macroeconomics

1. NATIONAL INCOME
Prabin Khanal
prabin.piscnepal@gmail.com
1

2. Course Outline
 Unit 1: Measuring a Nation’s Income
 Unit 2:Consumption, Saving and
Investment functions
 Unit 3: Equilibrium in product and money
market
 Unit 4: Fiscal policy
 Unit 5: Business Cycle
 Unit 6: Growth Models
 Unit 7: Migration
 Y=C+I+G+X-M
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3. TEACHING METHODS
 Lectures
 Assignments
 Presentation by students
 Paper Writing
 Case study
 Group Discussion and participation
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4. Four Sector Economy
 A modern economy consists of a four-
sector economy. The sectors are
 1. Household
 2. Private Sectors
 3. Government Sectors
 4. Foreign Sectors
 Every sector is interconnected through
goods and services by the payment of
other sectors.
 Money is medium of exchange.
4

5. The Household Sector
 This sector includes all the individuals in the economy.
 The primary function of this sector is toprovide the factors of production. The
factors of production include land, labour, capital and enterprise.
 The household sectors are the consumers who consume the goods and
services produced by the firms and in return make payments for the same.
The Firms Sector
 This sector includes all the business entities, corporations and partnerships.
The primary function
 of this sector is to produce goods and services for sale in the market and make
factor payments to the household sector.
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6.  The Government Sector
 This sector includes the center, state, and local governments. The prime
function of this sector is to regulate the functioning of the economy. The
government sector incurs both revenue as well as
 expenditure. The government earns revenue from tax and non-tax sources and
incurs expenditure for provide essential public services to the people.
The Foreign Sector
 This sector includes transactions with the rest of the world. Foreign trade
implies net exports(exports minus imports).
 Exports include goods and services produced domestically and sold to the rest
of the world and imports include goods and services produced abroad and sold
domestically
Circular flow of income in four sector economy
 The circular flow of income describes the movement of goods or services and
income among the different sectors of the economy. It illustrates the
interdependence of the sectors and the markets to facilitate both real and
monetary flow
6

7. Circular flow of income in four
sector economy
7

8. Leakages
 In equilibrium
 Y=C+I+G+X-M
 Leakages are that part of the income which the household withdraw from the
circular flow and is not used to purchase goods and services.This part of the
income does not go to the goods market. There are three main leakages and
these are:

 1. Saving: It is that part of the income that is not used by the household to
purchase of goods and services or pay taxes. It is kept with the financial
institutions like banks that can be lend further by the banks to the firms for
investment or capital expansion purposes.
 2. Taxes: Tax revenue is the income paid by the household and firms to the
government. It flows to the government rather that the goods market.
 3.Imports: Import payments are made to the foreign sector for the good and
services bought from them. This is an outflow of income from the economy.
Leakages = S + T + M Where, S = Saving; T = Taxes; and M = Imports
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9. Leakages and Injections
 Injections: An injection is an inflow of income to the circular flow. The volume
of income increases due to an injection of income in the circular flow. There
are three main injections and these are:
 1. Investment: It is the total expenditure by the firms on capital expansion. It
flows to the goods market.
 2. Government Expenditure: It is the total expenditure of the government on
goods and services, subsidies to the firms and transfer payments to the
household sector. Transfer payments are government payments like social
security schemes, pensions, retirement benefits, and temporary aid to needy
families etc.
 3. Exports: Export receipts are the payment made by the foreign sector for
the purchase of domestic goods. It is an inflow of income from the foreign
sector to the financial market.
 Injections = I + G + X Where, I = Investment; G = Government Expenditure;
and X = Exports
 Balance of leakages and Injections in an open economy is; S + T + M = I + G
+ X
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10. National Income
 Macro economics: Study of aggregate
variables of economy.
 Y= C+I+G+X-M, Unemployment, Poverty,
Inflation, General Price Level
 Ragnar Frisch coined the term in 1933.
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11. Measuring National Income
 National Income:
 NI is the total value of all final goods and
services produced in a country within one
year period of time.
 It counts the level of output with a market
value.
 National income is the flow variable.
 National income considers only final
goods.
11

12. Concepts of National Income
 Various Concepts
 GDP, GNP, NNP, NI, PI and DI
GDP
The market value of the output of final
goods and services produced in the
domestic territory of a country during an
accounting year, generally a year.
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13. GDP=Gross Domestic Product
 GDP may be defined as the total market value of
all currently produced final goods and services
within the geographical border during a given
period of time, generally for a year.
 GDP includes only currently produced goods and
services. That is to say, it includes goods and
services produced in that particular year
 GDP includes only final products. It excludes
intermediate goods. The goods which are used in
the process of production are called intermediate
goods.
 GDP includes production made by foreigners in
country X as well as the production made by the
resident of country X.
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14.  Let x1, x2, x3……………..xn be the final
goods and services produced in the
country Y where the corresponding
market price be p1,p2,p3………pn, then the
GDP is given as
 GDP=p1 x1+p2 x2+…………… pnxn
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15. Base Price and Factor Cost (Basic
Price)
 Market price is the last price of goods and
services paid by consumers at the time of
consumption. Final buyer’s price.
 Price actually received by producer is
called factor cost.
 Market price=Factor Cost+ Indirect tax-
Subsidies
 GDP at market price
 GDP at factor cost
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16. Source: World Economic Outlook Database,
International Monetary Fund, 2019
Million Dollar
World[20] 84,740,322
1 United States 20,494,050
2 China[n 2] 13,407,398
3 Japan 4,971,929
4 Germany 4,000,386
5
United
Kingdom
2,828,644
6 France 2,775,252
7 India 2,716,746
8 Italy 2,072,201
9 Brazil 1,868,184
10 Canada 1,711,387
Nepal 2040
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17. Gross National Product
 Net Domestic Product NDP
 NDP=GDP-Depreciation
 The wear and tear of physical capital is
called depreciation.
 Gross National Product: GNP is defined as
the current market value of all final goods
and services produced by the economy
during an income period regardless of
where the output is produced.
 GNP=GDP+NFIA, where NFIA is net factor
income from abroad.
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18. Measurement of GDP
 NFIA= Total inflow-Total outflow
 NFIA= Factor income received from the rest
of world –factor payments to the rest of the
world
 There are three different ways to
measure National Income:
 Product Method, Income Method and
Expenditure Method.
 These three methods of calculating GDP yield
the same result because National Product =
National Income = National Expenditure.
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19. Product Method
 1. The Product Method:
 In this method, the value of all goods and services produced
in different industries during the year is added up. This is also
known as the value added method to GDP or GDP at factor
cost.
 According to this method, GDP is measured in the form of
total product. The total product may be obtained from each
economic sector, namely, agricultural, industrial and tertiary
sector.
 Agricultaral sector: It includes agro-products, fishery and
forest product.
 Industrial sector: It includes manufacturing, electricity, water
supply etc.
 Tertiary sector: It includes service sector such as banking,
insurance, transportation, communication etc.
 GDP= Total production from each sector
(Agriculture+Industry+service)
 GNP=GDP+NFIA
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20.  Under Product Method, there are two approaches
for measuring national income.
 A. Final Product Method
 B. Value Added Method
 A. Final Product Method: In this method the market
value of goods and services produced by all sectors
are added. Basically, there are three sectors
 1) Primary sector: Economic activities focused with
the agricultural sector……
 2)Secondary sector: Manufacturing sector, and this
sector uses raw materials and intermediate goods
and produces final goods. Eg: construction,
electricity, gas and water supply; transport, …….
 3) Tertiary sector: Service sector eg: Banking,
communication, insurance, medical and teaching
profession, public administration……………..
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21.  B. Value Added Method:
 Value added means the addition to the value of raw materials
and other inputs during the process of production.
 Value added of any producer is the value of its output minus
the value of inputs it purchases from other producers.
 Value added =Value of output-cost of intermediate goods
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Producer Stages of
Production
Sales Cost of
intermediate
good
Gross
value
added
Farmer Wheat 1000 - 1000
Miller Flour 1900 1000 900
Baker Bread 2700 1900 800
Total 5600 2900 2700

22. Income Method
 2. The Income Method:
 According to this method, national income is obtained by adding
all incomes received by individuals of a country.
 Thus GDP is the sum total of the following items:
 (i) Wages and salaries:
 Under this head are included all forms of wages and salaries
earned through productive activities by workers and
entrepreneurs. It includes all sums received or deposited during a
year by way of all types of contributions like overtime,
commission, provident fund, insurance, etc.
 (ii) Rents:
 Total rent includes the rents of land, shop, house, factory, etc.
and the estimated rents of all such assets as are used by the
owners themselves.
 (iii) Interest:
 Under interest comes the income by way of interest received by
the individual of a country from different sources. To this is
added, the estimated interest on that private capital which is
invested and not borrowed by the businessman in his personal
business..
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23.  (iv) Dividends:
 Dividends earned by the shareholders from companies are
included in the GNP.
 (v) Undistributed corporate profits:
 Profits which are not distributed by companies and are retained
by them are included in the GNP.
 (vi) Mixed incomes:
 These include profits of business, self-employed persons and
partnerships. They form part of GNP.
 (vii) Direct taxes:
 Taxes levied on individuals, corporations and other businesses are
included in the GNP.
 viii) Indirect taxes:
 The government levies a number of indirect taxes, like excise
duties and sales tax.
 These taxes are included in the price of commodities.
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24.  ( (ix) Depreciation:
 Every corporation makes allowance for expenditure on wearing out
and depreciation of machines, plants and other capital equipment.
Since this sum also is not a part of the income received by the factors
of production, it is, therefore, also included in the GNP.
 (x) Net income earned from abroad:
 This is the difference between the value of exports of goods and
services and the value of imports of goods and services. If this
difference is positive, it is added to the GNP and if it is negative, it is
deducted from the GNP.
 GDP by income method,
 GDP=Wages and salaries+Interest+Rent+Dividends+Undistributed
corporate profits+corporate profit tax+social security
contribution+income from self employment+Depreciation
 GNP=GDP+NFIA
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25.  GDP by expenditure method includes:
 (1) Consumer expenditure on services and durable and
non-durable goods (C),
 (2) Investment in fixed capital such as residential and non-
residential building, machinery, and inventories (I),
 (3) Government expenditure on final goods and services
(G),
 (4) Export of goods and services produced by the people of
country (X),
 (5) Less imports (M). That part of consumption, investment
and government expenditure which is spent on imports is
subtracted from GDP. Similarly, any imported component,
such as raw materials, which is used in the manufacture of
export goods, is also excluded.
 Thus GDP by expenditure method at market prices = C+ I
+ G + (X – M), where (X-M) is net export which can be
positive or negative.
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26.  Personal Income:
 Personal income is the total income received
by the individuals of a country from all
sources before payment of direct taxes in one
year. Personal income is never equal to the
national income, because the former includes
the transfer payments whereas they are not
included in national income.
 Personal Income = National Income –
Undistributed Corporate Profits – Profit Taxes
– Social Security Contribution + Transfer
Payments + Interest on Public Debt.
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27.  Disposable Income
 In order to obtain disposable income,
direct taxes are deducted from personal
income. Thus Disposable
Income=Personal Income – Direct Taxes.
 Per Capita Income:
 The average income of the people of a
country in a particular year is called Per
Capita Income for that year. This concept
also refers to the measurement of income
at current prices and at constant prices.
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28. Rank Country
GDP (PPP) per capita (Int. $)
2019
times to
world
diff 2023 Rank
1 Qatar 133,254 7.03 - 158,296 1
2 Macao SAR 126,584 6.68 6670 156,622 2
3 Luxembourg 112,623 5.94 13961 124,410 3
4 Singapore 102,027 5.38 10596 118,202 4
5 Brunei Darussalam 86,480 4.56 15547 109,767 5
6 Ireland 81,686 4.31 4793 95,211 6
7 Norway 76,621 4.04 5066 85,034 7
8 United Arab Emirates 72,182 3.81 4438 78,123 9
9 Kuwait 69,257 3.65 2925 77,294 10
10 Hong Kong SAR 67,558 3.56 1700 80,065 8 28

29. Rank Country/Economy
GDP per capita (Nominal) ($) Growth
(%)
2019 diff 2023 Rank
1 Luxembourg 115,203 -
131,95
6
1 3.51
2 Macao SAR 86,339 28864
102,75
7
2 6.28
3 Switzerland 85,157 1182 97,020 4 1.82
4 Norway 82,773 2384 88,956 6 2.06
5 Iceland 79,271 3502 97,659 3 2.94
6 Ireland 77,160 2110 91,750 5 4.01
7 Qatar 72,677 4484 84,874 7 2.82
8 United States 65,062 7615 72,861 10 2.54
9 Singapore 62,984 2078 73,619
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30. Nominal and Real GDP
 Nominal and Real GDP:
 GDP measured on the basis of current market price is
called nominal GDP.
On the other hand, when GDP is calculated on the basis of
fixed prices in some year, it is called GDP at constant prices
or real GDP.
Nominal GDP adjusted for inflation is called real GDP.
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31. Calculation
YEAR OUTPUT MARKET
PRICE
NOMINAL
GDP
REAL GDP
2000 2000 10 20000 20000
2001 2100 12 25200 21000
2002 2200 13 28600 22000
2003 2300 14 32200 23000
2004 2400 17 40800 24000
2005 2500 18 45000 25000
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32. DIFFICULTIES IN MEASURING NI
 DIFFICULTIES IN MEASURING NATIONAL INCOME
 1. Insufficient data
 2. Underground economy: illegal transaction, such as drugs, smuggling,
prostitution etc
 3. Depreciation value
 4. Government transfer payment
 5. Non market activities: Household chores, consumption of own agricultural
products
 6. Problem of Double Counting
Only final goods and services is included in the national income accounting.
But, sometimes it is very difficult to distinguish between final and intermediate
goods.
 So, there is highly likely chances of double counting.
 7. Illiteracy and Ignorance
 8. Environmental damage
 9. Petty Production
There are large numbers of petty producers and it is difficult to include their
production in national income because they do not maintain any account.
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33. GDP DEFLATOR
 GDP Deflator:
 GDP deflator is an index of price changes
of goods and services included in GDP. It
is a price index which is calculated by
dividing the nominal GDP in a given year
by the real GDP for the same year and
multiplying it by 100.
 GDP Deflator=Nominal GDP/Real
GDP*100
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34. Key Takeaways
 NATIONAL INCOME CALCULATION
FORMULA
 Market Price (MP)=Factor Cost (FC)+Indirect Tax-
Subsidies
 Gross National Product (GNP)= Gross Domestic
Product (GDP)+Net Factor Income from Abroad
(NFIA)
 NFIA=Total Inflow to Country A from rest of the world
– Total outflow from Country A to the rest of the
world.

34

35. Key Takeaways
 INCOME METHOD
 GDPFC = Compensation of Employees (COE)+ Operating Surplus
(OS)+ Mixed Income (MI)+ Depreciation
 where, COE=Wages and Salaries+ Employer’s contribution to
social security+ Bonus+ Commission+ Insurance+----
 OS= Rent+ Interest+ Profit, Profit= Corporate profit which
includes dividend, corporate income tax and undistributed profit
(retained earning).
 Depreciation=Gross Capital Formation – Net Capital formation.
Depreciation is also called as consumption of fixed capital or
capital consumption allowance.
 GNPFC = GDPFC +NFIA
 NDP=GDP-Depreciation
 NNP=GNP-Depreciation
 Personal Income (PI)=National Income-Undistributed Profit-Social
Security Contribution-Corporate Income Tax+ Transfer payment
 Disposable Income=PI-Personal Taxes
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36. Key Takeaways
 EXPENDITURE METHOD
 GDPMP = C+I+G+X-M
 GDPMP = GDPFC +Indirect tax-Subsidy
 GNPMP = GDPMP +NFIA
Product Method
GDP=Total products of all sectors of the
economy, namely: primary, secondary and
tertiary
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37. What is not included in National Income ?
 National income does not include transfer
payments. Transfer payments are not connected
with any production.
 National income does not include capital gain.
 NI does not include money receive from sale of
existing assets.
 NI does not include windfall gain. Eg lottery
it does not add to the flow of goods and services
in the economy.
 Interest on public debt is not included in NI
 Intermediate goods that are used to produce
other final goods are not included in NI.
 Purchase of financial assets. These do not show
flow of income and expenditures in the economy.
37

38. What is not included in National
Income ?
 Non-market transactions
 Intermediate consumption expenditure
 Sale of purchase of second had goods
 Capital loss like destruction of building,
machinery etc by earthquake
 Capital gains
eg: Rs 100 house is sold for Rs 150. The
difference is capital gain.
National debt interest or interest paid by
household to the commercial banks.
38

39. Computation of National Income
 MP=FC+Indirect tax-Subsidy
 GDPMP = GDPFC +Indirect tax-Subsidy
Calculation of GDP
1. Product Method, GDPMP
 GDPMP =Value added in Primary Sector+ Value added in
secondary sector+value added in tertiary
2. Income Method, GDPFC
A. Compensation of Employees- Wages and Salaries,
Payments (cash/kinds), social security, pension (retirement)
+B. Operating surplus-Rent+Interest+Profit
(Dividends+Corporate tax+Undistributed tax)+c. Mixed
Income+Depreciation
3. Expenditure Method GDPMP =C+I+G+X-M
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40. Question no. 1
 Q.1 Information of an economy A is given as below
 Gross Investment=10
 Net export=5
 Indirect tax=2
 Depreciation=2
 NFIA=5
 Private Expenditure=10
 Government Expenditure=10
 Find GDPFC
GDPMP =C+I+G+X-M=10+10+10+5=35
As MP=Factor cost+Indirect tax-Subsidy
MP=FC+2-0
FC=MP-2
Therefore, GDPFC = GDPMP - 2=35-2=33
40

41. Question no. 2
 Q.2 Information of an economy A is given as below
1. Compensation of Employees=5
2. Operating surplus=5
3. Mixed income=5
4. Depreciation=2
5. NFIA=3
6. Susidies+2
7. Indirect tax=3
Find GDPMP
GDPFC = 10+5+5+2=22
GDPMP= GDPFC+Subsidy-Indirect tax
=22+2-3=23 billion doallar
41

42.  1. From the following data calculate Gross Domestic
Product at Market Price by using Income method.
42
i) Gross national product at factor cost 6,150
ii) Net exports (-)50
iii) Compensation of employees 3,000
iv) Rent 800
v) Interest 900
vi) Undistributed Profit 1,300
vii) Net indirect taxes 300
viii) Net domestic capital formation 800
ix) Gross fixed capital formation 850
x) Change in stock 50
xi) Dividend 300
xii) Factor income to abroad 80

43.  Solution
 Gross Domestic Product at Market Price
=Compensation of employees+ Rent+ Interest+
Undistributed Profit +Mixed income+ Net
Indirect taxes+ Consumption of fixed capital (depreciation)
=Rs 3,000+ Rs 800 + Rs 900 + Rs 1,300 + Rs 0crore+ Rs
300 + (Rs 850 + Rs 50 - Rs 800 )
= Rs 3,000+ Rs 800 + Rs 900 + Rs 1,300 + Rs 300 + Rs
300 + Rs 100
= Rs 6,700 crore
Note: Consumption of fixed capital (depreciation) = Gross
fixed capital formation+ Change
in stock – Net domestic capital formation
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