session 13&14 me
TRANSCRIPT
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Session 13&14
Anatomy &Anatomy &
Functioning of theFunctioning of theEconomy:NI aEconomy:NI a
precursorprecursor
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IntroductionIntroduction
ME examines the economic
behaviour of a nation and GDP is one
of the indicators based on which wecan examine the economic health of
a nation.
GDP and its sectoral distribution
also gives us an idea about structural
composition and income distribution.
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Contd...
The growth of national income
and its composition gives a fairidea to a firm as what is there in
store for the firm in terms of its
growth prospects and scope ofdiversification if any.
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Objectives
To understand circular flow on income and
expenditure.
To understand various concepts of NI To examine measures of national income
accounting.
To understand difficulties in the measurement
of national income.
To distinguish bet real GDP and nominal GDP
and concept of deflator.
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When judging whether the
economy is doing well or poorly, it
is natural to look at the total
income that everyone in the
economy is earning.
TThe Economys income andhe Economys income and
expenditureexpenditure
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For an economy as a whole, income
must equal expenditure because:
Every transaction has a buyer and a
seller.
Every rupee of spending by some buyer
is a rupee of income for some seller.
The Economys income andThe Economys income and
expenditureexpenditure
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Gross domestic product (GDP) is a
measure of the income and expenditures
of an economy.
It is the total market value of all final
goods and services produced within a
country in a given period of time
notwithstanding the ownership of the
FOPs.
Gross Domestic Product
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The Circular-Flow Diagram
The equality of income and
expenditure can be illustrated
with the circular-flow diagram.
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The Circular-Flow Diagram
Firms Househ
olds
Market for
Factors
ofProduction
Market for
Goods
and Services
SpendingRevenue
Wages, rent,
and profit
Income
Goods &
Services soldGoods &
Services
bought
Labor, land,
and capital
Inputs for
production
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The Measurement of GDP
Output is valued at market prices.
It records only the value offinal goods,not intermediate goods (the value is
counted only once).
It includes both tangible goods (food,
clothing, cars) and intangible services
(haircuts, housecleaning, doctor visits).
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The Measurement of GDP
It includes goods and services currently
produced, not transactions involving
goods produced in the past.
It measures the value of production
within the geographic confines of acountry.
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It measures the value of production
that takes place within a specific
interval of time, usually a year or a
quarter (three months).
The Measurement of GDP
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What Is Counted in GDP?
GDP includes all itemsproduced in the economy
and sold legally in markets.
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What Is Not
Counted in GDP?
GDP excludes most items that are
produced and consumed at home and that
never enter the marketplace such as
services of housewives and various services
we render for our friends and family.
It excludes items produced and soldillicitly, such as illegal drugs.
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OtherMeasures of Income
Gross National Product (GNP)
Net National Product (NNP)
National Income
Personal IncomeDisposable Personal Income
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Gross National Product
Gross national product (GNP) is the total
income earned by a nations permanent
residents (called nationals) irrespective of their
place of work.
It differs from GDP by including income that
our citizens earn abroad and excluding income
that foreigners earn here.
GNP=GDP+NFIA(net factor income from
abroad)
GDP=GNP-NFIA
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Net National Product (NNP)
Net National Product (NNP) is the total
income of the nations residents (GNP)minus losses from depreciation.
Depreciation is the wear and tear on
the economys stock of equipment and
structures(capital).
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National Income
National Income is the total income
earned by a nations residents in the
production of goods and services.
It differs from NNP by excluding indirect
business taxes (such as sales taxes) andincluding business subsidies.
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Personal Income
National income is all earned by the residentFOPs for their contribution to current
years's output.
However all earned income is not received byFOPs.
At the same time FOPs receive income which
are not earned.
Personal income is the income that
households and noncorporate businesses
receive.
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Personal IncomePersonal Income
Unlike national income, it excludes
retained earnings, which is income that
corporations and PSUs have earned but
have not paid out to their owners.
In addition, it includes households
interest income, government transfers and
dividends.
PI =NI income earned but not
received+income received but not earned.
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Disposable Personal Income
Disposable personal income is the income
that household and noncorporate
businesses have left after satisfying all
their obligations to the government.
It equals personal income minus personaltaxes and certain nontax payments.
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The Components of GDP
GDP (Y) is the sum of the following:Consumption (C)
Investment (I)
Government Purchases (G)
Net Exports (NX)
Y= C + I + G + NX
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The Components of GDP
Consumption (C):
The spending by households on goods and
services, with the exception of purchases of
new housing.
Investment (I):The spending on capital equipment,
inventories, and structures, including new
housing.
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The Components of GDP
Government Purchases (G):
The spending on goods and services by
central, state, and local governments.
Does not include transfer payments because
they are not made in exchange for currently
produced goods or services.
Net Exports (NX):
Exports minus imports.
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Real versus Nominal GDP
Nominal GDP values the production of
goods and serv
ices at current prices.Real GDP values the production of
goods and services at constant prices.
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Real versus Nominal GDP
An accurate view of the economyrequires adjusting nominal to real
GDP by using the GDP deflator.
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Calculation ofReal GDPCalculation ofReal GDP
G & S Base Yr Current YP Q P Q
X1 2 40 3 60
X2 8 90 10 150
X3 80 100 90 110
X4 70 120 80 130
NY at Base yr- 17200
NY at current yr - 21980
Real=60*2+150*8+110*80+130*70=19220
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GDP Deflator
The GDP deflator measures the current
level of prices relative to the level of
prices in the base year.
It tells us the rise in nominalGDP that is
attributable to a rise in prices rather thana rise in the quantities produced.
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GDP Deflator
100GDPReal
GDPNominal=deflatorGDP
The GDP deflator is calculated as follows:
PIN of the chosen year
100
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100X
)fl t r(
)( i ll
20xx
20xx20xx
Nominal GDP is converted to real
GDP as follows:
Nominal GDP
PIN/100
Cont . . .Cont . . .
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Measurement of GNPMeasurement of GNP
Net Product Method or value added
method
Factor income method
Expenditure method
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National income estimationNational income estimation
CSO through its National Accounts
Statistics brings out the estimates of NI.
It has divided economy into 14 sectors
constituting three broad sectors of the
economy: Primary sector, secondarysector, tertiary sector.
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Contd..Contd..
Primary Sector comprises: agriculture,
forestry and logging, fishing, mining and
quarrying.
Secondary sector comprises:
manufacturing, both registered andunregistered sector, construction,
electricity, gas and water supply.
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Contd..Contd..
Tertiary sector comprises:
transport,storage and communication;
trade,hotels and restaurants; banking
and insurance; real estate, ownership of
dwellings and business services; public
administration and defence; other
services and last foreign sector.
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contd...contd...
In preparing estimates, theCSO follows
the product and income methods.
The product method is used in the
commodity producing sectors like
agriculture, forestry, fishing, mining,etc.,and manufacturing.
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Contd..Contd..
Under thisfrom the gross value of output,
value of inputs such as raw materials,
service inputs and depreciation of assets
are deducted.
The income method is used to estimate the
income from service sector.
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Contd...Contd...
Under this, the prodct of per person
average earnings and the no. of people
working is appliedto computing income
To the combined estimates so arrived at by
using these two methods are added theestimates of net income from abroad.
Depreciated value of assets is added to
NNP to get GDP.
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Difficulties in estimation of NIDifficulties in estimation of NI
Presence of large non-monetised sector:
One third of productive activities
according to RBI are outside the purview
of money. Examples: ag. Output retained
by the farmers for self-consumption,
services rendered by housewives.
Lack of reliable data from vast
unorganised sector
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Contd..Contd..
Unreported illegal income
Difficulties in the classification ofworking population
Black money
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GDP is the best single measure of the
economic well-being of a society.GDP per person tells us the income
and expenditure of the average person
in the economy.
GDP and Economic well-being
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Higher GDP per person indicates a
higher standard of living.
GDP is not a perfect measure of the
happiness or quality of life, however.
GDP and Economic well-being
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Some things that contribute to well-being are
not included in GDP.
The value of leisure.
The value of a clean environment.
The
value of almost all acti
vity that takes place
outside of markets, such as the value of the time
parents spend with their children and the value of
volunteer work.
GDP and Economic well-being
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GDP, Life Expectancy, and Literacy
Country Real GDP perPerson (1997)
LifeExpectancy
AdultLiteracy
United States $29,010 77 years 99%
Japan 24,070 80 99
Germany 21,260 77 99
Mexico 8,370 72 90
Brazil 6,480 67 84
Russia 4,370 67 99
Indonesia 3,490 65 85
China 3,130 70 83
India 1,670 63 53
Pakistan 1,560 64 41
Bangladesh 1,050 58 39
Nigeria 920 50 59
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Measuring the Cost of Living
Inflation refers to a situation in which the
economys overall price level is rising.
The inflation rate is the percentage change
in the price level from the previous period.
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The Wholesale Price Index
When theWPI rises, the typical family
has to spend more dollars to maintainthe same standard of living.
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How the Consumer Price Index Is
Calculated
Fix the Basket: Determine what prices are
most important to the typical consumer.
The MOF identifies a market basket of
goods and services the typical consumer
buys.
The NSSO conducts periodic consumer
surveys to set the weights for the prices of
those goods and services.
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Contd..Contd..
Choose a Base Year and Compute the
Index:
Designate one year as the base year, making it
the benchmark against which other years are
compared.
Compute the index by dividing the price of
the basket in one year by the price in the base
year and multiplying by 100.
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Contd..Contd..
Compute the inflation rate: The
inflation rate is the percentage change
in the price index from the preceding
period.
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Contd..Contd..
Compute the inflation rate: The
inflation rate is the percentage change
in the price index from the preceding
period.
Inflation rate:
WPI in Yr.2-WPI in Yr.1 X 100
WPI in Year 1
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What is there in WPIWhat is there in WPI
Manufactured Prodcuts:64%
Food and nonfood articles:22%
Fuel, oil, lubricants: 14%
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Summary
Because every transaction has a buyer and
a seller, the total expenditure in the
economy must equal the total income in
the economy.
Gross Domestic Product (GDP) measures
an economys total expenditure on newly
produced goods and services and the total
income earned from the production of
these goods and serv
ices.
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Summary
GDP is the market value of all final goods
and services produced within a country in
a given period of time.
GDP is divided among four components
of expenditure: consumption, investment,
government purchases, and net exports.
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Summary
Nominal GDP uses current prices to
value the economys production. Real
GDP uses constant base-year prices tovalue the economys production of goods
and services.
The GDP deflator--calculated from the
ratio of nominal to real GDP--measures
the level of prices in the economy.
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Summary
GDP is a good measure of economic well-
being because people prefer higher to
lower incomes.
It is not a perfect measure of well-being
because some things, such as leisure time
and a clean environment, arent
measured by GDP.