Meaning and Features of Marketing

What is marketing? Producers say the activity of production of goods or services is marketing. Sellers say the activity of selling of goods or services is marketing. Similarly, buyers say the activity of purchasing goods or services is marketing. Advertisers say the activity of promoting sale of goods or services by making effective advertisement is marketing. Most of the
general public says the promoting of sale and advertisement is marketing. According to them, promoting sale of goods or services through effective advertisement is called marketing. But any one of these definitions cannot give satisfactory meaning of marketing.

Sale and advertisement are the two activities among many of marketing. Nowadays, marketing is understood not from the old concept ‘Telling and selling’ but it is understood from the concept of ‘Satisfying customers’ needs’. This means the modern concept does not accept the marketing is to collect as much profit as can be by selling goods or services through effective advertisement and influencing customers. The modern concept of marketing gives first priority to customers’ satisfaction. It accepts profit as the gift of customers’ satisfaction.

The age of today is the age of marketing. All types of organizations need marketing to exist and develop. It helps to produce goods or services by identifying wants and needs of customers. So, marketers should at first identify wants of customers and produce goods or services accordingly. Many writers and experts have defined marketing, but some of the important ones are given as follows:
According to William J. Stanton, Michael J. Etzel and Bruce J. Walker, “ Marketing is total system of business activities designed to plan price, promote and distribute want-satisfying products to target market to achieve organizational objectives.”
According to Prof. Philip Kotler and Gray Armstrong, “Marketing is a social and managerial process by which individuals and groups obtain what they need and want through creating and exchanging products and value with others.”
According to American Marketing Association, “Marketing is the process of planning and executing the conception, pricing, promotion and distribution of ideas, goods and services to create exchanges that satisfies individuals and organizational objectives.”
According to Prof. Pyle, “Marketing comprises both buying and selling.”
In conclusion, the whole activity of providing goods or services to satisfy targeted market in order to achieve organizational goal is called marketing. This includes planning, pricing, promoting, selling and distributing. Various activities are included in marketing. All these activities are related to product, price, place and promotion. The activities of marketing satisfy the wants of customers. Besides, the activities help to achieve organizational goal. The above mentioned definitions of marketing have given emphasis to market research and customers’ satisfaction. Marketing conducts its activities by focusing on customers. Different activities such as selection of goods or services, planning, production, development of goods, packaging, labeling, advertisement etc. are performed to satisfy the customers.

Features of Marketing

According to the above mentioned definitions, the features of marketing are as follows:
  1. Satisfying customers’ needs: Marketing begins from human wants, needs and demands. Marketing satisfies customers’ wants, needs etc. by producing goods and supplying them to the customers’ according to their needs, wants and demands.
  2. Helps to achieve organizational goal: Organizations are established and conducted with certain objectives. Marketing helps to achieve such objectives.
  3. Marketing consists of various activities: Marketing consists of various activities. They are related to product, place, price and promotion.
  4. Facilitates exchanges: Giving and taking between buyer and seller is called exchange. Marketing facilitates such exchange. As a result, exchange becomes effective.

Core Concepts of Marketing

The following figure makes the core concept of marketing clear:
Core Marketing Concept

1. Needs, Wants and Demands

Needs

The necessity of something is need. Food is needed when one is hungry; water is needed when one is thirsty. Human needs are of complex nature. When one want is fulfilled, another want is felt. There are different types of human wants, which the human tries to fulfill one after another. They are physical needs (food, shelter, and clothes), security needs (free from fear, security of job etc.), social needs (giving importance by society, involvement in social activities etc.), need ego (respected post, honor, praise etc.) and self actualization needs (creativeness, expectation of challenging task, expectation to take part in decision making etc). Such needs were not found out by marketers. They are basic aspects of human life.

Wants

Expectation of the things for meeting the need is called want. There are various types of wants of human being. Such wants are directly influenced by level of income, family, education, friends, school, personality, life style etc. wants are also affected by religious, cultural and social elements. For example, a hungry Nepalese wants to eat bitten rice, curry, momo, water etc., but a hungry American wants Hamburger, Coke, and French fries etc. Here needs are same but wants are different.

Demands

The want with willingness and ability to pay price of things is called demand. If a poor man wants to buy a car, it is not a demand, because he cannot have ability to pay the price of car even if he was willingness. Similarly, if a rich but miser man wants to buy a car, he does not become ready to pay the bill of the car. So, it is compulsory to the both willingness and ability to pay the price to be a demand.

2. Product

The thing which satisfies human wants and needs is called products. Product may or may not have physical existence. Machines, tools, foods, clothes, etc. have physical existence but service, experience, ideas, personality, etc. have no physical existence. The broad meaning of product includes characters, form, quality, diversity, branding, packaging, color, price, dignity of seller, etc.

3. Value, Satisfaction and Quality

Value: The capacity of the goods to satisfy the want of customers’ as expected is called value. Cost of the goods is taken as the basis to estimate its value. Although wise customers can measure the value and cost of the goods but cannot measure it with accuracy. They select goods on the basis of their perceived value. Value may be in the form of status, image, benefit, beauty, attractiveness, confidence etc.

Satisfaction: The customer feels satisfied from the value of the goods what he/she expects to get from. Satisfied customer becomes brand loyal. He or she tells his friends and neighbors about the value of the goods that full satisfaction can be got from the goods. As a result, advertisement of the goods is done automatically. So, the goods should be produced according to the expectation of the customers to satisfy their wants.

Quality: Customers’ satisfaction depends on the quality of the goods. In the recent years, most of the companies are found to have followed the total quality management – TQM. They are trying to improve the quality of goods, services and the process of marketing. Quality should be looked through customers’ satisfaction not through absence of defects. The quality of goods or services starts from wants of customers and ends in their satisfaction.

4. Exchange, Transaction and Relationship

Exchange: Giving something and taking any other needed thing from others is called exchange. In simple words, the task of giving and taking things to fulfill mutual interest is called exchange. Giving things for things is called barter system and giving money for things is called exchange money. In the ancient marketing (before the invention of money), the whole part of exchange was taken by barter system. But not it has been taken by money-exchange of money. Exchange is the main concept of marketing. The following conditions should be fulfilled to be called exchange:-
  • At least there should be two sides (parties),
  • Each side should have some value/ utility, which each other side should like,
  • Each side should agree to exchange,
  • Each side should be free to accept or reject the proposal of one another side, 
  • Each side should be able to communicate and handover.
Transaction: Trade between two or more sides is called transaction. In other words, the result of exchange is transaction. Transaction can be made in barter system or in money exchange. For example, taking rice by giving any thing is called barter transaction. Taking (buying) a television by giving money is monetary transaction.

Relationship: The transaction taken place between two or more parties/sides establishes relationship among them. A marketer should establish good and long lasting relationship with customers, distributors, dealers and suppliers. There is also a saying – Build good relationship and profitable transactions will follow. So, good relationship should be established with the concerned sides. Confidence should also be given to strengthen such relationship.

5. Markets

The process of buying and selling of goods or services is called markets. Some concepts have been developed about markets. They are: place concept, product concept, area concept, demand concept and exchange concept. Market has been defined on the basis of all these concepts. Goods, buyer, seller, price and area are necessary to be a market.

Incomes Policy

The concept of ‘Incomes Policy’ has gained currency in recent years, especially in developed countries of the west, as a means to fight ‘demand pull’ and ‘cost push’ inflation. The central objective of this policy is to reconcile economic growth and price stability. The price stability is to be ensured by restraining increase in wages and other incomes from outstripping the growth of real national product.

Incomes policy seeks to concentrate on curbing the private consumption expenditure in an effort to reduce the pressure of ‘aggregate demand’ on ‘aggregate supplies’. This concentration on restraining the private consumer expenditure is justified on the ground that out of the important constituents of aggregate effective demand, (private consumption expenditure; government consumption expenditure; investment expenditure in private and public sectors; and the excess of exports of goods and services over their imports in the market) this item is the largest – accounting for about two-thirds to three-fourths in most countries. (In fact, variations from country to country are wide and this is only a rough approximation). In other words, incomes policy implies deliberate intervention by the authorities in gross money incomes from rising excessively in relation to the growth of national output in real terms.

Need and Working of Incomes Policy

The necessity for an appropriate incomes policy is being increasingly felt on account of the intensification of the tendencies towards cost inflation, because the proportion of incomes and prices determined in non-competitive markets is likely to increase with increasing industrial employment, growing unionization, and collective bargaining and increasing scale of enterprises. Further, longer experience of consistently high level of aggregate demand as enunciated above may lead to encouragement of a more aggressive attitude on the part of labor and more permissive attitude on the part of the employers towards wage increases, leading to a strengthening of the bargaining position of unions.

The inducement to adopt income policy is stronger in some countries than in others, depending on the prevailing socio-economic circumstances. The inducement is more where relative price stability is needed to facilitate expansion of employment (either before or when the employment objective is met) or to improve a critical balance of payments position. Disciplinarians in the field of international economics prefer incomes policy to set right chronic balance of payments to a policy of devaluation or deflation.

However, when it comes to guidelines for other types of incomes like profit, rent and interest, its policy prescription is less clear. While the general objective, as discussed above, has been laid down in many developed countries like Netherlands, Sweden, France, Norway, U.K. and U.S.A., no operational incomes policy has been adopted in any country except Netherlands. In U.K., first attempt at incomes policy was made during the Second World War and met with a little success due to accompanying circumstances (exceptional in nature) like subsidies, price controls, rationing, compulsory savings etc, all played an important part in holding down prices. There was a good deal of suppressed inflation in the economy but towards the end of 1950, wage restraint began to break down and incomes policy was held in abeyance in U.K. during the fifties. The labor government which took office in 1964 presented a policy on productivity, prices and incomes as an integral part of its plan for promoting economic growth but later on due to bad economic conditions, balance of payments difficulties and rising prices and incomes ran into difficulty. The U.S. abandoned wage price controls in 1974. European incomes policy, however, did not fare badly, though it proved to be a costly experiment and in the long run not only inflation continued but it also led to distortions in the economy giving rise to more severe inflations in U.K., U.S.A. and Japan from 1974 onward. In U.K., where a beginning was made, many practical implications came to light during the course of its working. One of these is that in a period of excessive overall demand an incomes policy though useful can play a role only subordinate to fiscal, monetary and other economic policies to fight cost inflation.

Goal / Role of monetary policy in an underdeveloped economy

The role of monetary policy may be explained as follows:
i) Economic development
In developing countries, the monetary policy should aim at promoting economic development. The monetary policy can play a vital role in acceleration to economic development. It influences the supply and uses of credit. Controlling inflation and maintaining equilibrium balance of payment.

ii) Development of banking and financial institutions
One of the main functions of central bank or primary aim of monetary policy is to establish more banks and financial institutions. Underdeveloped countries lack these facilities. These facilities will help in increasing banking habit, mobilizing voluntary savings of the people, channelizing them into productive uses and raising the rate of capital formation.

iii) Debt management
In the developing economy, debt management is one of the main functions of monetary policy. The tools under the aims of debt management are deciding proper timing and issuing of government bonds, stabilizing their prices and minimizing the cost of servicing the public debt. These tools collect the means and sources of economic development. Monetary policy helps it in goal specific way.

iv) Control inflation
Monetary policy is an effective measure to control inflation. Increase in government expenditure on developmental schemes increase aggregate demand but aggregate supply of consumer’s goods does not increase in the same proportion. This increases the price level. The monetary policy controls inflationary tendencies by increasing saving, checking expansion of credit by banking system and discouraging deficit financing by the government.

v) Correct the adverse balance of payment
Monetary policy in the form of interest rate policy plays as important role in correcting the balance of payments deficit. In the developing countries like Nepal, there is serious balance of payment difficulties to fulfill the planned targets of development. To develop infrastructure such as power, irrigation, transport, etc. and directly productive activities like iron, steel, chemicals, electrical, fertilizers, etc., developing countries have to import capital equipment, machinery, raw materials, spares and components thereby raising their imports.

The exports are almost stagnant. They are high priced due to inflation. As results, an imbalance is created between imports and exports which lead to imbalance in the balance of payments. Monetary policy can help in decreasing the gap balance of payments deficit through high rate of interest. The high rate of interest attracts the inflow of the foreign investment and help in bridging the balance of payment gap.

vi) Reduction of economic inequality
In an underdeveloped economy, there is wide disparity of income and wealth and absence of an integrated interest rate structure. Monetary policy can play a significant role to maintain equal distribution of income and wealth and a suitable rate of interest rate. The central bank should take effective steps that benefit the poor and to integrate the interest rate structure of the economy. For this, low rate of interest should be fixed for the poor and small farmers, and entrepreneurs and subsidy may be given for them. A suitable interest rate structure encourages savings and investment in economy and discourages unproductive loans and speculative.

vii) Adjusting demand and supply of money
Monetary policy can be of great use in these economies for effecting necessary adjustment between the demand for and supply of money. The demand for money is likely to go up on account of increased transactions and gradual disappearance of non-monetized sector combined with increased demand for money on account of precautionary and speculative motives. The use of money and credit for speculative purposes has to be controlled by the monetary authorities though suitable monetary policy and by the government through direct physical controls, falling which inflation is likely to appear, which may stifle growth instead of helping it.

viii) Maintain economic growth rate
Monetary policy can also help growth. The sectoral impacts of such policy in a developing economy are worth nothing. Monetary expansion can be used at least in theory, to change the terms of trade against the agricultural sector, which tends to benefit from increased production in the secondary or tertiary sectors. If the prices of industrial goods can be raised through inflation without affecting the prices of food-stuffs and raw materials, it may be difficult to follow.

Similarly, monetary policy should try to maintain in the economy at most suitable interest rate structure. At present the interest structure is amendable only in the upward direction and very little in the downward direction, but with the help of monetary policy the structure becomes somewhat manageable in the downward direction also. For a large public debt that has to be raised in poor economies, rates of interest must be kept low.

How monetary policy helps to control inflation?

What are the objectives/goals of fiscal policy of underdeveloped countries?

Fiscal policy plays a dynamic role in developing countries. The monetary policy alone ineffective due to the existence of underdeveloped money and capital markets, fiscal policy can be used as an important adjust to monetary policy in accelerating the rate of capital formation.

The importance/significance of fiscal policy in development countries are below:

i) Increase in rate of capital formation: One of the main objectives of fiscal policy is to increase the rate of capital formation. Capital formation is an important determinant of economic development. Saving and investment are the two components of capital formation. In the economy as the saving flow is the formal investment in the productive sector, the rate of capital formation increases. Economic development takes place rapidly when the rate of capital formation increases. The fiscal policy should be formulated in such a manner as to increase the rate of investment both in public and private sectors. This needs large amounts of financial resources which can be obtained by raising the incremental saving ratio and curtailing conspicuous consumption and unproductive investment. Fiscal policy helps in the formation of capital in two ways:
  1. Fiscal policy expands investment in private and public sector through planning wise development. Specially, government invests in the economic sector. It helps to provide necessary means to invest in such sectors. It collects necessary amount for the progress of the physical capital formation and human capital formation.
  2. Fiscal policy encourages unproductive investment to mobilize it in productive sector. This is done by making the tax free, low tax rate, subsidy, reduction policies etc. It helps in reducing unnecessary consumption and will increase capital formation rate, from unproductive sector to productive sector through the mobilization of resources.
ii) Resource mobilization: Resources are limited in developing countries. The aim of economic development can be obtained only if the limited resources are utilized optimally. The available resources should be mobilized rationally and effectively. Fiscal policy plays a central role for resource mobilization in the economy. The fiscal policy is more effective means for resource allocation and mobilization than any other means. In this context, according to OKun and Richardson, “The main task of fiscal policy in underdeveloped countries is to make available adequate saving for financing economic development from excessive low production and prepare the environment for increasing significantly the private investment activities.”
  1. Fiscal policy provides tax facilities in order to increase saving and in investment. Government may increase the tax rate and give priority for the public sector for investment.
  2. Fiscal policy can be the means for mobilizing the investment and resources of agriculture to the productive sector such as trade industry, tourism etc. then after the available saving from agriculture should be maintained in the form of tax to the economic development.
iii) Promotion in employment opportunity: Fiscal policy plays a crucial role to create conditions of full employment and provide with higher living standards. Fiscal policy therefore should aim at increasing employment opportunities and reducing unemployment. For this, government expenditure on economic and social overheads should be incurred to generate employment. Government should increase productive efficiency in the economy. Government can encourage labor based small industries by reducing tax or by providing subsidies. Likewise, government can increase local community development programs involving more labor and requiring less capital per head. Government should give greater emphasis to the family planning performance to control the high growth of population which is the major reason of population growth. For this reasons, above mentioned fiscal measures can help to increase employment.

iv) Effective role in counteracting inflation: In the initial stage of economic development creeping inflation is not bad but higher inflation is dangerous in the economy. Inflation creates uncertainties which are the barrier for investment and economic growth. That is why fiscal policy can play an effective role in counteracting inflation. In this context, according to Henry C. Murphy, fiscal policy is an effective in counteracting inflation in developing countries as it is in industrial countries. The following are the effective roles in counteracting inflation:
  1. Curtail government expenditure without changing tax rate: This increases the saving of government budget and reduces the purchasing power of public. These are the forces which influence or increase the inflation will be declined.
  2. Curtail government expenditure with the increase in tax rate: This helps to increase the rate of saving and reduce the purchasing power of public. In this, aggregate demand will be decreased which help in controlling inflation.
  3. Fixed in government expenditure with the increase in tax rate: Sometimes, government expenditure cannot be controlled. In such situation, inflation can be controlled by increasing tax rates with the help of reducing purchasing of public.
  4. Curtail in government and reduce tax rates in equality: If the government expenditure and tax rate is inequality is reduced, the income between the beneficiaries of government expenditure and the class of tax payers will be redistributed. This process reduces the net propensity to consume and reduces more in the national income than government expenditure. Through this, the multiplier value of balanced budget will be greater than the unity and the effects occur against inflation.
  5. Increase in government debt: Government may increase public debt and pull public saving which reduce purchasing and demand. This helps in controlling inflation.
v) Reduction of income inequality and wealth distribution: In underdeveloped countries, inequality of income and wealth distribution widely spread. This inequality is socially injustice and economically helpful. Until the problem of such inequalities exists in the economy. There will be hardly developed of economy and social welfare. That’s why inequality of income exists and wealth distribution should be reduced. For this, fiscal policy plays very important role.
  1. Implementation of progressive tax system. To achieve this, government has to impose high tax rate to the rich people and low tax rate or free tax to the poor people.
  2. Levy tax on the basis of class of consumption patter: Government should levy taxes at high rates on the luxurious goods and services, which there should be lower tax rates on the goods and services that are consumed by poor people.
  3. Increase facilities to the poor class: Basic facilities should be increased to make easier life for poor class than the rich class.
  4. Expenditure on human capital for poor people: Government should spend a lot of money on physical capital and human capital. Such expenditure provides job opportunities for the poor people by developing human capital on them.
vi) Correct adverse balance of payment: Fiscal policy helps to correct adverse balance of payment. This policy discourages the import and encourages the exports of the economy. For this, government should reduce the taxes of imports and increase the tax of exports goods, subsidies and other facilities.

vii) Economic stability: One of the most serious problems of developing countries is economic instability. Generally they are affected by inflationary tendencies. Fiscal policy adopts the various methods to maintain economic stability. Contra-cyclical fiscal policy should be adopted to offset the effects of fluctuations in world market prices thereby to promote economic stability in the economy. During the inflation, government can increase direct tax and reduce the government expenses to control the inflation. On the other hand, the government can increase public expenditure and decrease tax rate to control the deflation. During depression period, government should make deficit budget and surplus budget policy will be made in the period of prosperity. From this stability will be maintained.

viii) Control inflation: The objective of fiscal policy should be to protect the economy of an underdeveloped country from the demon of inflation. Inflation can prove ruinous to an underdeveloped economy. It can undermine the very process of economic growth. As such, the fiscal policy of an underdeveloped country should be designed in such a manner as to curb inflationary forces arising during the process of economic growth.

Besides these, the objective of fiscal policy should be to eliminate, as far as possible, sectoral imbalances arising in the economy from time to time. Though the fiscal policy as visualized above, will help to maintain price-stability in the economy as a whole by curbing inflationary forces, there may arise sectoral price fluctuations in certain sectors of the economy on account of the existence of certain bottlenecks. To ward off that possibility, fiscal policy must be attuned to correct such imbalances in time before they could inflict any damage of the economy.

Measures needed to control Inflation

There are three lines of action to check and contain an inflationary boom namely, Monetary Measures, Fiscal Measures and other Measures.

i) Monetary Measures

Following are the monetary measures, which can be used to curb inflationary pressures:
  1. Increased re-discount: To curb inflation, the Central Bank generally increases the re-discount rates. An increase in the re-discount rates leads to an increase in bank rates, because there is a definite relationship between the two. An increase in bank rates tends to discourage borrowing by businessmen from banks, resulting in a fall in the intensity of inflationary pressures in the economy. An increase in interest-rates consequent upon the increase in the bank rate will make savings attractive than before and induce people to spend less on consumer goods. But the increase in re-discount rates as a weapon to check an inflationary boom has its limitations tool. Firstly, if the bank rates do not rise with the rise in re-discount rates, there will be no decline in business borrowings, and hence, the inflationary pressures will continue, even though the re-discount rates have been raised. Secondly, the effectiveness of higher re-discount rates as an anti-inflationary weapon shall be considerably undermined if the commercial banks have an easy access to additional reserves.
  2. Sales of government securities in the open market: Another method to check the inflationary boom is to resort to sale of government securities to the public by the central bank. As the buying public purchases and pays for those government securities, the commercial banks’ reserves with the central bank are correspondingly reduced and they are obliged to adopt a restriction credit policy in relation to business requirements. But the sale of government securities as an anti-inflationary weapon is also subject to limitations. Firstly, this policy may be rendered ineffective if the commercial banks are able to increase their reserves by selling their stocks of government securities to the central bank. Secondly, this policy may also be offset by increased borrowing from or by increased sales of treasury bills to the central banks of the commercial banks.
  3. Higher reserve requirements: An increase in reserve requirements of the member banks also serves as an anti-inflationary weapon during inflation. It absorbs the excess reserves of the banking system and, thus, prevents them from forming a basis for further credit expansion. But this method is also subject to limitations. Firstly, if the commercial banks happen to have very large excess reserves, even the raising of the reserve requirements may not significantly curtail their power to create credit. Secondly, the ability of commercial banks to increase the reserves through sale of government securities may render higher reserve requirements ineffective to check credit expansion. 
  4. Consumer credit control: During an inflationary boom, facilities for installment buying are reduced to the minimum to curtail excessive spending on the part of the consumers. This is done (i) by raising the minimum initial payments on specified goods, (ii) by extending the application of consumer credit control to a large number of consumer goods, and (iii) by reducing the length of the payment period, etc.
  5. Higher margin requirements: It is a method of selective credit control. The central bank is its pursuance of higher levels. The central bank in its pursuance of an anti-inflationary policy may raise the margin requirements of loans to higher levels. The higher the margin requirements, the lower the amount of loan that the borrower can obtain from the bank. Thus, higher margin requirements have the effect of checking undue monetary expansion.

ii) Fiscal Policy

The major anti-inflationary fiscal measures are the following:
  1. Government expenditure: To counteract increased private spending at a time of inflation, the government should, at such a time, reduce its own expenditure to the minimum extent possible to help limit the aggregate demand. As against this, it may, however, be said that it is not so easy to reduce government expenditure particularly during the war period. Secondly, any drastic cut in government expenditure to cure inflation may actually land the economy in a slump.
  2. Taxation: The problem during inflation is to reduce the size of disposable income in the hands of the general public in view of the limited supply of goods and services in the market. It is, therefore, necessary to take away the excess purchasing power from the public in the form of taxes. The rates of existing taxes should be steeply increased, while new taxes should be imposed on commodities so as to leave less money supply with the public to spend.
  3. Public borrowing: The object of public borrowing is to take away from the public excess purchasing power which, if left free, would surely exert an upward pressure on the price-level in view of the limited supplies of goods and services in the economy. If voluntary borrowing does not yield adequate results, it may become necessary to resort to compulsory borrowing from the public.
  4. Debt management: The existing public debt should be managed in such a manner as to reduce the existing money supply and prevent further credit expansion. Anti-disciplinary debt management usually requires the repayment of bank-held debt out of a budgetary surplus. The idea is that the government securities held by commercial banks should be retired by the government out of the budgetary surplus. This would check the power of commercial banks to en-cash their securities and add to the reserve for the purpose of credit expansion.
  5. Overvaluation: An overvaluation of domestic currency in terms of foreign currencies will also serve as an anti-inflationary measure. Firstly, it will discourage exports and thereby increase the availability of goods in the domestic market. Secondly, by encouraging imports from abroad, it will add to the domestic supply of goods in the economy. But, overvaluation as an anti-inflationary weapon suffers from several limitations.
  6. A suitable income policy: At a time of inflation, the government must also adopt a suitable price-income policy. It should strictly control wages, salaries and profits to keep spending at a low level to fight inflation.

iii) Other Measures

These measures can be used to supplement monetary and fiscal measures undertaken to contain inflationary pressures.
  1. Expansion of output: Increased production is the best antidote to inflation because inflation arises partly due to inadequacy of output. But it becomes rather difficult to increase output at a time of inflation because of the full utilization of resources. It is suggested that if it is not possible to increase output as a whole, steps should be taken to increase the output of those goods which seem to be extremely sensitive increase the output of those goods which seem to be extremely sensitive to inflationary pressures by shifting productive resources from the less inflation-sensitive goods. In other words, a reallocation of productive goods, such as food, clothing, housing, etc. Steps may also be taken to increase supply of consumer goods through large-scale imports from other countries to absorb excess money supply.
  2. Wage policy: During an inflationary boom, the wages have to be controlled so as to curb the inflationary pressures in the economy. Wage increases may be allowed to workers only if their productivity increases. If this principle is observed, higher wage shall not lead to higher unit costs and, hence, it higher unit prices.
  3. Price control and rationing: The object of control is to lay down the upper limit beyond which the price of a particular commodity would not be allowed to rise. To ensure the successful functioning of price control two conditions will have to be satisfied. Firstly, the government should have under its control adequate stocks of the commodities concerned. Secondly, the demand for the concerned commodities should be controlled through rationing, failing which the richer sections shall be able to buy a major portion of the available stocks.

Effects of Inflation in the Economy

Inflation has serious social and economic effects. Some economists have named it legal dacoits. It invisibly imbalance economic factors and delay the speed of economic growth. The following are the main effects of inflation.

Effects on Production

  1. Decrease in the quality of goods: The demand for goods increase due to inflation. So, any type of goods can be sold. As a result, the profit seekers lessen the quality of goods to increase the profit.
  2. Reduces saving: Due to inflation, most of the income is spent on consumption. So the saving reduces. As a result, there is less capital investment.
  3. Encourages holding and speculation: The producers start to store the necessary goods. Due to this, the goods become even scarce; the businessmen hide the goods and create artificial scarcity, for black marketing.
  4. Reduction in productivity: In the time of inflation, there is less capital formation. As a result, it is difficult to make available factors of production. It brings uncertainties in the economy, and entrepreneurs become discouraged in the production.
  5. Devaluation of money and loss in faith: People have less trust of money due to the devaluation of money and its decreasing purchasing power. Foreign investors also can return their investment due to the loss of faith.

Effects on Consumption

  1. Change in consumption pattern: In the time of inflation, the demand for quantity decrease as the price of the quantity increases. Those who have various sources of income buy luxury goods, foreign goods and goods of comfort but those who have limited source of income start to buy only essential goods. Most of the consumers start to consume artificial goods than natural ones.
  2. Debt instead of saving: In the time of inflation, the consumer surplus slowly decreases because he has to pay more than he wants to pay. If there is high inflation, he will get loan.
  3. Unequal consumption and lifestyle: In the time of inflation, the lifestyles of rich and poor will become more polarized. Those who have only limited income, is compelled to buy only the essential goods. Due to this, life becomes more difficult. But those, who have various sources of income feel opposite of that.

Effects on Distribution

  1. Fixed income groups: Government officials, pensioners and those depend on post savings are the fixed income group. In the time of inflation, general price increases, so the expenditure on living increases and the life becomes harder.
  2. Creditors and debtors: In the time of inflation, creditors are in loss and debtors are in profit because of the decrements in the purchasing power of money. As the creditor give the money having more purchasing power and get it back when it has less purchasing power. Therefore, they get in loss.
  3. Salary and wage earners’ group: This group will be in hard time as the expenditure of living increases where as wage and salary do not increase.
  4. Merchants and industrialists benefited: In the time of inflation, merchants and industrialists get sudden profit. The price of assets (stock) increase but the cost of current capital does not increase so much, so merchants and industrialists get extra profit.
  5. Effect on Balance of Payment: Inflation has negative effect on balance of payment. Indigenous goods happen to be more expensive than foreign goods. So the farmer cannot compete with foreign goods. As a result, import increase and export decrease. Thus, balance of payment becomes negative. In the long run, it creates scarcity in the foreign exchange.

Inflation: Cost Push Inflation

Supply Shock Inflation / Cost Push Inflation

Inflation is also caused by increase in the cost of production. As a result of increase in the cost of production the aggregate supply schedule shifts downwards to the left, indicating that a lesser quantity is supplied at the existing prices. Aggregates demand schedule remaining unchanged, any leftward shift in the aggregate supply schedule will push
the prices upwards as could be seen in figure.
Cost Push Inflation
In the figure, DD is the aggregate demand schedule which remains unchanged; S1S1 is the original aggregate supply schedule which intersects DD at point K. At the full employment equilibrium point K, the level of full employment output is OY0 and the price level is OP1. With increase in the costs (may be due to rise in wage rates, higher prices or inputs, etc.), the aggregate supply schedule shifts to S2S2 intersecting the aggregate demand schedule DD at point K1. At new equilibrium point K1, the level of real output OY1 is less than the full employment output, therefore, the price level rises to OP2. A further shift in the aggregate supply schedule to S3S3 pushes the price level of OP3.

Causes of Cost Push Inflation

Cost-push inflation is generally caused by three factors.
  1. Increase in money wages: In the modern business world trade unions have become very well-organized and have been also to secure higher wages for their members. Whenever the products are compelled to accept the demand for higher wages by the trade unions, they try to shift the burden of increasing costs on to the consumers by charging higher prices for the final goods and services. This leads to ‘wage-price-spiral’. Increase in the wage rates leads to rise in prices, the real wages of the workers decline. To neutralize this fall, still higher wages are demanded and granted, and thus inflationary spiral continues.
  2. Higher profit margins: As discussed earlier aspiration for higher profit margin sets in motion ‘profit-push inflation’. This situation is typical to a sellers’ market in which demand exceeds the supply. Pressure on demand leads to increase in prices. Taking advantages of this situation, the producers set higher profit margins, which again would push the prices upwards.
  3. Rise in the prices of basic inputs: Scarcity of strategic and basic raw materials results in an increase in their prices, and in turn, the prices of final goods and services are increased. A fall in the supply of cement, iron and steel, sugarcane, cotton, etc., would raise their costs, and finally, the prices of the finished goods will also go up. The cost-push inflation may also be caused by the scarce supply of imported raw materials and intermediate goods.
  4. Administered higher prices of inputs: The prices of inputs do not always increase due to their scarcity but may increase due to some administrative action on the part of the government. Higher administered prices of basic inputs would affect the prices of final goods and services of the concerned business units. Thus, rises in administered prices sets in motion, the cost push inflationary forces in the economy.
  5. High rate of taxes: Taxes imposed on goods and services (i.e., indirect taxes) also generate inflationary pressure in the economy. As a result of increase in indirect taxes, the prices of raw material in international market. It is also known as supply shock inflation.
  6. International reasons: Another case of supply inflation on cost-push inflation is prices of the raw material in international market. It is also known as supply shock inflation.

Inflation: Demand Pull Inflation

Inflation is a fall in the market value or purchasing power of money. It is the opposite of deflation. It refers to a continuous increase in the aggregate price level of goods and services rather than just a one-time increase in it. In other words, inflation means rise in price level or fall in the value of money. Inflation is simply the increase in the general price level in sufficiently a long period. In
some context the term inflation is used to refer to an increase in the money supply, although this concept is also often referred to as monetary expansion. Due to the causes of inverse relationship between general price level and value of money, inflation is continuous decrease in value or the purchasing power of money.

Inflation results from an increase in the amount of circulating currency beyond the needs of trade; an oversupply of currency is created. In the past, inflation was often due to a large influx of bullion, such as took place in Europe after the discovery of America and at the end of 19th century. In modern times, wars are the most common cause of inflation, as government borrowing, the increase in money supply, and a diminished supply of consumer goods, increase demand relative to supply and thereby cause rising price. The economists have defined inflation in many ways. Some of the definitions have been presented here.

According to Edward Shapiro, “Inflation is a persistent and appreciable rise in the general level of prices.” In the words of Gardner Ackley, “Inflation is defined as a persistent and appreciable rise in the general level of prices. This clearly makes inflation a process rising prices not higher prices.” In the words of Coulbourn, “Inflation is too much money charging too few goods”. According to Sir RG Hawtrey, “Inflation is the issue of too much currency.” Similarly, in the words of Prof. Samuelson, “Inflation occurs when the general level of prices and costs is rising.”

Demand Pull Inflation

Demand pull inflation occurs when there is an excess demand over the available supplies at existing prices. Excess demand means aggregate real demand for output in excess of maximum feasible, or potential, or full employment output. Excess demand is generated by forces operating on the demand side of the commodity market.

As a result of increase in demand, the aggregate demand function shifts upwards to the right (supply function remaining constant). In this case, rise in price is caused exclusively by the increase in demand as could be seen in the figure.
In the figure, OU shows the full-employment level of real output. Beyond OU, rise in prices does not, result in increase in the real output. As the demand for real output increases from D1 to D2 and D3 to D4, the prices level also rises from P1 to P2, P3 and P4 respectively.

Causes of Demand Pull Inflation

Demand-pull inflation is caused by the following factors.
i) Excess demand
Prof. Keynes has explained the effect of excess demand on prices through his notion of ‘inflationary gap’. Inflationary gap may be defined as an excess of aggregate demand for goods over their aggregate supply measured at constant prices.

ii) Increase in money supply
Monetarists held excess increase in the quantity of money responsible for inflation. According to the quantity theory of money, at a given level of national income (potential as well as actual) the general price level (P) rises in the same proportion as increase in the quantity of money (M), the velocity of money being held constant. In a static economy, M is policy-determined; therefore, the rate of inflation also becomes policy-determined.

In a dynamic economy, the real demand for money grows over time and the national income also grows over time. Apparently, the rate of growth of real demand for money will be equal to the rate of growth of the national income. However, excess increase in the stock of money will lead to increase in prices. Excess supply of money is nothing but the excess demand for output that causes inflation.

iii) Disposable income
It refers to the income payments to factors after personal taxes have been paid. An increase in disposable income results in increased purchased power with the people. There is increasing pressure on the demand for goods and services, as a result, prices tend to rise.

iv) Increase in business outlays
During the prosperity phase of business activities, increase in business outlays or capital expansion take on a speculative character. New equipment and plans are often financed by speculative borrowings. Most of business outlay finds their way into the income stream via dividends, wages and other factor payments. These business outlays are inflationary in character.

v) Increase in foreign demand
Increase in the export demand for domestic goods and services also lead to inflation. This is particularly true of the economies which maintain considerable inflationary pressure on domestic areas of shortages which may be a focal point of spreading inflation.

vi) Increase in government expenditure
There may be an increase in the government expenditure of government revenue. This might have been made possible through government borrowings from banks or through deficit financing, which implies an increase in the money supply.

vii) Reduction of taxation
If government reduces taxes, households are left with more disposable income in their pockets. This leads to increase consumer spending, thus increasing aggregate demand and eventually causing demand pull inflation.

Causes of Business Cycle

Business cycle, term used by economists to designate a periodic increase and decrease in an economy’s production and employment. Ever since the Industrial Revolution of the 1800s, the overall level of production in industrialized capitalist countries has varied from high output and employment to low output and employment. Economists study business cycles because they have a significant impact on all aspects of an economy.

A variety of explanations have been offered for business cycles. The Austrian American economist, Joseph Schumpeter published his innovation theory in the late 1930s. He relates upswings in the business cycle to new inventions, which stimulate investment in capital-goods industries. Because new inventions develop unevenly, business conditions alternate between expansion and contraction, according to Schumpeter’s theory.

Economists believe that business cycles are caused by many factors out of which the important ones are:

i) Changes in capital expenditures

When the economy is strong businesses have expectations of sales growth; they invest heavily in capital goods (e.g., machines, equipment, factory buildings, etc.). After a while businesses may decide that they have expanded to their limit, so they begin to pull back on their capital investments and cause an eventual recession.

ii) Innovation and imitation

Invention and innovations are assumed to the sources of business cycle. Innovations include new products, new inventions, or a new way of performing a task. Joseph Schumpeter early in the twentieth century pointed out the importance of invention and innovation in causing the business fluctuation. When a business innovates, it often gains an advantage on its competitors because of its costs decrease or its sales increase. Whatever the case, profits increase and the business grows. If other businesses in the same industry want to keep up, they then copy (imitate) what the innovator has done or they come up with something better. Imitation/Replication companies usually invest heavily and an investment boom follows. Once the innovation spreads to another industry, the situation changes. Further investments are unnecessary and economic activity may slow.

In modern time the real business cycle (RBC) theory developed by Edward Prescott, Finn Kydland, P. Long, and Charles Plosser in the twenty first century regard ‘technological shocks’ as the main cause of business fluctuations.

iii) Credit and loan policies

Economists also regard ‘credit and loan’ policies of commercial banking as the important source of fluctuation in economic activities. Monetarist economists claim that improper management of money and credit supply is the main cause of cyclical fluctuation in a market economy. When “easy money” policies are in effect, interest rates are low and loans are easy to get. They encourage the private sector to borrow and invest, thus stimulating the economy. Sooner or later, the increased demand for loans causes the interest rates to rise, which discourage new borrowers. As borrowing and spending slow down, the level of economic activity declines. The economy keeps declining until interest rates fall and the business cycle begins over again.

iv) External shocks

Economists also regard ‘external shocks’ as the cause of cycle. Shocks such as increases in oil prices, wars and international conflict, have the capacity to either drive the economy up, or drive it down. The economy may benefit when a new supply of natural resources is discovered. Such was the case with Great Britain in the 1970s when an oil field was discovered off its coast in the North Sea. The British economy of course profited seeing that world oil prices were at an all time high, but the high prices hurt the United States at the same time.

American economists Robert J. Gordon has stressed in supply shocks as the main cause of business cycle. Supply shocks in an economy occur when business fluctuations are caused by shifts in aggregate supply. In the USA, the classic examples came during the oil crises of the 1970s, when sharp increase in oil prices contracted/reduced aggregate supply, increased inflation, and lowered output and employment. Many economists think that the low inflation and rapid growth of the American economy in the 1994-2000 periods may be explained by favorable supply shocks. During this period, costs grew slowly because of declining oil and commodity prices, declining import prices, rapid productivity growth, and below-par increases in medical care prices.

v) Political business cycles

Many analysts link/connect fluctuations to politicians who manipulate economic policies in order to be re-elected. Initially credited to German political economist Karl Marx (1818 – 1883) but later revised by, among others, Polish-born engineer and economist Michal Kalecki (1899 – 1970), political business cycle regards that economic fluctuations are caused by politicians who use fiscal and monetary policies (choosing between employment or inflation) in order to get elected/re-elected.

The evil effects of cyclical fluctuations of business firms

Certain effects of business cycles on individual concern are favorable. During revival and expansion, demand increases, selling prices rise more rapidly than costs, profits increase and individual manufacturer and merchants generally feel happy.
  1. Business cycles, however, land individual business firms into a number of disabilities and difficulties. Even during revival and the beginning of expansion phase, certain ill effects start appearing. The increase in raw materials price, in labor costs and routs, and the higher rates charged for credits accommodation increase the costs of carrying on business when the situation becomes more difficult, the evil of cancellation develops.
  2. The businessman that his customers are refusing to take goods, which they have ordered, and that there is a decline in the volume of orders.
  3. During the later stages of expansion, business enterprises are conformed by much more severe competition. Prices are maintained with difficulty.
  4. The decline in prices, which is characteristics of the period of recession, usually finds merchants and manufacturers with large inventories, which depreciate materially in value at this time. These excessive inventories are usually made up of finished goods rather than raw materials.
  5. The individual businessman usually suffers through being compelled to sell his goods at a loss in order to meet his obligations. This may result in either at least a sacrifice of profits, or possibly necessitating the carrying on of business at an actual loss.
  6. During contraction, one of the most important reasons for financial loss during such a period is found in the continuation of fixed charges of all sorts. It is possible during contraction for an individual concern to reduce its direct costs by the discharges of labor and the reduction of purchases of raw materials, but most of the elements of overhead cost cannot be so reduced.

Business Cycle: Meaning and Various Phases of it

Business cycle is an important feature of capitalist economy. It means alternating periods of prosperity and depression in the country. It has been defined as an alternative expansion and contraction in overall business activity as evidenced by fluctuations in measures of aggregate economic activity, such as, the gross product, the index of industrial production and
employment and income. Generally speaking, the cyclical fluctuations have a tendency towards simultaneous appearance in all the branches of national economy. But, sometimes, they may be confined only to an individual industry of individual sectors of the economy. Cyclical fluctuations in such cases are referred to as specific cycles.

Phases of a Typical Business Cycle

A typical business cycle is characterized by five different phases or stages- depression, recovery (or revival), prosperity (or full employment), boom (or overfull employment) and recession.

i) Depression

The depression is the first stage of trade cycle. It is a protracted period in which business activity in a country is far below the normal. It is characterized by a sharp reduction of production, mass unemployment, falling prices, falling profits, low wages, contraction of credit, a rate of business failures and an atmosphere of all-round pessimism and despair. A decline in output or production is accompanied by a reduction in the volume of employment. A construction activity comes to a more or less complete standstill during a depression. The consumer goods industries, such as food and clothing, are not so much affected by unemployment as the basic capital goods industries. The prices of manufactured goods fall to low levels. Since the costs are ‘sticky’, and do not fall as rapidly as prices, the manufacturing suffer huge losses. Many of the firms have to close down on account of accumulated losses. The two longest depressions in the US history were those of 1873-1879 (65 months) and 1929-1933 (44 months).

ii) Recovery

It implies increase in business activities after the lowest point of the depression has been reached. During this phase, there is a slight improvement in economic activity, to start with. The entrepreneurs begin to feel that the economic situation is, after all, not so bad as it is in the preceding stage. This leads to further improvement in business activity. The industrial production picks up slowly and gradually. The volume of employment also increases steadily. There is slow but sure rise in prices accompanied by a small rise in profits. The wages also rise, though they do not rise in the same proportion in which the prices rise. Attracted by rising profits, new investments take place in capital goods industries. The banks expand credit. The business inventories also start rising slowly. The recovery continues until business activity reaches approximately the same level that it had achieved before the decline set in. the rate of recovery is generally related directly to that of the preceding depression. The more severe the depression, the more rapid will the recovery be.

iii) Prosperity

This stage is characterized by increased production, high capital investment in basic industries, expansion of bank credit, high prices, high profits, high rate of formation of new business enterprises and full employment. There is a general feeling of optimism among businessmen and industrialists. The longest sustained period of prosperity occurred in the USA between 1923 and 1929 with some minor interruptions in 1924.

iv) Boom

It is the stage of rapid expansion in business activity to new heights, resulting in high stocks and commodity prices, high profits and overall employment. The prosperity phase of the trade cycle does not end up with a stable state of full employment; it leads to the emergence of boom. The continuance of investment even after the stage of full employment results in a sharp inflationary rise of prices. This causes undue optimism among businessmen and industrialists who make additional investment in the various branches of the economy. This put additional pressures on the factors of production which are already fully employed, causing a sharp rise in their prices. Soon, the situation develops in which the number of jobs exceeds the over full employment. Attracted by rising profits, the businessmen further increase their capital investments. Runaway inflation raises its head in all its ugliness. Prices rise sky-high. There is an atmosphere of over-optimism all round.

But the developing boom carries within it the seeds of self-destruction. Factors of production become scarce causing spurt in their prices. The costs of calculations are upset. Some new hastily set up firms collapse. This makes the businessmen over-cautious. They now begin to stay away from new projects and even stop the expansion of existing units. This prepares the ground for the succeeding stage. A boom is inevitably followed by a bust.

v) Recession

A feeling of over-optimism of the earlier period is replaced now by over-pessimism characterized by fear and hesitation on the part of the businessmen. The failure of some among businessmen. The banks also get panicky and begin to withdraw loans from business enterprises. More business enterprises fail. Prices collapse and confidence is rudely shaken. The initial unemployment spreads to other industries. Unemployment leads to a fall in income, expenditure, prices and profits. Once a recession starts, it goes on gathering momentum and finally assumes the shape of full-fledged depression- the first stage of the trade cycle is complete. The 1957-58 recession in the USA was a severe one.

The various phases of the business cycle can be illustrated in the diagram as below.
Phases of Business Cycle
In this diagram, PM is the full employment line. Above this line, we have two stages of the trade cycle, a boom in the upswing and a recession in the downswing. Below this line again we have two stages of the trade cycle, a recovery in the upswing and depression in the downswing. The business cycle as shown in the diagram passes through five stages. It starts with depression to be followed by recovery, prosperity, boom, recession, and ultimately ends up again with depression.

Calculation of National Income and Difficulties while Calculation

Production of goods and services gives rise to income, income given rise to demand for goods and services, demand gives rise to expenditure, and expenditure gives rises to further production. Thus, there is a circular flow of production, income and expenditure. On the basis of these, three related flows; national income can be looked at (i) as a flow of goods and services, or
(ii) as a flow of incomes, or (iii) as a flow of goods and services. Thus, there are three methods of measurement of national income.

i) Product/Output Method

Product method measures national income at the phase of production in the circular flow. This method is also called value added method. Data of all productive activities like agricultural products, industrial products, contribution of transport to production, service of lawyer, doctor, professors etc., are collected and measured their value at market prices. Under this method, there are two approaches to the estimation of national income.

a) Final Product Method: In this method, national income is estimated by finding the market value of final goods and services produced in the economy in a given period. Various steps in final product of calculating national income are:

The market value of all final goods and services produced within the territorial limits of the country gives estimate of GDP at market price.

Thus, GDP at market price = market value of all goods and services produced within the country.

Hence, GDP = Total agricultural product + Total industrial product + Total contribution of tertiary sector.

GNP = GDP + Net foreign income

NNP = GNP – Depreciation

Further, by deducting indirect taxes from NNP at market price, that gives NNP at factor cost of national income.

Hence, NNP at Factor Cost or National Income = NNP at market price – Net indirect taxes.

While calculating national income using final product approach, problem of double counting may be appeared. In order to avoid the double counting problem, we use value added approach.

b) Value Added Method: In this method, instead of taking market value of final product, the value added at different stages of production is counted for estimating national income. Thus, according to this method, national income is the sum total of value added by different producing units of a country in their production process. Value added means the addition to the value of raw materials and other inputs during the process of production. In order to calculate the value at a particular state of production, the cost of intermediate products is subtracted from the total value of output.

Hence, Value added = Value of capital – Cost of intermediate goods.

Produer
Stage of 
Production
Value of 
Output
Cost of 
Intermediate Goods
Gross 
Value Added
FarmerPaddy
100
50
50
MillerRice
150
100
50
WholesalerFlour
200
150
50
BankerBread
250
200
50
Total
700
500
200

The table is constructed on the supposition that the entire economy for purposes of total production consists of four sectors. The table below shows the contribution of different sectors to the GDP and computation of national income.

Measuring National Income by Output Method
($ in Million)
S.No.
Sector
Contribution of 
Different Sector
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
Agriculture, Forest and Fisheries
Transportation and Communication
Public Administration and Defense
Health and Education
Banking and Financial Institution
Irrigation, Electricity and Drinking Water
Construction Industry
Mine Industry
Industry, Trade and Commerce
Others
20
5
10
6
4
3
2
5
5
1
Gross Domestic Product (GDP)
61
11.
Net Income from abroad
+ 10
Gross National Product (GNP)
71
12.
Value of depreciation fund
- 6
Net National Product (NNP)
65
13.
Indirect Tax
- 4
Subsidies
+ 1
National Product (NP = NI = NE)
62

Despite the popularity gained in application, this method is not free from the problem of over estimation (double counting). To avoid the problem of double counting economists have suggested two alternative methods, viz., final product method and value added method. We should keep in mind that whichever the method is applied, the result will be the same.

ii) Income Method

Income method measures national income from side of factor incomes. It is also known as distributive share method of factor payment method. In this method, net incomes received by all factors of production are added to obtain the national income. It means national income comprises the net rents paid to land, net wages paid to labor, net interest paid to capital and net profit earned by entrepreneurs. It does not include transfer payments.

According to Income Method,

GDI = Rents + Wages and salaries + Interests + Dividends + Undistributed profits + Indirect taxes + Depreciation

Where, GDI = Gross Domestic Income

GNI = GDI + Net foreign income

NNI = GNI – Depreciation

The measurement process can be shown in the table as below:
Measuring National Income by Income Method
($ in Million)
S.No.
Headings
In Million $
1.
2.
3.
4.
5.
6.
7.
8.
9.
Wages and Salaries
Interest
Rent
Dividends
Undistributed corporate profit
Corporate profit tax
Social Security Contribution
Income from self employment
Depreciation
12
10
16
8
6
1
2
3
3
Gross Domestic Income (GDI)
61
10.
Net Income from abroad
+ 10
Gross National Income (GNI)
71
11.
Depreciation
- 6
Net National Income (NNI)
65
12.
Indirect Tax
- 4
Subsidies
+ 1
National Income (NI = NP = NE)
62

iii) Expenditure Method

Expenditure method measures national income as the aggregate of all final expenditure on Gross Domestic Product in an economy within a year. In other words, the expenditure method measures the disposal of GDP. Final expenditure means expenditure on final product. Total final expenditure or national expenditure (Y) represents the sum total of final expenditure incurred on consumption goods © and investment (I). Symbolically;

Y = C + I

Final consumption expenditure includes private household consumption and government final consumption expenditure. Similarly, final investment expenditure comprises (i) Gross final investment, or Gross fixed capital formation; (ii) Changes in stock or inventory investment; and (iii) Net export of goods and services or net foreign investment.

Hence, GDE = C + I + G

GNE = GDE + (X – M)

NNE = GNE – Depreciation

Where, GDE = Gross Domestic Expenditure
GNE = Gross National Expenditure
NNE = Net National Expenditure
C = Consumption Expenditure
I = Investment Expenditure
G = Government Expenditure
X = Export earning
M = Import expenses
X – M = Net income from abroad (net foreign investment)

The measurement process can be shown in the table as below:

Measuring National Income by Expenditure Method
($ in Million)
S.No.
Expenditure Head
Expenditure
1.
2.
3.
4.
5.
Individual consumption expenditure
Total internal investment expenditure
Expenditure on goods and services by government
Exports of goods in monetary value
Imports of goods in monetary value
25
15
11
16
- 6
Gross Domestic Expenditure (GDE)
61
6.
Net income from foreign investment
+ 10
Gross National Expenditure (GNE)
71
7.
Depreciation
- 6
Net National Expenditure (NNE)
65
8.
Indirect Tax
- 4
Subsidies
+ 1
National Expenditure (NE = NP = NI)
62


So, from the above table, it is clear that if the entire production of a country is purchased at market price, the amount will represents the GNE of the country.

Difficulties in the Measurement of National Income

There are, however, some theoretical and practical difficulties in the way of the exact measurement of national income. A clear understanding of these difficulties, therefore, becomes necessary to understand the concept of national income relation to any particular country.

  1. Lack of statistical data: We can’t easily take statistical data of national income. The available data are inadequate and unreliable. For example, statistics of agriculture in developing countries is not complete. We have no reliable estimates of production cost in developing countries. These are not also statistical value of small scale industry and middle scale industries production.
  2. Existence of non-monetized sectors: All agricultural outputs do not reach the market. Either it is consumed at home or exchanged for other goods in the village. This presents several in the calculation of national income.
  3. Illiteracy and ignorance: The majority of the small producers in the underdeveloped countries are illiterate and ignorant. And the producers are not able to keep any account of their productive activities. So, they can’t give the information about the value of their output.
  4. Lack of occupational specialization: There are little occupational specializations people in underdeveloped country. Many people take up more than one activity to earn money. It becomes difficult to collect information about their income. A farmer engaged in agriculture, industries and other sectors during off season.
  5. Frequent changes in price level: National income depends on monetary price of production. But the problem of changing prices is one of the major problems of national income accounting.
  6. Problem of double and multi-counting: It is very difficult in national income calculation only one time. The goods can be counted as intermediate goods and final goods. For example, orange produced by a farmer can be taken as final goods if they consume it and intermediate goods if they sell it to the wholesaler. Sometimes it is difficult to find the exact amount of consumption and sales.
  7. Illegal incomes: Such economic activities do not occur easily, for example, gambling, prostitution, black marketing, drug dealing etc. All their activities are not included in national income. So, due to the presence of illegal economic activities, national income underestimates the value of the output of an economy.
  8. Value of money may not be suitable measure of national income: Firstly, the value of money does not remain stable. It, therefore, cannot give a correct account of national income. Secondly, even though value of money may remain the same, the quality of goods may change. Lastly, there may be certain goods and services which may not have any money value at all, for example, services rendered in friendship or even in mercy (i.e., housewife’s work in the family).
  9. International transactions: National income determination in an economy having international economic relation would create a number of problems. Foreigners own a part of the output produced in the country, and the people of the country may receive income payments from aboard. How are these payments to be accounted for in the national income? Including in the national income produced within the country can solve this problem plus any income earned by the nationals of that country in other countries by way of interest, banking charges, etc., minus any payments of foreign countries by way of interest, bank charges etc.
In calculation of depreciation valuation is also another difficulty to the measurement of national income.

In underdeveloped countries, conceptual and statistical difficulties of national income calculations become more severe. Major difficulties are given below:

  • A large portion of produced, especially in the agriculture sector, is not bought to the market for sale. It is either directly consumed by the producers or exchanged for other goods.
  • People are socially backward. They are superstitious and do not disclose their incomes easily and correctly.
  • Most of producers do not keep accounts of their produced because of illiteracy.
  • Lack of occupational specialization; an individual is engaged in supplementary occupations too. Due to this, the income from supplementary activities is not included in the estimation of national income.
  • Adequate statistical data are not available, and; if available, they are not reliable.
  • There is a lack of trained and efficient statistical staff.
  • Problems of calculating national income also arise due to regional disparities of language, customers etc.
  • Mostly, people are indifferent and non-cooperative to the acquirement regarding the national income estimates.
  • A large number of producers are pretty producers, who do not have any accounts of their business. Hence it is difficult to include in national income.

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