NATIONAL INCOME ACCOUNTING

Unit 2

CIRCULAR FLOW OF INCOME & EXPENDITURE

CIRCULAR FLOW OF INCOME & EXPENDITURE

• Two Sector Model (Household & Firm)• Three sector Model (Household, Business,

Govt.)• Four Sector Model (Household, Business, Govt.

& Foreign Sector)

Circular Flow of Income & Expenditure: Two sector model

Assumption: Household spend their entire income on goods and services

produced by the firms. They do not hoard any part of their income.

Firms produce goods and services only as much as demanded by the households. They do not maintained inventory.

Firms make factor payments to the households in the form of rent, wages, interest and profits

There is no inflow or outflow of income or of goods and services from any outside source. This assumption is specific to 2-sector and 3-sector models.

• One important feature of Income-Expenditure Flow is that the Values that flow are equal.

Y = FPFP = w+r+i+p

w+r+i+p = V = M

where, Y=Household IncomeFP= Factor Income,w= Wagesr= Renti-=InterestV= Value of OutputM=Money flow s (at constant prices)

Three Sector Model

CIRCULAR FLOW OF INCOME & EXPENDITURE - 4Sector Model

NATIONAL INCOME• National Income Accounting deals with the measurement of

aggregate production and income.

• National Income is the money value of all economic activities of the people of a country in a year.

• National Income is also meant: * What is included in and excluded from the National Income . * What method is used for estimating National income.

National Income is analyzed broadly with the help of two concept & measures:

GROSS NATIONAL INCOME (GNP) GROSS DOMESTIC PRODUCT (GDP)

GROSS NATIONAL PRODUCT

• The Gross Domestic product (GDP) is defined as the sum of market value of all final goods and services produced in a country during a specific period of time, generally a year.

• Nominal GDP• Real GDP

Calculation of Real GDPGoods or Service

(Items)

Base Year

(P) (Q)

Current Year (P) (Q)

X1 2 40 3 60

X2 8 90 10 150

X3 80 100 90 110

X4 70 120 80 130

• Real GDP=Value of Final goods & Services in constant prices

• Nominal GDP=Value of Final goods and services in current prices

Nominal GDP• GDP Deflator=……………………….... Real GDP)

GDP Vs. GNP• GDP refers to the value of final goods and

services produced within the geographical boundaries of a country.

• GNP , on the other hand, on production of goods

and services by the residents only irrespctive of the geographical area.

GNP=GDP+NFIA (NFIA= Net Factor Income from Abroad)

GDP Measurement

• Expenditure Method: The total spending on all final goods and services (Consumption goods and services (C) + Gross Investments (I) + Government Purchases (G) + (Exports (X) - Imports (M))

GDP = C + I + G + (X-M).

• Output Method: GDP is calculated using the output approach by summing the value of sales of goods and adjusting (subtracting) for the purchase of intermediate goods to produce the goods sold.

• Income Method: GDP based on the income approach is calculated by adding up the factor incomes to the factors of production in the society.

Relation between Expenditure, Output and Income Methods of measuring GDP

Stages of Production

(1)

Sales Receipt(2)

Cost of Intermediate Products

(3)

Value added(4)

Factor incomes(5)

Wheat 24 0 24 r+w+i+p

Flour 33 24 9 r+w+i+p

Dough 60 33 27 r+w+i+p

Bread 90 60 30 r+w+i+p

The relationship emerges as follows:

1. Total Sales Receipt = Cost of Intermediate Products2. Total Sales Receipt = Cost of Intermediate Products =

Final expenditure3. Total Revenue-Cost of Intermediate Products = Value

added4. Final Expenditure = Value added = r+w+i+p5. Expenditure Method = Output Method = Income

Method

GDP Vs NDP

• NDP=GDP-Depreciation

National Income & Per Capita Income

NNPfc (National Income)

• Per Capita Income = ………………………………………………………. Total Population of the Country

GNPmp = GDPmp +NFIAGNPfc = GNPmp - Net Direct TaxesNNPfc = NNPfc – DepreciationNI = NNPfc

Personal Income Vs Disposable Income

PI = NI - Income earned but not received + Income Received but not earned

DI = Personal Income- Direct Tax DI = C+S