NATIONAL INCOME & CIRCULAR FLOW OF INCOME CLASS – XII

National Income It is regarded as the most comprehensive measure of the level of economic activity and index of economic growth of an economy.

What is National Income? It is defined as the value of all final goods and services produced by the normal residents of a country, whether operating within the domestic territory of the country or outside, in a year.

Monetary Expression Money – Common Denominator We can assign monetary value in terms of market prices or in terms of factor costs.

Final Goods & Services These are sold to the final users during the year. Finished goods for final consumption and investment. Final goods and services: Food items, refrigerators etc. – consumption Machines, buildings etc. - Investment

Intermediate Products These are used by the producers as input into a further stage of production. Resold after converting into final goods. Seeds, fertilizers, etc.

To measure NI accurately… All goods and services produced during a year must be counted once, but not more than once. Intermediate products are excluded from NI. i.e. flour mills sell flour to bakeries, and bakeries use this flour in making breads which are sold to households…

Flow NI is a flow concept. It is the flow of goods and services. A flow is a quantity which is measured over a period of time. It tells us how many rupees worth of goods and services are flowing in the economy per unit of time. Conventionally, NI is expressed over one year.

Current Output NI measures the value of currently produced goods and services. Excludes ‘pure exchange transactions’, such as sale and purchase of second hand goods or used goods, purchase and sale of securities and transfer payments. Why? Because, nothing new is produced in the current year.

Current Output What to do with the value of the services of the commission agents involved in the second hand sales? Regarding sale and purchase of financial assets (both old and new) like bonds and shares? Services of the share brokers? Transfer payments like social security payments (pensions, etc.), donations and gifts (unilateral payments).

Normal Residents Those persons who ordinarily reside in a country which they live and whose economic interest lies in that country. May or may not be the citizens of that country, i.e. normal residents include national, as well as foreign nationals. They produce goods and services by selling their factor services to production units located within and outside the domestic territory of a country.

Domestic Territory Geographical or political boundary excluding foreign embassies and international institutions located within the geographical territory, and including the embassies of this country located outside its geographical territory. Domestic product: value o final goods and services + NFI received from abroad NI is not the sum total of personal incomes

Circular Flow of Income Interaction and inter-dependence between various economic activities like production, exchange and consumption is called the circular flow of income. NI is a flow concept. Production give rise to Income which gives rise to Consumption/Expenditure and expenditure gives rise to income again. It goes on continuously and indefinitely in a circular way; it has neither any beginning nor any end.

Circular Flow of Income Thus, CFI is defined as the flow of payments and receipts for goods and services and factor services between different sectors of the economy. Flows: Real Flows Flow of factor services Flow of goods and services Money Flows

THREE PHASES OF CIRCULAR FLOW 2. Income 1. Production 3. Expenditure

Involvement of Different Sectors in Circular Flow 2. The Household Sector 1. The Producing Sector 4. Rest of the World Sector 3. The Government Sector

Households / Resources (Factors of Production) LAND LABOUR ENTREPRENEUR CAPITAL

Circular Flow Model in 2 Sector Economy (Closed Economy) 4 Consumption Expenditure (Money Flow) 3 Goods & Services (Real Flow) Households Producers/ Firms 1 Factor Services (Real Flow) 2 Factor Payments (Money Flow)

2 Sector Model with Savings/Financial System Factor Payments (Money Flow) Goods & Services (Real Flow) Households Producers/ Firms Borrowing for Investment Money / Finance Saving Consumption Expenditure (Money Flow) Factor Services (Real Flow)

The Circular Flow Model in 3 Sector Economy Taxes Taxes Government Expenditure on Goods & Services Transfer Payments Subsidies Borrowing Saving Households Producers Saving Money / Finance Saving Borrowing Borrowing Consumption Expenditure Factor Payments

The Circular Flow Model in 4 Sector Economy (Open Economy) Rest of the World Saving Government Net Transfer Payments Taxes Borrowing Net Factor Payments Transfer Payments Export Receipt Govt. Consumption Expenditure Payments Transfer Import Payment Taxes Households Producers Money / Finance Saving Saving Borrowing Borrowing

Leakages in the Circular Flow Flow Variables which have negative impact on the process of production in the economy. Savings [S] 1 Taxes [T] 2 Imports [M] 3

Injections in the Circular Flow Flow Variables which cause expansion in the process of production in the economy. Investment [I] 1 Govt. Consumption Expenditure [G] 2 3 Exports [X]

The circular flow of income INJECTIONS Export expenditure (X) Government expenditure (G) Investment (I) Factor Payments Consumption of domestically produced goods & services (Cd) BANKS, etc Net saving (S) ABROAD Import expenditure (M) GOV. Net taxes (T) Leakages

Circularity Never Stops… 1. The discovery of new resources 2.Innovative Technology both in the areas of Production and Management

Significance of the Study of Circular Flow of Income Knowledge of Interdependence Identification of Injections & Leakages Estimation of National Income Level and Structure of Economic Activity

Its Quiz Time…. State following sentences whether true of false Economy is broadly classified into two sectors Production refers to ‘Value Addition’ 2-sector model of economy is also known as Open Economy Triplet Identity in circular flow is; Production=Income=Expenditure Money flows are opposite to real flows in circular flow Circularity stops when leakages are there in system

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