Unit 5: National Income Notes for MBA & BBA Student

National Income

National income is the total money earned by everyone in a country over a year, including wages, profits, rents, and taxes.

National income includes all the income generated in a country, such as wages, profits, rents, and taxes (minus subsidies). It reflects how much money is circulating in the economy.

National income can be measured in three main ways:

1. Production Approach: Calculates the total value of goods and services produced in the country.
2. Income Approach: Adds up all the incomes earned by individuals and businesses.
3. Expenditure Approach: Sums up all spending on goods and services in the economy.

Importance in Managerial Economics:

• Understanding Market Size: National income helps businesses understand the potential market size for their products or services. A higher national income typically means more spending power among consumers.
• Economic Planning: Managers can use national income data to forecast future sales and plan production accordingly. This helps in resource allocation and budgeting.
• Policy Impact: Changes in national income can indicate economic health. For example, rising national income might lead to more investment opportunities, while falling income could suggest economic trouble

Real vs. Nominal National Income:

• Nominal National Income: Measured at current market prices, without adjusting for inflation.
• Real National Income: Adjusted for inflation, providing a more accurate picture of economic growth and purchasing power over time.

Various Methods of Measuring National Income

National income can be measured using three main approaches:

1. Production Approach (Value Added Method):

• This method calculates national income by adding up the value added at each stage of production for all goods and services produced within the country.
• Calculation:

$$\text{<b><span style="color: red;">National Income</span></b>}<b><span\; style="color:\; red;">=</span></b>\text{<b><span style="color: red;">Gross Value of Output</span></b>}<b><span\; style="color:\; red;">-</span></b>\text{<b><span style="color: red;">Value of Intermediate Consumption</span></b>}$$

• Example: If a company produces furniture, the value it adds (i.e., the sales revenue minus the cost of raw materials) is included in the national income.

2. Income Approach:

• This method sums up all incomes earned by factors of production within a nation. It includes wages, rents, interests, and profits.
• Calculation:

$$\text{<b><span style="color: \#ffa400;">National Income</span></b>}<b><span\; style="color:\; \#ffa400;">=</span></b>\text{<b><span style="color: \#ffa400;">Wages</span></b>}<b><span\; style="color:\; \#ffa400;">+</span></b>\text{<b><span style="color: \#ffa400;">Rent</span></b>}<b><span\; style="color:\; \#ffa400;">+</span></b>\text{<b><span style="color: \#ffa400;">Interest</span></b>}<b><span\; style="color:\; \#ffa400;">+</span></b>\text{<b><span style="color: \#ffa400;">Profits</span></b>}<b><span\; style="color:\; \#ffa400;">+</span></b>\text{<b><span style="color: \#ffa400;">Taxes (minus subsidies)</span></b>}$$

• Example: If workers earn wages, landlords receive rent, and businesses make profits, all these incomes are added to determine national income.

3. Expenditure Approach:

• This method calculates national income by adding up all expenditures made on final goods and services within the economy.
• Calculation:

$$\text{<b><span style="color: \#783f04;">National Income</span></b>}<b><span\; style="color:\; \#783f04;">=</span></b>\mathrm{<b><span\; style="color:\; \#783f04;">C</span></b>}<b><span\; style="color:\; \#783f04;">+</span></b>\mathrm{<b><span\; style="color:\; \#783f04;">I</span></b>}<b><span\; style="color:\; \#783f04;">+</span></b>\mathrm{<b><span\; style="color:\; \#783f04;">G</span></b>}<b><span\; style="color:\; \#783f04;">+</span></b><b><span\; style="color:\; \#783f04;">(</span></b>\mathrm{<b><span\; style="color:\; \#783f04;">X</span></b>}<b><span\; style="color:\; \#783f04;">-</span></b>\mathrm{<b><span\; style="color:\; \#783f04;">M</span></b>}<b><span\; style="color:\; \#783f04;">)</span></b>$$

 where,

C = Consumption expenditure by households
I = Investment expenditure by businesses
G= Government spending on goods and services
X = Exports of goods and services
M = Imports of goods and services

• Example: If households spend money on food, businesses invest in machinery, the government builds roads, and the trade balance is accounted for, all these expenditures contribute to national income.

Concept of National Income

National income is a fundamental economic indicator that measures the total income earned by a nation’s residents and businesses over a specific period, usually a year. It serves as a crucial metric for assessing the economic performance and overall health of a country. Here are key aspects of the concept:

Gross Domestic Product (GDP)

Gross Domestic Product (GDP) is the total monetary value of all goods and services produced within a country's borders in a specific period, typically measured annually or quarterly. It represents the economic activity and output of a nation and is commonly used to assess the overall health of an economy.

GDP (MP)

Gross Domestic Product (GDP) at Market Prices is a key indicator used to measure the economic performance of a country. It reflects the total monetary value of all final goods and services produced within a nation's borders over a specified period, usually a year. The term "market prices" indicates that the values are based on the prices at which goods and services are sold in the market, including taxes and excluding subsidies.

GDP at Market Prices Formula

The formula to calculate GDP at market prices is:

$$\text{<b>GDP</b>}<b>=</b>\mathrm{<b>C</b>}<b>+</b>\mathrm{<b>I</b>}<b>+</b>\mathrm{<b>G</b>}<b>+</b><b>(</b>\mathrm{<b>X</b>}<b>-</b>\mathrm{<b>M</b>}<b>)</b>$$

Where:

C = Consumption Expenditure: The total spending by households on goods and services.
I = Investment Expenditure: The total spending on capital goods that will be used for future production.
G = Government Spending: The total expenditure by the government on goods and services.
X = Exports: The value of goods and services produced domestically and sold abroad.
M = Imports: The value of goods and services produced abroad and purchased domestically.

Example of GDP Calculation

Let’s consider an example to illustrate the calculation of GDP at market prices.

Example Data:

Consumption (C): $800 billion (spending by households on goods and services)
Investment (I): $300 billion (spending by businesses on capital goods)
Government Spending (G): $200 billion (government expenditure on infrastructure, defense, etc.)
Exports (X): $150 billion (value of goods and services sold to other countries)
Imports (M): $100 billion (value of goods and services purchased from other countries)

Step-by-Step Calculation:

Identify the Components:

Consumption (C) = $800 billion
Investment (I) = $300 billion
Government Spending (G) = $200 billion
Exports (X) = $150 billion
Imports (M) = $100 billion

1. Apply the GDP Formula:

$$\text{GDP}=C+I+G+(X-M)$$

Substituting the values:

$$\text{GDP}=800+300+200+(150-100)$$

2. Perform the Calculation:

• Calculate net exports (X - M): $$X-M=150-100=50$$
• Now substitute back into the formula: $$\text{GDP}=800+300+200+50$$

3. Final Calculation:

$$\text{GDP}=800+300+200+50=1350\text{ billion}$$

Conclusion

In this example, the GDP at market prices for the country is $1,350 billion. This figure represents the total monetary value of all final goods and services produced within the country during the specified period, reflecting the overall economic activity.

GDP at market prices is essential for understanding the economic health of a nation, guiding policy decisions, and making comparisons with other countries or over time.

GDP(FP)

Gross Domestic Product (GDP) at Factor Prices is another important measure of a country’s economic performance. Unlike GDP at market prices, which measures the total value of goods and services based on market transactions, GDP at factor prices reflects the total income earned by the factors of production (labor, capital, land, and entrepreneurship) within a country, excluding indirect taxes and subsidies.

Formula for GDP at Factor Prices

The formula to calculate GDP at factor prices is:

$$\text{<b>GDP at Factor Prices</b>}<b>=</b>\mathrm{<b>C</b>}<b>+</b>\mathrm{<b>I</b>}<b>+</b>\mathrm{<b>G</b>}<b>+</b><b>(</b>\mathrm{<b>X</b>}<b>-</b>\mathrm{<b>M</b>}<b>)</b><b>-</b>\text{<b>Indirect Taxes</b>}<b>+</b>\text{<b>Subsidies</b>}\text{<br>}$$

Where:

C = Consumption Expenditure: The total spending by households on goods and services.
I = Investment Expenditure: The total spending on capital goods that will be used for future production.
G = Government Spending: The total expenditure by the government on goods and services.
X = Exports: The value of goods and services produced domestically and sold abroad.
M = Imports: The value of goods and services produced abroad and purchased domestically.
Indirect Taxes: Taxes imposed on goods and services, which are included in market prices but not in factor prices.
Subsidies: Financial assistance provided by the government to reduce the cost of production, which is deducted from market prices.

Example of GDP at Factor Prices Calculation

Let’s consider an example to illustrate the calculation of GDP at factor prices.

Example Data:

Consumption (C): $800 billion
Investment (I): $300 billion
Government Spending (G): $200 billion
Exports (X): $150 billion
Imports (M): $100 billion
Indirect Taxes: $50 billion (e.g., sales tax, VAT)
Subsidies: $20 billion

Step-by-Step Calculation:

Identify the Components:

Consumption (C) = $800 billion
Investment (I) = $300 billion
Government Spending (G) = $200 billion
Exports (X) = $150 billion
Imports (M) = $100 billion
Indirect Taxes = $50 billion
Subsidies = $20 billion

1. Apply the GDP at Factor Prices Formula:

GDP at Factor Prices=C + I + G + (X−M) − Indirect Taxes + Subsidies

Substitute the values:

GDP at Factor Prices = 800 + 300 + 200 + (150 − 100) − 50 + 20

2. Perform the Calculation:

Calculate net exports (X - M):

X − M = 150 − 100 = 5

Now substitute back into the formula:

GDP at Factor Prices = 800 + 300 + 200 + 50 − 50 + 20

3. Final Calculation:

GDP at Factor Prices = 800 + 300 + 200 + 50 − 50 + 20 = 1320 billion

Conclusion

In this example, the GDP at factor prices for the country is $1,320 billion. This measure reflects the total income generated by the factors of production in the economy.

Key Differences Between GDP at Market Prices and GDP at Factor Prices

1. Inclusion of Taxes and Subsidies:

• GDP at market prices includes indirect taxes and excludes subsidies.
• GDP at factor prices excludes indirect taxes and includes subsidies.

2. Focus:

• GDP at market prices focuses on the total value of output.
• GDP at factor prices focuses on the income earned by the factors of production.

Gross National Product (GNP)

Gross National Product (GNP) is another important economic indicator, similar to Gross Domestic Product (GDP), but with a key distinction. GNP measures the total economic output produced by the residents of a country, regardless of where that production takes place. This means it includes the income earned by residents from investments abroad and excludes the income earned by foreign residents within the country.

GNP at Market Prices (GNP MP)

GNP at Market Prices (GNP MP) represents the total monetary value of all final goods and services produced by the residents of a country at current market prices. It includes indirect taxes and excludes subsidies.

Formula:

The formula for calculating GNP at market prices is:

$$$$GNP MP=GDP MP+Net Income from Abroad

Where:

• GDP MP = Gross Domestic Product at Market Prices
• Net Income from Abroad = Income earned by residents from investments abroad minus income earned by foreign residents from investments within the country.

Example:

Let’s assume:

• GDP MP = $1,200 billion
• Net Income from Abroad = $50 billion

Using the formula:

$$\text{GNP MP}=1200+50=1250\text{ billion}$$

So, GNP at Market Prices would be $1,250 billion.

GNP at Factor Prices (GNP FP)

GNP at Factor Prices (GNP FP) represents the total income earned by the factors of production (labor, capital, land, and entrepreneurship) owned by residents of a country, measured at factor prices.

Formula:

The formula for calculating GNP at factor prices is:

$$\text{GNP FP}=\text{GDP FP}+\text{Net Income from Abroad}$$

Where:

• GDP FP = Gross Domestic Product at Factor Prices
• Net Income from Abroad = Income earned by residents from investments abroad minus income earned by foreign residents from investments within the country.

Example:

Let’s assume:

• GDP FP = $1,100 billion
• Net Income from Abroad = $50 billion

Using the formula:

$$\text{GNP FP}=1100+50=1150\text{ billion}$$

So, GNP at Factor Prices would be $1,150 billion.

Key Differences Between GNP MP and GNP FP

1. Measurement:

• GNP MP is measured at market prices and includes indirect taxes and excludes subsidies.
• GNP FP is measured at factor prices, excluding indirect taxes and including subsidies.

2. Focus:

• GNP MP focuses on the total market value of goods and services produced by residents.
• GNP FP focuses on the income generated by factors of production owned by residents.

In Short

• GNP at Market Prices (GNP MP) measures the total value of goods and services produced by residents at market prices.
• GNP at Factor Prices (GNP FP) measures the total income earned by residents from factors of production, adjusted for taxes and subsidies.
• Both GNP measures provide insights into the economic performance and well-being of a nation’s residents, taking into account their earnings from domestic and foreign investments.

Net National Product NNP

Net National Product (NNP) is an important economic measure that represents the total value of all final goods and services produced by the residents of a country, adjusted for depreciation. NNP is derived from Gross National Product (GNP) by subtracting depreciation (also known as capital consumption allowance) from GNP. NNP can be measured at market prices (NNP MP) and at factor cost (NNP FC).

NNP at Market Prices (NNP MP)

NNP at Market Prices (NNP MP) reflects the total value of final goods and services produced by residents of a country, adjusted for depreciation, and measured at current market prices.

Formula:

The formula for calculating NNP at market prices is:

$$\text{NNP MP}=\text{GNP MP}-\text{Depreciation}$$

Where:

• GNP MP = Gross National Product at Market Prices
• Depreciation = The decrease in the value of capital goods over time due to wear and tear, obsolescence, or accidental damage.

Example:

Let’s assume:

• GNP MP = $1,250 billion
• Depreciation = $50 billion

Using the formula:

$$\text{NNP MP}=1250-50=1200\text{ billion}$$

So, NNP at Market Prices would be $1,200 billion.

NNP at Factor Cost (NNP FC)

NNP at Factor Cost (NNP FC) measures the total income earned by the factors of production owned by residents of a country, adjusted for depreciation, and measured at factor costs.

Formula:

The formula for calculating NNP at factor cost is:

$$\text{NNP FC}=\text{GNP FC}-\text{Depreciation}$$

Where:

• GNP FC = Gross National Product at Factor Cost
• Depreciation = The decrease in the value of capital goods over time.

Example:

Let’s assume:

• GNP FC = $1,150 billion
• Depreciation = $50 billion

Using the formula:

$$\text{NNP FC}=1150-50=1100\text{ billion}$$

So, NNP at Factor Cost would be $1,100 billion.

Key Differences Between NNP MP and NNP FC

1. Measurement:

• NNP MP is measured at market prices and includes indirect taxes and excludes subsidies.
• NNP FC is measured at factor cost, excluding indirect taxes and including subsidies

2. Focus:

• NNP MP focuses on the total market value of goods and services produced by residents, adjusted for depreciation.
• NNP FC focuses on the income generated by factors of production owned by residents, adjusted for depreciation.

In Short

• NNP at Market Prices (NNP MP) is the total value of final goods and services produced by residents, adjusted for depreciation and measured at market prices.
• NNP at Factor Cost (NNP FC) is the total income earned by residents from factors of production, adjusted for depreciation and measured at factor costs.
• Both measures of NNP provide insights into the economic performance and well-being of a nation's residents, accounting for the depreciation of capital over time.

Personal Income & Disposal Income

Personal Income (PI) 

Personal Income refers to the total income earned by individuals and households before taxes and other deductions. It includes all types of earnings such as wages, salaries, interest, dividends, rental income, and transfer payments (like pensions, social security benefits, and unemployment benefits).

Personal Income is an important indicator as it reflects the financial well-being of individuals within an economy and their capacity to spend or save.

It can be calculated using the following formula:

$$\text{(PI)}=\text{Wages and Salaries}+\text{Business Income}+\text{Rental Income}+\text{Interest Income}+\text{Dividends}+\text{Transfer Payments}$$

Components of the Formula

1. Wages and Salaries: Total earnings from employment, including bonuses and overtime.
2. Business Income: Profits earned from self-employment or business operations.
3. Rental Income: Money received from renting out property or real estate.
4. Interest Income: Earnings from interest on savings accounts, bonds, or other investments.
5. Dividends: Payments made to shareholders from a corporation's earnings.
6. Transfer Payments: Government payments made to individuals, such as Social Security benefits, unemployment compensation, and welfare payments.

Example Calculation

Let’s calculate Personal Income with some hypothetical numbers:

• Wages and Salaries: $50,000
• Business Income: $10,000
• Rental Income: $5,000
• Interest Income: $1,000
• Dividends: $2,000
• Transfer Payments: $3,000

Using the formula:

$$\text{PI}=50,000+10,000+5,000+1,000+2,000+3,000$$ $$\text{PI}=71,000$$

So, the Personal Income in this example would be $71,000.

Disposable Income

Disposable Income is the amount of income that households have available for spending and saving after paying taxes. It represents the income that can be used for consumption (spending on goods and services) or saving (putting money away for future use).

Formula for Disposable Income

$$\text{Disposable Income}=\text{Personal Income}-\text{Personal Taxes}$$

Where:

• Personal Taxes includes income taxes, property taxes, and any other taxes owed by individuals.

Example of Disposable Income Calculation

Using the previous example, let’s assume the individual pays $15,000 in taxes.

Now, we can calculate Disposable Income as follows:

$$\text{Disposable Income }=71,000-15,000=56,000$$

So, the Disposable Income is $56,000.

Key Differences Between Personal Income and Disposable Income

1. Definition:

• Personal Income is the total income received by individuals and households before taxes.
• Disposable Income is the income remaining after personal taxes have been deducted.

2. Purpose:

• Personal Income reflects the overall earnings of an individual or household, providing insight into financial resources.
• Disposable Income indicates how much money is available for consumption and savings, thus reflecting the financial flexibility of individuals and households.

3. Impact on Economy:

• A higher personal income can indicate economic growth, but it is the disposable income that affects consumer spending and saving behavior, which are crucial for overall economic health.

In Short

• Personal Income includes all earnings before taxes, representing the total financial resources available to individuals.
• Disposable Income is what remains after taxes are paid, reflecting the actual amount available for spending and saving. Understanding both concepts is essential for analyzing the economic well-being of individuals and households.

Per Capita Income (PCI)

Per Capita Income (PCI) is a measure that represents the average income earned per person in a given area, such as a country, region, or community, during a specific period, typically a year. It is used as an indicator of the economic health of a region and provides insights into the living standards and overall wealth of its residents.

Formula for Per Capita Income

The formula for calculating Per Capita Income is:

​

Where:

• Total Income refers to the total income generated within a specified area over a given time period (e.g., Gross Domestic Product (GDP) or Gross National Product (GNP)).
• Population is the total number of people living in that area.

Importance of Per Capita Income

1. Standard of Living: PCI provides insights into the average standard of living in a region. A higher PCI typically indicates a higher standard of living and better quality of life.
2. Economic Growth: Tracking changes in PCI over time can help assess economic growth. An increasing PCI suggests that the economy is growing and that residents are, on average, earning more.
3. Comparative Analysis: PCI allows for comparisons between different regions or countries. It helps in understanding economic disparities and targeting areas that may need development assistance or policy interventions.
4. Policy Making: Policymakers use PCI to design economic policies, assess the impact of economic programs, and allocate resources effectively.

Limitations of Per Capita Income

1. Income Distribution: PCI does not account for how income is distributed among the population. A high PCI may mask significant income inequality within a region.
2. Cost of Living Variations: PCI does not consider variations in the cost of living across different regions. Therefore, it may not accurately reflect the purchasing power of individuals.
3. Non-Monetary Factors: PCI focuses solely on monetary income and does not consider other factors that contribute to well-being, such as health, education, and environment.

In Short

Per Capita Income is a useful economic indicator that provides insights into the average income of individuals in a specific area. While it serves as a valuable tool for assessing economic health and living standards, it should be considered alongside other measures to gain a comprehensive understanding of a region's economic condition.

Income Method

The Income Method is one of the three primary approaches to calculating Gross Domestic Product (GDP), the other two being the Production Method (or Output Method) and the Expenditure Method. The Income Method focuses on measuring GDP by adding up all incomes earned by factors of production within a country over a specified period, usually a year.

Key Components of the Income Method

The Income Method includes several key components of income:

1. Wages and Salaries: The total compensation earned by employees, including bonuses and benefits.

2. Gross Operating Surplus: This includes profits earned by businesses before taxes. It can be further broken down into:

• Corporate Profits: Earnings of corporations.
• Proprietors’ Income: Earnings of self-employed individuals and unincorporated businesses.

3. Rental Income: Income earned from renting out property or real estate.

4. Interest Income: Earnings received from investments, such as savings accounts, bonds, and loans.

5. Taxes on Production and Imports: Indirect taxes, such as sales tax and value-added tax (VAT), that businesses pay to the government, minus any subsidies provided to businesses.

The formula for Calculating GDP Using the Income Method

The formula to calculate GDP using the Income Method can be expressed as:

$$\text{GDP}=\text{Wages and Salaries}+\text{Gross Operating Surplus}+\text{Rental Income}+\text{Interest Income}+\text{Taxes on Production and Imports}-\text{Subsidies}$$

Example Calculation

Let’s assume a hypothetical country has the following income data:

• Wages and Salaries: $600 billion
• Gross Operating Surplus: $300 billion
• Rental Income: $50 billion
• Interest Income: $20 billion
• Taxes on Production and Imports: $40 billion
• Subsidies: $10 billion

Using the formula:

$$\text{GDP}=600+300+50+20+40-10=1,000\text{ billion}$$

So, the GDP using the Income Method would be $1,000 billion.

Advantages of the Income Method

1. Comprehensive: It accounts for all sources of income, providing a complete picture of economic activity.
2. Direct Measurement: It directly measures the income earned by factors of production, aligning closely with the actual economic activity.
3. Useful for Analyzing Distribution: It can be used to analyze income distribution among different factors of production (labor vs. capital).

Disadvantages of the Income Method

1. Data Availability: It relies on accurate and comprehensive data collection on income, which may be difficult in some countries or sectors.
2. Informal Economy: The income method may underreport economic activity in countries with significant informal sectors where incomes are not recorded.
3. Tax Evasion: It may not capture income from tax evasion or unreported income.

In Short

The Income Method is a valuable approach to calculating GDP that provides insights into how income is generated within an economy. By focusing on the earnings of individuals and businesses, it helps to understand the overall economic performance and distribution of income among different factors of production. However, accurate data collection and accounting for informal economic activity are essential for its effectiveness.

Basic and Market Price

Basic Price and Market Price are two important concepts used in economics and national income accounting to measure the value of goods and services. They represent different ways of calculating the price of a product, considering various factors such as taxes, subsidies, and market conditions.

Basic Price

Basic Price refers to the price received by the producer for a good or service, excluding any taxes on the product (like sales tax or value-added tax) and including any subsidies provided to the producer. It represents the price at which the goods and services are sold without any additional costs or government interventions.

Characteristics of Basic Price:

1. Producer’s Perspective: It reflects the income received by producers for their goods and services.
2. Excludes Taxes: Basic price does not include indirect taxes, which means it represents the pure market price from the perspective of the producer.
3. Includes Subsidies: Any subsidies received by producers are included in the basic price.

Example:

If a manufacturer sells a product for $100 and receives a subsidy of $10, the basic price is:

$$\text{Basic Price}=\text{Selling Price}+\text{Subsidy}=100+10=110$$

Market Price

Market Price is the price that consumers pay for a good or service, which includes taxes but excludes subsidies. It reflects the actual price observed in the marketplace, taking into account all market conditions.

Characteristics of Market Price:

1. Consumer’s Perspective: It represents the price that consumers pay, including all additional costs.
2. Includes Taxes: Market price includes any indirect taxes (like sales tax), making it higher than the basic price in many cases.
3. Excludes Subsidies: Market price does not account for subsidies received by producers.

Example:

Using the same manufacturer, if the selling price is $100 and there is a sales tax of $15, the market price is:

$$\text{Market Price}=\text{Selling Price}+\text{Tax}=100+15=115$$

Basic Price and Market Price are two important concepts used in economics and national income accounting to measure the value of goods and services. They represent different ways of calculating the price of a product, considering various factors such as taxes, subsidies, and market conditions.

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Basic Price

Basic Price refers to the price received by the producer for a good or service, excluding any taxes on the product (like sales tax or value-added tax) and including any subsidies provided to the producer. It represents the price at which the goods and services are sold without any additional costs or government interventions.

Characteristics of Basic Price:

1. Producer’s Perspective: It reflects the income received by producers for their goods and services.
2. Excludes Taxes: Basic price does not include indirect taxes, which means it represents the pure market price from the perspective of the producer.
3. Includes Subsidies: Any subsidies received by producers are included in the basic price.

Example:

If a manufacturer sells a product for $100 and receives a subsidy of $10, the basic price is:

$$\text{Basic Price}=\text{Selling Price}+\text{Subsidy}=100+10=110$$

Market Price

Market Price is the price that consumers pay for a good or service, which includes taxes but excludes subsidies. It reflects the actual price observed in the marketplace, taking into account all market conditions.

Characteristics of Market Price:

1. Consumer’s Perspective: It represents the price that consumers pay, including all additional costs.
2. Includes Taxes: Market price includes any indirect taxes (like sales tax), making it higher than the basic price in many cases.
3. Excludes Subsidies: Market price does not account for subsidies received by producers.

Example:

Using the same manufacturer, if the selling price is $100 and there is a sales tax of $15, the market price is:

$$\text{Market Price}=\text{Selling Price}+\text{Tax}=100+15=115$$

Key Differences Between Basic Price and Market Price

In Short

• Basic Price reflects the price received by producers, excluding taxes and including subsidies. It represents the fundamental economic value of a good or service.
• Market Price reflects the actual price consumers pay, including taxes and excluding subsidies. It captures the real-world transaction price in the marketplace.

Circular flow in 2 Sector 

Two-Sector Economy (Households and Firms)

In a simple economy, there are only two sectors:

• Households (people who work and consume)
• Firms (businesses that produce goods and services)

How it works:

• Households provide labor to firms, and in return, they receive wages (income).
• Households then use that income to buy goods and services produced by firms. This creates a flow of money.
• The firms use the money from selling goods to pay workers again, and the cycle continues.

This is called a circular flow because money circulates between households and firms.

Circular flow in 3 Sector

Three-Sector Economy (Households, Firms, and Government)

In reality, there is also a government involved in the economy.

How it works:

• Households and firms both pay taxes to the government.
• The government spends money on services (like infrastructure, education) which benefits both households and firms.
• The government also provides subsidies or funding to firms to help them grow.

Circular flow in 4 sector 

Four-Sector Economy (Households, Firms, Government, and Foreign Sector)

In a more open economy, there is also a foreign sector involved.

How it works:

• Households and firms not only trade within the country but also import goods and services from other countries and export goods to them.
• This creates an additional flow of money between the domestic economy and the rest of the world.

Inflation

Inflation is the increase in prices of goods and services over time, which means the purchasing power of money decreases. For example, if a candy bar costs ₹10 today and ₹12 next year, inflation has occurred because you now need more money to buy the same candy bar.

Type of Inflation

There are several types of inflation based on different factors.

1.  Demand-Pull Inflation

• What it is: This happens when demand for goods and services is higher than what the economy can produce. More people want to buy things, but the supply is limited, so prices go up.
• Example: During festival seasons like Diwali, when everyone is shopping for gifts, clothes, and gadgets, prices of these goods increase because the demand is very high.

2. Cost-Push Inflation

• What it is: This happens when the cost to produce goods and services goes up, leading to higher prices for consumers. It’s not about demand but about rising costs for companies.
• Example: If the price of petrol increases, transportation becomes more expensive. As a result, the prices of goods that rely on transport (like vegetables, food items) will also rise.

3. Built-In Inflation (Wage-Price Spiral)

• What it is: This is a cycle where higher wages lead to higher costs for businesses, which in turn raise prices, which causes workers to demand even higher wages. It’s a back-and-forth increase.
• Example: When workers in a company demand higher wages due to rising prices, the company raises the prices of its products to cover the increased wages. This leads to a cycle of rising wages and prices.

4. Hyperinflation

• What it is: Extremely high and out-of-control inflation. Prices rise rapidly and lose value quickly. This usually happens when a country's economy is in severe trouble.
• Example: In 1920s Germany, after World War I, prices increased so rapidly that people had to carry bags of money just to buy bread. A loaf of bread would cost millions of marks.

Causes of Inflation

There are several key causes of inflation:

1. Increase in Demand (Demand-Pull):

• When too many people want to buy a limited amount of goods, prices rise.
• Example: During a holiday shopping season, prices of popular items increase.

2. Increase in Production Costs (Cost-Push):

• When the cost of raw materials (like oil, metals) increases, businesses raise prices to cover these costs.
• Example: If petrol prices go up, transportation costs rise, and the price of everything that uses transport (like food, and goods) increases.

3.  Money Supply Increase:

• When the government prints more money than the economy can handle, it leads to too much money chasing too few goods, causing prices to rise.
• Example: If a country prints a lot of money without increasing production, the value of the currency falls, leading to higher prices.

4. Wage Increases (Wage-Price Spiral):

• When workers get higher wages, companies often raise prices to cover the higher wage costs. This leads to a cycle of rising prices and wages.
• Example: Workers demand a raise, and companies raise prices to pay them, leading to more inflation.

A business cycle refers to the ups and downs (fluctuations) in an economy over time. It shows how an economy expands (grows) and contracts (shrinks) in a repeating pattern.

Phases of the Business Cycle:

1. Expansion (Growth):

• This is when the economy is doing well.
• Businesses are making money, more jobs are available, and people have more money to spend.
• Think of it as the "good times" when everything is moving up.

2. Peak:

• This is the highest point of growth.
• The economy has grown as much as it can at this stage.
• It's like reaching the top of a mountain.

3. Contraction (Recession):

• After reaching the peak, the economy starts to slow down.
• Businesses make less money, some people may lose jobs, and spending decreases.
• This is the "bad times" or downward movement.

4. Trough:

• This is the lowest point of the cycle.
• The economy hits rock bottom and can’t shrink much further.
• It’s like being at the base of the mountain, but now things can only get better.

5. Recovery:

• After the trough, the economy starts growing again.
• Businesses start making more money, and people get their jobs back.
• It’s the journey back up the mountain, toward expansion.

Here’s the graph representing the business cycle and its phases: Expansion, Peak, Contraction (Recession), and Trough.

To summarize:

• Expansion: The economy is growing.
• Peak: The highest point of growth.
• Contraction: The economy is shrinking.
• Trough: The lowest point before recovery.