Chapter 1

INTRODUCTION TO
MACROECONOMICS

Macroeconomics? How is it different from Microeconomics?

Q.1. What is
Or
between Micro and Macro economics.
Define Macroeconomics. Distinguish
been taken from the Latin Word Macros' which
Ans. The term Macro has
means 'Big'. In this way,
the study of various economic aggregates comes under
In short, macroeconomics refers to the study of
the scope of macroeconomics. of
wheren economic relations between various aggregates
economic aggregates,
-
like total employment, aggregate demand, national income, total
an economy
savings, total investment
etc. are studied. This study is based on the principle of
of various units are expressed as a variable. The
aggregates wherein aggregates
determination of level of employment and national income is a
part subject of the
macroeconomics is a branch of Economics
matter of macroeconomics. Thus,
decision making of an
with the performance structure, behaviour and
dealing behaviour
Economics that studies the
economy as a whole. It is that branch of
economic
and performance of an economy as a
whole. The study of large scale
whole is known as macroeconomics.
factorsaffecting an economy as a macroeconomics:
Following are some major definitions of - Shapiro
"Macroeconomics deals with functioning of
the economy as a whole.
but with
individual quantities as such
"Macroeconomics deals, not only with national income,
incomes but with thhe
these quantities, not with individual
a88Tegates of not with the individual output,
but
but with the price level,
not with the individual prices - Prof. Kenneth Boulding
with the national output". it. In
the as a uwhole or large segments of
Macroeconomicsis concerned with economy
as the level of unemployment,
on such problems
macroeconomics, attention is focussed wide
nation's total output and other matters of economy having
therate the
of inflation, -M.H. Spencer
Sgificance"
1
2 Shiv Das DELHI UNIVERSITY SERIES
indicators and the other factors
Thus, macroeconomics analyses all aggregatemodels are used
Macroeconomics by governments
that influence the economy.
and strategies.
to formulate their economic policies
and corporations of Economics that studies the
Microeconomics, on the
other hand, is a branch
the allocation
behaviour of individuals and firms in making decisions regarding
these individuals arnd firms.
of and the interactions among
scarce r e s o u r c e s
'Mikro which signifies
taken from the greek prefix
The word Micro' has been
related to individual industries, firms,
small. In microeconomic theory, problems determination of a
are studied such as price
markets and other economic units etc.
of an industry
commodity, equilibrium of a firm, equilibrium
Economics it is examined the as to how
In other words, under this branch of
how much quantity of a product a firm
price of a commodity will be determined, how many units of
will produce, how many units of a factor a firm will employ,
the main economic
a commodity a consumer will demand etc. Therefore,
as follows:
problems that form the scope of micro-economic theory are
) Theory of demand
(ii) Production theory
(ii) Price theory
(iv) Factor pricing
Following are some important definitions of microeconomics:
"Microeconomics is the study of the economic actions of individuals and well defined
Sroups of individuals". - Henderson
"Microeconomics is the study of particular firms, particular households, individual1
prices, wages, incomes, individual industries, particular commodities".
-Prof. Kenneth Boulding
Difference between Microeconomics and Macroeconomics
Microeconomics Macroeconomics
(i) Microeconomics studies the ) Macroeconomics studies the
roblems of individual economic economic problems relating to an
units such as a firm, an industry, a economy such as National Income,
Consumer etc. total savings etc.
(ii) Microeconomics studies the (i) Macroeconomics studies the
problems of price determination,
resource allocation etc.
problems of economic growth,
employment and income
determination etc.
(ii) While formulating economic| (ii) In macroeconomics the economic
theories, microeconomics assumes variables are
that other mutually inter
things remain constant. related independently.
(iv) The main determinant of (iv) The main determinant of Macro-
microeconomics is price. economics is National Income.
Q.2. Explain the Macroeconomic issues in an
economy.
Or
Discuss the various issues studied under the
Macroeconomic theory.
Ans. Following are the major Macroeconomic issues in an
() Employment and Unemployment. Unemployment economy: is one of the most
 CHAPTER 1: INTRODUCTION TO MACROECONOMICS3
important macroeconomic issues. It refers to involuntary idleness of
resources including manpower. In case of persistent unemployment,
economy' s actual output will be less than its potential output. This is the
reason why reduction of unemployment is one of the major objectives of
various policies adopted by the government. Each and every government
aims at securing full employment in the economy. Full employment
implies absence of involuntary unemployment of any kind.
( Inflation. Inflation reters to an increase in the general price level of
various goods and services in the economy. When there is fall in the
general price level of goods and services, the situation is known as
deflation. To0 much intlation or too much deflation, both are not good for
the economy. Government aims at achieving the objective of price
stability by striking a balance between aggregate demand and aggregate
supply. Government adopts various fiscal measures for the purpose of
maintaining stable prices within the economy.
in the
(i) Trade cycle. Trade cycle is associated with periodic fluctuations
levels of business or economic activities. It implies that the gross national
output and employment tend to fluctuate over time in a recurring
boom periods, both employment as
sequence of ups and downs. During
well as output are high whereas during recession periods, both output
and employment are low. Trade cycle and its study is very important
affects the level of
from macroeconomic point of view, as it directly
output, employment and prices
in the economy. It is important to analyse
behind business cycles and identify the various remedial
the causes

measures for it.

the modern mixed economics suffer from the evil of
(iv) Stagflation. Many of existence of inflation and unemployment in a
stagflation that implies co-existence of inflation and
the time. The
stagnant economy at
same
issues today.
unemployment is one of
the most complex macroeconomic
hard to deal with the
Most of the countries in the
world are struggling
issue of stagflation.
macroeconomic issue faced by most of
() Economic growth. Another major The
the globe is the issue of economic growth.
the countries throughout is
in the country's total output over the long period
trend of changes measured by the
Economic growth is generally
called economic growth. It is expressed
income of the nation.
annual rate of increase of per-capita Curve (PPC).
the rightward shift of Production Possibility
8raphically by include technological progress,
economic growth
h e various s o u r c e s of labour forece. A
nation
and the growth of standard of
capital formation (lnvestment) by raising the
economic growth mainly
aims at achieving of a
living of the people. Balance of payments
balance of payments.
(1) Exchange rate and
the and payments in
record of its receipts
includes balance of
country is a systematic a financial year. It
transactions in given and exports of
international
difference in the value of imports
trade which refers to
the trade are influenced by
payments and balance of
balance of
goods. Both
4 Shiv Das DELHI UNIVERSITY SERIES

the foreign exchange rate. Foreign exchange means foreign currency and
foreign exchange rate refers to the external value of currency. In simple
words, foreign exchange rate is the rate at which country's currency is
exchanged for another foreign currency. The trend in the value of the
rupee in terms of two major currencies of the world namely U.S. dollar
and British pound, has been downward in the last two decades.
Economists and currency experts always try to find out the reason and
outcomes of such changes.
(vii) Interest rates. Interest rates are the charges that are levied by the banks
for lending loans. A business usually borrows
money from the banks.
Hence, changes in interest rates directly influence the business.
in the rates of interest
Changes
directly influence the way industries and firms
operate in an economy.
 Chapter 2
INTRODUCTION TO
NATIONAL INCOME
ACCOUNTING

you know about withdrawals and

injections? How are these
Q.1. What do
Income?
related to circular flow of National
income generation and expenditure involving
Ans. The flow of production, is
in the form of wages, rent and dividends,
different sectors of the economy income (factor
income. Production gives rise to
known as circular flow of
turn gives rise to
demand for goods and services. This
incomes), which in services
the households on goods and
demand leads to expenditure by units reaches back to
In this way income generated by production
produced.
makes the circular flow complete.
production units and

Goods and services

Consumption
Expenditure OOOOOOD

wages, rent
dividends Firms
Households
a c t o r s for ction

other sector in the

that does not flow to any
o n e sector of incom
The income received by withdrawal. It is that part
or
known as leakage For example, savings,
form of payment is flow of income.
the circular the flow of
back to w i t h d r a w a l s reduce
that does not flow or
Leakages
imports, taxes by the government.
income in the economy.
5
6Shiv Das DELHI UNIVERSITY SERIES
On the other hand, increase in income from a source that exists outside the
circular flow of income is called Injections of Income. It arises due to spending
of any sector of the economy. For example, exports, investment, consumption
expenditure incurred by government or households. An economy is said to be in
equilibrium when the rate of injections = the rate of withdrawals from the circular
flow.
Q.2. Describe the circular flow in monetary terms in a three sector economy.
Ans. The three sectors in the economy are-Households, Firms
Government.
Asfinal consumers of goods and services, the household sector demands these
goods and services whereas the firms produce and supply the same by using the
tactor services provided by the households, so both firms and households play
dual role, i.e., as consumers, households demand goods and services, and as
oWners of factors, supply factor inputs to firms.
On the other hand, firms supply the goods and services as producers and
demand the factor inputs as consumers. The role of the government is to collect
taxes from firms and households to generate revenue so that it can be used for
the welfare of the society (i.e., firms and households are taken together) in the
form of providing transfers such as pension, scholarships for the households and
subsidies for the firms.
lncome
Markets for factors Factor payments
of production
Private
avns Financial Markets
ublic Savings||
Taxes
HOUSEHOLDS GOVERNMENT FIRMS
Government Investment
Purchases
Markets for Goods
Consumption and Services Firm revenue
Circular flow between these sectors takes the form of real flow and money
flow
Real flow. Households as owners of factors of production supply factor inputs
such as land, labour, capital and
entrepreneurship to firms who organise them
to produce commodities. These commodities or output are in turn distributea
among the households through market. The flow of inputs from households
firms and the flow of output from firms to households are called real flow in tne
economy.
Money flow. Firms pay for factor services supplied by the households. Price
paid by the firms for hiring or purchasing factors becomes factor income earne
by the households as owners of those factors. For example, the incomes receive
by households for providing land, labour, capital and entrepreneurship are
called rent, wage, interest and profit respectively. This is called income flow
the economy from firms to households.
 CHAPTER 2: INTRODUCTION TO NATIONAL INCOME ACCOUNTING 7
On the other hand, when firms
supply output, the households incur
expenditure on them in the market by paying the price. This is called
expenditure flow.
So income and expenditure tlows are part of money flow. In the
given
diagram for related money flows in the economy, it should be noted that money
flow is channelled through the banking sector.
0. 3. Explain the circular flow of income, output and spending in an open
economy.
Ans. An open economy is an economy in
which there are economic activities between Goods and services
the domestic community and outside. Hence Consumption
open economy is an economy that has foreign Expenditure
transactions. In an economy, there are various Wages, rent
Households dividends Firms
like household, producing
types of sectors
sector, financial market and the government actors for productio
sector. An open economy is characterised by having one more sector ie, the rest
and spending in
of the world or the external sector. The exchange of income, output
an open economy can be better understood with the help of the following

diagram. it is important to
To study the circular flow of income in an open economy,
is the receipt of some other
understand that payment made by any one sector
and receiver of money income. In the same
sector. Each sector is the payer
as well as the provider of
various goods and
manner, sector
each is.recipient
flow of income, output and spending among
services to each other. The circular
are discussed below.
the various sectors of the open economy sector of any
Household sector is the most important
(i) Household sector. receives factor incomes from the producing sector in
economic model. It services
and profits against various
the form of rent, interest, wages of source
sector. Government acts
as a
rendered to the producing income is, in the form
household sector. Transfer
transfer income for the sector to the
and scholarships, flow from government
of pensions to the
sector also makes payments
Household
household sector. for the
and services which buys it
producing sector against goods household sector to the
Money also flows from
purpose of consumption. flows from
form of taxes. Similarly, money
in the
government sector
market in the form
of savings. In the
sector to the financial takes
household
households buy imported
goods, exchange
same manner, when external sector.
sector and the
between the household income from
place sector receives money
sector. Producing sold to
and services
1) Producing sectors against goods in
household and government income from government
receive money to the
them. Producing sector may fromfinancial market
Money also
moves
sector
the form of
subsidies. Producing
form of loans and borrowings.
in the sector against
producing sector income from
the foreign
household
of money sector to the
is also the recipient from producing various
profits against
moves
also
exports. Money interest, wages
and
sector also
form of rent, producing
sector in the sector. The
to the producing
services rendered
 8Shiv Das DELHI UNIVERSITY SERIES
pays taxes to the government. This sector also makes payment to tho
external sector against imports. Moreover, there is exchange betwen
producing sector and financial market in the form of savings of #h
producing sector.
the
(in) Financial (Capital Market). All the savings of the household sector as
as
well as the producing sector flow to the financial system of the economy
through capital market. Even the savings of the government flow to the
financial market. These savings are further circulated by the
capital
market in the economy in the form of loans. These loans are used
by the
various sectors of the economy for the
purpose ot consumption,
production and investment. Thus money income flows from the capital
market to other sectors of the economy
consumption and investment.
encouraging production,
iv) Government sector. Government sector plays an important role in each
and every type of economic
system. The government imposes taxes on
producing sector and households. The money so collected by the
gOvernment is then spent on the welfare and upliftment of the
Similarly, it pays subsidies to the economy.
various types of transfer income to the
producing sector and also pays
households. It also deals with the
financial market by
depositing its savings and
earned by firms operating in the financial imposing tax on the profit
sector. In the same manner, it
deals with the external sector
duties on imported
by imposing various types of taxes and
of
goods and services. Regulation is the prime function
government sector, especially
forcing the other sectors to do whatpassing
they
laws,
collecting
would not do
taxes and
buys a portion of gross domestic product as voluntarily. It
Thus, government deals with each and government purchases.
within the economy. every other sector operating
() Rest of the world/external sector. An
open economy is characterised by
having foreign transactions. The external sector
producing sector against imports of goods receives payments from
and services by the
producers. Similarly, money and income flow from
producers export goods and services to the restexternal sector when
of the world. The
residents of the country also receive
transfer payments from the
sector. Factor incomes like
rent, interest, wages and external
receiv ed by the residents of the profits are also
same manner, factor
country from rest of the world. In the
payments also flow from the residents of the
country to the rest of the world. Goods and services are
economic transactions with the external sector exchanged by
Q.4. What is depreciation? Why is it through exports and imports.
Ans. During a year, the value of important to compute
depreciation?
fixed assets like machines and
declines due to wear and tear and buildings etc.
value of fixed assets is called anticipated obsolescence. This decline in the
consumption
in the value of fixed assets is not of fixed capital depreciation. This fall
or
made up by the maintenance for
repairs and hence a separate provision for depreciation is current
Hence depreciation refers to the fall in the provided by the firms.
wear and tear and
value of fixed assets due to normal
expected obsolescence
 CHAPTER 2: INTRODUCTION TO NATIONAL INCOME ACCOUNTING 9

Asset depreciation allows for businesses to use a tax write-off to pay for fixed
assets over time. When companies buy large assets, they record them. Assets
represent long-term value for a company's facilities. Expensing such items when
purchased would create distorted net income.
Hence these items should be recorded as assets with a corresponding expense
recorded when the company uses each item. Businesses use depreciation to
report asset use Depreciation also reduces the historical value of
to stakeholders.
when to
assets. Stakeholders can have a look at this information and ascertain
Tax benefits are also
expect replacement of assets purchased by a company. non-cash
possible with depreciation. Although depreciation represents
a

Lower net
expense the income statement, it does reduce a firm's net income.
on

income will incur a smaller tax liability. Hence it

is important for firms to
calculate and compute depreciation.
GDP.
Q.5. Distinguish between Real and Nominal
Ans. Difference between real and nominal GDP
Real GDOP
Nominal GDP
() Real GDP refers to the value of
1) aggregate market value of|
The
economic produced in a
output
the economic output produced in
a year within the boundaries of given period, adjusted according
to the changes in the general price
the courntry is known as nominal
level.
GDP.
inflation adjusted GDP.
It is GDP without the effect of| (7) It is
(i1)
inflation.
current year |(11) It is expressed in base year prices
11) It is expressed in or constant prices.
prices. value of real GDP is
The
The value of nominal
GDP is |(iv)
(iv) relatively lower.
usually higher. of two or

of various (v) It helps in comparison

() It helps in comparison more financial year.
quarters of the given year. economic
indicator of
indicator of |(vi) It is a good
(01) It is good
not a
growth.
economic growth. (GDP) and Gross
Domestic Production
between Gross
Q. 6. Distinguish
National Product (GNP). and GNP
Difference between GDP
Ans. National Product)
GNP (Gross
GDP (Gross Domestic Product) value of goods
and
The money
value of| (i) the country's
) GDP refers to the money services produced by
produced of the
goods and services citizens irrespective
called
within the domestic territory ot geographical
location is
Product (GNP).
the country. Gross National
with production
of
concerned
(ii) lt is the
lt is concerned with production of| and services by
(17) goods
residents
within the country's
enterprises
owned by the
products economic territory.
boundary or of the country.
10 Shiv Das DELHI UNIVERSITY SERIES
(in) It is determined on the basis of |(ii) It is determined on the basis of
location. citizenship.
() It is calculated by adding (iv) It is calculated by adding net
consumption, investment, factor income from abroad
(NFIA)
government spending and net to Gross Domestic Product
(GDP).
exports.
() In case of GDP, the productivity is| v) In case of GNP, the productivity is
measured on a local scale. measured on international scale.
(vi) It focuses on domestic production. (vi) It focuses on
production by
nationals.
vin) It indicates the of the
strength (vii) It indicates the manner in which
country's domestic economy. residents are contributing towards
the country's economy.
Q. 7. What are the activities that are not included in
Ans. Following are the activities GDP?
that are not included in GDP:
i) Non-market activities. In
free market a
those GDP includes only
goods and services that are sold in theeconomy,
market. These are the
and services for which
consumers are goods
willing to pay a price for their
consumption. Those products and services for which consumers are
willing to pay are excluded from GDP. not
like home Various non-market activities
cooking, baby sitting, serving and helping the members
family are not counted while of the
this is that, it is computing GDP. The main reason behind
very difficult to estimate the actual
household services as do not
value of such
Just because these
they go through the market
transactions take mechanism.
not enter the place inside the household
market, they are not and do
are not included in GDP. considered as market
transactions and
(ii) Intermediate goods. Some goods are
For used as
other goods.
example, to
purpose of sugarcane is used as ingredients
a raw
produce
material for the
producing sugar. n order
avoid the to
counting, the value of only final
types of
problem of
is
good taken into double
are
intermediate goods is
not excluded from GDP.account. Value of all
counted in a nation's GDP Intermediate
as that goods
counting. Final only should be
would lead to double
is
intermediate goodproduct counted as the
value of the
GDP is a
already included in the value of
measurement of the market final good. Since
intermediate in final goods, value of
(ii) Resource goods the calculation would be
resource
depletion. Environmental
pollution, inappropriate. using
water
get
depletion are excluded from GDP. contamination and
depleted due to the Even though these
costs
are
resources
excluded process of production, their
in GDP economic value or
(iv) Sale of used or
caleulation.
second-hand GDP is a
production. Hence, value of sale items.
of used or measure of current
included in GDP. They were included second-hand goods are not
in the
produced for the very first time. year in which theywere
 CHAPTER 2: INTRODUCTION TO NATIONAL INCOME ACCOUNTING11
(v) Goods produced outside the country. GDP is the money value of final
goods and services produced within the domestic territory of a country.
Hence goods produced by an Indian company outside India will not be
a part of Indian GDP.
(vi) Transfer payments. Transfer payments are payments which are made
without receiving any service in return. For example, scholarships, pocket
money, social security, financial aid, etc. Since GDP measures the final
sale of goods and services in the economy, it does not include any type
of transfer payments. Transfer payments are not part of final sales of
goods and services.
(vi) illegal activities and parallel economy. Income generated through
illegal activities like smuggling, black marketing, hoarding etc. are never
accounted for. Hence they are not included in GDP. Similarly,
transactions associated with parallel economy can not be included while
the
estimating the value of GDP. There is not much relevant data about the
transactions of
magnitude of the underground economy. Hence
included in GDP.
underground or parallel economy are also not
GDP as a measure of
Q.8. Discuss the strengths and weaknesses of using
National Welfare.
Ans. The following points highlight the importance of GDP as an indicator of
national welfare:
The GDP has a practical importance in
i) Study of economic growth. of a In case GDP has increased
studying the economic growth that country. towards
over the years, it indicates the economy is heading
if GDP falls or is stagnant, it indicates
prosperity. On the other hand,
that the economy is declining.
distribution of wealth. The
GDP gives an idea about the
(ii) Unequal and the total output of the
earnings of the various factors of production distribution of
the output is less and unequal
there is
country. In case to increase its output and to reduce
can take m e a s u r e s
wealth, economy
the gap between rich and poor. the
GDP statistics help in understanding
(ii) Inflation and deflation.
deflation in the economy.
Ithelps in studying
problem of inflation and on consumption
of goods and to what
how much income people spend
the pattern of consumption, savings
extent they save. After analysing to
formulate policies and strategies
and investment, government can
deflation.
of inflation and
deal with the problems In a socialist economy,
in economic progress.
iv) Share of government and controlled by the
are owned, managed
m e a n s of production sector co-
both public and private
in mixed economy,
government, but,
a
the contribution of government
exist. GDP statistics help in identifying
of a mixed economy. the
in economic progress statistics help in ascertaining
other nations. GDP
countries. In case, a
() Comparison with of the various
of the people can take
economic position
of living, its government
having a poor standard
country is
measures to raise it.
 12 Shiv Das DElLHI UNIVERSITY SERIES

(i) Purchasing power. GDP figures throw light on the purchasing powa.
the people of the country. It also indicates power of the
people to s
and their ability to pay taxes.
save
Following points highlight the limitations of GDP as an indicator of nation
welfare: onal
() Distribution of GDP. If the distribution of GDP is
not
even though GDP rises the welfare of the uniform ththen
the rise in GDP people may not rise
becar
may be concentrated in the hands
individuals or firms. of very
(i) Composition of GDP. GDP only shows the total goods and
produced and does not exhibit the structure of the service
increase in GDP is mainly due to product. If tho
equipments, then such an increase increase in
production of war
cannot be associated with anu
improvement in economic welfare. ny
(iit) Non-monetary Exchanges. Many activities in an
evaluated in monetary terms and economy are
therefore are not included not
estimation of GDP. This is a case
of under-estimation of in
example, services of a housewife. GDP, for
(iv) Externalities. It refers
to the benefits
causes to another for (or harms) a firm or an individual
which it is not
externalities though increase economic paid (or penalized). Positive
Similarly, negative externalities, thoughwelfare are not included
decrease
in GDP.
the actual welfare are
not considered in
GDP. Hence, GDP is not a
true indicator of
welfare. economic
Q. 9. Distinguish between
income.
nominal national income and
real national
Ans. When national
the
income is estimated for
the current
prices prevailing in some other year year on the basis
called national income at constant (base year), then the national income ofis
called Real National Income. For prices. National income at constant prices is
real national income is used. For purposes of comparison
example, if we calculate
over a
period of time
year 2017-18 with the help of the national income for the
estimates would be known as national prices that prevailed in the year 2011, the
When national income is estimated income at constant prices.
on the basis of
current year it is called national theprices prevailing in the
income at current
current prices is called Nominal prices.
National Income. For
National income at
income is estimated for the example,
year 2017 on the basis of the
when national
2017, the national income is called nominal prices prevailing in
national income. Nominal
income helps in
making comparisons between different regions for thenational
same
year.
Q.10. Explain the various methods of estimation of
national income. What
problems are faced in the estimation of National Income?
Ans. There are three methods
I. Product method or value
of estimation of national income:
added method or output method
contribution of each producing unit or the value added measures the
by each enterprise in the
process of production. Following are the steps involved in
income according to Product method. measuring national
 NATIONAL INCOME ACCOUNTING 13
CHAPTER 2: INTRODUCTION TO
(i) Classifying all producing units into various industrial sectors as per
classified
their activities. All the producing enterprises can be broadly
sector
into three categories namely: (a) Primary sector, (b) Secondary
and (c) Tertiary sector.
The next is to find out Net value added at factor cost by each
step
(i) +
enterprise. In order to calculate this, first the value of output (Sales
intermediate
change in stock) is estimated and therefrom value of deducted.
consumption, value of depreciation and net indirect taxes are
obtained.
In this way, Net value added at factor cost of all enterprises is
us Net
Adding the total net value added of all enterprises gives
domestic product at factor cost (NDPFc).
factor income earned
(ii) In order to find out National income (NNPFc), Net
from abroad is added to Net domestic product at factor cost.
estimated with the help of income
I. Income Method. National income can be
is
method. Net value added in an economy during production process
as factor payments
distributed among the factors of production (Primary inputs)
or incomes that are generated in an economy.

As per the income method, the following steps are involved in the estimation
of National Income.
that use factor services are
i) In the very first step, al production units
identified.
are then classified into
the following:
(i) Factor payments

Factor Payments

Compensation of Mixed incone of Operatin8

self-employed Surplus
employees

Rent & interest Profits

Wages & Employers
Salaries contribution to Royalty
social security
schemes Undistributed
Dividends Corporate
tax profits

work. It
It is cailed income from
(a) Compensation of employees. contribution to social
includes and salaries and employers'
wages
security schemes. interest
It is the sum total of rent and royalty,
(b) Operating surplus.
and profits.
Rent. It includes imputed rent and royalty.
factors of production for
Interest. This is a factor payment made to
for investment purposes.
obtaining money componernts namely-dividends,
t includes three
Profits undistributed profits.
and
corporate tax It is the income of the
self*
income of self-employed.
(c) Mixed
14Shiv Das DELHI UNIVERSITY SERIES
employed persons, for example, incomes of. advocates, doctors and
owners of sole proprietorship firms.
These units or persons provide all the factor services
and hence their income is mix of income from work and
themselve es,
(ii) By adding up all the factor of of
property
payments enterprises all the
the factors
domestic factor income is obtained. This is called Net domestic factors,
at factor cost
produrt
(NDPFc).
(io) The next step is to estimate Net factor income from abroad (NFIA),.
() By adding Net factor income from abroad (NFIA) to Domestic factor
income (NDPFC) we obtain National Income
(NNPFc).
. National Income
=Domestic factor income + Net factor income from abroad
III. Expenditure Method.
According to expenditure method, we measure the
expenditures incurred on final products produced by production units located
within the domestic territory during the given year. Final products are those
goods and services which are required for consumption and investment.
Therefore, final expenditures are expenditures incurred on
for
goods and services
consumption and investment.
The main steps involved in this method are as
follow:
(i) Classify all the industrial sectors into three sectors, namely:
sector, secondary sector and tertiary sector. primary
() Categorising final expenditures into following sub-heads:
.Private final consumption expenditure. It refers to
expenditure
incurred by households and
goods for current use.
non-profit institutions on consumer
Government final consumption
expenditure. This is
imputed value of services produced and provided equal
to the
free by the
general Government to the people.
Gross domestic capital formation. This is the sum of Gross
domestic fixed capital formation and Net
Net exports which is equal to change in stocks.
Following are the major problems are Exports
minus Imports.
faced in estimation
) Types of goods and services. There are various of National Income:
services types of goods and
produced in the economy. Goods and services that have a
monetary value attached to them are included in national income but
there are certain goods and services that
may not contribute to the
current flow of money
payments. These may include services that are
offered out of affection, love, kindness
but no
etc. They have an economic value
money value. The major difficulty is that whether these should be
included in the national income or not. Moreover, it is
very difficult to
measure the money value of such services. For example,
fee for treating patients but when he takes medical care of his
a doctor charges
or her
family member then it becomes very difficult to estimate the value of
such a service. Moreover, the inclusion of such value in national income
is valid or not, is a big question.
(ii) Double counting. It signifies a situation when a commodity is counted
more than once in the estimation of national income. This can lead to
 CHAPTER 2: INTRODUCTION TO NATIONAL INCOME ACCOUNTING 15

over-estimation of national income. For example, a farmer produces one

tonne of rice and sells it for R1,000 in the market to an intermediary. The
intermediary sells it to another middleman for 1,200. That middleman
further sells it to an agent for 1,500. The agent then sells it further to a
foodchain hotel
or
industry for R1,800. The hotel industry sells the entire
stock of rice to final consumers for 72,000. Hence the value of output
will be R1,000 + 1,200 +1,500 + 71,800 + 72,000 77,500.
In the above example, the value of rice is counted five times. Hence the
counting of the value of an item more than once is called double counting.
This can result in wrong estimation of national income.
(i Excluded market transactions. There are certain transactions that take
place in the market and are excluded from the computation of national
income as they are not considered as valid income. In order to recognise
as income, the goods or services must be currently produced and should
use up the available scarce resources. Various transactions associated
with capital gains, transfer payments, second-hand sales, income from
market transactions.
illegal activities, etc. fall in the category of extended
Their inclusion and exclusion in national income has been
the topic of
decades.
great debate over the last few
Self consumption. This problemis particularly related to the primary
(iv) who produce food for themselves and
sector subsistence cultivators
consume a major proportion of their
own
their family members and
market it
basis. Since this output is not sold in the
output on an annual domestic product. Moreover, it is very
is often excluded from the gross
market value of such output. This creates
difficult to determine the
estimation of national income.
another problem in proper in
of reliable data is.another problem
(u) Lack of official data. Lack
least developed nations and other
estimation of national income. Many accounts of
reliable and official
countries do not maintain
developing unregistered,
by
are characterised
their transactions. The countries
it
retailers and traders. Hence,
sectors and roadside
unorganised transactions of such business
becomes very difficult to trace the
data and information regarding
enterprises. Lack of trustworthymakes it difficult to estimate the
of such business firms very
transactions
national income correctly. social
indicator of increase in
in national income
an
Q. 11. Is increase
welfare? Comment. members of the society.
refers to the well being among the
Ans. Social welfare social welfare but it is
is often linked to increase in
of a simple example. In
Increase in national income
be understood with the help of
not always the case. It increase in the production
can
increase due to
income and output increase in
case, national
tobacco and liquor it may indicate
like On
socially undesirable goods lead to decline in social welfare of the people.
income and output but
will increase in the
increase due to
national income and output in social
the other hand, if will lead to increase
goods like milk then it increase
indicator of
production of healthy always an
national income is
not
increase in
welfare. Thus,
16 Shiv Das DELHI UNIVERSITY SERIES

in social welfare. Similarly, if increase in national income gives

inequalities income and wealth within an economy, again, it will rise to
of
decline in the welfare of the result
people
increase in national income increases the
of an economy. On the other
hand, if.
n

to increase in social
living standard of the poor it will lo an
welfare. Hence, increase in national income does
indicate increase in social welfare. not alwa.
ays
Q.12. How is GDP
computed using the expenditure method?
Ans.
Following steps are involved in measuring GDP with the
expenditure method: help of tho
) In the very first
step all the industrial units
are identified. All these industrial units incurring final expenditure
into three are classified
namely primary, secondary
and tertiary sectors. sectors
ors
11) In thenext step all the final
following subheads: expenditures are classified into the
Private final
consumption expenditure. It refers to the
expenditure incurred
by households, and other
institutions on consumer
goods for current use. non-profit
Government final consumption expenditure. This refers to
imputed value of services produced and the
general government the people.
to
provided free by the
Gross domestic
capital formation. It is the sum of gross
fixed capital formation and domestic
opening stock).
change in stock (i.e., closing stock -

Net exports. It is the

difference
(ii) By adding up all the above mentionedbetween exports and imports.
final
product (GDP) is obtained. While expenditures gross domestic
method following precautions must calculating
be taken:
GDP from
expenditure
Expenditure second hand goods should not
on

Expenditure on purchase of both old and newbe included.

should not be included shares by people-
of an economy.
as
they do not contribute to the
production=
.Government expenditure on transfer payments like
should not be
included. pensions etc-
Only expenditure on final goods and
otherwise
there will be double services is to be calculated,
Q. 13. How is GDP counting.
computed using income method?
Ans. In order to
compute
() First of all, all
GDP from income
method following
production units which use factor steps are takent"
(i) Factor payments are clássified services are identified.
into the
Compensation of followingcategories:
with employees. It includes wages and salaries along
employers' contribution to social
they known as income from work. security schemes. Together-
are
Rent. This includes
imputed rent and royalty.
Interest. This is also a factor
payment made to a
money for investment purposes. factor productior
for obtaining of
Profit. It includes three
components
and undistributed profits. namely dividends, corporate ta
 CHAPTER 2:
INTRODUCTION TO NATIONAL INCOME ACCOUNTING
17
.Mixed income. It is the
income of the self-employed persons. For
example, incomes of advocates, doctors and owners of sole
proprietorship firms.
(11) By adding up all the above mentioned factor
Domestic Factor Income (NDPFC) is obtained. payments National
(i) The next step is to estimate the value of
from abroad and Net Indirect depreciation, Net Factor Income
taxes
(o) By adding depreciation Domestic factor income (NDPFc), we get Gross
domestic product (GDP).
(vi) It should be noted that in order to compute GDP at factor cost there is
no need of
deducting net indirect taxes from Domestic factor income
(GDPFc). On the other hand, in order to calculate GDPMp i.e., Gross
domestic product at market price, it is essential to add Net indirect taxes
to Domestic factor income
(GDPFc)
Q. 14. Explain the value added method for measuring of Gross domestic
product.
Ans. Following steps are involved in measuring Gross domestic product
(GDP) through value added or output method or product method:
(i) The very first step is to identify productive enterprises of an economy
and classifying them into three categories on a sector-wise basis namely
Primary sector, Secondary sector and Tertiary sector.
( The next step is to estimate the value added by each enterprise by
deducting intermediate consumption from the value of output (Sales
+

Change in stock).
Value added = Value of output - Intermediate consumption

.where. Value of output =

Sales +
Change in stock
Change in stock =
Closing stock -Opening stock
in various
value added by each productive enterprise falling
(iii) By adding value added at market price
sectors of the economy, we derive Gross
market price (GDPMp).
(GVAMP) Gross domestic product at
or
at
order to calculate Gross domestic product
(iv) It should be noted that in Net indirect taxes from
factor cost it is essential to deduct
(GDPfc)
GDPMP from value added method it important
is to take the
While calculating GDPup
following precautions: should be excluded.
of intermediate expenditures
() All types second-hand goods
should be excluded.
and purchase of
(17) Value of sale should be included.
for self-consumption
Production included as they
(11) o w n e r occupied
houses should be
rent of
(10) Imputed
a rental value.
possess not be included.
services should included.
(v)
Self-consumed
units should be
of the producing
Own account production national income.
(7) method of measuring the
Q.15. Explain the product
method m e a s u r e s
added method or output
the
Ans. Product method
or value each enterprise in by
or the
value added
unit
contribution of each producing
process of production.
18Shiv Das DELHI UNIVERSITY SERIES
national income ing to
accordingto
Following are the steps involved in measuring
product method: industrial sectors as per
various
units into
sS1ying all producing can be broadly classifieg
producing enterprises
neir activities. All the sector, () Secondary sector
(a) Primary
to three categories namely: cost by each
and (c) tertiary sector. Added at factor
the Net Value
T h e next step is to find out value of output (Sales +
calculate this,
f1rst the
enterprise. In order toestimated and therefrom value of intermediate
change in stock) is net indirect
taxes a r e deducted.n
depreciation and
consumption, value of factor cost of all
enterprises is obtained,
Added at us Net
this way, Net Value all enterprises gives.
Value Added of
Adding the total Net cost.
Domestic Product at factor Factor Income earned from
National Income, Net
(11) In order to find out factor cost.
Domestic Product at
abroad is added to Net National Income.
method of measuring
Q.16. Explain the income of income method. Net
Ans. National income can
be estimated with the help
distributed among the
process is
production
value added in an economy during or incomes that are
factors payments
factors of production (Primary inputs) as
generated in an economy.
involved in the estimation
As per the income method, the following steps are
of National Income:
In the very first step, all production units that use factor services are
i)
identified
(i) Factor payments are classified into the following:
Factor Payments
Compensa tion of Mixed income of
Operating
employees self-employed Surplus
Wages & Employers Rent& Interest Profits
Salaries contribution to Royalty
social security
schemes
Dividends Corporate Undistributed
tax profits
(a) Compensation of employees. It is called income from work.
includes wages and salaries and
security schemes. employers' contribution to socia
(b) Operating surplus. It is the sum total of rent and
and profits. royalty, intere-
Rent. It includes
imputed rent and royalty.
Interest. This is a factor
payment made to factors of production, f-
obtaining money for investment purposes.
Profits. It includes three Components
corporate tax and undistributed profits. namely-dividend
 CHAPTER 2: INTRODUCTION TO NATIONAL INCOME ACCOUNTING 19
(c) Mixed income of self-employed. It is the income of the self-
employed persons, for example, incomes of advocates, doctors and
owners of sole proprietorship firms.
These units or persons provide all the factor services themselves,
and hence their income is mix of income from work and
property.
(ii1) By adding up all the factor payments of enterprises of all the factors,
Domestic Factor Income is obtained. This is called Net Domestic Product
at factor cost.
(iv) The next step is to estimate Net Factor Income from Abroad.
() By adding Net Factor Income from Abroad to Domestic Factor Income
(NDPFC) we obtain National Income (NNPFc).
National Income = Domestic factor income + Net factor income from abroad
Q.17. Explain the expenditure method of measurement of National Income.
Ans. According to expenditure method, we measure the expenditures
incurred on tinal products produced by production units located within the
domestic territory during the given year. Final products are those goods and
services which are required for consumption and investment. Therefore, final
expenditures are expenditures incurred on goods and services for consumption
and investment.
The main steps involved in this method are as follow:
() Classify all the industrial sectors into three sectors, namely: primary
sector, secondary sector and tertiary sector.
(i) Categorising final expenditures into following subheads
Private final consumption expenditure. It refers to expenditure
incurred by households and non-profit institutions on consumer
goods for current use.
the
Government final consumption expenditure. This is equal to
the
imputed value of services produced and provided free by
general Government to the people. sum of gross domestic
Gross domestic capital formation. This is the
fixed capital formation and net change in stocks.
minus Imports.
Net exports which is equal to Exports
Q.18. Write short notes on the following:
(a) Depreciation
(b) Net Income from abroad
c) Problems of Double counting
) Operating Surplus of fixed assets like machines
Ans. (a) Depreciation. During a year, the value obsolescence.
etc. declines due to wear
and tear and anticipated
and buildings
is called consumption of fixed capital
or
This decline in the value of fixed assets made up by the
of fixed assets is not
depreciation. This fall in the value for depreciation
maintenance for current repairs
and hence a separate provision
value of
refers to the fall in the
Is provided by the firms. Hence depreciation obsolescence.
tear and expected
fIXed assets due to normal wear and tax write-off to pay
for fixed
businesses to use a
ASSet depreciation allows for assets, theyrecord them. Assets
assets over time. When companies buy large
20 Shiv Das DELHI UNIVERSITY SERIES
represent long-term value for company's
a facilities. Expensing such items w
whe
net income.
purchased would create distorted
Hence these items should be recorded as assets with a corresponding exten.
recorded when the company uses each item.
(b) Net Income from albroad. It refers to the difference between factor income
received from the rest of the world and factor income paid to the rest of the wor
NFIA = Factor income earned from abroad Factor income paid abroad
The above two can be explained as follow:
1. Factor incomefrom abroad is the income earned by the normal resident
of a country from the rest of the world in the form of wages and salarie,
rent, interest, dividend and retained earnings.
2. Factor income to abroad is the factor income paid to the norma
residents of other countries (i.., non-residents) for their factor service
within the economic territory.
(c) Problems of Double counting. It signifies a situation when a commodity ie
counted more than once in the. estimation of national income. This can lead to
over-estimation of national income.
For example, a farmer produces one tonne of rice and sells it for 71,000 in the
market to an intermediary. The intermediary sells it to another middleman fo
1,200. That middleman further sells it to an agent for R1,500. The agent ther
sells it further to a foodchain or hotel industry for ?1,800. The hotel industr
sells the entire stock of rice to final consumers for 2,000. Hence, the value o
output willbe 1,000 +R1,200 +R1,500 + 1,800 + 72,000 = 7,500.
In the above example, the value of rice is counted five times. Hence the
counting of the value of an item more than once is called double counting. Thi
can result in wrong estimation of national income.
) Operating surplus. Operating surplus refers to the sum of rent, interestan
profits. t is defined as the income due to ownership of resources om
entrepreneurship. Operating surplus includes the following
i) Rent and royalty. Rent is a factor income earned from lending the
services of land and building. Royalty is income received from
grantin=
leasing rights of sub-soil assets.
(ii) Interest. It is the price of borrowed funds. Money is usually borrowed
business for the purpose of investment. Interest is considered as the
reward or payment which the borrower makes to the lender of the
money capital for using his capital for a specific time period.
(ii) Profit. Profit is the residual factor payment to owners of production
units. Hence profit is the income of the factor
input called entrepreneur.
It is a reward that owners of businesses get for being in business and
taking various types of risks. Profit is the sum total of corporate tax,
dividends and undistributed profits.
Corporate tax is the tax paid by joint stock companies. Dividend is that
part of profit of a corporate enterprise that it pays to its shareholders.
Undistributed profits refer to that part of profit which is left with the
business after paying corporate tax and dividend.