Understanding National Income and Economic Cycles

Posted on May 17, 2024 in Economy

Causes of Recession

An economic dip, as measured as a decline in GDP, must occur for two or more successive quarters to qualify as an official recession.

Loss of Confidence in Investment and the Economy: Loss of confidence prompts consumers to stop buying and move into defensive mode. Panic sets in when a critical mass moves toward the exit. Businesses run fewer employment ads, and the economy adds fewer jobs. Retail sales slow. Manufacturers cut back in reaction to falling orders, so the unemployment rate rises. The federal government and the central bank must step in to restore confidence.

Falling Housing Prices and Sales: Homeowners can be forced to cut back on spending when they lose equity and can no longer take out second mortgages. This was the initial trigger that set off the Great Recession of 2008. Banks eventually lost money on complicated investments that were based on underlying home values, which were in decline.

Manufacturing Orders Slow Down: One predictor of a recession is a decline in manufacturing orders. Orders for durable goods began falling in October 2006, long before the 2008 recession hit.

Deflation: Prices falling over time have a worse effect on the economy than inflation. Deflation reduces the value of goods and services being sold on the market, which encourages people to wait to buy until prices are lower. Demand falls, causing a recession. Deflation caused by trade wars aggravated

Causes of Economic Booms

Expansionary monetary policy: If the economy is growing close to the long-run trend rate and monetary policy is loosened (cut in interest rates). This will further increase demand in the economy. The lower costs of borrowing will encourage investment and consumer spending. This will cause a further rise in aggregate demand. Lower interest rates will also make it more attractive to take out a mortgage and buy a house.

Expansionary fiscal policy: If the economy is getting close to full capacity and the government cut taxes – financed by higher borrowing, then this will have the effect of boosting consumer spending and aggregate demand.

Confidence: If consumers and firms are confident – then they are more likely to borrow to finance investment and spending. This can cause a fall in the savings ratio and encourage a higher percentage of income to be spent.

CONCEPTS OF NATIONAL INCOME National income is the money value of all goods and services produced by a country during a period of one year. National income consists of a collection of different types of goods and services of different types. The main concepts of National Income are: GDP, GNP, NNP, NI, PI, DI, and PCI. These different concepts explain about the phenomenon of economic activities of the various sectors of the economy. Gross Domestic Product (GDP) The most important concept of national income is Gross Domestic Product. Gross domestic product is the money value of all final goods and services produced within the domestic territory of a country during a year. Algebraic expression under product method is, GDP=(P*Q) where, GDP=Gross Domestic Product P=Price of goods and service Q=Quantity of goods and service According to expenditure approach, GDP is the sum of consumption, investment, government expenditure, net foreign exports of a country during a year. GDP includes the following types of final goods and services. They are:

Gross National Product (GNP) Gross National Product is the total market value of all final goods and services produced annually in a country plus net factor income from abroad. Thus, GNP is the total measure of the flow of goods and services at market value resulting from current production during a year in a country including net factor income from abroad. The GNP can be expressed as the following equation: GNP=GDP+NFIA (Net Factor Income from Abroad) or, GNP=C+I+G+(X-M)+NFIA Hence, GNP includes the following: Consumer goods and services. Gross private domestic investment in capital goods. Government expenditure. Net exports (exports-imports). Net factor income from abroad. Net National Product (NNP) Net National Product is the market value of all final goods and services after allowing for depreciation. It is also called National Income at market price. When charges for depreciation are deducted from the gross national product, we get it. Thus, NNP=GNP-Depreciation or, NNP=C+I+G+(X-M)+NFIA-Depreciation

Measurement of National Income – Income Method

Estimated by adding all the factors of production (rent, wages, interest, profit) and the mixed-income of self-employed.

1. In India, one-third of people are self-employed.
2. This is the ‘domestic’ income, related to the production within the borders of the country

Measurement of National Income – Production Method

Estimated by adding the value added by all the firms.

Value-added = Value of Output – Value of (non-factor) inputs

1. This gives GDP at Market Price (MP) – because it includes depreciation (therefore ‘gross’) and taxes (therefore ‘market price’)
2. To reach National Income (that is, NNP at FC)
   • Add Net Factor Income from Abroad: GNP at MP = GDP at MP + NFIA
   • Subtract Depreciation: NNP at MP = GNP at MP – Dep
   • Subtract Net Indirect Taxes: NNP at FC = NNP at MP – NIT

Measurement of National Income – Expenditure Method

The expenditure method to measure national income can be understood by the equation given below:

Y = C + I + G + (X-M),

where Y = GDP at MP, C = Private Sector’s Expenditure on final consumer goods, G = Govt’s expenditure on final consumer goods, I = Investment or Capital Formation, X = Exports, I = Imports, X-M = Net Exports

Any of these methods can be used in any of the sectors – the choice of the method depends on the convenience of using that method in a particular sector