CHAP 11:

NATIONAL INCOME AND ITS

ACCOUNTING
Q1: Define National Income ?
Ans: INTRODUCTION: The total number of the goods
produced in a country during a particular year is called National Income like food grains,
manufactured goods and minerals etc. Not only the good are produced but the people also
render the services like doctors, teacher, clerks etc. These services are also included in
the national income. In this manner, national income refers to the total sum of the good
and services produced in a country during a particular year.
DEFINATION :
The market value of all the goods and services produced in a country during the
period of time is called national income.
OR
National income is the collective of achievement of nation. OR
National income is the aggregate of the individual income. OR
The total sum of goods and services produced by the people of the country with the help
of capital and natural resources is called National Income.
Q2: What are the various concepts of national income?
Ans: DIFFERENT CONCEPTS OF NATIONAL INCOME
 Gross National Product(G.N.P)
 Net National Product(N.N.P)
 Personal Income (P.I)
 Disposable Personal Income
 Gross domestic products.

GROSS NATIONAL PRODUCT:

Gross national product (G.N.P) is the market value of all goods services produced
in a country with the help of factors of production”
OR
In the words of W.C Peterson:
“Gross National Product may be defined as the current market value of all final goods
and services produced by the economy during an income period regardless of where the
output is produced”
GNP = GROSS DOMESTIC PRODUCT + NET
FACTORS INCOME FROM ABROAD
NET NATIONAL PRODUCT (NATIONAL INCOME AT MARKET PRICE):
In the production of Gross national product of a year we consume or use some
capital i.e. machinery, equipment etc. the continuous decrease in the value of fixed assets
during their utilization in producing goods is called depreciation. If the depreciation is
subtracted from GNP the resultant is called Net National Product (NNP).
NNP is defined as:
 “The net value (after providing for depreciation) of all final goods and services produced
in a year evaluated on the basis of market prices”
OR
Net national product (N.N.P) is obtained by subtracting depreciation with gross national
product.
N.N.P = G.N.P- Depreciation
PERSONAL INCOME:
The income earned by anybody in his personal capacity is termed as personal
income. The personal income includes earning from charity, donation, pension etc
PERSONAL INCOME = National Income – Social
Security Contribution – Corporate Taxes –
Undistributed Corporate Profit + Transfer Payments.
DISPOSABLE PERSONAL INCOME:
When personal taxes are deducted from personal income then disposable personal
income arrived.
D.P.I = P.I – direct taxes
GROSS DOMESTIC PRODUCT: The incomes are solely sale by the
country is called gross domestic product. It excludes foreign earning. OR
“Gross Domestic Product is the total market value of all final goods and services
produced within a year by the factors of production located within a country”
G.D.P = G.N.P – foreign income
Q3: What is the difference between GDP and GNP?
Gross National Product Gross Domestic Product
1) Concept
Gross National product is Gross domestic product
defined as the total is the total market value
market value of all final of all final goods and
goods and services services produced within
produced with the help of a year by the factors of
factors of production of production located within
any country inside or the country.
outside the country during
a year.
2) Abbreviation:
The abbreviation of gross The abbreviation of gross
National product is G.N.P Domestic product is
G.D.P
3) Formula:
G.N.P = Gross domestic G.D.P = Gross National
Product + net factors product – Net factor
income from abroad Income from abroad

Q4: What is the Difference between P.I and DP?

Ans:
 Goods/Services Total Currents Total
product of price value
a year (billion)
Wheat 130 metric 1 billion per 130
tons
Rice 170 metric 1 billion per 170
tons
Coal 50 metric 1 billion per 50
tons
Iron 60 metric 1 billion per 60
tons
Radio 20,000 units 1000 per 20
unit
T.V 16,000 units 1000 per 80
unit
Doctors 25 doctors 1 billion 25
annually
Professors 150 100,000 15
professors
GNP 550
LESS: (25)
Deprecation
N.INCOME 525
Q:5 What are the differences between personal income and disposable personal income?

Ans:
Personal Income Disposable Personal Income
1
Concept: Personal Disposable personal income is that
)
Income is that income with is actually pact of personal income which is
recited by all individual liking in an actually auilible to the people for
economy dueling a period of one year consumption.
formal the possible source.
2 Abbreviation: The abbreviation of personal
) The abbreviation of Personal income disposable income is P.D.I.
is P.I.
3 Formula: Disposable personal income personal
) Personal income = Nationajl income – income – personal tax OR
social searity contribution – compete Disposable personal al income –
taxes – undistributed cooperate profit consumption + Savings.
+ trcinsfel payment.
Q6: What are the different methods’ of measuring national income ?
Ans: MEASUREMENT OF NATIONAL INCOME:
Following are the methods of measuring national income:
1. Product approach
2. Income approach
3. Expenditure approach
 1) PRODUCT APPROACH:
The money value of all the find good and services produced in a country.
*GOODS INCLUDE:
Agricultural product like vegetables, fruits, rice etc.
 Minerals like coal, oil etc.
 Industrial goods like electronic, machine.
 Miscellaneous goods like live stock etc.
Services Includes,
Doctors, teacher, lawyer etc
PRECAUTIONS
Avoid double country:
Either count final value of goods a services a count
intermediate good .It is called value added method.

The vale added method

Production Total value (Rs) value added (Rs)
process
Cotton 10 10
Thread 17 7
Dye 22 5
Cloth 32 10
Shirt 35 3
Avoid Counting Free services: The free services are
rendered by are one person for another should not be calculating as this will lead to
double counting.
For Example: if a husband gives 3000 per month to his wife than it could not be wife
personal income because it is not reward of a labor.
Depreciation Allowance Are Subtracted: In this approach depreciation
should be subtracted in order to get national income.
2) INCOME APPROACH: There are four factor
of production that is land labour, capital, organization. If there rewards are summed up
than national income arrived.

S.No Reward (per annum) Total

amount(billion)
1 Wages 20
2 Interest 30
3 Rent 50
4 Profit 100
National income 200
PRECAUTIONS:
Illegal income should not be added for example smuggling.
Transfer of payment such as scholarship, pension should not be added.
 3) EXPENDITURE APPROACH: The
combination of all expenditure of the country is called expenditure approach.

Amount(Billion
)

Personal consumption 400

expenditure
Gross domestic private 100
investment
Govt.expenditure on good & 75
services
Gross domestic public 25
investment
Export surplus 10
Net foreign investment 15
G.N.P 625
Less Depreciation (25)
N.N.P 600
Add Govt.subsidies 50
Less Indirect taxes (80)
Less Transfer payments (40)
Less Statiscal discipency (5)
National Income 525
Q7: What are the difficulties faced by the countries for calculating national income?
Ans: DIFFICULTIES IN MEASUREMENT OF NATIONAL INCOME:
 Shortage of statistical data.
 Lack of train man power.
 Lack of specialization.
 Free Services.
 Demonetization goods.
 Ignorance and illiteracy.
 Lack of responsibility.
 Price fluctuations.
 Earning of foreign firms.

1) STORAGE OF STATISTICAL DATA: One of the main

difficulty in measurement of national income is the storage of statistical data the govt. has
lack of information which is creating problem in determining national income.
2) Lack of train man power: There is lack of train man
power in our country. They have lack of knowledge, training etc.
3) Lack of Specialization:
Another factor which is creating hurdle in determining national income lack of
specialization. They have lack of skills, technology, management skill and interpretations
skills (lack of system).
 4) Free Services:
There are certain services which are rendered by a house wife are not included in
national income even those are reward of the labour.
5) Demonetized Good:
Those good which are consumed by the producer them self they are called
Demonetized good For Example farmer consume their own product.
6) Ignorance and Illiteracy:
Ignorance and illiteracy are also creating hurdle for determining national income
For Example in Pakistan 63% of the population on his alliterated.
7) Lack of Responsibilities:
People have lack of responsibilities For Example they cancel there income from
income tax department. Bribery, insufficient policy are also the main reason for
determining the national income.
8) Price Fluctuation:
Due to in fluctuation and changing in price good and services the actual figure of
national income can’t be determine.

9) Earning Foreign Firms:

Large number of foreign firm are working in our country the issue is that either
there income should be taking in the home country a foreign country.
Q8: What are the significance or importance of national income?
Ans: A, The study of national income is very importance because of the point of view of the
development of a country. Following are the importance of study of national income:
 Analysis of Economic situation of a country
 Rate of economic growth
 Analysis of Economic problems of a country
 Economic policies
 Economic planning
 Inflation and unemployment
 Importance in international trade
 Importance for entrepreneur
 Capital accumulation
 Determination of the level of employment
 Development of underdeveloped regions
 Importance for political parties
 Discourage illegal means of income
1) Analysis of Economic Situation of a Country:
It is not enough to say a country that whether it is developed or underdeveloped
because a lot of factors must be considered in order to understand its economic situation
such as level of growth, economics stability , balanced sartorial development etc.
National income helps us to understand about the economics situation of a country.
2) Rate of Economic Growth:
Every year annual growth rate of national income is measured in every country.
By measuring national income we can easily judge that what is the speed of growth of
development of a country with respect to other countries.
3) Analysis of Economic Problems of a Country:
 National income is also used measure the economic problems of the countries.
Once the problems is determined , then it is impossible for the policy makers to solve
these problems.
4) Economic Policies:
National income is used to form different types of policies such as monetary
policy, fiscal policy, commercial policy, labour policy etc.
5) Economic Planning:
It is rightly said that “A good plan of today is better than the perfect plan of
tomorrow” National income is used to make planning for the country. Once the planning
process is completed successfully, then it is easily for the country to implement it.
6) Inflation and Unemployment:
National income is used to control the problems of inflation and unemployment,
which are considered as core restriction for the development of any country.
7) Importance in International Trade:
National income is used to understand export surplus (i.e. export-import) which is
an important part of national income.
8) Importance for Entrepreneur:
National income statistics is used by the entrepreneur as a tool for investment.
When the investor wants to invest in any country he first consider the national income of
the country for decision making process.
9) Capital Accumulation:
National income is used to accumulate capital for the country. It means net
addition to the existing stock of capital assets in a country e.g. construction of new roads,
new bridges, new factories and new shopping centre. These capital are used to produce
more goods and services which further accelerate economic growth.
10) Determination of the Level of Employment:
There is a direct relationship between national income and level of employment.
Higher the level of national income higher the level of employment and vice versa.
Hence, national income is used to find out level of employment in a country.
11) Development of Underdeveloped Regions:
National income is used to analyze different regions of the country. So that
different programmers can be made for the development of the people living in different
regions.
12) Importance For Political Parties:
The success of any political party depends on the development of its people.
Through national income, the political leaders may come to know the problems of the
people and then make commitments to the people according to it. The problems may be
unemployment, poverty, inflation etc.
13) Discourage Illegal Means of Income:
National income helps to discourage the illegal means of income. The illegal
income is earned through hoarding ,
smuggling, money laundering , black marketing etc.
Q9: National Income at Factor Cost and National Income at Market Price?
Ans: Net National Product – NNP (National Income at Market Price) (NImp)
Net National Product – NNP is the total net market-value of final goods and
services a nation or a country produces during a year. In other words, it is the GNP minus
 the value of depreciation allowances of capital goods. Since in the process of production
of GNP during year, we have to use various capital goods like equipment, machinery,
instruments, tools and building etc. these capital goods are subject to wear and tear being
used. So their value goes on decline. Thus, while computing NNP, a certain percentage
of value has to be deducted. Therefore NNP is also called National Income at market
price. Briefly, we can define NNP as:
NNP or NIMP = GNP – depreciation of capital allowances

National Income – NI (National Income at Factor Cost)(NIFC)

National income is the total sum of all the income payments received by the
factors of production-land, labour, capital and organization. It can also be derived by Net
National Product (NNP) in the following manner.
NI of NIFC = NNP – Indirect taxes + Subsidies
It is, in fact, the national income at factor cost for which the term national income is
frequently used.
The difference between National Income (NI) or National Income at factor cost and net
National Product (NNP) or National Income at market prices arises from imposition of
direct taxes and provision of subsidies. These two elements cause market prices of output
to be different from the factor income resulting from it. Therefore, national income or
national income at factor cost is equal to national product minus indirect taxes plus
subsidies.
Q10: Define National Income and explain the Circular Flow of National Income with the
help of “Circular Flow” diagram?
Ans: Circular Flow of National Income:
National income accounting provides aggregate sum of the market value of the
final goods and services produced in a country during a certain one-year period. Gross
National Product (GNP). Net National Product (NNP) and National Income (NI) are the
different measures of aggregate output.
Throughout the year, national income flow like a stream. It flows from firms to
households and back to firm in a circular way, which is called circular flow of national
income.
The aggregate income of factors of production is equal to the money-value of all
the goods and services produced by them in a year. The people of a country, in aggregate
term, are by themselves producers as well as consumers of the national product. Thus, the
economy of a country can be divided into two main sectors.
1) Business Sector:
This sector consists of all the producing firms of all the goods and services. It may
also be called production sector.
2) Household Sector:
This sector is composed of all the consumers who consume produced goods and
services by spending their all sorts of income rewards in form of wages, interest, rent and
profits provided by the business sector.

Circular flow of national income14-1

Wages, Interst, Rent, and Profit

Services of Labour, Capital, National

Resources and Entrepreneurial Ability

Household Business
Sector Sector
 Money Expenditure for Goods and Services

Goods and Services

How the circular flow of national income takes place? Diagram 14-1 furnishes the
answer.
Diagram 14-1 represents a simplified model of national output as a flow of
expenditure ans income. In the model, the role of the government and the saving has been
excluded. The upper part of the circular flow shows that the national output is equal to
the household consumption expenditure for goods and services, while the lower part
measures national output by summing the household sectors receipts of wages, rents,
interest and profits. The inner part of circular flow traces the exchange of factor services
for final output.
Q11: National Income at Market Price and National Income at factor cost?
Ans: Measuring GDP:
We can measure GDP with the following two approaches. Measuring GDP with
both the approaches yield the same result because income and expenditure are always
equal.
1) Expenditure approach (GDP at market price)
2) Income approach (GDP at factors cost)
Expenditure Approach:
In expenditure approach, we measure GDP by summing up different types of
expenditures made on final goods and services. Therefore, it is the sum of expenditures
made on goods and services.
GDP = C + I + G + (X – M)
The different types of expenditures are as follows:
Personal Consumption Expenditure:
Personal consumption expenditure is the expenditure that individuals and
household make on purchasing final goods and services like video games, movies,
medicines, utilities (electricity, telephone) etc.

Gross Domestic Investment Expenditure:

It is the expenditure made by firms to buy capital and equipment like raw
materials, machines etc. it also includes expenditure made by household to buy new
homes.
Government Expenditure:
Government expenditure includes expenditure on making roads, bridges, dams
etc. it also includes salaries and transfer payments paid to employees.
Net Exports:
 It is the total value of goods and services exported minus total value of goods and
services imported. It is positive when exports are higher than imports and negative when
imports are higher than exports.
Income Approach:
Income approach measures GDP by summing up all the incomes that firms pay
for the resources and factors they hire i.e. rent for land, wages for labor, interest on
capital and profits for entrepreneurship. Incomes are divided in five categories, they are
as follows:
1. Compensation of employees:
(wages, salaries, transfer payments)
2. Net Interest:
(Difference between interest household receive and pay on loans)
3. Rental Income:
(income paid to household for the use of land and other rented inputs)
4. Corporate Profits:
(includes both dividends paid and profits retained by the corporation.)
5. Proprietor’s Income:
(Profits of the owner)

Adjustment: Factor Cost to Market Prices:

We need to make following adjustments to arrive at GDP at market prices.
(+) Add indirect taxes
(-) Less subsidies
(+) Add depreciation
To get from factor cost to market prices, we add indirect taxes because indirect taxes are
paid by consumers as part of a market price, but indirect taxes are not factor payments.
Therefore, consumers pay more than what it cost to producers and we add indirect taxes
to make factor cost and market prices equal.
In the next step, we subtract subsidies because subsidies are support prices paid to
producers by the government to encourage production of a particular commodity.
Because producers. Therefore, we less subsidies to make factor cost and market prices
equal.
In the final step, we add depreciation because income measured in the factor cost
approach is a net measure (excluding depreciation) whereas investment expenditure is a
gross measure (including depreciation). Therefore, we add depreciation to make factor
cost and market prices equal.
Q12: What are the Define Dumping ?
Ans: Dumping:
Is the selling of excess goods in a foreign market al a price below cost. Economic
cite two plausible reasons for this beheviour
1. Firm’s may use dumping abroad to drive out do mastic competitors there, thus obtaining
monopoly power and monopoly price and profits for the importing firm the long term
economic profit resulting from this strategy may more than offset the earlier losses that
accompany the below-cost sales.
 2. May be a form of price dissemination which is charging different prices to different
customers even though cost are the same. The foreign seller may find it can maximize it’s
profit by charging a high price in it united states. The surplus output may be needed so
the firms can obtain the overall per-unit cost saving associated with large-seals
production the higher profit in the home market more them. Market up for the losses in-
cured on sale abroad.

Chapter:12

CONSUMPTION
Q1: Define Consumption and consumption function?
Ans: INTRODUCTION:
It is a common observation that whenever income change consumption also
changes. In other word when income rise consumption also rice and vice versa. in other
words change income change consumer behaviour.
 DEFINITION: The consumption function
explain the relationship between disposable income and it consumption.
Q2: Explain average propensity to Consume (APC) and Marginal propensity to
Consume (MPC)?
Ans: PROPENSITY TO CONSUME: As a result of change in income the
mode according to which the consumption change is called propensity to consume.

P=C/Y when C = consumption

y= Income
CLASSIFICATION OF PROPENSITY TO COMSUME
(i) Average of propensity to consume
(ii) Marginal of propensity to consume
(APC) (MPC)
1) AVERAGE OF PROPENSITY TO CONSUME: It is a proportion to found
between different given
level of income and consumption. Apc = C
y
2) MARGINAL OF PROPENSITY TO CONSUME: The difference between
consumption to a difference of income is called marginal of propensity to consume.
Mpc = ∆C ∆y
Consumptio APC
Income n =C/Y MPC =∆ C/∆Y
 
1500 1700 1.133 -----
2000 2000 1 0.6
2500 2250 0.9 0.5
3000 2450 0.8166 0.4
3500 2600 0.7428 0.3
4000 2700 0.675 0.2
4500 2750 0.611 0.1

Q3: What are the determinates of consumption?

Ans: DETERMINATION OF PROPENSITY TO CONSUME:
Objective factors subjective factors (General) (person 2 person)
OBJECTIVE FACTORS:
 Price level.
 Expected income.
 Income Distribution.
 Liquidity preference
 Fiscal policy.
 Rate of interest.
1) Price Level:
 If the prices are expected to increase in future the people will improve income
there purchasing in presents because the goods will seem to be cheaper in present than
future.

2) Expected Income: If the people are expecting to

increase in income the consumption changes even those there income as not increase yet.
3) Income Distribution:
Pattern of income distribution also affect propensity to consume.
4) Liquidity Preference:
If the people are habitual to have there saving as cash with them the propensity to
consume are high vice versa.
5) Fiscal Policy:
If there is direct tax the propensity to consume will be low and vice versa.
6) Rate of Interest: Increase in rate of interest
decrease the consumption.
SUBJECTIVE FACTORS
1) Precautionary Matives: If the people are more
sensitive against accidental needs they save for a rainy day.
2) Habits from Religion and Culture: Some people adopt
consumption or saving habit from their religion and culture For Example jews, hindus,
banyar, save mora than other class.
3) Social Status & Prestige: Some time people save to
gain social status prestige so their consumption goes down.
4) Short Sightedness and Ditetracy: Some time short sightedness
and diteteracy make people extra vegant & hence propensity to consume decrease.

Chapter:13

SAVING

Q1: Define saving and saving function?

Ans: Saving is that part of disposable income which is not spend on consumption.
OR Saving refer to that part of
national income which is not consumed on goods and services by the individual and the
governments and due to which real volume of investment enhanced.
Q2: Explain Average propensity to save (APS) and Marginal propensity to save (MPS)?
Ans: Kinds of Propensity to Saving:
1) Average propensity to save (APS)
2) Marginal propensity to save (MPS)
 1) Average Propensity to Save:
The ratio or propensity between the different level of income and saving.
A.P.S = S/Y
2) Marginal Propensity to Save: The difference between
saving to difference of income is called marginal propensity to save (M.P.S).
APS
Income Saving =S/Y MPS =∆S/∆Y
-
1500 -200 0.1333 ----------
2000 0 -------- ----------
2500 250 0.1 0.5
3000 550 0.183 0.6
3500 900 0.257 0.7
4000 1300 0.325 0.8
4500 1750 0.388 0.9

Q3: What are the determinants of Saving ?

Ans: DETERMINENT OF SAVING:
Ability to save Willingness to save
ABILITY TO SAVE:
1) QUALIFICATION: Goods qualification includes
the ability to save of an individual. He can easily get more information from their work .
2) TRAINING: If the worker are more
trained so they can improve their working efficiency and hence their income will also
increase.
3) WORKING EFFICIENCY: If the working efficiency
could increase than get out the saving will also increased because efficient worker
produced more than inefficient worker.
4) PART TIME JOBS: We can also improve our
saving capacity of doing part time jobs.
5) ECONOMY: We can also save a heavy
amount by using economy in our life.
WILLINGNESS TO SAVE
1) FOR PROTECTING OLD HOOD: People save money for
protecting old hood because they have a fear about the future and the higher the age the
lower the saving.
2) ACCIDENTAL & CASUAL NEEDS: People save money for
emergency needs. So that they no need to take loans or borrowing from other people.
3) SOCAIL STATUS: some people save money to
gain social status because they tired of being poor.

Chept:14

INVESTMENT
Q1: Define investment?
Ans: Definition #1:
In accordance with the national income analysis:
“Investment refers to that part of national income which is converted into the installation
and establishment of new machines and factories or in new and durable goods.
Definition #2:
“The same thing can be described in brief that whatever is spent on the plant and
pre-requisites is called ‘INVESTMENT’ while the goods and stocks existing already in
the plant are known as ‘capital’. In other words
“Investment is the increase in the stock of capital”
Q2: What are different kinds / types of investment?
Ans: Classification of Investment:
There are two types of investment:
 Gross investment
 Net investment
1) Gross Investment:
In the gross investment all the amounts are included which are spent on new
factories, machines, furniture, etc. during a certain period of time.
2) Net Investment:
If the amount spent on depreciation is deducted from this amount residual is
called net Investment.
Kinds of Investment:
There are two kinds of investment
 Autonomous investment
 Induced investment
Autonomous Investment:
Definition#1:
Autonomous investment is made without any consideration given to existing
demand extended by the consumer.
Definition#2:
The investment which is made automatically.
Definition#3:
In the other words autonomous investment is not influenced by the increase or
decrease in national income.
Example:
The car plants established first time are included in the same kind of investment
because there was no demand for car at all. The investor invested these plants in hope and
on the confidence that the demand for cars will be created in the future. The amount spent
on such projects which could decease in cost are autonomous investment.
Induced investment:
Definition #01:
Induced investment is made by giving any consideration given to the exist
demand extended by the consumer.
Definition #02:
 The investment which is not made automat city
Definition#3:
Induced investment and the national income go together in the same direction.

Investment schedule Amount (Million.Rs)

AUTONOMOUS INDUCED INVESTMENT
INVESTMENT
Income Investment Income Investment
20 5 20 5
30 5 30 10
40 5 40 15
50 5 50 20
60 5 60 25

Autonomous Induced

25
20
15
10
5

10 20 30 40 50 60 10 20 30 40 50 60
Income Income
Q3: What are the determinant of investment?
Ans: Determent or factors of investment:
A basic and significance question is that under what motivation the people invest?
In response to this question various ideas have been propounded but the expert have no
common agreement on any one of them. Nevertheless there is a common agreement on
the fact that the investment is made under the motive of profits. There may be various
determinant of profit like level of economics activities, changes in the level of prices and
market condition etc. aggregately; this can be concluded that the level of investment is
determined by two factors;
There are two types of investment
 Rate of investment
 Marginal efficiency of capital
1) Rate of Interest:
 The borrower is required to play a particular rate of interest after a particular
period of time. He borrowed for investment which was made for earning the profit.
Therefore before agreeing on a particular rate of interest to pay, he compares the rate of
interest to be paid and the profit should at least be equal to the interest to be paid
otherwise, what will be justification to invest? Investment will continue so long the profit
will be higher than rate of interest
Rate of interest does not change rapidly but remains almost unchanged at least in the
short period therefore efficiency of capital plays decisive role in determining the volume
of investment.
Q4: Explain marginal efficiency of capital (MEC)?
Ans: Marginal efficiency of capital (mec):
Definition#1:
According to L.J.M Keynes, marginal efficiency of capital is nothing but the rate
of profit. He says
Marginal efficiency of capital is equal to that rate of discount which makes existing
returns through the capital equal to its price during the period of its investment.
Definition#2:
Marginal efficiency of capital or investment is the highest expected rate of profit
which is tikely to be had by a marginal increase in the rate of investment
Definition#3:
It is the maximum expected rate of return from an asset. Over its use full life
MEC =maximum expected rate of return
Price of asset
Example: mk price=100,000
Profit from m/c = 100,000
INVESTMEN EXPECTE MARGINAL
T D RETURN EFFICIENCY
(RS) (PERCENTAGE)

10,000 1200 12
12,000 1200 10
14,000 1120 8
16,000 960 6
18,000 720 4
20,000 400 2
Q5: What are the factors affecting marginal efficiency of capital?
Ans: Factors of efficiency
Marginal efficiency of capital depends on the following factors:
Expected demand:
Investment is made on the basis of expected profits. If the demand for goods,
against the expectations, falls, the MEC will also fall.
Density of population:
Increase or decrease in population influences the marginal efficiency of capital. In
case of rapid increase in population, the demand for goods increases and so the
 investment becomes more profitable due to enhancement of prices efficiency of capital
falls in otherwise situation.
Availability of capital goods:
Capital goods refer to the machines and tools. if these goods are abundantly
available, excess entry of the producer in the market makes competition severe and the
profits fall decreasing the efficiency of capital on the contrary. If the capital good are
short in the market, the efficiency of available capital goods increases.
Taxes:
Taxes increase cost of production and the prices and therefore the curtail in
demand becomes necessary. If the producers are heavily and excessively taxed the
efficiency of capital decreases.
Technological advancement:
As a result of technological advancements inventions and innovations come into
being due to which the industry expends making the market wide and the efficiency of
capital increases. This is the reason that the efficiency of capital is higher in the western
countries to the developing countries because the industrial revolution has created
unlimited opportunities of in vestment in the advanced countries of the world.
General out look:
A business man can never estimate precisely all factors involved over the life of
major investment will demand for the final product really be what he expects will a new
machine come along? The general outlook of business men often lays a big role on his
final decision whether or not to invest, and it is very hard to specify all the other factors
which may influence businessman’s attitude.

Chep15

THEORY OF EMPOLOYMENT

Q1: Explain the concept of full employment?

Ans: Concept of Full-Employment:
The concept of full-employment is an ambiguous concept. So far, it has been
defined by the different economists in different sense. Literally, it means zero
unemployment. Some economist regard voluntary unemployment as no unemployment
and fractional and structural unemployment as bad employment situation. According to
some economists, when the unemployment rate is close to 3 – 4 percent, it can be
 considered a full-employment situation. Some economists are of the view that since both
the demand for and supply of labour are sensitive to the wage-rate therefore full-
employment can also be considered such situation where the demands for labour equates
the supply of labour in the economy at a given wage rate. However this definition cannot
be considered a good one because it suffers from the problem of the mobility of labour as
well as the non-uniform wage rates of different occupations at different place.
Q2: Explain classical theory of employment? OR Explain says low of market?
Ans: Classical Theory of Employment or Say’s Law of Markets:
The classical theory of employment holds that full-employment of labour and
other productive resources is a normal state for the economy. The situation of
unemployment arises out of the state intervention in the free play of economic forces. If
the state does not interfere in the free play of economic forces there will always be a state
of full-employment. Classical theory of employment is based on Say’s Law of Markets.
The law was proposed by a French economist J.B. Say in 1803. According to this law,
“Supply creates its own demand,” hence there would never be over-production and
general employment because they are logically not possible. In other words, since every
supply generates an equivalent demand for output, therefore, there would be no problem
of over-production. The theory implies that the main source of demand is the income of
various factors of production which they get by way of participating in the process of
production. The remuneration received by them creates the demand for products they
produce. Thus, the entire new output would be sold out by the created new purchasing
power. On the basis of such logic. J.B. Say come to conclude that aggregate demand must
equal aggregate supply. If general over-production is not possible, then there is no
possibility of general unemployment. Classical economists were of the view, the work is
available to persons who are willing to work. If some willing persons are unemployed, it
would mean economic forces are being intercepted in their free play. If these forces are
allowed to play freely and wages are allowed to find their own level there will be no
unemployment.
Pigou’s Modification:
Pigou supported the theory by arguing if money wage-rates are flexible, there will
always be tendency of full-employment. The removal of interferences and existence of
free competition should force the wage level down until it is profitable for employers to
employ every willing worker. Thus, unemployment is due to rigidity towards wages
structure.

Assumptions Of Classical Theory

The classical theory of employment is based on the following four assumptions.
1) Perfect competition exists in the market therefore neither sellers nor buyers can affect the
price of output and inputs.
2) Wages and prices of goods are free to move according to their demand and supply.
3) People are motivated by their self-interest.
4) Government interference is not there.
Q3: What are the criticism of the classical theory?
Ans: Criticism of the Classical Theory:
 The classical theory of income and employment has been severely criticized by
Keynes and some other well-known economists on the following grounds.
1) Equality of demand and supply is not necessary:
The classical of income and employment is based on the assumption that supply
of goods and services create4s it own demand. All the income earned in the process of
production is consumed in purchasing the goods and service produced in the economy
maintains a level of full employment.
2) Automatic or self-adjusting in supply and demand is not necessary:
The classical theory implies that the economic system adjusts itself automatically.
Say’s law of markets stresses that aggregate supply will always be equilibrium with each
other and this process works automatically.
3) General wage-cut policy may lead to unemployment:
Pigou pleaded that by enforcing a general wage-cut policy unemployment may be
reduced to the minimum because employers will prefer to employ more employees.

4) Saving-investment equilibrium is not necessary:

According to the classical theory, flexibility in rate of interest bring equilibrium
between saving and investment. It means, at a particular rate of interest saving and
investment must be equal. Keynes did not agree with this view point. According to him,
saving and investment decisions are made by two different groups of the people having
different motives.
5) State interference is necessary:
The classical economists were of the view that to achieve the level of full-
employment the economy must be allowed to work smoothly without sate interference.
Keyness strongly opposed this view point and stressed the necessity of government
interference to promote employment level through appropriate fiscal measure.
6) Experience could not prove is validity:
The great depression of 1930 proved invalidity of Say’s law. During the period,
over-production was a common feature of the capitalist countries. Nearly one-fifty of the
labour force of these countries had to face the problem of unemployment. Supply could
not create is own demand.
Q4: Explain different types of unemployment?
Ans: Unemployment and its Kind
Definition:
Those people who are without jobs or those people who are looking for job are
said to unemployment.
Kind Of Unemployment
There are three type of unemployment.
1) Frictional Enemployment:
It is arised because of incessant movement of the people b/w regions and job or
through different stage of life cycle.

2) Structural Unemployment:
It signifies a mismatch b/w the supply of and the demand of workers.
3) Cyclical Unemployment:
 It exist when the overly demand for labour is low. As total spending and output
fall unemployment rises every where
Q5: How unemployment can be controlled? Suggest measures.
Ans: Unemployment can be controlled through following measures.
Promoting Labor Intensive Industries:
Labor intensive industries employ more labor force in the production process. In
labor-intensive industries more people are provided with jobs than in capital-intensive
industries.
Controlling Cyclical Unemployment:
Structural and frictional unemployment is unavoidable. The government has the
responsibility to control cyclical unemployment. This is done by smoothing the business
cycles. Providing liquidity in the economy in the times of recession and mopping up
funds when there is excess liquidity in the economy.
Providing Adequate Training:
With the passage of time, old jobs are removed and new jobs are created. With the
invention of printing press, many scribes lost their jobs. When training is provided to
people by imparting skills that are demanded in the market, several people who have
outdated skills will find jobs.
Micro Financing:
Pakistan is a developing country and it is also suffering from the chronic problem
of poverty. If the poor people are provided with finance, they have enough motivation
become self-employed and start cottage industries. This will supplement the large scale
industries and other sectors of the economy. The example of Bangladesh in using
microfinance to solve unemployment and poverty is a recent example.
Promoting Investment:
Foreign investment in Pakistan has come into sectors like real estate and stock
market which does not create real increase in output and does not provide employment to
the masses. Government schemes should promote investment in local industries, local
plants and equipment and manufacturing within Pakistan so that employment generation
can take place incised Pakistan.
CHEPTER 16
DETERMINATION OF
NATIONALINCOME
KEYNESS THEORY
Q1: How national income is determined through Keynes theory of income and
employment? OR
How equilibrium level of national income is determine? OR
Define inflationary and Deflating gap? OR
Prove AD = AS OR
Prove S = I OR
What is effective demand?
Introduction:
The fundamental thing to be noted about Keynes theory of employment is that
employment is a function of income, the greater the level of national income, the greater
the value of employment. Keynes as be is occurred with the short run only, assumes the
amount of capital, technology, equipment, quality of labour constant.

Income Employment

Income Employment
Approach # 01
National income is determined at a point where aggregate demand is equal to aggregate
supply where as,
AD = C + I
(Consumption) + (Investment)
Assumptions:
Following are its assumption
1) No interference of government
2) No retained earning
3) Two sector of economy.
1) No Interference Of Government:
In this approach there should be no interferences on the part of govt. This
means that only producer and consumer should determine the price of the product.
2) No Retained Earning:
 Retained earning is defined as accumulated profit of the pervious years. In
this approach there should be no retained earning but it should be spender or invested
some where else.
3) Two Sector Of Economy:
In this approach, there should be two sector:
1) Producers
2) Consumers.
Z=Y=C+S

Y U+I
U C=1

E
Effective demand (ageregan demand)
E G

O 45 X
Y Y Y
Approach # 02.
National income is determined at the point when saving is equal to investment.
S=I
Derivation of S = I
We known that
AD = AS
Or
C + I = G.N.P
C + I = National income
C + I = C + S (Saring)

I=S or S=I

I F E
I

O N
 S

Inflationary and Deflationary Gap

When the aggregate demand is more than aggregate supply, this situation is called
inflationary gap. Which means that the price are rising on the contrary when the
aggregate demand is less that aggregate supply it called deflecting gap. Showing
decreasing in price level.
AD > AS = inflationary gap.
AD < AS = Deflationary gap.

Chapter17:

THEORY OF MULTIPLIER AND

ACCELERATION
Q1: Define the concept of multiplier?
Ans: MULTIPLIER:
Introduction:
The concept of multiplier was initially used for the analysis of business
oscillations this idea was utilized by R.f Kehan in 1931 for analysis the “Great
Depression” of 1930 and afler a few year the same was used by L.J.M Keyness as one of
the most important tools for this well known theory of income and employment.
Definition:
The increase in national income by Autonomous investment can be known by
Multiplier.
OR
It is a change in income due to change in investment.

Multiplier = Change in income

Change in investment
K = ▲y/▲I
Deviation of Multiplier equation.
K = ▲y/▲I
But = ▲y/ s = I
So K = ▲y/▲s
But m.p.s = ▲s/▲y
OR
1
/m.p.s = ▲y/▲s
 So K= 1/m.p.s OR K= 1/1-m.p.c

Change in invents ▲y ▲c ▲s
Rs in (million)
100 100 90 10
90 81 09
81 73 08
73 66 07

100 1000 900 700

Q2: What are the significance of the theory of multiplier?

Ans:1) Highlights the Importance of Multiplier:
The multiplier theory stresses the importance of investment to income and
employment theory. An increase in investment leads to a cumulative increase in income
and employment due to multiplier effect and vice versa. Thus, it emphasizes the
importance of investment and explains the process of income generations.
2) Throws a Spotlight on the different Phases of a Trade Cycle:
Theory of multiplier explains the fact that when there is a fall in investment,
income and employment decline enormously leading to recession and resultantly to
depression.
Helps in Bringing Equality Between Saving and Investment:
The concept of multiplier helps in bringing the necessary equality between saving
and investment. If there is a disagreement between the two, an increase in investment
may lead to a rise in income by way of multiplier effect; more tan the increase in initial
investment. As a result of increase in income, saving will also rise to equalize investment.
Helps to check Trade Cycles:
A government can check effects of trade cycles with the help of multiplier by
influencing income and employment. When the economy is under inflationary pressure,
the government can control it by way of reduction in investment which leads to a
multiple decline in income and employment.
Underlines the Importance of Deficit financing:
In a state of depression, the policy of budget deficit, which demands increasing in
public expenditure through public investment can really help in increasing income and
employment by multiplier time. Hence, theory of multiplier underlines the importance of
deficit financing.
Underlines the Importance of Public Investment:
The importance of multiplier in public investments lies in creating or controlling
income and employment. The government can create desired multiplier effect on income
and employment by way of increasing public investment during the period of depression.
Q3: What are the limitation of multiplier?
Ans: Limitations of Multiplier:
1) Multiplier Period:
In Kenyesain analysis, it is assumed that as soon as the income is received by the
recipients it is spent to the extent of its MPC. But, in reality it is not so. There is certainly
a time gap between the receipt of income and its spending, though it may be of short
duration. The smaller the multiplier period, the higher is the value of multiplier, and vice
versa. Hence, the multiplier period is an important condition to the working of multiplier.
2) Maintenance of Investment:
For achieving the desired value of multiplier, maintenance of investment at
regular intervals in necessary. If the process is not duly repeated, the desired multiplier
effect in income generation will not be there.
3) Availability of Consumption Goods:
Multiplier can work accordingly if the goods and services on which the additional
income is to be spent, are available sufficiently in the economy. In case of shortage, the
income recipients will not be able to spend their full income in purchasing goods, Hence,
their MPC will not act accordingly.
4) Net Investment Addition:
Multiplier can work effectively with its full force only if a net addition of
investment is made. An increase of investment in one sector withdrawing the same from
another sector, will not help the multiplier to affect income and employment levels. It
implies that intersect oral investment can impede the working of multiplier.
5) Full Employment Level:
The multiplier cannot work fully in case the economy is working at, or near, full
employment level. The reason is, any increase in investment cannot push up the
production and employment because all factors are already at full employment. At full
employment level, increased investment will push up the price and not the production.
Here the ration of MPC remains inactive.
6) Existence of Closed Economy:
The value of multiplier can be realized only in closed economy: the economy not
involved in foreign trade. In case the country has trade relations with other countries, the
multiplier would have different value than its real value.
7) Role of Induced Consumption:
Just as investment induces consumption, similarly induced consumption can also
influence investment. But while valuing the multiplier, only investment is considered and
induced consumption is ignored just assuming that it has no effect on investment. If its
importance is also taken into account, the real value of multiplier will be much higher.
Q4: What do you know about the concept of acceleration?
Ans: Acceleration
Introduction:
The principle of acceleration was first time propounded by “john clark” in 1917.
According to which. During the business cycle, what ever increase take place in the
production of consumption goods, investment increase many time more. The concept of
interest was incorporated in the principle of acceleration after 1936.
Definition:
 It is the ration b/w the change induced investment and change in national
occurring through a change in consumption.
W = ▲k / ▲y
K = Induced investment
Y = National Income.
Example:
Value of machine = Rs 5 production of consumer good Rs = 01.
1) Life span of capital good is 10yrs.
2) 10 % Replacement cost
3) Price Level is constant
Years Induced Required Value of Depreciation Gross
Consumptio Capital new Invention
n K = yxw Machine (Induced
+ Dep)
01. 100 500 - 50 50
02. 110 625 50 50 100
03. 125 625 75 50 125
04. 125 625 0 50 50
05. 110 550 -75 50 -25
06. 100 500 -50 50 0
Explanation:
In above table induced consumption, required capital Dep, and gross investment
is shown the required capital can be known by Multiplying induced cooption with
acceleration and gross investment can be known by adding dep with induced investment.
Q5: What do you know about the interaction of concept of acceleration and multiplier?
Ans: Interaction of Multiplier and Accelerator:
Keynes did not attach any importance to the concept of Acceleration in his work
due to not greed with Say’s Law of Markets. He even did not mention is name in the
explanation of business cycles. He for the explanation of cyclical fluctuations,
emphasized on propensity to consume and the theory of Multiplier. However the
prominent economists of today like Samuelson. JR Hicks, Harrod and Hanson, are of the
view that neither the multiplier nor the accelerator alone offer a satisfactory explanation
of business fluctuation. According to them, it is the interaction of the both theories which
leads to changes in business activities in an economy.
How Does Interaction Occur:
When an increase in real investment is made, it leads to increase an national
income by a multiplier number depending upon the size of the multiplier. For instance, if
the size of the multiplier is 5, then an induced investment of Rs. 5 million will rise the
income level of the economy by Rs 25 million. People will now have more money with
them to spend on consumer goods. The increase in demand for consumer goods will have
a magnified accelerator effect upon the demand for capital goods. This is the interaction
multiplier and acceleration.
The process of interaction of multiplier and acceleration can be more clearly
explained with the help of a schedule. It has been assumed that.
1) MPC IS ½.
2) Acceleration coefficient is 2.
3) Autonomous investment of Rs 10 million remains constant every year.
 4) There is one period lag between consumption and investment.
Interaction between multiplier and accelerator (Rs in million)
Period Autonomous Induced Induced Total increase in
Investment Consumption Investment income
1 2 3 4 (2+3+4)
1 10.00 0.00 0.00 10.00
2 10.00 5.00 10.00 25.00
3 10.00 12.50 15.00 37.50
4 10.00 18.75 12.50 41.25
5 10.00 20.62 3.75 34.27
6 10.00 17.18 6.88 34.06
We have taken 6 period for explanation the interaction of the multiplier and the
accelerator. These period are indicating that an increase in income of one period leads to
an increase in consumption of the succeeding period. In first period, the autonomous
investment has been assumed to be Rs 10 million. It has also been assumed that an
increase in income in one period leads to investment in the second period. The 50
increased consumption and induced investment will be zero in the first period. The total
income will be equal to initial investment or Rs 10 million.
In the second period, the induced consumption is Rs 5.00 million (10x1/2=5.00).
Induced investment is Rs 10 million (5 x 2 = 10) the total income is Rs 25 million (10 + 5
+ 10)
In the third Period, initial investment is again Rs 10 million. Induced consumption
is Rs 12.50 million whereas induced investment is Rs 15 million (12.50 – 5.00 = 7.50 x 2
= 15) Total increase in income comes to Rs 37.50 in the third period and so on.
We therefore, can see that autonomous investment affect income which in turn
effects induced investment. National income thus increases with increase in investment
and vice versa.
Q6: What is the difference between multiplier and acceleration?
Ans: Theory of Multiplier and the theory Principle of Acceleration have the following
differences between them.
Multiplier Acceleration
1 Multiplier shows the effect of the Accelerator shows the effect of a
. change in vestment on income and change in consumption on investment.
employment.
2 The consumption is dependent upon Investment is dependent upon
. investment C = f (1) consumption; I = f (C)
3 It depends upon the marginal It depends upon the durability of
. propensity to consume. machine.
4 Multiplier depends upon The accelerator depends upon
. psychological factors Technological Factor.
5 It requires constant increase in It demand increase in consumption to
. investment for the purpose of increase increase in investment
in level of income.
6 It discuss with autonomous investment It discuss only with induced
. while it is assumed that induced investment and ignores autonomous
investment will not effect upon investment
autonomous investment.
7 Multiplier works as rigorously in Working of accelerator is restricted in
. reduction of income as it does the downward direction to the rat of
increasing of income. replacement of capital.