Circular Flow of Income

& National Income

Accounting

Group Members

Sneha Desai Kunal GaradMadhuri ThakurMangesh TalankarMilind WadkarRanjit GeorgeMayuri KhedekarAnamika VisputePratik LiyeNisha Ahide

National Income

Most important concept of macroeconomic is national income

National income represent total the income of nation

Measures of national income enables to know the economic growth, business cycle & so on

Circular flow of income

• It explains the process that determines national income & national output

• Functioning of the economy consist of the production of goods and services by production unit

• The cost of the production is expenditure to the firm and income the factor owner

Economic activities perform by economy are:

• Production • Distribution

• Consumption

• Exchange• Above activities are based on decision of economics agent i.e. firms and households.

Circular flow in a two sector economy without saving

Assumptions:• Economy consists of two sectors- Household and firms• Production takes place only in

firms• No inventory maintained by

firms• No government operations• No international economic

relations

Circular flow of economic activity

TWO SECTOR ECONOMY WITH

SAVING

Households

Financial markets

Firms

PAYMENT FOR GOODS AND SERVICES

FACTOR INCOMES

S

I

Households

Financial markets

Firms

FACTORS OF

PRODUCTION

FLOW OF GOODS

AND SERVICES

S

I

Households

Financial markets

Firms

FP S

I

FGS

FIPGS

TERMSY= NATIONAL INCOME

C = CONSUMPTION EXPENDITURE

I = INVESTMENT SPENDING

S = SAVINGS

Y = C + I

Y = C + S

C + I = Y = C + S

I = Y – C= S

I = S

Circular Flow In Three Sector Economy

• Government plays a major role in the functioning & governing of the economic system of a country

• Government receives income in the form of tax from households & firms

• Government expenditure comprises spending on goods & services & transfer payments.

• Money spent by government received by firms & households. hence circular flow.

• Thus leakages in the form of saving & taxes

Contd.

• Introduction of government affects the overall economic activity.

• Total expenditure = consumption + investment + government expenditure(E) = C + I + G

• Total income received is allocated to consumption , savings & taxes.

• Y= C + S + T

Contd.

• The economy is in equilibrium when the expenditure is equal to incomeC + I + G = C + S + T

I + G = S + T

G – T = S – I

sHouseholds FirmsFinancial Market

Government

Government

Circular Flow In An Open Economy Or Four Sector

Economy

World Economy

Households

Government

Business

FinancialMarkets

X - M

Fact

or In

com

e

Taxation Govt. spend

Taxation Govt. spend

Consumption

X – M

Investment

Savings

Importance of Circular Flow of Income

• Shows smooth functioning of Economy.

• Helps to know problem of disequilibrium.

• Helps to find out leakages in the circular flow.

• Highlights the importance of Monetary and Fiscal policies.

NATIONAL INCOME

• Sum of values of final goods and services produced in the economy in a year.

National Income

• Sum of all the incomes accruing to factors of production in the economy in a year.

National Income

• Sum of all the expenditures on final goods and services produced in an economy.

National Income

MEASURMENT

Product(Output) or Value

Added Method

Income Method

Expenditure Method

Product (Output) or Value Added Method

Add the value of all final goods and services produced in a given year

Problem of double counting can be avoided by adding only the value added by each firm at different stages of production.

Income Method

National Income = Sum of all the

incomes (Wages, Salaries, Rent,

Interest, Profits and Dividends)

Only income earned for productive services are included. (pensions, unemployment benefits are not included)

Expenditure Method

National income =C+I+G+(X-M)

Where, C=consumption expenditureI=Total investment expenditureG=Government expenditureNet receipts from foreign trade(i.e. export(X) - import(M))

Problems in the Measurement of National income

1. Capital Depreciation. • Replace the equipment worn out during

the process of production i.e. Depreciation

2.Market prices and Factor cost.Factor cost= Market price –indirect taxes + subsidies

OrMarket prices = Factor cost –indirect taxes + subsidies

3.Net factor incomes from abroad =R-P

Where,R=Income received by domestic factors for their contribution to production abroad.

P= Income paid to the foreign factors for their contribution to production in the domestic economy

Concept of National Income

Gross Domestic Product (GDP)

Gross Domestic Product is the money value of final goods and services produced within domestic territory of the country during a given period of time, a quarter or a year

In an open economyGDP = C + I + G + (X – M)In an closed economyGDP = C + I + G

Where,C=Consumption expenditure on domestically produced goodsI=Investment ExpenditureG=Government Expenditure(X-M)=Net receipts from foreign trade or net exports

Gross National Product (GNP)

GNP is the money value of final goods and services produced by the country’s factor of production wherever they are located during a given period of time, a quarter or a year.

GNP = GDP + Net Factor Incomes from abroad

Therefore,GNP = C + I + G + (X-M) + (R-P)

Net National Product (NNP)

&Net Domestic Product

(NDP)NNP = GNP – Depreciation

NDP = GDP – Depreciation

GNP, GDP, NNP and NDP at Market Price and at Factor

Cost

Market Prices=Factor Cost + Indirect Taxes – Subsidies

Factor Cost=Market Prices – Indirect Taxes + Subsidies

National income at current or constant

prices

•Current prices refer to price of goods prevailing in market at any given point of time i.e. market price of good and services•Constant prices e.g. GNP, GDP

Real Vs Nominal GNP

Nominal GNP

Real GNP

GNP at current prices

GNP at constant prices

GNP at current prices

GNP at constant prices

GNP deflector

GNP deflector

GNP deflector 2005-06

3363505

3239296

1.04156

Personal Income (PI) PI = National Income +Transfer Payment –

Undistributed Profits Of Corporate Sector-corporate Income Taxes –Social Security Contribution

Disposable Income (DI) DI=Personal Income –Direct Taxes Paid By

Individuals

Per capita income

National income

Population

Difficulties in measurement of national income

1. Treatment of non monetary transactions: w.r.t goods & services which are difficult to be assessed or are not transacted in terms of money.

2. Transfer incomes: income is received without any output of goods & services

3. Government income: received by government for any property or service rendered

Contd.

4. Income from illegal activities

5. Capital gains: gains or losses due to changes in market price

6. Imputed values: valuing of some goods & services that are not sold or bought

7. Inventories

Contd.

5. Depreciation

6. Problems of estimation in developing countries due to lack of

OrganizationAccounting practicesOccupational specializationStatistical data

Thank You