Lecture 6 - National Income Determination in Open Economy | Macroeconomics- Learning and Analysis PDF Download

 Page 1


National Income Determination in Open Economy 
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
 
Subject: Macroeconomics 
Lesson: National Income Determination in Open Economy 
Lesson Developer: Priyanka Chaddha 
College/University: Bharati College, University of Delhi 
 
 
 
 
 
 
 
 
 
 
Page 2


National Income Determination in Open Economy 
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
 
Subject: Macroeconomics 
Lesson: National Income Determination in Open Economy 
Lesson Developer: Priyanka Chaddha 
College/University: Bharati College, University of Delhi 
 
 
 
 
 
 
 
 
 
 
National Income Determination in Open Economy 
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
 
Table of Contents  
 Chapter: National Income Determination in an Open Economy 
? 1: Learning Outcomes 
? 2: Introduction to National Income and its Component 
? 3: Open Economy 
? 3.1: Net Export Function  
? 3.2: National Income Determination 
? 3.3: Foreign Trade Multiplier and its Impact 
? Summary 
? Exercise 
? Glossary 
? References 
 
 
1. Learning Outcomes 
 
After studying this topic, you will be able to: 
? explain the meaning of the term National Income, 
? list the various concept of National Income, 
? explain an Open Economy and money flows in it, 
? understand the term Net Export Function, 
? state the use of net export function in national income determination, 
? calculate the national income in an Open Economy, 
? describe Multiplier in Four Sector, 
? state the impact of Foreign Trade Multiplier on National Income. 
 
Page 3


National Income Determination in Open Economy 
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
 
Subject: Macroeconomics 
Lesson: National Income Determination in Open Economy 
Lesson Developer: Priyanka Chaddha 
College/University: Bharati College, University of Delhi 
 
 
 
 
 
 
 
 
 
 
National Income Determination in Open Economy 
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
 
Table of Contents  
 Chapter: National Income Determination in an Open Economy 
? 1: Learning Outcomes 
? 2: Introduction to National Income and its Component 
? 3: Open Economy 
? 3.1: Net Export Function  
? 3.2: National Income Determination 
? 3.3: Foreign Trade Multiplier and its Impact 
? Summary 
? Exercise 
? Glossary 
? References 
 
 
1. Learning Outcomes 
 
After studying this topic, you will be able to: 
? explain the meaning of the term National Income, 
? list the various concept of National Income, 
? explain an Open Economy and money flows in it, 
? understand the term Net Export Function, 
? state the use of net export function in national income determination, 
? calculate the national income in an Open Economy, 
? describe Multiplier in Four Sector, 
? state the impact of Foreign Trade Multiplier on National Income. 
 
National Income Determination in Open Economy 
Institute of Lifelong Learning, University of Delhi 
 
 
2. Introduction to National Income 
The national income of an economy includes the market value of all final 
goods and services produced in an economy in an accounting year. The 
different factor inputs of a country provide their factor services in production 
process and obtain their income either as wages of their labour, or as 
interest on their money capital, or as rent for their land, or as profit for their 
enterprise. The sum of incomes obtained as wages, rent, interest and profits 
is the national income of the country. Thus, the sum of all factor incomes of 
the people of a country is called national income. There are various concepts 
of national income which are as follows: 
Gross Domestic Product (GDP) 
GDP is the market value of all final goods and services produced by normal 
residents as well as non-residents in the domestic territory of a country in a 
year. It includes the market value of only final goods and ignores 
intermediate goods to avoid the problem of double counting i.e. to count all 
goods and services produced in any given year only once. 
GDP= C+I+G+NX 
Where, 
C= Value of final consumer goods and services produced in a year and 
consumed by households. 
I= Purchase of capital goods by Producing sector (Addition to physical stock 
of capital or stock) 
G= Net expenditure made by Government (Government purchase of goods 
and services) 
X-M= Net Exports i.e. the difference between foreign spending on domestic 
goods and domestic spending on foreign goods i.e. 
NX=Exports-Imports 
Gross National Product (GNP) 
Page 4


National Income Determination in Open Economy 
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
 
Subject: Macroeconomics 
Lesson: National Income Determination in Open Economy 
Lesson Developer: Priyanka Chaddha 
College/University: Bharati College, University of Delhi 
 
 
 
 
 
 
 
 
 
 
National Income Determination in Open Economy 
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
 
Table of Contents  
 Chapter: National Income Determination in an Open Economy 
? 1: Learning Outcomes 
? 2: Introduction to National Income and its Component 
? 3: Open Economy 
? 3.1: Net Export Function  
? 3.2: National Income Determination 
? 3.3: Foreign Trade Multiplier and its Impact 
? Summary 
? Exercise 
? Glossary 
? References 
 
 
1. Learning Outcomes 
 
After studying this topic, you will be able to: 
? explain the meaning of the term National Income, 
? list the various concept of National Income, 
? explain an Open Economy and money flows in it, 
? understand the term Net Export Function, 
? state the use of net export function in national income determination, 
? calculate the national income in an Open Economy, 
? describe Multiplier in Four Sector, 
? state the impact of Foreign Trade Multiplier on National Income. 
 
National Income Determination in Open Economy 
Institute of Lifelong Learning, University of Delhi 
 
 
2. Introduction to National Income 
The national income of an economy includes the market value of all final 
goods and services produced in an economy in an accounting year. The 
different factor inputs of a country provide their factor services in production 
process and obtain their income either as wages of their labour, or as 
interest on their money capital, or as rent for their land, or as profit for their 
enterprise. The sum of incomes obtained as wages, rent, interest and profits 
is the national income of the country. Thus, the sum of all factor incomes of 
the people of a country is called national income. There are various concepts 
of national income which are as follows: 
Gross Domestic Product (GDP) 
GDP is the market value of all final goods and services produced by normal 
residents as well as non-residents in the domestic territory of a country in a 
year. It includes the market value of only final goods and ignores 
intermediate goods to avoid the problem of double counting i.e. to count all 
goods and services produced in any given year only once. 
GDP= C+I+G+NX 
Where, 
C= Value of final consumer goods and services produced in a year and 
consumed by households. 
I= Purchase of capital goods by Producing sector (Addition to physical stock 
of capital or stock) 
G= Net expenditure made by Government (Government purchase of goods 
and services) 
X-M= Net Exports i.e. the difference between foreign spending on domestic 
goods and domestic spending on foreign goods i.e. 
NX=Exports-Imports 
Gross National Product (GNP) 
National Income Determination in Open Economy 
Institute of Lifelong Learning, University of Delhi 
It is defined as the total market value of all final goods and services 
produced in a year by normal residents of a country. These residents may be 
national or non national companies having their set up plants in India. 
It is calculated by adding net factor income from abroad in GDP. 
GNP=GDP+NFIA 
Where, 
NFIA is the difference between factor income received from abroad by 
normal residents of India for rendering factor services in other countries and 
the factor incomes paid to the foreign residents for factor services rendered 
by them in the domestic territory of India. 
Net Domestic Product (NDP) 
 The capital goods wear out or fall in value as a result of its consumption or 
use in the production process. This consumption of fixed capital or fall in the 
value of fixed capital due to wear and tear is called depreciation. So this 
depreciation is to be deducted from GDP to get NDP. So NDP is the net 
market value i.e. after providing for depreciation, all final goods and services 
produced by normal residents as well as non-residents in the domestic 
territory of a country in a year. Therefore 
NDP= GDP-Depreciation 
Net National Product (NNP) 
It refers to the market value of goods and services produced by normal 
residents of a country in a year after providing for depreciation. 
It is also known as National income at market price. 
NNP= GNP-Depreciation 
 Or 
NNP= GDP-Depreciation+ NFIA 
Net National Product at Factor Cost (NNP
 fc
) 
Conceptually NNP at MP and NNP at FC are supposed to be identical as value 
of final goods and services at market price is nothing but the sum total of 
Page 5


National Income Determination in Open Economy 
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
 
Subject: Macroeconomics 
Lesson: National Income Determination in Open Economy 
Lesson Developer: Priyanka Chaddha 
College/University: Bharati College, University of Delhi 
 
 
 
 
 
 
 
 
 
 
National Income Determination in Open Economy 
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
 
Table of Contents  
 Chapter: National Income Determination in an Open Economy 
? 1: Learning Outcomes 
? 2: Introduction to National Income and its Component 
? 3: Open Economy 
? 3.1: Net Export Function  
? 3.2: National Income Determination 
? 3.3: Foreign Trade Multiplier and its Impact 
? Summary 
? Exercise 
? Glossary 
? References 
 
 
1. Learning Outcomes 
 
After studying this topic, you will be able to: 
? explain the meaning of the term National Income, 
? list the various concept of National Income, 
? explain an Open Economy and money flows in it, 
? understand the term Net Export Function, 
? state the use of net export function in national income determination, 
? calculate the national income in an Open Economy, 
? describe Multiplier in Four Sector, 
? state the impact of Foreign Trade Multiplier on National Income. 
 
National Income Determination in Open Economy 
Institute of Lifelong Learning, University of Delhi 
 
 
2. Introduction to National Income 
The national income of an economy includes the market value of all final 
goods and services produced in an economy in an accounting year. The 
different factor inputs of a country provide their factor services in production 
process and obtain their income either as wages of their labour, or as 
interest on their money capital, or as rent for their land, or as profit for their 
enterprise. The sum of incomes obtained as wages, rent, interest and profits 
is the national income of the country. Thus, the sum of all factor incomes of 
the people of a country is called national income. There are various concepts 
of national income which are as follows: 
Gross Domestic Product (GDP) 
GDP is the market value of all final goods and services produced by normal 
residents as well as non-residents in the domestic territory of a country in a 
year. It includes the market value of only final goods and ignores 
intermediate goods to avoid the problem of double counting i.e. to count all 
goods and services produced in any given year only once. 
GDP= C+I+G+NX 
Where, 
C= Value of final consumer goods and services produced in a year and 
consumed by households. 
I= Purchase of capital goods by Producing sector (Addition to physical stock 
of capital or stock) 
G= Net expenditure made by Government (Government purchase of goods 
and services) 
X-M= Net Exports i.e. the difference between foreign spending on domestic 
goods and domestic spending on foreign goods i.e. 
NX=Exports-Imports 
Gross National Product (GNP) 
National Income Determination in Open Economy 
Institute of Lifelong Learning, University of Delhi 
It is defined as the total market value of all final goods and services 
produced in a year by normal residents of a country. These residents may be 
national or non national companies having their set up plants in India. 
It is calculated by adding net factor income from abroad in GDP. 
GNP=GDP+NFIA 
Where, 
NFIA is the difference between factor income received from abroad by 
normal residents of India for rendering factor services in other countries and 
the factor incomes paid to the foreign residents for factor services rendered 
by them in the domestic territory of India. 
Net Domestic Product (NDP) 
 The capital goods wear out or fall in value as a result of its consumption or 
use in the production process. This consumption of fixed capital or fall in the 
value of fixed capital due to wear and tear is called depreciation. So this 
depreciation is to be deducted from GDP to get NDP. So NDP is the net 
market value i.e. after providing for depreciation, all final goods and services 
produced by normal residents as well as non-residents in the domestic 
territory of a country in a year. Therefore 
NDP= GDP-Depreciation 
Net National Product (NNP) 
It refers to the market value of goods and services produced by normal 
residents of a country in a year after providing for depreciation. 
It is also known as National income at market price. 
NNP= GNP-Depreciation 
 Or 
NNP= GDP-Depreciation+ NFIA 
Net National Product at Factor Cost (NNP
 fc
) 
Conceptually NNP at MP and NNP at FC are supposed to be identical as value 
of final goods and services at market price is nothing but the sum total of 
National Income Determination in Open Economy 
Institute of Lifelong Learning, University of Delhi 
factor cost involved in their production as production process is the 
combined efforts of various factors of production namely land, labour, capital 
and enterprise. NNP 
fc
 is also called National Income as it is the sum of all 
incomes earned by factors of production for their contribution of land, 
labour, capital and entrepreneurial ability in the year’s net production. It is 
calculated by deducting indirect taxes and adding subsidies to the national 
income at market price as Indirect taxes lead to increase the market price as 
compared to factor cost and subsidies lead to decrease the market price as 
compared to the factor cost. 
NNP
 fc
= NNP
mp
- Net Indirect Taxes 
Net Indirect Taxes= Indirect taxes-Subsidies 
 
 
 
 
 
 
 
GDP
mp
-
Depreciation 
=NDP
mp 
NDPmp+NFIA 
=NNP 
mp 
NNP
mp
-Net 
Indirect Taxes 
=NNP
fc
=National 
Income