Conse uentl the ublic
Demerits
sector has failed either to increase the volume of production or reduce costs.
FAILURE TO ERADICATE ECONOMIC FLUCTUATIONS :
The principle of mixed economy had become popular in the capitalist
countries as it was considered to be a suitable method to eradicate economic
fluctuations. But somehow the problem still persists. Economic fluctuations can be
removed only when the entire economy is fully covered by the central plan. But thetype of regulation that is imposed on the private sector in a mixed economy leaves
much to be desired.
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National Income
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CONCEPTS
&MEASUREMENT
Vidya Suresh 45
NATIONAL INCOME
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Measuring Economic Activity through National Income
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g y g
When you can measure what you are speaking about, and
express it in numbers, you know something about it; when you
cannot measure it, when you cannot express it in numbers, your
knowledge is of a meager and unsatisfactory kind; it may be thebeginning of knowledge, but you have scarcely, in your
thoughts, advanced to the stage of science.
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- or e v n
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Measuring Economic Activity through National Income
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g y g
The single most important concept in macroeconomics is the grossdomestic product (GDP), which measures the total value of goods and
services produced in a country during a year.
When economists/policy makers want to determine the level of
economic development of a country, they look at its GDP per capita.
What is GDP? GDP is the total market value of the final goods and
services produced within a nation during a given year measured in
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monetary units.
It is sum of the dollar values of consumption (C), gross investment ( I),
government purchases of goods and services (G), and net exports (X)
produced within a nation during a given year.
GDP = C+I+ G+ X X = Exports - imports
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Contents
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Circular flow of Income
Approaches to measurement of National Income
Measures of Aggregate Income Problems in National Income Accounting
Comparison of NI over time
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Estimation of National Income in India Methodology of Estimation
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Circular Flow Of Income
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The mechanism of income and expenditure flows is extremelycomplex in reality.
To present the flows of income and expenditure, the economy
is divided into four sectors: Household, business, government and foreign
These 4 sectors are combined to make the following 3 models:
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Two-sector model including the household and business sectors Three-sector model including the household, business and
government sectors
Four-sector model including the household, business,
government and the foreign sectors.
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The Circular-Flow Diagram
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Market for
Goods
and Services
SpendingRevenue
Goods &Services sold Goods &Services
bought
Firms Households
Market for
Factors
of ProductionWages, rent,and profit
Income
Labor, land,and capital
Inputs forproduction
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The Circular-Flow Diagram
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Ca italROAD
Government
Tax By House Hold, Income Tax ,Wealth
Factor Payment (wages, Salary, interest, P/l)
Money
Savin s Investment
Internal
Borrowing Corpo
ratetax
NRI
Income
Market
us nessA
Final Goods and Services
(Land, Labor, Capital, Entrepreneur)
Factors of Production
Export & Import
Transfer
Payment
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Circular Flow Of Income In A Two Sector Economy
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House HoldFirms
Factor Services
Factors Income
ncome
Expenditure on goods and service
Flow of Good of Services
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Circular Flow Of Income In A Three Sector Economy
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Government
Factor Services
Factors IncomeTa
xes
Government expenditure on
goods and subsidies
Government expenditure on
Services & Transfer Payment
House HoldsCapital
MarketFirms
Expenditure on goods and service
Flow of Good of Services
Savings Investment
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Circular Flow Of Income In A Four Sector Economy
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Government
Factor Services
Factors IncomeTa
xes
Government expenditure on
goods and subsidies
Government expenditure on
Services & Transfer Payment
House HoldsCapital
MarketFirms
Expenditure on goods and service
Flow of Good of Services
Savings Investment
Foreign
Sector
P
aymentfor
im
ports
P
aymentfor
exports
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54
Approaches to measurement of National Income
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Net product method or value added method
Factor Income method
Expenditure method
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Net product method / value added method
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This method consists of 3 stages
Estimating the gross value of domestic output in
the various branches of production;
Determining the cost of material and services used
and also the depreciation of physical assets;
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Deducting these costs and depreciation from gross
value to obtain the net value of domestic output
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Net product method / value added method
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Estimating the gross value of domestic output in the various
branches of production
For measuring gross value of domestic product, output is
classified under various categories. The classification of
products varies form country to country depending on The nature of domestic industries
Their significance in aggregate economic activities
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Availability of requisite data 71 divisions are used in the US, a dozen in Netherlands half
a dozen in Russia, and 21-24 in India in CSO
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Cont
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After classifying the output in categories, the gross value of
output of each category is computed by any of the following
two alternative methods
Multiplying the output of each sector or category by their
respective prices and adding them together
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Collecting the data on gross sales and inventories from therecords of the companies and adding them up.
Net product method / value added method
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Determining the cost of material and services used and also the
depreciation of physical assets
The next step in estimating the net national product is toestimate the intermediate cost of production including
depreciation.
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Conventionally depreciation is estimated as some
percentage of original cost of capital, permissible under the
taxation laws.
In some countries dep is estimated as some percentage of
total output rather than cost of capital
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Net product method / value added method
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Deducting these costs and depreciation from gross value to
obtain the net value of domestic output (Value added)
Product Value of Inputs Value of Final
Output
Gross Value
Added
1 2 3 4
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eat
Flour 1000 1500 500
Bread 1500 2000 500
Sandwich 2000 3000 1000
Total 4500 7500 3000
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Factor Income Method
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National Income (GDP) = Rent + Wages + Interest + Profit +
Depreciation
Labor Income: wages and salaries, supplementary income,employers contribution , transfer payments
Capital income: dividends, undistributed before tax profits,
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interest on bonds, mortgages and saving deposits, interest
earned by insurance companies, net rents from land
building, royalties, profit of govt. enterprises
Mixed Income: farming enterprises, sole proprietorship,
medical, legal practice, consultancy, trade , transportation
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Expenditure Method
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This is also known as final product method- 2 methods are used
Income disposal method- money expenditures at market
prices are added up together to obtain the total finalexpenditure ( private consumption expen. Direct tax
payments, payments made to the non-profit organizations,
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charitable institutions, private savings)
Product disposal method- the value of the products finally
disposed of are computed are added together ( private
consumer goods and services, private investment goods,
public goods and services, net investment abroad)
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Measurement of National Income in India
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The history of measurement of NI can be divided under 2
phases:
Pre independence phase- The first attempt was made by
Dadabhai Naroroji in 1867-68. Subsequently, severalattempts were made by economists and government
officials to estimate Indias NI. Then Prof. V. K.R. V. Rao
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estimated I in the year 1925- 29 and1931-32. Though it
was considered to be superior it had serious limitations.
Post independence phase- The first official estimate of
Indias NI was made in 1949 by the Ministry of
Commerce, Government of India.
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Cont..
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National Income Commission (NIC) was set up in 1949 my
MOC with P. C. Mahalanobis, D. R. Gadgil and V.K.R.V. Rao
as its members. NIC estimated NI for 1948-49, and for 1951-
52. The methodology developed by NIC was followed till1967.
After 1967, the job went to Central Statistical Organization
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(CSO) and it adopted improved methodology to estimate
NI.
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Measurement of National Income in India
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Sectors of an economy: An economy comprises of a variety of
economic activities resulting in different sources and nature of
income. To make the NI data easy and comprehensive we
classify different activities into sectors. This is called sectoralaccounting of National Income.
CSO uses followin sectors for classification:
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Primary sector Secondary sector
Tertiary or service sector
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Measurement of National Income in India
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PRIMARY SECTOR Agriculture
Forestry and logging
Fishing Mining and Quarrying
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SECONDARY SECTOR Manufacturing
Registered manufacturing
Unregistered manufacturing Construction
Electricity, water and gas supply
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Measurement of National Income in India
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TERTIARY SECTOR
Transport, Trade and Communication
Transport, storage and communication
Railways
Other means of transport
Communication
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Finance and Real Estate Banking and insurance
Real estate for residential and business purpose
Community and Personal Services Public administration and defense
Other services
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Methods of measuring NI in India
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Production method or value added method: This is also
called net output method or value added method is used to
estimate income or domestic product of the following
production sectors:
Agriculture
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Fishing Mining and Quarrying
Registered manufacturing
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Methods of measuring NI in India
I th d i d f ti ti d ti i f th
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Income method is used for estimating domestic income of the
following sectors:
Unregistered manufacturing
Electricity, water and gas supply
Banking and insurance Transport, storage and communication
Real estate and business services
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Trade hotels and restaurants
Public administration and defense
Other services
-For the sake of comparison of estimates and to check their
reliability, CSO estimates national income also on the basisexpenditure method. In India, the sectoral accounting of GDP, based on
the expenditure method, follows the following classification of the NI
given below.
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Methods of measuring NI in India
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1. Private final consumption expenditure including
expenditure on
i. Durable goods
ii. Semi durable goods
iii. Non-durable goods
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iv. Services
2. Government final consumption expenditure
3. Gross fixed capital formation including construction,
machinery and equipments
4. Change in stocks, and
5. Net export of goods and services
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Some concepts related to NI
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Economic and Non-Economic Production
Economic Production
Marketable and non- marketable production
Non Economic Production
Services rendered to self, family and neighbor
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nterme ate an na ro ucts
Transfer Payments
Consumer and Producer Goods
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Economic Production
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It refers to the production of goods and services which are meantfor sale and have market value.
It also includes those goods and services which are produced
and provided jointly to the public by the government and publicorganizations, for which people pay indirectly through tax
payment.
Thus it includes both marketable and non-marketable
production.
Goods produced by farmers, firms, factories, shops, hoteliers etc
fall under marketable production.
Goods and services produced and supplied by the government,public institutions, social organizations, NGOs etc fall in non
marketable production.
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Non-Economic Production
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It includes production and services of goods that are not meantto be sold, nor there is any market for them, nor do they have a
market price. Some of the services which come under this are:
I. Services rendered to self, e.g., eating, shaving, exercising,washing ones own clothes, cooking for self, etc
II.Services to provide to the family members, e.g.,
housewives cooking for the family, parents teaching their
own children, doctors treating their own family members,etc
III.Services provided by the neighbors to each other, e.g.,
helping each other on festival and marriage occasions etc, While calculating national income we will include only
economic production and not non- economic production.
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Intermediate Goods
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Goods that flow from one stage to another in the process of production of a good, with their form changing are called
intermediate products.
A product sold by one firm to another for further processing orvalue addition in the process of production is called
intermediate products.
The need for distinction between intermediate and final
products arises because of the problem of double counting.
Double counting leads to overestimation of the national
income.
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Final Goods
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The goods that reach the final stage of the production and flowto their ultimate users are called final products.
Product that is sold finally to the consumer is the final product.
Final goods can be classified intoI. Final consumer goods goods that flow to the ultimate
II.Final producer or capital goods machinery, plant andequipments which are used by the firms in the process of
production.
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Transfer Payments
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These are payments made by people to the people, and by
people to the government, without corresponding transfer of
goods and services or addition to the total output.
For example, when a person gifts some money to a relative or
friend or when he/she donates an amount to a poor person
payment. When people pay taxes to the government and government pays
old age pension to the people, these are treated as transfer
payments.
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National Income Measures
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Gross and net concepts
National and domestic concepts
Market prices and factor costs GNP--- Gross national product
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---
GDP---gross domestic product NDP---net domestic product
Personal income
Disposable income
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Gross Domestic Product (GDP)
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It can be defined as the sum of market value of all final goodsand services produced in a country during a specific period of
time, generally one year.
The market value of domestic product is obtained at bothconstant and current prices.
GDP= consum tion + investment + overnment ex enditure +
net exports.
GDP = market value of goods and services produced by the
residents in the country + incomes earned in the country by
foreigners incomes received by residents of a country from
abroad.
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Gross national product(GNP)
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It includes the income of the resident nationals which they
receive abroad, and excludes the income generated locally but
accruing to the non-nationals.
GNP = market value of domestically produced goods and
services + incomes earned by the residents of a country in
country.
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Net national product(NNP)
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NNP = GNP depreciation or capital consumption
A part of capital goods is used up or consumed in the process
of production of these goods.
This is called depreciation or capital consumption.
NP s n act, t e actua measure o nat ona ncome.
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Personal income(PI)
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It can be defined as the sum of all kinds of incomes received
by the individuals from all sources of incomes.
It includes wages, salaries, fees and commission, bonus,dividends, interest earnings.
, ,
old age benefits. It also includes the income through illegal means
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National Income Measures
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Personal income
PI= NNP at factor cost-undistributed profits-corporate taxes
+ transfer payments Disposable income
D I= ersonal income ersonal taxes
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PI = DI +T DI =C+ S
Thus PI = C+S+T
C= Consumption spending S = personal saving
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National Income Measures
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NOMINAL and REAL GNP
The GNP/GDP are estimated at both current and constant
prices. The GNP estimated at current prices is callednominal GNP and the one estimated at constant prices in a
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.
The need for estimating GNP at constant prices arisesbecause GNP at the current prices produces a misleading
picture of economic performance when prices are
continuously rising or decreasing.
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National Income Measures
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GNP valued at current prices shows rise in GNP under thefollowing conditions:
Actual production is decreasing but prices are rising
Actual production remains constant and prices are rising
Estimating GNP at the prices of the base year is not an easy task.
Therefore we use GNP deflator or National Income Deflator to
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eliminate the effect of rising prices on the GNP and to work out
real GNP at the base year prices.
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National Income Measures
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The GNP Deflator and its Application
The GNP deflator is essentially an adjustment factor used to
convert nominal GNP into real GNP.
The GNP deflator is the ratio of price index number (PIN) of achosen year to the price index number (PIN) of the base year.
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The formula for converting nominal GNP of a year into realGNP:
Real GNP = Nominal GNP/ GNP Deflator
Real GNP = Nominal GNP/ PIN (cy)/100
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National Income Measures
Given the data:
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Nominal GNP of India/ GNP estimated at current prices in year 2000 =
Rs 500 billion
Price of Index number (PIN) , base year 2000 = 100
Nominal GNP at year 2005 = 600 billion PIN rises = 110
GNP deflator = PIN (2005) = 110 = 1.10
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100 100
Given the GNP Deflator at 1.10, the real GNP for the year 2005 can be :
Real GNP = Nominal GNP/ GNP Deflator
= Rs. 600 billion / 1.10= Rs. 545.45 billion
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National Income Measures
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Note that the Nominal GNP increases from Rs.500 billion to Rs
600 billion that is by 20 percent over a period of 5 years or at
an annual average rate of 4 percent.
Since PIN increases from 100 to 110, i.e., by 10 percent over 5
years, real GNP increases at a lower rate, i.e., at 9.12 percent or
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at an annual average rate of 1.8 percent.
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National Income Measures
GNP Implicit Deflator
A th i t f GNP d fl t i GNP i li it d fl t l ll d i li
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Another variant of GNP deflator is GNP implicit deflator, also called implicprice deflator. It is the ratio of nominal GNP to real GNP, i.e.,
GNP Implicit Deflator = Nominal GNP/ Real GNP
The GNP implicit deflator can be used for the following:
To construct price index
To measure the rate of change in prices or to measure inflation
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om na n e ear = s on
Real GNP in the year 2005 = Rs 545.45 billion GNP Implicit Deflator = 600/ 545.45
= 1.10
The GNP implicit deflator multiplied by 100 give the Price Index Number (PIN)
PIN (2005) = GNP Implicit Deflator * 100
= 1.10 * 100 = 110
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National Income Measures
Thus, 110 is the price index number for the year 2005. The same
d b d t d t l l t PIN f th
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procedure can be adopted to calculate PIN for other years.
Once PINs for different years are calculated, the same can be used to
calculate the rate of change in price, i.e., the rate of inflation.
Rate of Inflation = PIN 2005 PIN 2000 * 100
PIN 2000
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= 110 100 * 100 = 10 percent
100
This means that inflation over a period of 5 years was 10 percent or
at an annual average rate of 2 percent.
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Some problems in National Income Accounting
D ti f d ti ti it
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Demarcation of productive activity
Treatment of non marketed output
Distinction between final and intermediate goods
Avoiding double counting and the concept of value added
Value added = Total sales + Closing stock of finished and
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sem n s e goo s- tota expen ture on raw mater a s an
intermediate products purchased from other firms- openingstock of finished and semi finished goods.
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Is national income true measure of economic welfare?
Can national income be dependable measure of economic
welfare? Does its increase bring about a corresponding
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welfare? Does its increase bring about a correspondingincreases in economic welfare?
NI cannot be reliable as it takes into consideration tractions
done in terms of money. Barter system doesnt get intoaccount.
gain, the I may increase or decrease according to an
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increase or decrease in the general price level, because it is
expressed on the basis of current money value even when theactual NI has not changed at all.
Increase in NI may not mean rise in welfare as the more than
proportionate increase in population may decrease the percapita income, people may spend the increased income on
harmful goods and activities.
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