ECONOMICS FOR FINANCE
ECONOMICS FOR FINANCE: A CAPSULE FOR QUICK RECAP
At the Intermediate level , students are expected to not only acquire professional knowledge but also the ability to apply
such knowledge in problem solving. In this capsule for students, an attempt has been made to capture the significance and
importance of the subject of Economics for Finance with the intention to assist you in revision of concepts discussed in
the study material .
CHAPTER I: UNIT-I NATIONAL INCOME
National Income Usefulness of National Income Accounts
Net Value of all economic goods and services produced within the • For analyzing and evaluating the performance of an economy,
domestic territory of a country in an accounting year plus net factor • Knowing the composition and structure of the national income,
income abroad. • Income distribution, economic forecasting and for choosing
economic policies and evaluating them.
GNP at Market Prices
Gross National Product
GNP at Factor Cost
NNP at Market Prices
Net National Product
NNP at Factor Cost
Different concepts of GDP at Market Prices
Determination of National Income
Gross Domestic Product
National Income
GDP at Factor Cost
Net Domestic Product NDP at Market Prices
National Measurement of National
Income Income in India
NDP at Factor Cost
Accounting Per Capita Income
Limitations and Challenges of
National Income Computation Personal Income
Disposable Income
GNPMP NDPMP NNPMP Market Price
• GNPMP - Depreciation • Factor Cost + Net Indirect
• GDPMP + Net Factor • GDPMP - Depreciation • NNPMp = NDPMP + Net
Income from Abroad • NNPMP - Net Factor Factor Income from abroad Taxes= Factor Cost + Indirect
• NNPMP = GDPMP + Net Taxes – Subsidies
Income from Abroad Factor Income from Abroad -
Depreciation
Factor Cost = Market Price - Gross Domestic Product at Net Domestic Product at Factor Net National Product at Factor
Factor Cost (GDPFC) Cost (NDPFC) is defined as the
Cost (NNPFC) or National Income
Net Indirect Taxes = Market • GDP MP – Indirect Taxes + total factor incomes earned by
Subsidies the factors of production. • NNPFC = National Income
Price - Indirect Taxes +
• Compensation of employees • NDPFC = NDPMP - Net Indirect • FID (factor income earned in
Subsidies + Operating Surplus (rent Taxes
domestic territory) + NFIA.
+ interest + profit) + Mixed = Compensation of employees
Income of Self - employed + + Operating Surplus ( rent
Depreciation + interest + profit) + Mixed
Income of Self - employed
Personal income is a measure of the actual Disposable Personal Income (DI) that is
current income receipt of persons from all available for their consumption or savings
sources.
• PI = NI + income received but not DI = PI - Personal Income Taxes
earned - income earned but not
received
06 April 2018 The Chartered Accountant Student
, ECONOMICS FOR FINANCE
Product Method or Value Added
Distribution as Method is also called Industrial Origin
Value added Method or Net Output Method
factor incomes
Measurement of National
(Rent , Wages, Method or and entails the consolidation of the
Interest ,Profit) Production production of each industry less
Method intermediate purchases from all other
industries.
Under income method, national
Income
income is calculated by summation
Income of factor incomes paid out by all
production units within the domestic
Method territory of a country as wages and
salaries, rent, interest, and profit.
Circular flow of Transfer incomes are excluded.
income
Disposition Under the expenditure approach, also
Production called Income Disposal Approach, national
of goods and Consumption / Expenditure income is the aggregate final expenditure
services Investment Method in an economy during an accounting
year composed of final consumption
expenditure, gross domestic capital
formation and net exports.
UNIT-II: THE KEYNESIAN THEORY OF DETERMINATION OF NATIONAL INCOME
Determination of National Income The Keynesian theory of Determination of National Income
Two -Sector Model Three Sector Model Four Sector Model The Investment Multiplier
• John Maynard Keynes in his masterpiece ‘The General Theory of Employment Interest and Money’ published in 1936 put forth a comprehensive
theory to explain the determination of equilibrium aggregate income and output in an economy.
• The equilibrium analysis is best understood with a hypothetical simple a two-sector economy which has only households and firms with all
prices (including factor prices), supply of capital and technology constant; the total income produced Y, accrues to the households and equals
their disposable personal income.
• The equilibrium output occur when the desired amount of output demanded by all the agents in the economy exactly equals the amount
produced in a given time period.
• In the two-sector economy, Aggregate Demand (AD) or aggregate expenditure consists of only two components: aggregate demand for
consumer goods and aggregate demand for investment goods / being determined exogenously and constant in the short run.
Circular Flow in a Two Sector Economy The Keynesian assumption is that consumption increases
with an increase in disposable income (b > 0), but that the
Wages,Rent,Interest,Profit increase in consumption will be less than the increase in
Factor Payment disposable income (b < 1).
(Y) The propensity to consume refers to the proportion of the
Factor input total and the marginal incomes which people spend on
consumer goods and services.
The proportion or fraction of the total income consumed
Households Firms is called ‘average propensity to consume’ (APC)= Total
Consumption /Total Income
Goods and Since Y = C + S, consumption and saving functions are
Services (O) counterparts of each other. The condition for national
Consumption income equilibrium can thus be expressed as C + I = C + S
expenditure Changes in income are primarily from changes in the
(C) autonomous components of aggregate demand, especially
from changes in the unstable investment component.
The investment multiplier k is defined as the ratio of change
Consumption function expresses the functional relationship in national i ncome (∆Y) due to change in investment (∆I)
between aggregate consumption expenditure and aggregate The marginal propensity to consume (MPC) is the
disposable income, expressed as C = f (Y). The specific form determinant of the value of the multiplier. The higher the
consumption function, proposed by Keynes C = a + bY marginal propensity to consume (MPC) the greater is the
The value of the increment to consumer expenditure per unit value of the multiplier.
of increment to income (b) is termed as Marginal Propensity The more powerful the leakages are, the smaller will be the
to Consume (MPC). value of multiplier.
The Chartered Accountant Student April 2018 07
, ECONOMICS FOR FINANCE
Keynesian Consumption Function Effects of Changes in Autonomous Income
(A) Y= C+S C+I+ I
Y El
C
C+I
Aggregate Demand
C =f(Y)
Consumption E
Slope = b
I
b
450
a O Y0 Y1 Y2 X
(B)
S
Saving/Investment
Income Y E
I+ I
I S=I E
I
O
Y0 Y1 Y2 X
Consumption and Saving Function
Income Output
Y=C+S
Y
Three Sector Model
Saving
Consumption
C • Aggregate demand in the three sector model of closed economy
(neglecting foreign trade) consists of three components namely,
Dissaving C =a+by household consumption(C), desired business investment
C
demand(I) and the government sector’s demand for goods and
Y
services(G).
• The government sector imposes taxes on households and
a business sector, effects transfer payments to household sector
450
x and subsidy payments to the business sector, purchases goods
o Y1 Y2 Disposable Income and services and borrows from financial markets.
• In equilibrium, it is also true that the (S + T) schedule intersects
S
Saving
Saving the (I + G) horizontal schedule.
o S Circular Flow in Three Sector Model
x
a Y: Y Y2 Disposable Income
S Dissaving Goods and Services Goods and Services
Consumption
Expenditure on Product Expenditure
Market
Determination of Equilibrium Income: Domestic Products
Two Sector Model Investment Expenditure
Govt.Purchases
(A)
Y
Subsidies Transfer
Aggregate Demand
C+S Payments
C+I < C+S House
B Business Taxes Government Taxes hold
C+I
C+I=C+S
C+I > C+S A E C
Government
Borrowings
45O
O Y1 Financial
Y0 Y2 X Market
(B) Investment Savings
Saving/Investment
S
Factor Payments Personal Income
S=I Factor
I I Market
E Factor Services Factor Services
O Y1 Y0 Y2 X
Income Output
Y1
08 April 2018 The Chartered Accountant Student
ECONOMICS FOR FINANCE: A CAPSULE FOR QUICK RECAP
At the Intermediate level , students are expected to not only acquire professional knowledge but also the ability to apply
such knowledge in problem solving. In this capsule for students, an attempt has been made to capture the significance and
importance of the subject of Economics for Finance with the intention to assist you in revision of concepts discussed in
the study material .
CHAPTER I: UNIT-I NATIONAL INCOME
National Income Usefulness of National Income Accounts
Net Value of all economic goods and services produced within the • For analyzing and evaluating the performance of an economy,
domestic territory of a country in an accounting year plus net factor • Knowing the composition and structure of the national income,
income abroad. • Income distribution, economic forecasting and for choosing
economic policies and evaluating them.
GNP at Market Prices
Gross National Product
GNP at Factor Cost
NNP at Market Prices
Net National Product
NNP at Factor Cost
Different concepts of GDP at Market Prices
Determination of National Income
Gross Domestic Product
National Income
GDP at Factor Cost
Net Domestic Product NDP at Market Prices
National Measurement of National
Income Income in India
NDP at Factor Cost
Accounting Per Capita Income
Limitations and Challenges of
National Income Computation Personal Income
Disposable Income
GNPMP NDPMP NNPMP Market Price
• GNPMP - Depreciation • Factor Cost + Net Indirect
• GDPMP + Net Factor • GDPMP - Depreciation • NNPMp = NDPMP + Net
Income from Abroad • NNPMP - Net Factor Factor Income from abroad Taxes= Factor Cost + Indirect
• NNPMP = GDPMP + Net Taxes – Subsidies
Income from Abroad Factor Income from Abroad -
Depreciation
Factor Cost = Market Price - Gross Domestic Product at Net Domestic Product at Factor Net National Product at Factor
Factor Cost (GDPFC) Cost (NDPFC) is defined as the
Cost (NNPFC) or National Income
Net Indirect Taxes = Market • GDP MP – Indirect Taxes + total factor incomes earned by
Subsidies the factors of production. • NNPFC = National Income
Price - Indirect Taxes +
• Compensation of employees • NDPFC = NDPMP - Net Indirect • FID (factor income earned in
Subsidies + Operating Surplus (rent Taxes
domestic territory) + NFIA.
+ interest + profit) + Mixed = Compensation of employees
Income of Self - employed + + Operating Surplus ( rent
Depreciation + interest + profit) + Mixed
Income of Self - employed
Personal income is a measure of the actual Disposable Personal Income (DI) that is
current income receipt of persons from all available for their consumption or savings
sources.
• PI = NI + income received but not DI = PI - Personal Income Taxes
earned - income earned but not
received
06 April 2018 The Chartered Accountant Student
, ECONOMICS FOR FINANCE
Product Method or Value Added
Distribution as Method is also called Industrial Origin
Value added Method or Net Output Method
factor incomes
Measurement of National
(Rent , Wages, Method or and entails the consolidation of the
Interest ,Profit) Production production of each industry less
Method intermediate purchases from all other
industries.
Under income method, national
Income
income is calculated by summation
Income of factor incomes paid out by all
production units within the domestic
Method territory of a country as wages and
salaries, rent, interest, and profit.
Circular flow of Transfer incomes are excluded.
income
Disposition Under the expenditure approach, also
Production called Income Disposal Approach, national
of goods and Consumption / Expenditure income is the aggregate final expenditure
services Investment Method in an economy during an accounting
year composed of final consumption
expenditure, gross domestic capital
formation and net exports.
UNIT-II: THE KEYNESIAN THEORY OF DETERMINATION OF NATIONAL INCOME
Determination of National Income The Keynesian theory of Determination of National Income
Two -Sector Model Three Sector Model Four Sector Model The Investment Multiplier
• John Maynard Keynes in his masterpiece ‘The General Theory of Employment Interest and Money’ published in 1936 put forth a comprehensive
theory to explain the determination of equilibrium aggregate income and output in an economy.
• The equilibrium analysis is best understood with a hypothetical simple a two-sector economy which has only households and firms with all
prices (including factor prices), supply of capital and technology constant; the total income produced Y, accrues to the households and equals
their disposable personal income.
• The equilibrium output occur when the desired amount of output demanded by all the agents in the economy exactly equals the amount
produced in a given time period.
• In the two-sector economy, Aggregate Demand (AD) or aggregate expenditure consists of only two components: aggregate demand for
consumer goods and aggregate demand for investment goods / being determined exogenously and constant in the short run.
Circular Flow in a Two Sector Economy The Keynesian assumption is that consumption increases
with an increase in disposable income (b > 0), but that the
Wages,Rent,Interest,Profit increase in consumption will be less than the increase in
Factor Payment disposable income (b < 1).
(Y) The propensity to consume refers to the proportion of the
Factor input total and the marginal incomes which people spend on
consumer goods and services.
The proportion or fraction of the total income consumed
Households Firms is called ‘average propensity to consume’ (APC)= Total
Consumption /Total Income
Goods and Since Y = C + S, consumption and saving functions are
Services (O) counterparts of each other. The condition for national
Consumption income equilibrium can thus be expressed as C + I = C + S
expenditure Changes in income are primarily from changes in the
(C) autonomous components of aggregate demand, especially
from changes in the unstable investment component.
The investment multiplier k is defined as the ratio of change
Consumption function expresses the functional relationship in national i ncome (∆Y) due to change in investment (∆I)
between aggregate consumption expenditure and aggregate The marginal propensity to consume (MPC) is the
disposable income, expressed as C = f (Y). The specific form determinant of the value of the multiplier. The higher the
consumption function, proposed by Keynes C = a + bY marginal propensity to consume (MPC) the greater is the
The value of the increment to consumer expenditure per unit value of the multiplier.
of increment to income (b) is termed as Marginal Propensity The more powerful the leakages are, the smaller will be the
to Consume (MPC). value of multiplier.
The Chartered Accountant Student April 2018 07
, ECONOMICS FOR FINANCE
Keynesian Consumption Function Effects of Changes in Autonomous Income
(A) Y= C+S C+I+ I
Y El
C
C+I
Aggregate Demand
C =f(Y)
Consumption E
Slope = b
I
b
450
a O Y0 Y1 Y2 X
(B)
S
Saving/Investment
Income Y E
I+ I
I S=I E
I
O
Y0 Y1 Y2 X
Consumption and Saving Function
Income Output
Y=C+S
Y
Three Sector Model
Saving
Consumption
C • Aggregate demand in the three sector model of closed economy
(neglecting foreign trade) consists of three components namely,
Dissaving C =a+by household consumption(C), desired business investment
C
demand(I) and the government sector’s demand for goods and
Y
services(G).
• The government sector imposes taxes on households and
a business sector, effects transfer payments to household sector
450
x and subsidy payments to the business sector, purchases goods
o Y1 Y2 Disposable Income and services and borrows from financial markets.
• In equilibrium, it is also true that the (S + T) schedule intersects
S
Saving
Saving the (I + G) horizontal schedule.
o S Circular Flow in Three Sector Model
x
a Y: Y Y2 Disposable Income
S Dissaving Goods and Services Goods and Services
Consumption
Expenditure on Product Expenditure
Market
Determination of Equilibrium Income: Domestic Products
Two Sector Model Investment Expenditure
Govt.Purchases
(A)
Y
Subsidies Transfer
Aggregate Demand
C+S Payments
C+I < C+S House
B Business Taxes Government Taxes hold
C+I
C+I=C+S
C+I > C+S A E C
Government
Borrowings
45O
O Y1 Financial
Y0 Y2 X Market
(B) Investment Savings
Saving/Investment
S
Factor Payments Personal Income
S=I Factor
I I Market
E Factor Services Factor Services
O Y1 Y0 Y2 X
Income Output
Y1
08 April 2018 The Chartered Accountant Student
