Lesson at a Glance
• Circular Flow of Income : Circular flow of income refers to the flow of money income or the flow of goods and services across different sectors of the economy in a circular form.
Injecation : Injection is an addition to the circular flow of income. It increases the size of circular flow. These are: Investment, Exports, Consumption expenditure by the households or government.
Leakages : Leakages are withdrawals from a circular flow of income.It reduces the size of circular flow. These are: Savings, Imports, taxes by government.
For stability in the circular flow of income,
Leakages = Injections
• Real Flow means the flow of factor services (from households to producers) and flow of goods and services (from producers to households). It is also called product flow or output flow. These are real because they consist of actual goods and services. Factor services (land, labour, capital, enterprise) flow from households to firms which require them for producing goods & services. Similarly, goods & services produced by firms flow from producing enterprises to households who buy them for satisfaction of their wants. Such flows are continuous and there is no beginning or end point in these flows.
• Money Flow refers to the flow of factor income, viz., rent, interest, profit and wages from producing sector to household sector and flow of consumption expenditure from household sector to producing sector. It is also known as income flow.Factor incomes flow from firms to households for rewards of their factor services. Similarly, households spend their incomes on purchase of goods & services and as a result money flows back to firms.
• Economic Territory : According to United Nations, “Economic Territory is the geographical area administered by a government within which persons, goods and capital circulate freely.”Since government does not enjoy such freedom in the embassies even if these are located within political boundaries of a country, these are not included in economic territory of a country.
Based on freedom criterion, Economic territory includes:
- Political frontiers including territorial waters and air space.
- Embassies, consulates, military bases, etc. located abroad, but excluding those located within its own political frontiers. For example: Indian Embassy in USA is a part of domestic territory of India but Japanese Embassy in India is a part of domestic territory of Japan and not of India.
- Ships, aircrafts, etc. owned and operated by the normal residents between two or more countries. For example: planes operated by Air India between Russia and Japan are part of domestic territory of India.
- Fishing vessels, oil and natural gas rigs, etc. operated by the residents in the international waters or engaged in extraction in those areas, where the country enjoys the exclusive rights of operation.
• Resident : A resident, whether a person or an institution is one who ordinarily resides in a country for a period of more than one year and whose centre of economic interest also lies in that country. The `Centre of economic interest’ implies two things:
- The resident lives within the economic territory;
- The resident carries out the basic function of earnings, spending and saving/investment from that location.
Following are not included under the category of normal residents:
(a) Foreign tourists and visitors who visit a country for recreation, holidays, study, sports etc.
(b) Foreign staff of embassies, officials, diplomats and members of armed forces of a foreign country located in the given country.
(c) International organizations like UNO, WHO etc.are not the normal residents of the country in which they operate. They belong to international area.
(d) Employees of international organizations are considered as residents of the countries to which they belong.
(e) Crew members of foreign vessels, commercial travelers and seasonal workers provided their stay is less than one year.
(f) Border workers who live near the international border and cross the border on a regular basis to work in the other country.
• Intermediate goods: These refer to those goods which are used either for resale or for further production in the same year.For example: milk used in dairy shop, coal used in factory.These are generally purchased by one production unit from other production unit. Generally, intermediate goods lose their identity when they undergo production process.
• Final goods: These refer to those goods which are used either for consumption or for investment. All the goods purchased by consumer households are final goods as they are meant for final consumption. Goods purchased by firms are final goods if they are purchased for capital formation / investment. These are neither resold nor used for any further transformation in the process of production.
• Real National Income is defined as the value of current output at some base year prices. It is obtained by multiplying the goods and services produced in the current year with the prices prevailing in the base or constant year. The base year in India is 2004-05. This estimate is a reliable index of economic growth of a country. NI at constant prices will increase only when there is rise in output of goods and services in country during the year.
• Nominal National Income is defined as the value of current output at current year prices. It is a poor index to measure the economic growth of a country. It is obtained by multiplying the goods & services produced in the current year with the prices prevailing in the current year. It gives only the money value of national income. If the output of final goods & services produced in the current year remains the same and current prices rise, then NI at current prices will increase. But it is important to note that rise in national income only in monetary sense does not imply economic growth of an economy.
• Depreciation: It is the fall in price/value of an asset due to wear and tear. Obsolesce is fall in value due to change in technology; depreciation is fall in value due to usage. It is also known as‘consumption of fixed capital’. If the value of an asset falls due to unforeseen obsolescence or natural calamities like floods, earthquakes etc., it is called ‘capital losses and not depreciation.
• Net Indirect Taxes : It is the difference between Indirect taxes and Subsidies.
Net Indirect Tax = Indirect taxes – Subsidies
Indirect taxes are the taxes which are levied on the production and sale of goods and services and the burden of which can be transferred. For example: sales tax, excise duty, custom duty etc.They increase the price of a product in the market.Subsidies are the financial assistance given by the government to producers with an objective of keeping the price of a commodity below its factor cost.For example:subsidy given on LPG cylinder. They reduce the market price of the commodity.
Implication : The concept of NIT is used to differentiate between factor cost and market price.
• Net Factor Income From Abroad: NFIFA is the difference between the income received from abroad by the residents of a country for rendering factor services and factor income paid to the residents of other countries. NFIA belongs to the private sector. Public sector does not earn any income in the form of NFIA. Any income earned by government employees from abroad is paid by the government itself. For example, Indian employee working in Indian embassy in US will get salary from the Indian government.
NFIA = Factor income received from abroad by normal
residents–Factor income paid abroad to non-residents
• Different concepts of Domestic and National Income:
1. Gross Domestic Product at Market Price (GDPmp): It is the gross market value of final goods and services,inclusive of depreciation and net indirect taxes produced in an accounting year within the domestic territory of a country.
2. Net Domestic Product at Market Price (NDPmp): It is the market value of final goods and services, exclusive of depreciation produced in an accounting year within the domestic territory of a country.
3. Gross Domestic Product at Factor Cost (GDPfc): It is the gross market value of final goods and services,inclusive of depreciation produced in an accounting year within the domestic territory of a country.
GDPfc = GDPmp – Net indirect taxes (indirect taxes – subsidies)
Or
GDPfc = NDPmp + Depreciation – NIT (indirect taxes – subsidies)
4. Net Domestic Product at Factor Cost (NDPfc): It is the sum of net value added by all the producers exclusive of depreciation in an accounting year within the domestic territory of a country. It is the domestic income.
NDPfc = NDPmp – Net indirect taxes (indirect taxes – subsidies)
Or
NDPfc = GDPmp – Depreciation – NIT (indirect taxes –
subsidies)
5. Gross National Product at Market Price (GNPmp):It is the market value of final goods and services, inclusive of depreciation produced in an accounting year within the domestic territory of a country plus Net Factor Income from Abroad.
GNPmp = GDPmp + NFIA
Or
GNPmp = GDPfc + NFIA + NIT
6. Net National Product at Market Price (NNPmp): It is the market value of final goods and services, exclusive of depreciation produced in an accounting year within the domestic territory of a country plus Net Factor Income from Abroad.
NNPmp = NDPmp + NFIFA
Or
NNPmp = GDPfc + NFIFA + NIT – Depreciation
7. Net National Product at Factor Cost (NNPfc) or National Income: It is the sum of net value added by all the producers exclusive of depreciation in an accounting year within the domestic territory of a country plus NFIA. It is the national income.
NNPfc = NDPmp – Net indirect taxes (indirect taxes – subsidies) + NFIA
Or
NNPfc = GDPmp – Depreciation – NIT (indirect taxes – subsidies) + NFIA
8. Gross National Product at Factor Cost (GNPfc): It is the sum of net value added by all the producers inclusive of depreciation in an accounting year within the domestic territory of a country plus NFIA.
GNPfc = GNPmp – Net indirect taxes (indirect taxes – subsidies)
Or
GNPfc = GDPmp + NFIFA – NIT (indirect taxes – subsidies)
NOTE : Basis of difference between gross and net is DEPRECIATION.
Basis of difference between Domestic and national is NET FACTOR INCOME FROM ABROAD
Basis of difference between Market price and Factor cost is
NET INDIRECT TAXES (IT- SUBSIDIES)
• Private Income: It is the income which accrues to the private sector from all sources. It is the sum total of factor incomes and transfer incomes received by private sector.
Private Income = Income from NDPfc accruing to private sector
+
Net Factor Income from abroad
+
Net transfers from the government
+
Net Current Transfers from the ROW
+
Interest on national debt
• National debt interest : It is the interest paid by government on loans taken to meet its administrative expenditure and consumption expenditure. Since it is not a factor income (because this loan is not used for production purpose) it is not included in NDPfc but since it is a disposable income, it is included here.
• Personal Income : It is the sum total of income actually received by a person from all sources including factor income and transfer income.
Personal Income = Private income – Corporation tax – Undistributed profits
• Private Income vs Personal Income
• Disposable Income : Disposable income is defined as the income remaining with individuals after deduction of all taxes levied against their income and their property by the government. It is either spent on consumption or saved.
• National Disposable Income : It is the sum of factor and non-factor incomes accruing to the residents of a country.It is net of current transfers. It is the income from all sources, connected with production or otherwise. It is a measure of what is available to the residents of a nation for spending on consumption and for saving during a year. Gross National Disposable Income (GNDI) = GNPmp + Net current transfers from the ROW
Net National Disposable Income (NNDI) = NNPmp + Net current transfers from the ROW
Or
GNDI – Depreciation
Or
NNPfc + NIT + Net current transfers from ROW
• Personal Disposable Income : PDI is the sum of factor and non-factor incomes of households after payment of direct taxes. This income is actually at the disposal of households.They can either spend it or save it.
PDI = Personal Income – Direct personal taxes (i.e. income tax & property tax) – Miscellaneous receipts of government administrative departments (fees, fines, penalties etc.)
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