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Examining Methods Of Estimating National Income

Value added method: In this process, we calculate/estimate the money value of end products-i.e. goods and services produced in an economy during a year. The money value of these goods and services are calculated at market prices. The sum total is called GDP at market prices.

Formulae:

GDP (at market price) = Value of output in an economy in a particular year --- Intermediate consumption

NNP at factor cost = GDP at market price -- depreciation + NFIA (net factor income from abroad) -- net indirect taxes.

Because of the circular flow of income, these three measures yield the same total, which is called the Gross Domestic Product (GDP).

Expenditure Method

The Expenditure Approach: The expenditure approach measures GDP as total spending on final goods and services produced within a nation during a specified period of time.

Consider adding up the expenditures needed to purchase the final output produced in any given year. There are four broad expenditure categories.

Actual consumption expenditure, denoted as Ca, includes expenditure on all final goods during the year.

Actual investment expenditure, denoted as Ia, is expenditure on the production of goods not for present consumption, including:inventory, plant and equipment, andresidential housing.

Actual government purchases of goods and services, denoted as Ga, is the purchase of currently produced goods and services by government and, therefore, does not include transfer payments.Actual net exports, denoted as NXa, is the difference between exports and imports:

NXa = (Xa - IMa).

Exports are purchases of Indian-produced goods and services by foreigners. They are part of the total expenditure on Indian output.

Imports are the purchases of foreign-produced goods by Indians. This does not represent spending on Indian output, and so it is subtracted from total expenditure.

Formulae:

GDP = C + I + G + (X - M)

Where:

C = household consumption expenditures / personal consumption expenditures

I = gross private domestic investment

G = government consumption and gross investment expenditures

X = gross exports of goods and services

M = gross imports of goods and services

Note: (X - M) is often written as XN, which stands for "net exports”.

Income Method:

The income method from GDP is the summation of factor incomes plus claims on the value of output. Factor incomes mainly involves wages, rent, interest, and profits. They are combined to form the net domestic income(NDI).

Other claims on the value of output include: net of subsidies, and

depreciation of existing physical capital.

Formulae:

GDP = Net domestic income + Indirect taxes + Depreciation

Conclusion:

GDP measures the total output produced in India and the total income generated as a result of that production.GNP measures the total amount of income received by Indian residents, no matter where the income was generated.GDP is superior to GNP which is basically a measure of domestic economic activity.GNP is superior to GDP i.e a measure of the economic well-being of domestic residents. Disposable Personal Income (DPI) is GNP minus:

any part of it that is not actually paid to households,

personal income taxes paid by households, and

plus transfer payments received by households.

2. WHAT ARE THE TYPES OF PRICE INDEX AND THEIR DIFFERENCES ?

ANS. A weighted average method for a category of goods and services in an area for particular interval of time is known as price index. It is statistic and can be used for broad indices, the index can be said to measure the economy price level and in more close indices to help producers with business plan as well as pricing .They can be helpful in guiding investment .

Types of price Index

No index is perfect. The 3 basic price index are 1.GDP deflator, 2.the consumer price index and the 3.producer/wholesaler price index.

DIFFRENCES

GDP DEFLATOR:

The calculation of real GDP gives us measure of inflation known as the GDP deflator. The GDP deflator shows the ratio of nominal GDP in given year to real GDP of that year.

Since GDP deflator is based on the calculation involving all the good purchased in the economy, it is widely based price index that is frequently used to measure inflation. The deflator measures the change in prices that has occurred between the base year and current year. How to calculate GDP DEFLATOR

Nominal GDP GDP at current prices

GDP DEFLATOR = ------------------------- = --------------------------------

Real GDP GDP at constant prices

CONSUMER PRICE INDEX

It measures the cost of buying a fixed basket of goods and services representive of purchase of urban consumer. CPI and GDP deflator differs in three ways.1.deflators measures the prices of much wider group of goods than CPI does.

2. CPI measures the cost of given basket of good which is same from year to year. While the basket of goods included in GDP differs from year to year.

3. The CPI directly includes price of import , while deflator includes only the price of goods produced in united states.

The GDP deflator and CPI differ in behaviours from time to time. For example at times when the price of imported oil rises rapidly, the CPI is likely to rise faster than the deflator. However over long period the two produced quite similar measure of inflation

P1q0

Laspereys Index. = ------------- * 100; where P1=current price level,P0=base year P0q0 prices,q0=basket of goods in base year.

PRODUCER /WHOLESALER PRICE INDEX

Like the CPI, the PPI is a measure of the cost of a given product basket of goods .However it differs from CPI in its coverage; the PPI includes, for example raw material and semi finished goods. It differs too in that it is designed to measure prices at an early stage of the distribution system. Whereas the CPI measures prices where urban households actually do their spendings that is at retail level the PPI is constructed from prices at the level of the first significant commercial transaction.

This makes PPI a relatively flexible price index and one that frequently signals changes in the general price level or CPI. Sometime before they actually materialize. For this reason PPI and more particularly some of its sub indexes such as index of “sensivity material” serves as one of the business cycle indicator that are closely watched by policymakers.

3.WHAT is IS- LM CURVE?

ANS: .The IS/LM model describes the general equilibrium where there is simultaneous equilibrium in both the markets where IS stand for investment saving and LM liquidity preference money supply.(referenced metioned at the end)

LM

Y2

Y1

IS2

IS1

X1 X2

IS/LM MODEL

This model is presented as graph of two intersecting lines in first quadrant

1.Horizontal axis represents national income or gross domestic income and is labelled as X.

2.Vertical axis is represented by real interest rate Y.

3.The point where they intersect represent equilibrium .The equilibrium yields a unique combination of interest rate and real gap.

IS Curve

The dependent variable is level of income and independent variable is interest rate.It means for “Investment and saving equilibrium”.IS curve is locus of points of euilibirum in real economy .The IS curve is represented by equation

X=C(X-T(X)+Y(r)+G+NZ(X)

Where X represents income ,CX-T(X) represents consumer spending as an increasing function of disposable income ,X(r(represents investment in decreasing function,G is government spending ,NZ(X) represent net export.

LM Curve

The independent variable is the income and the dependent variable is the interest rate.LM curve shows the combination of interest rate.LM curve shows the combination of interst rates and level of real incomes.LM is the liquidity preference and money supply.However they are used to manipulate an economy's aggregate demand, which is an overall demand that is affected by consumption, investment, government expenditure and by export and import. When an economy is undergoing booming, they are used to reduce aggregate demand and and when undergoing a recession to increase aggregate demand.

The Keynesian model - shows what causes the aggregate demand curve to shift. In the short run, when the level of price is fixed, shifts in the aggregate demand curve lead to changes in national income, Y.

The IS-LM model = the leading interpretation of Keynes’ work.

The goal of the model: to show what determines national income for any given price level.

The Goods Market and the IS Curve

Keynes proposed: an economy’s total income was, in the short run, determined largely by the desire to spend by households, firms and the government.

The Keynesian Cross

Actual expenditure = the amount households, firms and the government spend on goods and services (GDP).

Planned expenditure = the amount households, firms and the government

would like to spend on goods and services. The economy is in equilibrium when:

Actual Expenditure = Planned Expenditure or Y=E

Q-4. WHY FISCAL POLICY AND MONETARY POLICY GO HAND IN HAND?

Ans: FISCAL POLICY:

The policy regarding the use of the government’s revenue & expenditure programme with a view to attaining certain macroeconomic goals is termed as fiscal policy. As said by an economist, Arthur Smithies, “a policy under which government uses its expenditure & revenue programme’s to produce desirable effects & avoid undesirable effects on the national income, production & employment.”

COMPONENTS OF FISACL POLICY

Tax : Higher the tax rate lesser is the availability of money in the market. Therefore the govt. increases the tax rate to reduce the money supply and decrease the tax rate to increase the money supply in the market

Govt. expenditure: It refers to the exp done by the govt. on the welfare of the

individuals of society. Higher the govt. exp the higher the money supply and vice versa.

Transfer payments: The govt. also made transfer payments such that old age pension payments to flood victims etc to support who are in needs. The govt. exp the higher the money supply and vice versa.

OBJECTIVES OF FISCAL POLICY:

To maintain economic stability by controlling business cycles

To attain & maintain full employment in the economy

To ensure a steady rate of economic growth

To maintain price stability

To remove inequality in the distribution of income & wealth

To remove regional inequality & to ensure balance regional development

TOOLS OF FISCAL POLICY:

To maintain economic stability by controlling business cycles

To attain & maintain full employment in the economy

To ensure a steady rate of economic growth

To maintain price stability

To remove inequality in the distribution of income & wealth

To remove balance of payments deficit

To remove regional inequality & to ensure balance regional development

MONETARY POLICY:

Monetary policy refers to the government process in which monetary authority of country and central bank controls cost of money, availability of money, rate of interest or the supply of money for the attainment of certain goals focused with respect to growth and stability of the economy.

COMPONENTS OF MONETARY POLICY:

Cash Reserve Ratio: It refers to the minimum cash balance which a bank has to maintain with the RBI as apart of security. When the rbi wants to increase the money supply it reduces CRR and vice versa.

Statutory Liquid ratio : It refers to the minimum cash balance which a bank has to maintain with in itself as art of liquidity. When rbi wants to increase the money supply it reduces (Slr) and vice versa.

Repo rate: It refers to the interest r.t.e at which the banks borrows from rbi. It borrows on the basis of securities, which is being held by the rbi. If rbi wants to reduce the money supply it increase the repo rate and vice versa.

Reverse Repo rate: It refers to the interest rate the rbi borrows from the banks. It mortgage securities to the banks and borrow the funds if rbi wants o increase the money supply then reverse repo tate is made higher made by rbi and vice versa.

Reasons why should fiscal and monetary policy go hand in hand:

The system of issuance adhoc T bill sand automatic monetization has been replaced by a system of ways and mean advance.

Fiscal deficit of the governments being financed by borrowings at market related rates of interest.

Public enterprises are being encouraged to borrow from market through voluntary transcriptions.

States are also being encouraged to access market on a standalone basis for a part of their borrowing programme.

Administered rate of ineterst regime has been dismantled and there are very prescription of interest rate.

The government has decided to reduce its ownership further in banking sector.

There is a diversified ownership of bank, and less than a third of total commercial banking. Activity is now transacted by wholly owned public sector banks..

An appropriate legal, institutional and technological framework has been put in place for regulation and development of money, government securities and forex markets.

The government budget has to recognize the increasing need to convince the financial market to raise resources to finance its deficit.

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