GNP, GDP, NNP, National Income

GNP and its properties

The sum of the money values of all final goods and services produced by domestically owned factor production of an economy during twelve month period is called Gross National Product.

Some important properties of GNP are

Inclusion of final goods and services all finally produced goods and services are come to the count of GNP of intermediate goods and services are considered here.

GNP is a monetary term there is no other way of adding up the different sorts of goods and services produced in a year except in terms of their money prices.

GNP is a flow concept it is measurable in terms of time.

Own factors of production goods and services that are produced by own factors of production is included in GNP. Any sorts of factors may work in home or abroad.

GDP and its derivation

The money values of all final goods and services produced by normal residents as well as non residents in the domestic territory of a country , during  a specified time period, usually a year, is called Gross  domestic product (GDP).

GDP at market prices or simply

GDP_mp=GNP_mp-net factor income from abroad

Net National Product or NNP

NNP means the market value of all final goods and services after providing for depreciation .In other word, when charges for depreciation are deducted from ht e gross national product we get net national product.

Sometimes, it is called national income at market prices .Therefore, national income = wages +rent +interest +profits =national product

National income at factor cost

National income at factor cost means the sum of all incomes earned by resource suppliers for their contribution of land, labour, capital and entrepreneurial ability which go into the year’s net production. In other words, it is the market prices of output less the indirect taxes and subsidies.

National income at factor cost, NNP_FC =Net national product at market prices - indirect taxes + subsidies.

Or, national income = net national product - net indirect taxes.

Disposable income

The income available for households to spend, I.e. personal incomes after deducting taxes on incomes.

Disposable income = personal income - personal taxes

GNP verses GDP

GNP is the sum of money values of all final goods and services produced by domestically owned factors of production regardless of where they work.

GDP is the sum of the money values of all final goods and services produced in the domestic territory of a country.

The difference between GDP and GNP arises due to the existence of `net factor income from abroad’.GDP does not include it but GNP does .suppose, x =home factor income from abroad, m =foreign income at home.

                           Thus,

                      When x-m=0; GDP =GNP

                     When x>m; GDP <GNP

                     When x<m; GDP>GNP

Real GNP verses nominal Gnp

On the other hand, the sum of the money values of all final goods and services produced by domestically owned factors of production of an economy during a year at constant prices is called real GNP.

Changes in nominal GNP that result from price changes does not  tell us anything about the performance of the economy, while real GNP as the basic measure for comparing output in different years.

Measurement of National Income

Income method: Under this method, national income is obtained by summing up of the all individuals of a country. In other words, this method measures national income at the phase of distribution and appears as income paid and received by individuals of the country.

Step 1;(FP)_I = W_i +R_i+I_i+∏_i+(MI)_I

Where,

(FP)_{I =}Factor payment of ith enterprise

W_i =compensation of employees of ith enterprise

R_i =rent paid by ith enterprise

I_i =interest paid  by ith enterprise

(MI)_i =mixed income of ith enterprise

_I =profit earned by ith enterprise

Step 2;

Where,

FP_i=factor payment of ith enterprise

FP_j=factor payment of jth industry

Step 3;   =NDP_FC

Where,

FP_j =factor payment of jth industry

NDP­_FC =net domestic production at factor cost

Step 4; NNP_FC = NDP_fc +(x-m)

Where,

NNP_FC =net national product at factor cost

(x-m) =net factor income earned from abroad

Expenditure method: Expenditure method arrives at national income by adding up all expenditure made on goods and services during a year. The different steps in calculating national income are as follows.

Step 1; GDP_mp =C+G+I+(X-M)

Where,

GDP_mp =gross domestic product at market prices

C =final private consumption expenditure

G=govt’s expenditure on goods and services

I =gross domestic investment

(X-M) =net export

Step 2; NDP_mp=GDP_mp-depriciation

Where,

NDP_mp=net domestic product at market prices

Depreciation = consumption of fixed capital

Step 3; NDP_fc=NDP_mp-NIT

Where,

NDP_fc=net domestic product at factor cost

NIT= net indirect taxes I.e. indirect taxes minus

Subsidies.

Step 4; NNP_fc=NDP_fc+(X-M)

Where,

NNP_fc=net national product at factor cost

(X-M)=net factor income from abroad

Value added method /product method: Under this method, the contribution of each enterprise to the generation of flow of goods and services is measured .Then, the net value added at factor cost (NVA_fc) by each productive enterprise as well as by each industry or sector is estimated.

In this method measurement of national income is as follows:

Step:1 (GvA_FC)_i-(IC+dep+NIT) = (NVA_FC)_i

Where,

(GVA_fc)_I = Gross value added at ith enterprise

IC = Intermediate consumption

                 Dep= Consumption of fixed capital or

                            Depreciation

NIT =Net indirect taxes

Step 2 _FC)=NDP_FC

Where, NDP=Net domestic product at factor cost

Step 3 NNP_FC =NDP_FC+(x-m)

Where, NNP_fc=Net national product at factor cost

NDP_FC=Net domestic product at factor cost

(X-m) =Net factor income from abroad

This method of calculating national income can be used where there exists a census of production for the year.

Circular flow of national income:

Briefly circular flow of national income explains how an economy functions. To explain this idea, Let us take an economy where there are only two agents: households and firms. Firms are required to produce goods. To produce them, they require services of factors of production. Factors of production are paid the rewards for their contribution to the production of goods. Thus income of these factors arises in the course production. This income again returns to the firm’s when expenditure is made by the households on the goods produced by the firms. So, according to circular flow of income: NATIONAL INCOME= NATIONAL PRODUCT=NATIONAL EXPENDITURE.

CIRCULAR FLOW OF NATIONAL INCOME IN THE TWO SECTOR ECONOMY:

ASSUMPTION: 

1. Neither the households save from their incomes, nor do the firms save from their profits.

2. Govt does not play any part in the national economy.

3. The economy neither imports goods and services, or exports anything

  It is clear from the figure that, each money flow is in opposite

direction to the real flow. In the upper loop of this figure, the resources such as land, labor, capital, and entrepreneurial ability flow from households to business firms as indicated by the arrow mark. in opposite direction to this ,money flows from  business firms to the households as factor payments such as wages, rent, interest, and profits. In the lower part of the figure, money flows from households to firms as consumption expenditure, while the flow of goods and services is in opposite direction from business firms to households. Thus we see that, money flows from business firms to households as factor payments and it flows from households to firms.

CIRCULAR FLOW OF NATIONAL INCOME IN AN OPEN ECONOMY

Assumptions:

Business Firms and Households:- In the upper loop of the figure, the resources flows from households to business firms and money flows from business firms to the households as factor payments such as wages, rent, interest and profits. In the lower part of the part of the figure, money flows from households to firms as consumption expenditure, while the flow of goods and services is in opposite direction from business firms to households.

      Financial Market:- In free market economies, there exists a set of institutions such as bank, insurance companies, financial houses, stock markets where households deposit their savings. All these institutions together are called financial market. Circular flow of money with saving and investment is illustrated in the above figure where in the lower part a box representing financial market is drawn. Money flow of savings is shown as borrowing by business firms from the financial market.

   Government:-In the figure, it will be seen that government purchases of goods and services from firms and households are shown as flow of money spending on goods and services. Government expenditure may be financed through taxes, out of assets or by borrowing. In the lower part, the money flow includes all the tax payments made by households less transfer payments received from the government. Another method of government financing is borrowing from the financial market to the government.

   Foreign Sector:-In the upper loop of the figure illustrates additional money flows that occur in the open economy when exports and imports exist in the economy. A flow of money spending on imports has been shown to be occurring from the domestic business firms to the foreign countries. On the contrary, a flow of money expenditure on exports of a domestic economy has been shown to be taking place from foreign countries to the business of the domestic economy. Thus,

If X > M then trade surplus occurs

If M > X then trade deficit occurs.

Foreigners interact with the domestic firms and households through borrowing and lending in the financial market. Thus

If X > M, net capital inflow will take place.

If X < M, net capital outflow will take place.

Thus, in the open economy,

       Total Expenditure, E = C+I+G+(x-M) _ _ _ (1)

       Total Income, Y = C+S+T _ _ _ _ _ _ _ _ (2)

For equality,

       C+I+G+(X-M) = C+S+Y _ _ _ _ _ _ _ _ _ _ (3)

Difficulties of measurement of national income in under-developed countries:

In underdeveloped countries like Bangladesh, we face some special difficulties in estimating national income. These difficulties are given below:

1. The first difficulty arises because of the prevalence of non-monetized transactions in under-developed countries like Bangladesh, so that a considerable part of output does not come into the market at all. The national income statistician, therefore, has to face the problem of finding a suitable measure for this part of output.  

2. Because of illiteracy, most producers have no idea of quantity and value of their output and do not keep regular account. This makes the task of getting reliable information from a large number of producer’s difficulty. 

3. Because of under-development, occupational specialization is still incomplete so that obtaining appropriate data becomes difficult.

4. There is a general lack of adequate statistical data and this adds to the difficulties of estimating national income.

Precautions to be taken while measuring national income:

Only final goods included: GNP is the value of final goods and services. The insistence of final goods and services is simply to make sure that we do not double count. For example, the wheat that goes into bread is an intermediate good. We count only the value of the bead as part of GDP; we do not count in the value of the wheat sold to the miller and the value of the flour sold to the baker.

Only current output included: Output not produced in the current period should not be included in GNP. Because such output does not contribute to the current year production therefore we count the construction of new houses as part of GDP, but we do not add trade in existing houses.

Self occupied house and self consumption: Imputed rent values of self occupied house and value of production for self-consumption should be counted while measuring national income.

Housewives services: value of housewives services should not be included because it is not easy to find out correctly the value of these services.

                                                                                                                                 Windfall gains: windfall gains such as prizes, lotteries, should not be included.

Transfer payments not included: transfer payments such as unemployment benefits, old-age pension should not be treated as income no goods or services are produced against these types of payments.

Limitations of GNP in measuring nation’s well-being: there are specifically, four major limitations for which GNP cn not be used as a measure of nation’s economic well-being:

1. Non-market activities such as volunteer work , works done by housewives, and do-it-yourself activities in the home certainly contributes to the nation’s well-being ,but these are not measured in the GNP.

2. It is very difficult to account correctly for improvements in the quality of goods and services. So GNP does not reflect the quality improvement.

3. The GNP does not take environmental pollution and delegation into account.

4. The GNP places no value on leisure even though leisure so important for well-being.

Problem of double counting and its solution:

In order to measure national income, total market value of all finally produced goods and services by domestically owned factors of production during a specified period of time, usually a year is taken. But if we consider the money value of intermediate goods besides final, the problem it creates is called problem of double counting.

                 In this case, the figure of national income is greater than it should be. An example as to explain the problem more closely, we may consider three different products, e.g. wheat, floor and bread.

Stage of production	Sales receipts(1)	Cost of intermediate goods(2)	Value added(3)=(1)-(2)
wheat	24	0	24
Flour	33	24	9
Bread	60	33	27
	117	57	60

Finally, we can get the GNP through summing up value added at each production stage. Hence, the GNP is equal to $60. It is also needed to mention $117 is greater than $60.   

To avoid double counting, two ways can be followed in measuring GNP-                                                                        

 1) VALUE ADDED METHOD: Value added is the price of goods over the cost of factors. The method in which value added in different steps of production of goods to appear at GNP is called value added method. For example summing up value added at different stages in previous table, we have able to get the exact calculation of GNP.

2) FINAL product method: To overcome the double counting problem one can sum up the prices of finally produced goods and services to have GNP. For example-

As a final good, we can get proper calculation of GNP, through monitoring the market price of bread. In this case, the market price of bread is $60 which is equal to sum up of value added.

Keynesian cross 

In the Keynesian cross diagram (or 45-degree line diagram), a desired total spending (or aggregate expenditure, or "aggregate demand") curve (shown in blue) is drawn as a rising line since consumers will have a larger demand with a rise in disposable income, which increases with total national output. This increase is due to the positive relationship between consumption and consumers' disposable income in the consumption function. Aggregate demand may also rise due to increases in investment (due to the accelerator effect), while this rise is reduced if imports and tax revenues rise with income. Equilibrium in this diagram occurs where total demand, AD, equals the total amount of national output, Y, (which corresponds to total national income or production). Here, total demand equals total supply.
In the diagram, the equilibrium level of output and demand is determined where this desired spending curve intersects a line that represents the equality of total income and output (AD=Y). The intersection gives the equilibrium output, Y'.
The movement toward equilibrium is mostly via changes in inventories inducing changes in production and income. If current output exceeds the equilibrium, inventories accumulate, encouraging businesses to cut back on production, moving the economy toward equilibrium. Similarly, if the level of production is below the equilibrium, then inventories run down, encouraging an increase in production and thus a move toward equilibrium. This equilibration process occurs when the equilibrium is stable, i.e., when the AD line is less steep than the AD=Y line.
The equilibrium level of output determines the equilibrium level of employment in the model. (In a dynamic view, these are connected by Okun's Law.) There is no reason within the model why the equilibrium level of employment should correspond to full employment. Bringing in other considerations may imply this correspondence, though.
If any of the components of aggregate demand (C + I_p + G + NX) rises at each level of income, for example because business becomes more optimistic about future profitability, that shifts the entire AD line upward. This raises equilibrium income and output. Similarly, if the elements of AD fall, that shifts the line downward and lowers equilibrium output. (The AD=Y line does not shift under the definition used here).

Assumptions

The Keynesian cross produces an equilibrium under several assumptions. First, the AD (blue) curve is positive. The AD curve is assumed to be positive because an increase in national output should lead to an increase in disposable income and, thus, an increase in consumer consumption, which makes up a portion of aggregate demand.^[1] Second, the AD curve is assumed to have a positive, vertical intercept. The AD curve must have a positive, vertical intercept to cross the AD=Y curve. If the curves do not cross, there is no equilibrium and no equilibrium output can be determined. The AD curve will have a positive, vertical intercept as long as there is some aggregated demand—from consumer spending, investment, net exports, or government spending—even if there is no national output.^[1] Finally, the AD curve must have a slope less than 1. This holds true as long as an increase in output does not lead to an equal or greater increase in aggregate demand. As long as some of the additional output is either spent on exports or saved, this assumption holds true.^[1]

Consumption Expenditure & Savings

Consumption Expenditure & Savings

  

As the demand for a good depends upon its price, similarly consumption of a community depends upon the level of income. In other words, consumption is a function of income. The consumption function relates the amount of consumption to the level of income. When the income of a community rise, consumption also rises. How much consumption rises in response to a given increase in income depends upon the propensity to consume or consumption function. It should be borne in mind that the consumption function or the propensity to consume is the whole schedule which describes the amount of consumption at various levels of income. The consumption function shows the relationship between the level of consumption expenditures and the level of disposable personal income. This concept, introduced by Keynes, is base on the hypothesis that is a stable empirical relationship between consumption and income. For example,

c=f(y)

Where, c stands for consumption expenditure and y stand for national income. It should be borne in mind that consumption function or propensity to consume is the whole schedule which describes the amount of consumption at various levels of income.

There are two important concept of propensity to consume, the one being average Propensity to consume and the other marginal propensity to consume. They should be carefully distinguished, for they are equal in some cases but different in other.

The marginal propensity to consume (MPC) is the amount of extra consumption generated by an extra dollar of disposable income. On the other hand, the average propensity to consume (APC) is the proportion of total disposable income that goes on consumption. According to formula, MPC is the ratio of change in consumption to the change in income, i.e.  Graphically, MPC is given by the slope of the consumption function where APC is not the slope of the consumption function.

The saving function shows the relationship between the level of saving and income. Became, what is saved equals what is not consumed, savings and consumption schedules are mirror.

An important relationship between income and saving is described by the concept of average propensity to save is the proportion of disposal income that is saved.  So APC is the proportion of disposable income that is saved. Arithmetically,

APS=Saving/Disposable Income=S/Y.

This implies that APS will increase as income rises.

Let us derive an important relationship between APC and APS. Restating below the relation that income is either consumed or save:

C+S=Y

C/Y+S/Y=Y/Y

C/Y+S/Y= 1

APC+APS=1

This means, for example, that if a society consumer 75% of its disposable income, that is, APC=.75 then it will save 25% of its disposable income.

Whereas average propensity to save indicates the proportion of income that is saved, marginal propensity to save represent how much of the additional disposable income is devoted to saving. The marginal propensity to save is therefore change in savings induced by a change in the disposable income. Since the additional income is either consumed or saved, any change in income must induce either change in consumption or change in saving. Thus,

   Change in C+ Change in S=Change in Y/ Change in Y

Change in C/ Change in Y+ Change in S/ Change in Y=Change in Y/Change in Y

Change in C/ Change in Y+ Change in S/ Change in Y=1

MPC+MPS=1

In, for example, disposable income increases form 10000 to 12000, that is Change in Y=2000, the saving increases by 500. Putting theses values in equation, we get

MPC=1-MPS

=1-Change in S/Change in Y

=1-500/2000

=1-0.25

=0.75

So the society must consumed 75% of disposal income.

Keynes’s propounded a basic law about the consumption function. This has been described as psychological law of consumption by Prof Kurihara. According to this psychological law of consumption, when the aggregate income increases but by a somewhat smaller amount. It means that out of the increment in income, a part is saved and not consumed. In other words, marginal propensity to consume is less then one. We have explained above the various subjects and object factors which influence the propensity to consume. Many factors are responsible which induce the people to save somewhat out of the extra income. It has also been established by empirical evidence that people on average do not consume the whole of their increment in income.

Keynes in his General Theory published in 1936 laid the foundation of modern macroeconomics. Theory of consumption function plays a crucial role in his theory of income and employment.

Keynes Proposition:

Consumption expenditure depends mainly on absolute income of the current period. Consumption expenditure does not have proportional relationship with income.APC falls as income increases. Since APC falls as income increases, MPC is less than APC at each income level.

The Keynes Law of consumption can be expressed in the following form of consumption:

C=a + by

Where c=consumption function and yd=real disposable income. The parameter a and b are constant, where a is the intercept term and b is the marginal propensity to consume (MPC=Change in C/Y). The Keynesian consumption function is depicted in the following way.

B=MPC=Change in C/Change in Y and APC=C/Y

 In the figure, we have shown a linear consumption function, with an intercept term. In this form of consumption function, though marginal propensity to consumption (MPC) is constant, propensity to consume (APC) is declining with the increase in income. Because, a tangent indicating average propensity to consume (APC) drawn at point B at higher income level y2 has a relatively less slope then tangent drone at point A at lower income levelY1.  Moreover assumption implies a progressively large proportion of national income would be saved. Therefore, to achieve and maintain Equilibrium at full employment level of income, increasing proportion op national income is needed to be invested. Otherwise, problem of demand effluent would emerge.

Empirical studies of long-term time’s series data of the US economy for the period 1869-1938 made by noted American economist Kuznets estimated a consumption function which contradicts this data. On the basis of empirical study of time series data of the US Kuznets has found that there is proportion relation between consumption and income i.e. the long-run APC is constant and therefore MPC =APC in the long run consumption function and the two remain constant . As this is contrary to Keynes theory of consumption function, this became a puzzle for the economists.

An American economist J.S Duisenberg put forward the theory of consumer behavior which is called Relative Income Hypothesis. According to this theory, consumption of an individual is not the function of his absolute income but of his relative position in the income distribution in a society.

Relative Income theory of consumption states that, if the proportion of income devoted to consumption of the average family at each income level remains the same as its income increases, the aggregates consumption of the community as proportion of its income will also remain constant though its absolute consumption and absolute savings will increase with the absolute increase in income. This theory also suggests that as income increases consumption function curve shifts above so that average propensity to consume (APC) remains constant.

By emphasizing relative income as determinant of consumption, the relative income hypothesis suggests that individuals try to imitate the consumption levels of their neighbors in a particular community. This is called Demonstration effect or Duisenberg effect. Two things follow from this. First, the APC does not fall. Secondly, a family with a given income would devote more of his income to consumption at its living in a community in which that income regarded as relatively low because of the working of demonstration effect.

Duisenberg’s relative income hypothesis suggests that when income of individuals falls, their consumption expenditure does not fall much. This is often called a ratchet effect. This is partly due to the fact that they become accustomed to their previous higher level of consumption and it is quite hard and difficult to reduce their consumption expenditure when their income has fallen. They are able to maintain their consumption level by reducing their saving.

Life cycle theory of consumption has been put forward by Modigliani and Audi.  According to this theory, the consumption in any period is not the function of current income of that period but of the whole life-time expected income.

Assumptions:

Life cycle hypothec is has been depicted in the following figure.

Here, working age = (65years-15years) =50years.

Expected life-time=75years.

Disserving before the age of 15 years =Change in ACY.

Disserving before the age of 65 years=Change in BCY.

Total disserving = Change in ACY + Change in BCY.

Total saving =Change in AHB.

Income line=YY

Consumption curve = CC, which is slightly increasing as the individual grows old.

 In the figure, horizontal axis measures the life-time of the individual axis measures the income and consumption. In is assumed that our individual enters into labor force (i.e. working life) at the age of 15 years and up to the age of 28 years his income is less than his consumption. To finance his excess consumption over his income, he may be borrowing from other. Beyond the age of 28 years and up to the age of 65 years his income exceeds his consumption. With these saving (i.e. income is greater than consumption) he will build up assets or wealth.

He many uses savings or wealth to pay off his debt incurred by him in the early stage of his working life .Another  important motive is to provide for his consumption after retirement when his income drops below his level of consumption.

Permanent Income Theory of consumption has been put forward by Milton Friedman. According to Friedman consumption is deter mind by long-term expected income rather than currant level of income. And Friedman defined long term expected income as permanent income on the basis of which people make their consumption plants.

Relationship between consumption and permanent Income:

Friedman thinks that consumption is proportional toper anent income, i.e.

cP = kyP----------------1

Where, yP stand for permanent income cP stands for permanent consumption and k stand for the proportion of permanent income that is consumed.

In addition to permanent income, the individual’s income may contain a transitory component which have not much effect on consumption,

yM = yP+yT--------------2

Where, yM stands for (current) measured income in a period, yP stands for permanent Income and yT stand for trausitory income.

Here, permanent income can be measured as under,

yP=yt-1+a(yt-yt-1)-----------3

yP=yt-1+ayt-ayt-1

yP=ayt+(i-a)yt-1-----------4

Where a is a proportion of change in income between the last year (t-1) and the current year(t), yt is the level of income in current year and yt-1 is the last year’s income.

Now, we can describe the precise relationship between consumption and income both in the shortrun and the long- run as under,

C=kyP

C=k[ayt+(1-a)yt-1]

C=kayt+k (1-a)yt-1-------5

Where ka is the marginal propensity to consume in the short run and k(1-a)yt-1 is the intercept of the short run consumption function. This is illustrated in the following figure:

It shall be seen in this figure that permanent consumption function is represented by the long run consumption function curve cLR. This consumption function shows the proportional relationship between consumption and income and is a straight line passing through the origin which implies that APC is constant and is equal to MPC. It will also be seen that short run consumption function curves are flatter as compared to the long run consumption function curve indicating that the short run MPC is lower than run MPC.