National Income

National income of a country cab be defined as the total market value of all final goods and services produced in the economy in a year. The concept of national income has three interpretations: The sum of values of all final good and services produced The sum of all incomes, in cash and kind accruing to the factors of production in a year The sum of consumers expenditures, net investment expenditure and government expenditure on goods and services

The Components of the Macroeconomy

Everyones expenditure is someone elses receipt. Every transaction must have two sides.

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Concepts of national income

Gross national product (GNP): total market value of all final goods and services produced in a country in a year GNP=C + I + G + + (X-M) + NFIA Gross domestic product (GDP): it is the money value of all final goods services produced by normal residents in the domestic territory of a country GDP=C + I + G + + (X-M) The difference between GDP and GNP at market prices arises due to existence net factor income from abroad

Contd..
NIFA less depreciation Groos Private investment Net exports Govt. purhases Consumption GNP Groos Private net private investment invesment Net exports Net exports profits Govt. purhasesGovt. purhases interest Consumption Consumption GDP NDPmp Rent NDPfc Less net indirect taxes Wages

Contd..
Net national product or National income at market prices: GNP Depreciation National income or National income at factor cost : National income at market pricesIndirect taxes + Subsidies Personal Income: It is the sum of all incomes received by all individuals or households during a given year

Contd..
Disposable income: Personal income-Taxes DI= Consumption + Saving

Measurement of national income

Production method: In this method, the total value of final goods and services produced in a country during a year is calculated at the market prices. Income method: In this method, the net income payments received by all the citizens of the country in a particular year are added up. Expenditure method: In this method, the total expenditure incurred by all the citizens in a particular year is added together

Difficulties in measurement of NI
Treatment of non-monetary transactions Treatment of income generated by foreign firms

Nominal GDP Vs real GDP

Aggregate Supply and Aggregate Demand

Aggregate demand is the total demand for goods and services in an economy.
Aggregate supply is the total supply of goods and services in an economy.

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Consumption function
Y = C+I (S) Individual consumption depends on disposable income, C= f (Y) Relationship between income and consumption Average propensity to consume is the ratio of amount of consumption to total income, APC=C/Y MPC is defined as the ratio of consumption changes to income changes, MPC=dC/dY C= bY (long run), C= a + bY (short run)

Savings Function
Yd= C+S Relationship between income and savings APS is the proportion of disposable income that is saved, APS= S/Y APS will increase as income rises MPS is defined as the ratio of changes in savings to the changes in disposable income, MPS=dS/dY C+S =Y APC+APS=1 Since additional income is either consumed or saved,MPC+MPS=1

Investment function
Investment involves the acquisition of capital goods designed to provide us with consumer goods and services in the future Various types of investment : Gross investment: it is the total value of productive assets created during a given period Net investment: it is the gross investment and depreciation

Contd..
Private and public investment Autonomous and inducted investment AI is the investment when the income is inelastic Induced investment is one that takes place due to various factors such as higher expected rate of return, increase in demand for capital goods. Acc. to Keynes, induced investment depends on two factors, i) Marginal Efficiency of capital and ii) rate of interest MEC is defined as the expected rate of return on investment Supply price of the asset is called rate of interest

Credit creation
The act of lending and borrowing created both credit and bebit Debt means the obligation to pay the money which is borrowed Credit means the claim to receive the money from other party Creation of credit is a special type of exchange transaction which involves future payment of the principle sum borrowed as well as the rate of interest on it.

Contd..
Balance sheet of a bank of great importance for understanding the sources of funds it possess and the uses to which these funds are put. Liabilities of a bank shows the sources of its funds and assets shows its uses by it

Credit creation
Cash Bank A- Balance sheet Assets Liabilities 100000 Deposits 100000 When the bank sanctions loan of Rs. 80000 but before loan is cashed Bank A- Balance sheet Assets Liabilities Cash 100000 Deposits 100000 New deposits Loan 80000 (created) 80000 Total 180000 Total 180000 After the whole newly created deposits withdrawn Bank A- Balance sheet Assets Liabilities Cash 20000 original Deposits 100000 New deposits Loan 80000 (created) 0 Total 10000 Total 100000

Contd..
Cash Bank B- Balance sheet Assets Liabilities 80000 Deposits 80000 When the bank sanctions loan of Rs. 64000 but before loan is cashed Bank B- Balance sheet Assets Liabilities Cash 80000 Deposits 80000 New deposits 64000 (created) 144000 Total

Loan Total

64000 144000

After the whole newly created deposits withdrawn Bank B- Balance sheet Assets Liabilities Cash 16000 original Deposits 80000 New deposits 64000 (created) 80000 Total

Loan Total

0 80000

Bank C
Assets Cash Rs. 64,000 Liabilities Deposits Rs. 64,000

Loan
Total

Rs. 51,200
Rs. 115,200

New deposits
Total

51,200
Rs. 115,200

Bank D
Assets Cash Loan Total Rs. 51,200 Rs. 40,960 Rs. 92,160 Liabilities Deposits New deposits Total Rs. 51,200 40,960 Rs. 92,160

Credit created by commercial banks = 1,00,000 + 80,000 + 64,000 + 51,200 + . = Rs. 5,00,000 Since CRR = Rs. 1,00,000 Deposits created by the banking system 5,00,000 1,00,000 = 4,00,000

Bank A

Bank B

Bank C

Bank D

Cash Deposits

Rs. 1,00,000

Rs. 80,000

Rs. 64,000

Rs. 51,200

Required Deposits

Rs. 20,000

Rs. 16,000

Rs. 12,800

Rs. 10,200

Excess Deposits

Rs. 80,000

Rs. 64,000

Rs. 51,200

Rs. 40,960

Deposits created

Rs. 80,000

Rs. 64,000

Rs. 51,200

Rs. 40,960

Contd..
Total expansion of deposits by the banking system depends upon the cash reserve ratio. The smaller the cash reserve ratio the larger the expansion of deposits or credit. The deposits in the banking system leads to multiple expansion in the total deposits. This is known as deposit multiplier. The magnitude of dm depends on the CRR dm= 1/r, when CRR is 20% i.e. 0.20 or 1/5, the deposit multiplier is 1/1/5=5

Limitations of credit control

Cash reserve ratio The habit of the people regarding the use of cash The amount of money which the public choose to hold as deposits in the banks

Methods of credit conrol

Volume and direction of bank credit has an important bearing on the level of economic activity. Excessive credit will tend to generate inflationary pressures in the economy, while deficiency of credit may tend to cause depression. At times of depression, there is a need to expand credit and times of booms there is need to contract the credit. In order to maintain economic stability, central bank seeks to control credit in accordance with the needs of sitation.

Contd..
Broadly, there are two types of methods of controlling the credit. Quantitative methods: aims at changing the total quantity of credit in general Qualitative or selective control methods: aims at changing the specific volume of credit

Quantitative methods
Bank rate policy : The rate at which the central bank of a country lends money to the commercial banks of the country When the central bank rises the bank rate, the cost of borrowing by Commercial banks from the central bank would rise. This would discourage commercial banks to borrow from the central bank When the bank rate is raised, the commercial banks also rise their lending rates(rate of interest) The reduction of money supply leads to reduction of aggregate demand finally leads to check inflation

Contd
Limitations of bank rate policy: bank rate policy does not have always the desired effects If the commercial banks have considerable reserves of their own at their disposal and therefore, their dependence on borrowed funds from the central bank will be less The responsiveness of businessman to the changes in the lending rates of interest

Contd..
Open market operations: means the purchase and sale of securities by the central bank the sale of securities by the central leads to the contraction of the credit and the purchase of securities to credit expansion OMO method is sometimes adopted to make the bank rate policy effective If the commercial bank do not raise lending rates following the rise in the bank rate due to surplus funds available to them, the central bank can withdrawn the surplus funds by the sale of securities and thus compel the CB to raise their lending rates

Contd..
Limitations: The sale of securities may be offset by return of notes from the circulation and hoards The bank will expand and contract the credit based on the economic and political circumstances For success of open market operations active financial market In view of the excessive limits banks are willing to invest in Govt. securities

Contd..
Change in cash reserve ratio (CRR): by law, banks have to keep a certain amount of cash money with themselves as reserves against the deposits
Selective credit controls: Changes in minimum margin for lending by banks against the stocks of specific goods Fixation of maximum limit or ceiling on advances to individual borrowers against the stock of particular sensitive commodities

Latest statistics
Bank Rate- 9% w.e.f 17.04.2012 Decreased from 9.50% to 9.00% which was continuing since 13/02/2012 CRR:4.75% (w.e.f 10/03/2012) Decreased from 5.50%which was continuing since 24/01/2012 CRR cut by 25 bps (CRR reduced from 4.75% to 4.50% wef 22/09/2012). Statutory Liquidity Ratio (SLR):23%(w.e.f. 11/08/2012), Decreased from 24% which was continuing since 18/12/2010 Repo Rate:8.00% (w.e.f.17/04/2012), Decreased from 8.50% which was continuing since 25/10/2011 Reverse Repo Rate:7.00% (w.e.f.17/04/2012), Decreased from 7.50% which was continuing since 25/10/2011