Learning Objectives End use classification of goods Meaning and types of investment gross investment 2 net investment 4 eprediton (consumption of xed capital) 4 Domestic or economic territory ce 4 Normal residents of @ country w +: importance of concepts of domestic territory ond normal resident e 4 Factor cost and market price a 4 Domestic income and national income 2 net factor income from abroad ft 4 Factor payment and transfer payment x «difference between factor payment and transfer payment 4 National income accounting : meaning and its uses O 4 Aggregates related to national income % definitions: GDP» NDPyp and reloted aggregates NATIONAL INCOME AND RELATED AGGREGATES : SOME BASIC CONCEPTS A\n understanding of the following concepts is required to analyse and calculate national income by three methods namely, product, income and expenditure method. To measure national income and to understand the relationship among production, income and expenditure, we need to first know these basic concepts of macroeconomics, 29eS 30 UNIT 1; NATIONAL INCOME AND RELATED AGGREGAT! 3.1 END USE CLASSIFICATION OF GOODS This can be illustrated as follows : | end use classification of Goods | (A) Intermediate Goods (used by producers).as a _ Capital goods Rav materials Consumer goods are Example. Cloth purchased by tailor (used by consumers) Produces) Purchased for direct * Purchased for the produc * Goods purchased for resale meu nee of goods and services Example. A car purchased by a Example : A car purchased ‘car dealer for resale driver tobe used a * Durable capital goods purchased by government for defense services [Refer to Box 3.(0)] Example. A car purchased by a ‘consumer for personal use (A) Intermediate Goods These are those goods and services which are purchased by one production unit fon, ath Production units during the year for : > further processing during the year (raw materials), eg, sugar used for making suey * resale during the year by dealers (without making any alteration by dealers) e~, gy purchased by a grocer. Expenditure on intermediate goods during an accounting year is called intermediate consumption. Two characteristics of intermediate goods are : (i) These goods are purchased by one production unit from another production unit. (ii) When these goods (raw materials) are processed, they lose their existence as they are used up in the process of production e.g., wheat (raw material) when processed into flour (final good), cotton when processed into cloth etc. or these are resold without making any alteration (by dealers) during the same year. Intermediate goods remain within the production boundary. (Refer to Box 3.2 for concept Production Boundary) Let us know more about intermediate goods : (a) These remain within production boundary ic, they are purchased by one production unit from another production unit for processing further. However, there are some goods which ate purchased by one production unit from the other for own use like purchase of machines, equipments, vehicles etc. These are examples of final goods (and not of intermediate goods), 8 these are used to produce goods and services for sale in the market, Hence these are final goods (discussed in 3.1(B)). () There are some durable capital goods purchased by government for defence (military) service like missiles, bombs, tanks, military vehicles etc. which are treated as intermediate goods. These are taken as raw materials (as exceptions for defence services) used for: generating defence services NOTE However not all sons 4 Purchases by one produce unit from the other produsix unit are intermediate oui, Goods which are not comple used up like machines, vehi, tools, equipments etc, a called final capital goods. Introductory MACROECONOMICS--xilChapter 3 : NATIONAL INCOME AND RELATED AGGREGATES 31 (8) Final Goods Goods and services which are either purchased or there is own account production for the purpose of consumption and investment are called final goods. These goods are outside the production boundary. These goods are acquired for > consumption called consumer goods. > investment called capital goods. (9 Consumer goods. These satisfy wants of consumers directly. These are finally purchased by the consumers for the satisfaction of their wants, ¢.g., bread, scooter, T.V. set etc. These can further be divided into four categories : (a) Durable goods. These are those goods which can be used in consumption over a long period of time e.g,, refrigerators, televisions, cars etc. () Semi-durable goods. These are the goods which can be used for a limited period of time as compared to durable goods e.g., furniture, crockery, shoes, clothes etc (0 Non-durable goods. These are used up in a single act of consumption. Their existence is over, the moment these are consumed. For example, milk, ghee, bread, vegetables etc. (@) Services. These are invisibles which are purchased by consumers for direct satisfaction of their wants e.g., services of doctors, lawyers, teachers, banks etc. (ii) Capital goods. These are those final goods which help in production of goods and services further (capital formation). These can be used over and over again to produce goods and services. These have derived demand as these are used to produce goods and services demanded by the economy. For example, plants, equipments, machinery etc. Box 3.2 ‘The concept of production boundary is used to differentiate between intermediate goods and final ‘goods. It is an imaginary line around the production sector which shows the nature of goods produced in this sector. The goods which remain within the production boundary are intermediate goods and when the goods cross the production boundary, these become final goods. paca rr eee oe wheat and sells ae bread and sells Final good (for consumption) ects pe cp Smeatt ay Fmt or neni (worth 71000) ‘to baker (worth 71500) (worth 2000) 3.1.1 Classification of Producer Goods Producer Goods eee ae cream ate) teers gene erat nd er Introductory MACROECONOMICS32 UNIT 1: NATIONAL INCOME AND RELATED AGGREGATES 3.1.2 Features of Intermediate Goods 1. These goods are used by producers. (Purchased by one production unit production unit). 2. These remain within the production boundary (production boundary is an im; drawn around the production sector signifying production processes invol 3. The value of intermediate goods is not included in national income. This is done problem of double counting. (Problem of double counting is discussed in 3.1.3. Features of Final Goods ‘aginay ved), from oth, a Y lng to avoid iy, chapter 4) 1. These goods are used by consumers (called consumption goods) oF used by produce (called capital goods). 2. These cross the production boundary. 3. The value of final g00ds is included in the calculation of national income. Os ea ee “Machine purchased is always a final good”. Do you agree ? Give reasons for your answer (CBSE SP 201213) Ans. Whether ‘machine’ is a final good or not, depends on how it is being used. If the machine is bought by a household, then it is a final (consumer) good. If the machine is bought by a firm for its own use, then also it is a final (capital) good. If the machine is bought by a firm for resale by a dealer then it is an intermediate good. 2. Which among the following are capital goods and which are consumer goods and why ? (CBSE AI 18) (a) A car used as taxi (b) Refrigerator in a hotel (¢) Air-conditioner in a house Ans. (a) Capital good because the car (investment by producer) is used as taxi. It is producing a service to consumers, hence generating income. (#) Capital good. The refrigerator (investment by producer) is producing a service to consumers, hence generating income. (©) Consumer good as air-conditioner is purchased by the household for final consumption. 3.1.4 Difference between Intermediate Goods and Final Goods [basis i= Intermediate Goods a Meaning | © These are used for production of other goods | These are meant for resale (purchased by a dealer for resale.) [2 Production and are not ready for use by final users. “Final Goods Final goods are of fwvo types | and services (raw materials) and are comple- | (a) Consumer gods : When purchased by | tely used up in the process of production. | Consumers fer final consemption (®) Capital goods : When purchased by | producers for investment. ‘These remain within the production boundary | These are outside the production boundary and are ready for use by the | boundary | | final users. Value | Value is added to these goods Value is not to be added to these | | addition | goods. | 4. Nature of | Demand for intermediate goods is derived | Demand for final goods is direct | demand | demand as their demand depends on demand | demand as these satisfy the wants (of consumers and producers) directly. | for final goods. These goods are not included in the estimation of | 5. Inclusion in National | national income (to avoid the problem of Income | double counting). Introductory MACROECONOMICS-XIl ‘These goods are included in fhe esti- mation of national product oF income.33 Clossify the following as intermediate goods or final goods : 16. 17. 19. 20. Answers Final good: 3.1.5. Difference between Consumption Goods and Capital Goods Paper purchased by a publisher. 2. Milk purchased by households. Purchase of sugar by a grocery shop. 4, Cloth used by a tailor. Construction of houses by the consumer households. Furniture purchased by a school (case D1) Chemical fertilizers used by the farmers. (CBSE D 11) ‘Machine purchased for installation in a factory. Coal purchased by a factory. 10. Textbook purchased by a student. Books purchased by a book seller. Expenditure on research and development by a company. Seeds purchased by a farmer. 14, Electricity consumption in a business. Mobile sets purchased by a mobile dealer. (CBSE D1) Chalks dusters etc. purchased by a school. (cBsE D1) Milk purchased by a hotel 18, Fees paid to the lawyer by a producer. Computers installed in an office, (case D1) Unsold wood with a furniture producing firm at the end of a year. : 2,5,6,8, 10, 19, 20 Intermediate goods : 1, 3, 4, 7, 9, 11, 12, 13, 14, 15, 16, 17, 18 Basis: Consumption Goods Copital Goods 1. Satisfaction | These goods satisfy human wants directly. | These goods satisfy human wants indirectly. of human wants | Z_Usage | These are used by consumers (iret demand), | These are used by producers (derived demand), 3, Expected | Most of the consumption goods have limited | Capital goods generally have an expected life time _| expected life time. life of more than one year. 3.2 3.2.1 MEANING AND TYPES OF INVESTMENT Investment means additions made to the existing stock of capital during the year. It increases productive capacity of the producers i,, = AK (/ = Investment, K =capital stock). Investment can be gross or net. Gross Investment or Gross Domestic Capital Formation The total addition of capital goods to the existing stock of capital during a given time period is called gross investment. Components of gross investment are : Gross Investment (oF Capital Formation) | Gross fixed investment or Change in stocks or Gross fixed capital fermation Inventory investment Introductory MACROECONOMICS-Xi3.4 UNIT I: NATIONAL INCOME AND RELATED AGGREGATES (A) Gross Fixed Investment It is expenditure on the following = NOTE —— Gross Business fixed investment. It is defined] Difference erween | Capital” ang as expenditure on fixed assets e.g., machinery, Orel goo : : noes te stock i ildit inning of equipments, factory buildings etc. : guid way see > Gross Residential construction investment. It is ‘and additions made (0 the capita during the year is called investmeny, Hence difference between closing stock and opening stack of capital goods is Investment or Capital formation. amount spent on construction of flats and residential houses. (By producers, households and government sector) > Gross Public investment. It is expenditure by govt. on hospitals, schools, roads, dams etc. Calculatior Gross fixed _ (Stock of fixed assets) _ (Stock of fixed assets investment ~|_ at theend of year in the beginning of year (8) Inventory Investment It is a change in stock of finished goods, semifinished goods and raw materials. Calculation : Inventory ( Closing stock of finished, ) _{ Opening stock of finished, investment ~ | semifinished and raw materials | semifinished and raw materials 3.2.2 Net Investment During the production process, some amount of capital stock is used up or consumed. This consumption of fixed capital in the production process is called depreciation or consumption of fixed capital. By subtracting depreciation from gross investment, we get net investment. Net investment is actual addition to the capital stock of the economy. It enhances the production capacity, helps in generation of employment and accelerates economic growth and national income, \ To sum up, —— ——— ~ Nore —— | Net investment = Gross investment ~ Depreciation Inventory is profitable if main. tained to cope with the shortage “OR Gross investment = Net investment + Depreciation | in supply. However, if inver | tory stock is due to lack = Gross investment — Net investment _ demand, te will cause tosses oR Depreciati Components of Investment (Gross) Fixed investment Inventory investme (Difference in closing stock and opening stock of raw material finished goods and semifinished goods) (@) Net value of machinery (©) Depreciation of and equipment (Construction of business xed assets promises, buildings ctChapter 3: NATIONAL INCOME AND RELATED AGGREGATES 35. 33 DEPRECIATION (CONSUMPTION OF FIXED CAPITAL) or or Depreciation is defined as loss or fall in the value of fixed assets due to normal wear and tear and expected obsolescence. The concept of depreciation is very important in economics to understand the difference between gross value and net value. The terms gross is inclusive of depreciation and net is exclusive of depreciation. Gross = Net + Depreciation Gross — Net = Depreciation Net = Gross ~ Depreciation 3.3.1 Causes of Depreciation Depreciation is the loss in the value of capital goods or fixed assets due to 1. Normal wear and tear, During production process, the productive capacity of the fixed assets (e.g., machines, tools, trucks, engines etc.) goes on declining because of its continuous use, leading to fall in its value e.g, when you sell your car, it does not fetch you the same value you bought it for 2 years before. 2, Expected obsolescence. It refers to loss in the value of fixed assets due to : > continuous changes in technology or technique of production. For example, fallin value of typewriters due to introduction of computers is an example of technological obsolescence, > expected changes in demand of goods and services due to change in tastes and preferences, fashion trends, life style etc » expected changes in govt's policy. Due to above reasons fixed assets may have to be abandoned even when these are still in working conditions. Depreciation is also known as % Consumption of fixed capital. + Replacement cost of fixed capital. ¢ Current replacement cost. + Capital consumption. 3.3.2. Depreciation Reserve Fund or Provision for Depreciation ‘Owing to their depreciation, fixed assets need to be replaced after some time. Replacement of fixed assets requires a provision of fund, to enable the producer to buy a new asset after the expiry of life time of the asset e.g, if a machine is purchased for %1,00,000 and its expected life time is 5 years, then the annual provision of fund would be 20,000[ 20,00 =#20,000) NOTE —— Depreciation should not be misunderstood with capital loss. The fund so accumulated is called depreciation reserve fund. t Introductory MACROECONOMICS-XIl36 UNIT 1 NATIONAL INCOME AND RELATED AGGREGATES 3.3.3 Capital Loss or Unexpected Obsolescence Capital loss is a loss in the value of fixed assets due to : 1. Natural calamities like floods, earthquakes, fires etc. 2. Unforeseen factors like war, theft etc, Thus, loss of value of fixed asset due to unexpected obsolescence is called capital loss 3.3.4 Provision for Capital Loss This loss can not be financed from depreciation reserve fund. Provision for capital loss is insurance. Getting things insured against unexpected obs, scence provides provision for the capital loss. 3.3.5 Difference between Depreciation and Capital Loss Basis | Ta 1. Meaning Its loss in the value of fixed assets due | Iti loss inthe value of fixed assets due to to normal wear and tear and expected | natural calamities and unforeseen | Capital Loss obsolescence. (unexpected) obsolescence. 2._Nature of Loss | Its expected loss in the value of asset. | Its unexpected loss in the value of asset 3. Provision Provision for depreciation is by main- | Provision for capital loss is by getting taining depreciation reserve fund. insurance done 3.4 DOMESTIC OR ECONOMIC TERRITORY Domestic territory, as used in national accounting, has a special meaning and is much bigger than the political frontiers of a country. According to United Nations, “Economic territory is the geographical territory administered by a government within which persons, goods and capital circulate freely”. Domestic territory includes 1. Political frontiers (geographical territory) including territorial waters and air space. Fer example, Telecommunication services produced by Reliance Communications in India Embassies, consulates, military bases etc. located abroad (but excluding the foreig ones located within political frontiers). For example, Indian Embassy in America is: part of the domestic territory of India. 3. Ships, aircrafts etc. operated by the residents between two or more countries. Fr example, Services provided by Air India between Singapore and Japan are a part o domestic territory of India 4. Fishing vessels, oil and natural gas rigs etc. operated by residents in the internation waters or other areas over which country enjoys exclusive rights. For example Research projects undertaken by Indian government in International waters of Indian ‘ocean is a part of domestic territory of India " Implication of Domestic/Economic Territory National income and related aggregates are basically measures of production activity. Thee are two categories of national income aggregates : domestic and national, or domes Introductory MACROECONOMICS XIChopter 3 : NATIONAL INCOME AND RELATED AGGREGATES 37 product and national product, Production activity of the production wits located within the Pronomic territory is domestic product. Gross domestic product, net domestic product are some examples. We will learn more about the implications after studying the concept 0 resident. PATA Identify the domestic territory of India : 4. Indian embassy in Australi 3, American embassy in India 5. Indian consulates in France. 6. Branch of State Bank of India in France. 7. Indian Military forces sent to maintain peace in Syria. 8. Microsoft office in India. 2. Branch of American bank in India. 4, Branch of an Indian company in London. Answers 1, 2, 5, 7, 8 3.5 NORMAL RESIDENTS OF A COUNTRY National income has been defined as sum of factor incomes earned by of a country. Thus, the term ‘normal resident’ is an important concept in national income accounting. A normal resident is said to be a person or an institution. the normal residents > Who ordinarily resides or is located in a country and > Whose centre of economic interest lies in that country. Thus, there are two conditions to become a normal resident of a country i., his/her/an institution's 1. stay in the country should be more than a year and, 2. interest of staying in that country should be economic, (The resident carries out the basic economic activities of earnings, spending and accumulation from that location.) There is basic difference between the terms resident and citizen. A person is citizen or national of a country in which he is born or citizenship is allowed on some legal criterion. A person is treated resident of a country on the basis of economic criterion discussed above. A person can be citizen of a country and normal resident of some other country. For example, a large number of Indian Nationals have settled in U.S.A, England, etc. as residents (and not as Nationals) of these countries. For India, they are non-resident Indians but are Indian nationals. Implication of Normal Residents Production activity of the residents of an economic territory is national product. GNP, NNP, are some examples. National product includes production activities of residents (normal) irrespective of whether performed within the economic territory or outside it. In comparison, domestic product includes production activity of the production units located in the economic territory irrespective of whether carried out by the residents or non-residents. Introductory MACROECONOMICS-XIl38 UNIT: NATIONAL INCOME AND RELATED AGGREGATES 3.5.1 Examples of Non-Residents These are called non-residents because these do not fulfill the criterion of centre of econ, Omi interest : 1, International organizations like the World Bank, W.H.O,, I.M.F. are not treat residents of any country but of international area. These are non-resi dat organisations for the country in which these are situated. J Employees of international organisations are considered residents of the countries , which they belong and not of the international area. : Workers from across the border who cross borders regularly to work in the give, country. They are treated as residents of the country where they live and not the residents of the country where they work. Foreign visitors or travellers visiting the given country for studies, medical treatment, recreation or to take part in sports, cultural events etc. These are non-residents for the country they are visiting. 5. Foreign staff of embassies and members of foreign armed forces located in a given country. 6. The crew of foreign ships, aircrafts etc. Identify the following as Normal Residents of India 1. Indian officials working in the Indian Embassy in China. 2. An American tourist who stays in India for 2 months. 3. Indians going to Australia for watching the cricket match. 4, Indian employees working in W.H.O,, located in India. ing India for a month to see the Commonwealth games. 5. American tourists vi 6. Indian going for medical treatment to U.S. 7. Indian workers employed in power projects of Nepal on daily wages and crossing into Indian territory every week. An American citizen visiting India for attending a business meeting Indians working in USA embassy in India. Students from India going to Australia for higher studies. 8. 9. 10. Answers Normal Residents: 1, 3, 4, 6, 7, 9, 10 3.5.2 Importance of Concepts of Domestic Territory and Normal Resident The concepts of domestic territory and normal resident are important to differentiate between ‘domestic product’ and ‘national product’. 1. The concept of Domestic territory helps to estimate ‘Domestic Product’. Domestic product includes goods produced by production units located in the economic territory irrespective of the fact whether carried out by the residents or non-residents. The monetary value of domestic product is termed as domestic income. The concept of Normal Resident helps to estimate ‘national product’. National product includes goods produced by normal residents irrespective of fact whether performed within the economic territory or outside it. The monetary value of national product is termed as national income. Introductory MACROECONOMICS-XilChapter 3 : NATIONAL INCOME AND RELATED AGGREGATES 39 Relation between National Product Een cae rd ‘The concept of domestic product is based on the production units located within economic terz100¥- Sperated both by residents and non-residents. The concept of national products based on residents, and includes their contribution to production both within and ‘outside the economic territory. Normally, in practical estimates, domestic products estimated first, National product then derived from the domestic product by making certain adjustments. Let us see how ? National product is derived in the following way : National product = Domestic product + Resident's contribution to production outside the economic territory — Non-resident’s contribution to production inside the economic territory In practical estimates the resident's contribution outside the economic territory is called “fastor oi rected from abroad’. The non-residents’ contribution inside the economic territory is called “factor income paid to abroad”. Therefore, National product = Domestic product + Factor income received from abroad = Factor income paid to abroad Factor income received from abroad’ is added to domestic product because this contribution of residents is in addition to their contribution to domestic product. ‘Factor income paid to abroad’ is ‘subtracted because this part of domestic product, does not belong to the residents. By subtracting “factor income paid” from "factor income received” from abroad, we get a net figure “Net factor income from abroad” popularly abbreviated as NFIA. a National product = Domestic product + Net factor income from abroad =Domestic product + NFIA 3.6 FACTOR COST AND MARKET PRICE While estimating national income and related aggregates, monetary value of final goods and services can be estimated in two ways — at factor cost (FC) and at market price (MP). 3.6.1 Factor Cost (FC) Factor cost refers to all factor payments made by the producing unit (firm) to the factors of production (land, labour, capital, entrepreneur) for rendering productive services in the production of goods and services. Itis called factor cost because it is cost of the producer firm towards factors of production in the form of rent, wages, interest, profits etc 3.6.2 Market Price (MP) Market price is the price at which a commodity is sold in the market. It is the price what the buyers pay for the commodity. Market price is sum total of factor cost and net indirect taxes. MP=FC+NIT where, MP=Market price; | FC=Factor cost; NIT = Net indirect taxes Introductory MACROECONOMICS--Xi40 UNIT: NATIONAL INCOME AND RELATED AGGREGATES 3.6.3. Net Indirect Taxes (N/7) It is the difference between indirect taxes and subsidies. 1. Indirect taxes. All taxes on goods and services during their production ie, on facturing, selling, transporting etc. are called indirect taxes. Excise duty, custom uty =, tax, licensing fees, service tax, entertainment tax etc. are some examples of indirect, before the introduction of GST. These taxes raise the prices of goods and Fi Produced. These are called indirect because burden of these taxes is shifted to buy! although the responsibility of paying these taxes is on production units. : Box 3. Goods and Services Tax (GST) is an indirect tax which was introduced in India on 1 July 2017 and it EPlaced multiple cascading taxes levied by the central and state governments. It was introduced sy the Constitution (One Hundred and First Amendment) Act 2017. The CST i governed by a GST Council and its chairman is the Finance Minister of India 2. Subsidies. These are financial assistance by government to an enterprise on production of a certain commodity or a compensation for selling a good at a certain price fixed by the Bovernment which is below the open market price. Some kinds of subsidies are (@) as compensation for selling goods below open market price (8) to encourage exports, (©) to encourage employment Subsidies reduce the prices of goods and services. Net indirect taxes are calculated to know net impact of taxes on price of a commodity by subtracting subsidies from indirect taxes, 3.7 DOMESTIC INCOME AND NATIONAL INCOME Domestic income is the money value of all final goods and services produced within the domestic territory of a country during the period of one year. If net factor income earned from abroad (by normal residents of the country) is added to it, it becomes national income o the country. 3.7.1 Domestic Income (Net Domestic Product at Factor Cost) Domestic income is the sum of factor incomes generated by all the producing units located within domestic territory of a country in an accounting year. It is the sum of net domestic product at FC by all producing units in the domestic economy. Following are the three components of domestic income namely C.O.E., ©.$ and ML. 1. Compensation of employees (C.O.E.). It refers to all monetary and non-monetary benefits which the employees receive directly and indirectly from their employers in return for rendering productive services. It consists of wages and none _ salaries in cash, compensation in kind (like rent free [does not inclade piplopeet oat accommodation, free lunch etc), employer's contri- I bution to social securty scheme ae bution to social security schemes (like provident fund, ff compensation received by an injured life insurance etc.). worker from insurance company. Introductory MACROECONOMICS-XilChopler 3 : NATIONAL INCOME AND RELATED AGGREGATES 41 2. Operating surplus (O.S.). It is the income earned from property and entrepreneurship. Operating surplus is Income From Property Entrepreneurship feincomes Profits Rent (rom land) Dividends+ & Interest (from capital) = Corporate tx + Corporate savings or undistributed profits or retained earnings ~ Royalty (from patents/copyrights) 3, Mixed income of self employed (MLL). Income of own account workers (like farmers, doctors, bankers etc) and unincorporated enterprises (like small shopkeepers, repair shops, ttc) is known as mixed income. They do not maintain proper accounts. They use their own resources like land, labour, funds, etc. As a result, it NOTE ecomes difficult to classify their income among COLE. ]) Components of domestic nalvis and OS. are also discussed in section 422 Hence, domestic income/NDPrc =C.0.E. +0.5.+ M.I. of chapter 4. 3.7.2. National Income (Net National Product at Factor Cosi) Production is the outcome of combined efforts of four inputs, also called factors of production eared, labour, capital and entrepreneur. Factors of production are paid for their services out of value of output, therefore income is generated in the production process. Income is first generated in the production process and: then distributed among factor inputs for their productive services. Income gives rise to expenditure on goods and services satisfy wants. Expenditure leads to further production. There are three phases in circular flow of national income - production phase, income phase and expenditure phase. Accordingly, national income can be defined in three different ways > flow of goods and services produced. (Product method) > flow of income (distributed). (Income method) > flow of expenditure (disposition). (Expenditure method) National income = Domestic income + Net factor income from abroad (i) From production point of view “National income is the sum of monetary value of flow of all the final goods and services produced by normal residents of a country during a period of an accounting year.” (ii) From income point of view, Central Statistical Organization (CSO) has defined «National income is the sum of factor incomes earned by normal residents of a country in the form of rent, wages, interest and profit in an accounting year. (ii) From expenditure (disposition of national income) point of view, Simon Kuznets defines, “National product is the net output of commodities and services flowing during the year from the country’s productive system into the hands of ultimate consumers or into the net ‘addition to the country's capital goods”. Introductory MACROECONOMICS-Xi42. UNIT NATIONAL INCOME AND RELATED AGGREGATES Itis the sum total of domestic income and net factor income from abroad Domestic income + Net factor income from abroad, ‘Thus, _ National income = 3.7.3. Net Factor Income from Abroad (NFIA) It is the difference between factor incomes (rent, interest, profit, wages) earned by omg fesidents of a country from rest of the world and factor incomes ‘eared by non-residents, the domestic territory of the country. It may be positive or negative (if receipts are more tha, payments, NFIA is positive and vice versa). NEIA Net retained earnings + of resident companies abroad Net Compensation [Net income frm ‘ofemplyees = + property and (Net COE) entrepreneurship (@) Net C.OLE. Its the difference between C.O.E. eamed by normal residents of India from abroad and C.O.E. earned by non-residents in India (0) Net income from property and entrepreneurship (Net O-S.). Its the difference between rent, interest, profit and royalty earned by normal residents of India from abroad and similar payments made to non-residents in India. ‘earnings of resident companies abro ident companies abroad (0) Net retained ad. It is the difference between and foreign companies in India undistributed profits of resi ca 7 Components of National Income Net foctor income from abroad ‘National Income i ‘Compensation of, Net compensation ‘employees ‘of employees Not income from property Operating am omen | Maxed income of Nec retained earings of — ‘self employed Se ee | 374 Difference between Net Factor Income from Abroad (NF) and Ne! Exports ate : NEIA “Net Exports |] It is the difference between value of exports related | | 7 | this the difference between factor income eamed by normal || 7 feidens ofa county from abroad and for income eae | and imports of goods and servi by non-residents in a country. to domestic territory of a country This a part of domestic income. | It is a part of national income. Its components are © Exports and imports of goods, 8 Exports and imports of services Its components are : Net COE. m= Net 0.5. (Net income from property and entrepreneurship) & Net retained earnings of resident companies abroad. Introductory MACROECONOMICS-XIlChapter 3 NATIONAL INCOME AND RELATED AGGREGATES 43 38 FACTOR PAYMENT AND TRANSFER PAYMENT National income includes only those incomes or payments which correspond to flow of goods and services. In an economy, there are fwwo types of payments made. They are factor payments and transfer payments. 3.8.1 Factor Payment It is made to a factor of production in return for rendering factor services. For example, rent, wages, interest and profit. Factor incomes earned by factors of production and factor payments made by an entrepreneur to factors for their services are, in fact, the same. All factor payments (or factor incomes) are included in the national income because there is corresponding flow of goods and services in the economy, 3.8.2. Transfer Payment 3.8.3 Difference between Factor Income (Payment) and Transfer Income |Payr It is payment received without any corresponding good or service. This is also called unilateral payment. For example, old age pension, scholarships to students, unemployment allowances, charity etc. These payments are received without making contribution to production. They are not | pocket money received from your included in the national income of a country because there is no |) father isa transfer payment. Why ? corresponding flow of goods and services in the economy. | because you do not give anything Transfer payments can be current or capital. Current back in return and do not assume transfers are for consumption purposes whereas capital | that your promise to fetch good transfers are for capital formation. (Refer to HOTS.Q. 10) | ™a"ksis commodity or a service | basis Factor Income (Payment) ____Transfer Income (Payment) 1. Meaning | It is the income received in return for rendering | It is income received without any factor services by the factors of production. sood and service provided in return. Concept _| It is an earning concept. Itis a receipt concept. Types ‘Types are : rent, wages, interest and profits. These are from household, corporate or government sectors and vice-versa | __| eg. gifts, donation etc. a “4. Inclusion | These are included in national income because | These are not included in national in National | there is corresponding flow of goods and | income as there is no corresponding, Income services. | flow of goods and services. Ma Classify the following as factor income or transfer income 1. Rent received by the owner of a factory building from the industrialist. 2. Deamess allowance added to basic salary of an employee. 3 Financial help to victims of Uttrakhand tragedy. 4. Salary received by an employee of State Bank of India. 5. Old age pension received by public. 6. Taxes paid to government. Answers : Factor income :1,2,4 ; Transfer income : 3, 5, 6 Introductory MACROECONOMICS-XI{E AND RELATED AGGREGATES 3,9. NATIONAL INCOME ACCOUNTING : MEANING ne vie . i tire Macroeconomics deals with the study of various ageregates © sony ‘Ageregate income, output, employment, etc. / al cof macro-aggregates is essential £0 determine the actual performance ley, the economy. National income accounting facilitates the task of meas provides a set of procedures and techniques Meaning of National Income Accounting National income accounting is a method of preparing and presenting nati : seed on the principle of double entry system of business accounting. National incony accounting facilitates the measurement of macro aggregates involved in the study of mac, economics. It helps to identify specific economic schievement of a country and accordingl provides an objective basis of evaluation and review of policies under implementation. 44 UNIT |: NATIONAL INCOME urement of macro-ageregates a, 3.9. ting national income accoury, 3.9.2. Uses of National Income Accounting 1. It indicates specific contribution of indivi 2. Ithelps to find out structural changes in secondary sector and tertiary sector. Tereflects how national income is shared among various factors of pro It enables comparison of national income and per capita income among nations, Itidentifies specific economic strengths and failures. * It enables us to understand and interpret the working, of an economy. 3.10 AGGREGATES RELATED TO NATIONAL INCOME National income is the sum of money value of final goods and services produced by norma] residents of a country within and outside the country during an accounting year. According to Central Statistical Organization, «National income isthe sum of factor incomes earned by normal residents of co in an accounting year” form of wages, rent, interest and profi it ceceeveve should be kept in mind that product aggregates anj rroduction is generation of income : ridual sectors. fhe economy i, shift from primary sector to duction. 3. 4, 5. 6. untry in the The main aggregates are given below. It income aggregates are used interchangeably because P 5. Gross Domestic Product (GDP) 1. Gross Domestic Product (GDP) 2. Net Domestic Product (NDP) 6. Net Domestic Product (NDP) 3. Gross National Product (GNP) 7. Gross National Product (GNP) 4, Net National Product (NNP) 8, Net National Product (NNP) at factor cost (FC) at market price (MP) National income is net national product at factor cost (NNP; ; =) and domestic inc domestic product at factor cost (NDP,c) m eincomees or NN =National Product; NDPr¢ = Domestic Product Before studying these eight aggregates, let us understand the three basic formulae Introductory MACROECONOMICS-XiChapter 3» NATIONAL INCOME AND RELATED AGGFEGH 3.10.1 Three Basic Formulae 4. Between Gross and Net Gross variables in national income accounting are inclusive of depreciation. Gross - Net = Depreciation/consumption of fixed capital or Gross = Net + Depreciation or Net = Gross ~ Depreciation Examples : (ir GDP yp = 500 Depreciation =50, find NDPyyp NDPyp =GDPyp Depreciation (To convert gross ino net, we subtract dep) = 500 ~ 50 = 450. (iit NDPyyp = 4000, Depreciation = %600, find GDP 4p GDPyyp = NDPyyp + Depreciation = 4000 + 600 = 4600. 2. Between National Income (NI) and Domestic Income (01) NTs inclusive of NFIA (Net factor income from abroad) NI-DI=NFIA (Here I denotes income) or NI=DI+NFIA NOTE or Di = NI -NFIA NIA is. the difference Examples : between factor income received from abroad by (it DI = 4,000, NFIA = 400, find NI eee pessdoras of baa aad NI = DI + NFIA = 4000 + 400 factor income paid abroad to NI=% 4400 non-residents of India. (it GDPyp = 14,000, NFIA = %400 find, GNPyp GNPyp = GDPyyp + NFIA (To convert domestic into national, we add NFIA) =14,000 + 400 GNP yp = 14,400. 3. Between Market Price (MP) and Factor Cost (FC) Market price is inclusive of net indirect taxes. MP -FC =Net indirect taxes (NIT) MP = FC+NIT —yote—— FC = MP-NIT Market price (MP) includes 1. Rent (land) 2. Wages (labour) | 3. Imerest (capital) | 14 23,4 are factor cost given to four factors of production 4, Profit (entrepreneur) 5. NIT (government) Introductory MACROECONOMICS -l46 UNIT |: NATIONAL INCOME AND RELATED AGGREGATES Hence = FC + NIT Le (Factorsof production) (Govt.) So, MP=1+24+3+4 + 5 ee FC ir Fxamples (If ~~ MP=5,000 NIT =500, find FC FC = MP-NIT (To convert market price into factor cost, we subtract NIT) 5,000 ~ 500 = 4500 NOTE 1. If you are converting bigge aggregate into smaller, the, subtract and vice versa. 2. Gross, national and marke price are bigger in the above rretattons. (ii) GDPyp = 15,000 NIT =500, find GDPc GDP ye = GDP yp - NIT = 15,000 ~ 500 = 14500 Box 3.3 a Revision of three basic formulae : For example, convert GDPyp into NNPre- In the above conversion, all three relations are to be used as all three places in the given and asked aggregates are different NNPre =GDPyp (these are not equal) Tofind out given Remember, it will be easy for you to write the given NN P ébp aggregate on right hand side as this is to be converted Fe eee af [a MP3 into whichever aggregate is asked NIT Let us make the above aggregates equal =NEIA Hence, — Depreciation NNPyc = GDPyyp — Depreciation + NFIA- NIT 3.10.2 Aggregates Related to National Income (Definitions) 1. GOP yp Itis defined as the market value of all the final goods and services produced by all production units within the domestic territory of a country during a period of one year. The important points to remember about GDPyp are : (i) Being gross aggregate, it includes depreciation. (ii) Being at market price (MP), it includes net indirect taxes. (Value of production is calculated by multiplying output sold by the price which buyers pay and not the price which production units actually receive). (ii) Being domestic, it implies final goods produced within domestic territory of a country by all producers (residents and non-residents). Introductory MACROECONOMICS-XIlChopter 3 : NATIONAL INCOME AND RELATED AGGREGATES 47 (iv) GDP yp =GVOyp — IC Or Sum total of value added by all producing units. (v) It is the primary measure as it is an important indicator of growth. (vi) Once GDPy4p is estimated we can derive other aggregates explained below. NDP yp It is the market value of all the final goods and services, produced within the domestic territory of a country during the year by all production units excluding depreciation NDPyyp = GDPyyp ~Depreciation . GNP yp It is the market value of all the final goods and services produced in the domestic territory of a country by normal residents during an accounting year including net factor income from abroad GNP yp = GDP yp + NFIA 5. NNP yp It is defined as the market value of final goods and services produced by normal residents of an economy in its domestic territory during an accounting year exclusive of depreciation and inclusive of net factor income from abroad NNPyp = GNPyp ~ Depreciation or NNPyp = GDPyp ~ Depreciation + NFIA . NDP re / NVA re It is the sum total of factor incomes generated within domestic territory of a country during the year, in other words, it is income eamed by the factors of production NDP; < = COE +OS+MI where, COE = Compensation of employees ; OS = Operating surplus ; MI = Mixed income 6. GDP re It is the sum total of factor incomes generated within domestic territory of a country during the year along with depreciation or consumption of fixed capital or it is net value added at factor cost by all the producers in the domestic territory of a country including depreciation. GDP rc = NDPrc | NVAge + Depreciation . GNP re Gross national product is the sum total of factor incomes earned by normal residents of a country from domestic territory and rest of the world along with deprecation during the year. GNPye = NNPre + Depreciation or GNPhe = NDPre + NFIA + Depreciation 8. NP, It is defined as the factor income accruing to normal residents of the country (rent, wages, interest, profit) during a period of one year from domestic territory and abroad NNPyc = NDPyc + NFIA Introductory MACROECONOMICS-Xit48 UNIT |: NATIONAL INCOME AND RELATED AGGREGATES = Problems Based on Aggregates Example 1 Calculate NDP at FC ; Particulars & in Lakhs (| GNP at MP 16,000 (ii) | Subsidies 1,200 (iii) | Depreciation 1,000 (iv) | Factor income received from abroad 1,400 (») | Indirect taxes (GST) 1,300 Solution, NDPr¢ =GNPyp ~ Depreciation ~ NFIA - NIT NDPre =GNPyyp ~ Depreciation ~ Net factor income from abroad ~ Indirect tax ~ Subsidies = 16,000 — 1,000 - 1400* — {1,300 — 1,200} = 13,500 NDPre = 713,500 lakh “NFIA = Factor income received from abroad — Factor income paid abroad = 1400-0 =1400 Example 2 Calculate GNPpo : Particulars & in Crores @ | NDPyp 25,000 (ii) | Depreciation 15,000 (iii) | Indirect taxes (GST) 1,300 (iv) | Subsidies 300 (2) | Factor income from abroad 400 (vi) | Factor income to rest of the world 600 Solution. GNP rc = NDP\yp + Depreciation + NFIA ~ NIT GNP, = NDPyqp + Depreciation + (Factor income from abroad — Factor income to the rest of the world) = (Indirect tax - Subsidies) = 25,000 + 15,000 + (400 — 600) — (1,300 — 300) = 38,800 GNP = %38,800 crore Example 3 Calculate consumption of fixed capital : Particulars & in Crores | NNPrc 4,000 | (ii) | GDPyp 5,000 (iii) | Net indirect tax 300 (iv) | Net factor income from abroad 1,200 Introductory MACROECONOMICS-XIIChapter 3: NATIONAL INCOME AND RELATED AGGREGATES 49 Solution. Consumption of fixed capital = GNPpo — NNPrc GNP,c =GDPyp ~ Net indirect tax + Net factor income from abroad = 5,000 -300 + 1,200 =5,900 Consumption of fixed capital =GNPy- ~ NNPre 5,900 - 4000 = 1,900 crore Consumption of fixed capital =%1,900 crore Example 4 Suppose in an imaginary economy GDP at Market Price in a particular fiscal year woas %4,000 crore, National Income was 82,500 crore, Net Factor Income paid by the economy to Rest of the World was %400 crore and the value of Net Indirect Taxes is %450 crore. Estimate the value of consumption of fixed capital for the economy from the given data. (CBSE Sample Paper 2015-16) Solution. Depreciation/CFC =GDPyp - NDP yp NDPyqp = NNFye ~ NFIA+ NIT = 2500 — (—-400) + 450 = 2500 + 400 + 450 = 3350 Depreciation = 4000-3350 = %650 Crore. Or NNPye = GDPyyp ~ Depreciation — Net factor income paid abroad - NIT 2500 = 4000 - Depreciation — 400 ~ 450 2500 = 4000-850 - Depreciation Depreciation = 3150-2500 Depreciation = %650 Crore Example 5 Calculate Net Indirect Tax Porticulars & in Crores (i) | GNP yp 41,7000 (ii) | NDPre 6,200 (iii) | Depreciation 600 (iv) | Net factor income from abroad (400 Solution. Net indirect tax = NDPy_p ~ NDP pc Net indirect tax = (GNPyyp — Depreciation - Net factor income from abroad) ~ NDPrc = 17,000 — 600 — (-400) ~ 6,200 = 10,600 Net indirect tax = 10,600 crore Example 6 On the basis of following real data at current prices of Indian economy during 1982-83, find out NNPec, NNPyyp, GNPyyp, GDPyyp GNP ec and NDPyyp Porticulars | Rin Grore (i) | NDPre | 133,151 (ii) | Depreciation | 11,242 (ii) | Net indirect taxes 19,400 | (io) | Net income from abroad (= 000 Ietroductor MACROECONOMICS. XLOe 50 _ UNIT 1: NATIONAL INCOME AND RELATED AGGREGATES Solution, () NNPz¢ = NDP; + Net factor income from abroad = 1,33,151 + (-J1,000 = %1,32,151 crore (ii) NNPyp = NNP;- + Net indirect taxes = 1,32,151 + 19,400 = %1,51,551 crore (iti) GNPyp = NNPyp + Depreciation = 151,551 + 11,242 = &1,62,793 crore (i) GNP,c = GNPyp - Net indirect taxes = 1,62,793 - 19,400 =%1 43,393 crore (2) GDPyp =GNPyyp - NFIA = 162793 - (-1000) = 1,63,793 crore (i) NDPyp = GDPyp ~ Depreciation = 1,63,793~11,242 = %1,52,551 crore Example 7 Calculate from the following data : (Net domestic product at market price (NDPyyp) (ii) Net national product at market price (NNPyp). (Gi) Net national product at factor cost (NP) . (2) Gross national product at market price (GNPyp) Particulars ( | Depreciation (i | Net income from abroad (ii) | Gross domestic product (GDP yp) | (| (0) | Indirect taxes (GST) Subsidies by government Solution. () NDPyp =GDPyp ~ Depreciation = 15,000 - 100 =%14,900 crore (i) NNPyp = NDPyp + Net factor income from abroad = 14,900 + 800 = 15,700 crore (iti) NNPrc = NNPyp ~ Net indirect taxes (indirect taxes - subsidies) = 15,700-75 +50 Or 15,700 - 25 NNPye = 215,675 crore (i) GNPyyp = GDPyp + Net factor income from abroad = 15,000 + 800 = 215,800 crore Introductory MACROECONOMICS-XilChapter 3; NATIONAL INCOME AND RELATED AGGREGATES 51 Example 8 From the information given below calculate (a) GDPyyp (b) NNP rc: Particulars in Crores () | NDPyp 74,905 (ii) | Net indirect taxes 8344 (iii) | Income from domestic product accruing to government 1972 (iv) | Current transfers to households 2,305 (v) | Depreciation 4,486 (vi) | Net factor income from abroad (232 Solution. (@) GDP yp = NDPyp + Depreciation = 74,905 + 4,486 = 279,391 crore (0) NNPr¢ = NDPyp ~ Net indirect taxes + NFIA = 74,905 ~ 8,344 + (~232) = %66,329 crore Example 9 Find out NDPyyp from given data : Particulars Zin Crores () | GNPup 97,503 (ii) | Net factor income from abroad (9201 (iif) | Net indirect taxes 10576 (iv) | Consumption of fixed capital 5,699 ;NPyyp ~ Consumption of fixed capital - NFIA = 97,503 - 5,699 -(-)201 "92,005 crore Solution. NDPyyp NDP yp Example 10 GNPyyp of an imaginary economy is 1,20,000 crore and its capital stock is worth %3,00,000 crore. If capital stock depreciation is @ 20% per annum, indirect taxes amount to %30,000 crore and subsidies are 15,000 crore. What is national income ? Solution. National income NNP,¢ =GNPyp —Dep* - NIT* =1,20,000 - 60,000 - {30,000 - 15,000} NNP;< = 45,000 crore Example 11 Calculate NNPyyp from the following : i Porticulars & in Crores [| GDP up 50,000 (ii) | Depreciation (iii) | NIT fio) | NFIA__ a Solution. NNPyyp=GDPyyp ~ depreciation + NFIA = 50,000 - 5,000 + (—1,000) NNPyyp= 244,000 Introductory MACROECONOMICS-XIL52 UNIT 1: NATIONAL INCOME AND RELATED AGGREGATES Example 12 Find NDPpe Particulars & in Crores @ | GNPyp 14,000 (ii) | Depreciation 600 (iii) | Indirect taxes (GST) 1,000 (iv) | Subsidies 200 (2) | Factor income received from abroad 400 (vi) | Factor income paid abroad 500 Solution. NDPrc =GNPyp ~ Depreciation - NFIA - NIT = GNPyp ~ Depreciation ~ (factor income received from abroad = factor income paid abroad) - (Indirect taxes - Subsidies) = 14,000 — 600 - (400 - 500) - (1000 - 200) NDP rc = %12,700 crore Example 13 Find GDPee from the following data : Particulars in Crores (| GNP yp | 500 (ii) | Consumption of fixed capital 20 (iii) | Factor income from abroad 300 (iv) | Net indirect taxes 20 (v) | Factor income paid abroad 100 Solution. GDP ¢ =GNPyp — NFIA- NIT = GNP yp ~ (Factor income received from abroad — Factor income paid abroad) ~) = 500 — (300 — 100) — 20 = 500 — 200 - 20 = 2280 crore Cuestion Bank MULTIPLE CHOICE QUESTIONS 1. Goods which are purchased for resale are (2) final goods (®) capital goods —_(c) intermediate goods 2. Fall in the value of assets due to expected obsolescence is (a) capital loss (®) depreciation _(c) shut down point 3. Normal residents of India (@) an official working in Indian embassy in America () Indian visiting Japan as tourist (©) Indian working in W.H.O. located in India (@) all of these. Introductory MACROECONOMICS-Xil (@) none of these. (@) all of these.CChopler 3: NATIONAL INCOME AND RELATED AGGREGATES 53 4, Salary paid to worker is an example of (@ transfer income (@) govt. revenue _(c) factor payment __(@) none of these. 5, Aggregate used for domestic income (@ NDRe (©) NNRe (© GNF yp (@ NNPyp. 6. Acar purchased by a dealer of cars is (@) consumer good () capital good (0) intermediate good (@) all of these. 7. National income is the sum of factor incomes accruing to (@) Nationals (& Beonomic territory (0) Residents (@ Both residents and non-residents (CBSE OD 16) 8. Depreciation of fixed capital assets refers to (@) Normal wear and tear (©) Foreseen obsolescence (€) Normal wear and tear and foreseen obsolescence (@ unforeseen obsolescence (CBSE D 16 9. Unforeseen obsolescence of fixed capital assets during production is : (Chose the correct alternate) (@) Consumption of fixed capital (®) Capital loss (6) Income loss (@ None of the above. CBSE F 16) 10. GST was introduced in Indian economy in : (a) 2008 (b) 2010 (©) 2015 (@) 2017 Answers L@ 2 © 3. @ 40 5. (@) 6 (© 72 © 8 (0) % © 10. OBJECTIVE TYPE QUESTIONS |. Define domestic territory. Ans, Domestic territory refers to the geographical territory within which persons, goods and capital circulate freely. [Refer to section 3.4 for details) 2. Define normal resident (CBSE D 130) Ans. Normal resident refers to an individual or an institution who ordinarily resides in the country for a period of more than one year and whose centre of economic interest also lies in that country. [Refer to section 3.5 for details} 3. What is factor income ? ‘Ans. Factor income is the income received by the factors of production for rendering factor services in the process of production. 4. What is transfer income ? Ans. It refers to the income received without rendering any productive service in exchange. 5. What are final goods ? (CBSE OD 13¢) \ns. Final goods refer to those goods which are used either for final consumption or for investment. ‘These are included in the national income. 6. Define intermediate goods. Ans Intermediate goods refer to those goods which are used either for resale or for further production. Introductory MACROECONOMICS-X1I54 UNIT I: NATIONAL INCOME AND RELATED AGGREGATES 7. What are consumption goods ? (CBSE " O Ans. Consumption goods refer to those goods which satisfy the wants of the consumers x Rp 8. What are capital goods ? a ° SE Ans. Capital goods are those final goods which help in further production of goods and sen Ry 9. Define gross investment. = Ans. Gross investment refers to total investment made in a Br < " given period in an economy. Itis the. gross domestic fixed capital formation and change in stocks. 7S te ay 10. Define net investment, Ans. Net investment is the actual addition to the stock of assets. It is gross investment — Depreciation. (Depreciation is subtracted to assess the actual value of fixed capital] 11. Define depreciation. (CBSE OD 11, 14C ; D yy, OE shite ition refers to a fall in the value of fixed assets due to normal wear and tear, and expec, 12. What is net indirect tax ? Ans. Net indirect tax refers to the difference between indirect taxes and subsidies. 13, What is net factor income from abroad ? Ans. It refers to iffere r income receive y tha ret ofthe wonld ane the Teton income paid tie ator he eed Coes ae country). : 14. What are the three components of NFIA ? Ans. (i) Net compensation of employees. (ii) Net income from property and entrepreneurship. (iif) Net retained earnings of resident companies abroad. 15. Define domestic income (NDP¢c). Ans. It refers to the net value added (NVA) of all the final goods and services produced within ty domestic territory of a country earned by factors of production during a period of one year. 16. Define national income (NNP,¢). Ans. It is the net value added (NVA) of all final goods and services produced by the normal residents of; country (factors of production) during a period of one year. It includes NFIA. 17. Give two examples of intermediate goods. (CBSE OD 13, De ‘Ans. Cloth purchased by tailor, machine purchased by a dealer of machines. (CBSE D 11C, 13¢, 4 18. Define capital formation. ‘Ans. It refers to additions made to the existing stock of capital during the year. CONCEPTUAL QUESTIONS © 1. What is difference between intermediate goods and final goods ? Ans. "Intermediate goods Final goods 1. | These are used for production of other | These are used for consumption or goods and services or for resale investment. i It is not included in national income. | It is included in national income. Introductory MACROECONOMICS-XilChopler 3 : NATIONAL INCOME AND RELATED AGGREGATES Sa 2. Classify the following as final goods or intermediate goods : (i Clothes purchased by an individual household. (ii) Textbooks purchased by a student. iii) Seeds purchased by a farmer to grow wheat. a ‘Machines purchased by a dealer of machines. (CBSE OD 2010) (v) Car purchased by a household (CBSE OD 2010) (vi) Refrigerator purchased by an individual household. (vif) Refrigerator purchased by a confectioner. (citi) Refrigerator purchased by a dealer of refrigerators. (jx) Butter purchased by a bakery shop for making cakes. (2) Butter purchased by a household for consumption. ‘Ans. Final goods : (), (i), (0), (vi), (wi), (x) Intermediate goods : (ii), (io), (vii), (ix). 3. Why does national income include only final goods ? ‘Ans Intermediate goods are not included in the national income to avoid double counting, The value of intermediate goods is already included inthe final goods. If the value of intermediate goods is added again, it ww ead to double counting, For example, the value of shirt (final god) includes the value of cloth (intermediate good), So, if we include the value of cloth along with the value of shirt, it will ead to double counting: of cloth. 4. When does NFIA become positive or negative ? ‘Ans. NFIA is positive when the income earned by the normal residents of the country from abroad is more than the income earned by foreigners in India and vice versa. 8. What are retained earnings ? ‘Ans. Retained earnings refer to that part of the profit which is kept as reserve after paying the corporate tax and dividends out of total profits. 6. Differentiate between gross domestic product at market price and national income, Ans. Basis GOP y NMP, | 1. | Nature Tt is a domestic concept as it includes | It is a national concept as it includes the value of goods produced within | the value of goods produced in the the domestic territory of a country. domestic territory and NFIA. 2. | Producers GDPyp considers all the producers | NNP,- considers only the normal within the domestic territory of a residents of a country. country. 3. | Net indirect taxes | It is at market price ie., it includes It is at factor cost ie., it does not include net indirect taxes. net indirect taxes. Depreciation It is inclusive of depreciation. It does not include depreciation. 5._| Formula GDP yp = NNPpc—NFIA+Dep+ NIT | NNPec = GDPyp + NFIA—Dep— NIT 7. Classify the following as factor income or transfer income : (i) Old age pension. (ii) Salary received by Amit from a company. (iii) Financial help to earthquake victims. _(iv) Rent received from buildings. (0) Wages received from employer. (0%) Birthday gift received from a relative. (cii) Rent free accommodation from employer. (ciii) Donations received by a charitable trust. ‘Ans, Factor income : (i), (iv) (v), (vil); ‘Transfer income : (i, (ii), (vi), (vil). Introductory MACROECONOMICS-XiL56 UNIT; NATIONAL INCOME AND RELATED AGGREGATES HHisrer Order Thinking Skills HOTS 1. Define replacement of capital Ans. A producer maintains a depreciation reserve fund over the expected life time of the capital Ase replace it at the end of its life. This is called replacement of capital and estimated value of depreciation i, called current replacement cost. 2. What is a low level equilibrium trap ? ‘Ans. If worn out assets are not replaced, it causes a fall in the stock of capital with the producers, furth, implying a fall in production capacity and output of the economy. The economy will enter into a state g depression as the level of income and output also falls. It is a situation of low level equilibrium trap, , situation when low income causes low demand and low level of demand causes low level of output ang low income. 3, Define production boundary. Ans. Production boundary is the imaginary line around the production process. All goods and services which cross this line are considered as final goods. Goods within the production boundary are treated as intermediate goods which need value addition. 4. What is the difference between goods (material goods) and services (non-material goods) ? Ans. | Basis Material goods Non-material goods J (i) | Meaning | These are tangible goods ic, which can | These are goods which are intangible iv, : © | te men ceed touched cannot be seen or touched. These are called services. There is time lag in their production and | There is no time lag in their production and consumption as these can be stored. consumption as these cannot be stored (it) | Durability | Certain goods are durable and can be | Services are not durable and can be used used again and again. only once. - (iv) | Examples | Refrigerators, cars, pens, fans etc. Services of doctors, teachers, lawyer: etc. (i | Time lag | banks 5. What is the importance of distinction between intermediate and final goods ? Ans. The difference between intermediate and final goods is important to avoid double counting. If value of intermediate goods is taken then it will cause the problem of double counting. When intermediate goods are used as raw materials in the production of final goods the value of intermediate goods gets automatically included in the value of final goods. Therefore value of only final goods is taken into estimation of NI. 6. When is operating surplus in a producing unit zero ? Ans. A firm's net value added at FC is distributed as factor income in the form of rent, wages, interest and profit. Sum of rent, interest and profit (i.e,, income from property and entrepreneurship) is called operating surplus. Clearly, operating surplus is zero () When loss to the firm is equal to sum of rent, interest and profit. In other words, income generated by the firm is just equal to compensation of employees (i) In general government enterprises and non-profit institutions serving households which do not ‘eam income from property and entrepreneurship. Introductory MACROECONOMICS-XIlCChopter 3 : NATIONAL INCOME AND RELATED AGGREGATES 57 7. State whether the following statements are true oF false. Give reasons for your answer (a) Capital formation is a flow. (b) Bread is always a consumer good. (b) Butter is only a final product. Ans. (CBSE Sample Paper 2010) (CBSE D 16) (@) True. Capital formation is measured over a_period of time. (0) False. It depends on the use of bread, When it is purchased by a household, it is a consumer good. If it is purchased by hotel, itis a producer (intermediate) good. (c) False. It depends on the end use of butter. Ifit is purchased by a household, then it isa final good. If it is purchased by a baker to bake cakes, then it is an intermediate good. 8 Differentiate between consumption of fixed capital and capital loss. Ans. Basis Consumption of fixed capital Capital loss (| Mearing | Terefers to fall in the value of fixed assets | It refers to loss in value ofthe Fixed soso | due to normal wear and tear and expected | due to unforeseen obsolescence, natural obsolescence calamities, thefts, accidents, ete. (ip | Kind of loss _| Expected loss. Unexpected loss. I (i | Provision for | Provision is made for replacement of | No such provision is made {ea of loss. fixed assets as it is an expected loss, | capital loss as it is an unexpected loss provision is depreciation reserve fund. | (goods can be insured against loss), | 9. “All producer goods are not capital goods”. Comment ‘Ans. A producer uses two types of goods or Producer goods include : (@ Raw materials ; (ii) Fixed assets like plant and machinery. “The first type of producer goods (ie, raw materials, their identity in the production process, They are intermed be used again in the production process. So, it can be said that all capital goods are producer goods, producer goods are not capital goods. The second type iv, fixed assets can be used repeatedly in the production process, hence they are eapital goods like coal, wood, etc.), are not capital goods as they lose late or single-use producer goods and cannot butall 10, Differentiate between current transfers and capital transters. ‘Ans. Transfer receipts are of two types : © Current transfers © Capital transfers 1. Current transfers are made out of current income, whereas, capital transfers are made out of the accumulated wealth of the payer. 2 Current transfers are meant for consumption purposes, whereas, capital transfers are meant for ‘capital formation. Examples of current transfers : Old age pension, unemployment allowance etc Examples of capital transfers : Investment grant, capital gains tax, compensation for war damages ete. Introductory MACROECONOMICS58 UNIT 1: NATIONAL INCOME AND RELATED AGGREGATES Yiive Based Questions 1. Why are transfer payments not included in the estimation of National Income ? Do we arrive atthe va are not important for the economy ? ane tl : - ‘Transfer payments are not included in National Income as these do not lead to correspond of goods and services. These are not included because of limitation of being one sided. These aye important for growth and welfare of economy like donations, old age pension, unemployment allowane payments. These do promote social and economic justice of those who receive these payments. 2. A company maintains a depreciation reserve fund for replacing its fixed assets after expiry of its life time. Cy company claim that the machines are protected against obsolescence ? = Ans. A depreciation reserve fund is maintait i : tained to enable a es en company to replace its fixed assets after th, (i the obsolescence is expected then company’s claim is justified. (Refer to section 33.1 of ch 3). (ii) the obsolescence is unexpected i., on account of natural calamities or unforeseen factors like theft etc then the company’s claim is not justified. 3. Compensation given to victims of Uttrakhand tra nm ind tragedy is a good te 207 ‘nol Compensation given to vein igedy is a good measure taken by government. Why is it mo _Ans, Compensation given to victims of Uttrakhand tragedy is a welfare measure taken by government of India but it is not included in estimation of national income because it is a transfer payment which does not lead to corresponding flow of goods and services. risen To NCERT Questions 1. What is the difference between planned and unplanned inventory accumulation ? ed Inventory. It refers to change in the stock of inventories which has been planned. Ina ise inventories. It is positive for the Ans, Plann situation of planned inventory accumulation, firm will plan to rai firm. Unplanned Inventory. Itrefers to change in the stock of inventories which has occurred unexpectedly. In a situation of unplanned inventory accumulation, due to unexpected fall in sales, the firm will have unsold stock of goods. It is negative for the firm. 2. Write down the three identities of calculating the GDP of a country by the three methods. Also briefly explain why each of these should give us the same value of GDP. National expenditure. Ans. _ National income = National produ lculated at three methods is same. The only difference is that with product method, NI is cal come method NI is measured at distribution level and with expenditure NI by disposal level. It is because value of production causes generation of income production level, with in method, NI is measured at which further causes expenditure. Net factor income from abroud Suppose the GDP at market price ofa country in a particular year oas 81,100 crore. BIPPA100 crore. The value of indirect taxes~subsidies was %150 crore and national income was 2850 cr Calculate the aggregate value of depreciation. Introductory MACROECONOMICS-XIlChapter 3 : NATIONAL INCOME AND RELATED AGGREGATES 59 Ans. National income (or NNP,<) = GDPyyp ~ Depreciation + Net factor income from abroad —Net indirect taxes. 850 = 1100 -Depreciation + 100-150 100 + 100-150-850 Depreciation = €200 crore Depreciation 4. Ina single day, Raju, the barber, collects %500 from haircuts ; over this day, his equipment depreciates in value by 350, Of the remaining 8450, Raju pays indirect tax worth 30, takes home %200 and retains €220 for improvement and buying of new equipment. He further pays 20 as income tax from his income. Based on this information, complete Raju's contribution to the following measures of income (a) GDPyp (6) NNPyp (ONNP ee (@) Personal income _(e) Personal disposable income Ans. (@) GDPyp = 2500 )_NNPyp = GDP yp ~ Depreciation + NFIA (since no information on NFIA given we take it as zero) = 500-50+0 =%450 (© NNPrc = NNPyp~ NIT = 450-30 = 2420 (@ Personal income = NNP,¢~ Retained earnings = 420-220 =%200 (©) Personal disposable income = Personal income ~ Income tax = 200-20 =7180 (For detail on Personal Income and Personal Disposable Income, refer to section 4.2.4 of Chapter 4) VERY SHORT ANSWER TYPE QUESTIONS (1 Mark) 1. What are net indirect taxes ? 2. Give the meaning of market price. 3. When will GDP of an economy be equal to GNP? 4. Define domestic income. 8. Define capital goods. 6, Give the meaning of factor income. 7. What is meant by factor cost ? 8. What is the meaning of final goods ? 9. What is meant by transfer income ? 10. Calculate the national income, if domestic income is €30,000 and the NFIA is %3000. 11. Define current transfers, 12. What is meant by intermediate goods ? 13, What is the difference between GNPyc and GNPyyp ? Introductory MACROECONOMICS-XIl60 14. 15. 16. V7. 18. > UNIT |; NATIONAL INCOME AND RELATED AGGREGATES What is meant by net factor income from abroad ? If NDP rc is 84,000 crore and NFIA is (~)%5 crore, how much will be the national income > Define depreciation. : {BSE op, Give two examples of intermediate goods. (CBSE gy ‘ ° Define gross investment. sch Hy SHORT ANSWER TYPE QUESTIONS (3/4 Marks) What is meant by national income ? Distinguish between national income and domestic income What is meant by depreciation ? Distinguish between intermediate goods and final goods. Differentiate between factor income and transfer receipt (income). Differentiate between domestic income and national income. Discuss the meaning of consumption goods and capital goods. Distinguish between net domestic product at factor cost and gross domestic product at market price What is meant by net factor income from abroad ? Briefly discuss its various components. What is meant by domestic territory of a country ? ‘Machine purchased is always a final good.’ Do you agree ? Give reasons for your answer. (CBSE Sample Paper 12 Explain with the help of an example the basis of classifying goods into final goods and intermediate goods. (CBSE AL 17 Define intermediate consumption and explain it with an example. How is it different from fina consumption ? (CBSE ALG LONG ANSWER TYPE QUESTIONS (6 Marks) 1. Discuss the concept of factor income and transfer income with the help of examples. Briefly discuss the concept of normal residents. Distinguish between the following, giving suitable examples in support of your answer () Domestic product and national product. (if) Intermediate goods and final goods. Explain, briefly, the meaning of domestic territory. Distinguish between market price and factor cost. Explain the concept of gross investment. Explain end use classification of goods. Differentiate between consumer goods and capital goods. Introductory MACROECONOMICS-XiIlChopler 3 : NATIONAL INCOME AND RELATED AGGREGATES 61 An Extra Mil 1 CATEGORIES OF PRODUCERS ‘There are different categories of producers from the view point of national income accounting, ‘These producers are broadly categorised as follows 1. General Government ‘The general government produces services like defence, law and order, health, education and other social services. These services are not sold for profit motive, but are supplied to the community either free of cost or at a nominal price. There are some non-profit organisations like community welfare centres, government emporiums, etc, to assist government in providing welfare to public. 2. Corporate and Quasi Corporate Enterprises (i) Corporate enterprises. These are enterprises which operate on a large scale in private and public sectors. These operate as per rules and regulations of the Jaw of land (under the Companies Act 1956). These need to obtain a license from the government after the completion of formalities of the law, (ii) Quasi corporate enterprises. These are set up as sole proprietorships or as large partnerships. These are not incorporated under the Companies Act. Financial institutions like banks and co-operative organisations come under this category. NOTE Government sector enterprises are divided into two categories : (@) Departmental enterprises. These get their finances from the government budget. Enterprises such as post offices, railways, defence ‘manufacturing are the examples of departmental enterprises. (b) Non-departmental enterprises. These are managed by government but these are not financed by government, These include financial enterprises such as state finance corporations, industrial finance corporations etc. ‘and non-financial enterprises such as HMT, BHEL, SAIL etc. 3. Households Households are also producers as they are owners of factors of production and supply factor services. Apart {om being suppliers of factor services, at times we may find producers as household enterprises in the following forms : (a) Households as unincorporated enterprises like farmers, carpenters, goldsmiths ; artisans etc. (b) Households rendering domestic services like domestic servants, chauffeurs, gardeners ete. (0) Non profit institutions serving households like charitable hospitals, charitable trusts etc. Infroductory MACROECONOMICS-xValue added method Income method Expenditure method Items that are excluded from GNP measurement National income at current prices and constant prices eee eee Treatment of different items in the calculation of national income + Reconciliation of three methods of measuring national income CHAPTER 4 MEASUREMENT OF NATIONAL INCOME METHODS OF CALCULATING NATIONAL INCOME TWiccey value of physical goods and services generates income. It means, there is an income flow corresponding to the flow of output. Goods and services are purchased by people through consumption expenditure, which gives rise to income for the producers of goods and services. We have seen in the previous chapter that production gives rise to income, income ives rise to expenditure and expenditure causes production of goods and services. It is a circular flow which keeps repeating. Accordingly, national income of a country can be measured by three different methods : © Value added/Output/Product method CO Expenditure Method/Disposition method © Income Method/Distribution method All the three methods give the same estimate of national income. Each method is important in its own way as it refers to different approaches to study National Income. 6364 41 4.1.1 UNIT |: NATIONAL INCOME AND RELATED AGGREGATES VALUE ADDED/PRODUCT/OUTPUT METHOD Let us discuss value added method of estimating national income under three sub-heads Method, Steps, Precautions. Methods for Estimating National Income ‘There are two approaches ~ ‘Final Product Approach’ and ‘Value added Approach’ 1. Final Product Approach (Method) Final product is broadly called Gross Domestic Product. GDP is defined as monetary value of all the final goods and services produced by all producing units located in the domestic territory of a country in an accounting year. It is estimated by multiplying the gross product with market prices. GVO yp = Price x Output +4 in stocks or GVO yp = Sales +A in stocks Since it is gross, it includes depreciation ; being at MP, it includes net indirect taxes (GST) and since domestic, it includes production by all production units within domestic territory of a country. Value of only final goods and services is included to avoid problem of double counting. There is always a problem of double counting implying a commodity may be counted more than once in estimating national income. To overcome the difficulty of double counting, value added approach is used. 2. Value Added Approach (Method) 412 According to this method, national income is calculated by adding ‘net value added at FC ‘by all the producing units during an accounting year within the domestic territory. By adding net factor income from abroad to Domestic Income (NDP;«. ), we get National Income (NNP,.). In value added method, domestic income is estimated at the stage of production ie,, at the stage of value addition. GVA yp /GDPyp =GVO yp — Intermediate consumption NVApe =GVA yp ~ Depreciation - NIT Steps for Estimating National Income 1. Identification of Producing Units or Industrial Categories of Producers. These are (a) Primary sector : which exploits natural resources ¢.g,, agriculture, fishing, mining ete. (b) Secondary sector : which transforms one type of commodity into another e.g., cloth produced from cotton ete, (©) Tertiary sector : renders services e.g., banking, insurance etc Introductory MACROECONOMICS-XilChapter 4 : MEAS UREMENT OF NATIONAL INCOME . METHODS OF CALCULATING... 65 ti 2, Calculation of GDP yp or GVAyp . First gross value added is calculated for each sector separately and then added to find GDPyyp (GDP yp = EVA yp) p = LVAyp (@) GVOy4p = Sales + Chang a stocks + Goods produced for self consumption (if given) = (Domestic sales + Exports) + (Closing stock - Opening stock) (b+) GVAyp / GDP 4p =GVO x4» — intermediate consumption* (IC) = GVO yp ~ (Domestic purchases + Imports) - NOTE — + Intermediate Consumption is expenditure incurred on inter- mediate inputs which are used up in the process of production. €.9.» Raw materials, fuel, electricity etc. + Purchase of machine is not a part of intermediate consumption. 3. Calculation of Domestic Income (NDP,c) NDPrc = GDP yp ~ Depreciation - NIT 4. Calculation of National Income (NNPec) NNPhe = NDP pc + NFIA 4.1.3. Precautions for Estimating National Income Following items should be included (i) Value of final goods and services as these are ready for use by their final users. (i) Imputed rent of owners occupied houses as house provides service to the owners and generates rental income. (ii) Imputed value of goods (primary) produced for self consumption by producers as these contribute to the current year’s output. (own account production for self consumption) (iv) Imputed value of fixed assets produced for self consumption by enterprises, government and households as these contribute to current year's output. (own account production for investment) (v) Imputed value of free services produced by general government and private non- profit institutions serving households as these contribute to current year’s output. Following items should not be included (i) Sale and purchase of second hand goods. It does not represent any net addition to current year’s output. Their value had already been included in the national income of the year in which they were produced. If the transaction has been made through a dealer, his commission or brokerage should be included because he has rendered productive service. (ii) Sale and purchase of shares and bonds (new and old). This is merely a financial transaction which does nof correspond to the flow of goods and services, but brokerage paid to the broker will be included as he is generating a new service. (iit) Production by illegal activites like smuggling theft, etc. All illegal activities are excluded from the national income. (iv) Value of intermediate goods and services as their value has already been included in final goods (To avoid double counting). (2) Services produced for self-consumption (by producers and consumers) like services of housewife, kitchen gardening etc. as it is difficult to assess their market value. These services do not enter the market. These are also known as non-market transactions. (For detail, refer to Page 97) Introductory MACROECONOMICS-XII66 UNIT I; NATIONAL INCOME AND RELATED AGGREGATES iy yale Ud 1. Goods produced for self consumption by producers are included in the estimation of national income as these contribute to the current year’s output, 6g. a part of wheat production is used by the farmer for his family consumption requirement 2. Goods produced for self consumption by consumers are not included in the estimation of national income as there is no data available for these goods (non-market transactions) ¢, vegetables grown in kitchen garden by a household. ucers are not included in the estimation of 3. Services produced for self consumption by prod’ national income as these services do not enter the market and there is no data available (non-market transactions), eg. teacher teaching her own child or a doctor looking after ailing patient at home etc. ' 4 Services produced for self consumption by consumers are not included in the estimation of national income as these services do not enter the market and there is no data available (non-market transactions), eg, electric faults repaired by households. 4.1.4 Problem of Double Counting Double counting means counting of the value of sa o than once. If certain items are counted for more than once resulting in over national product to the extent of the value of intermediate goods included, this will cause the problem of double counting ¢., there are four producers ~ farmer, mill owner, baker and me product (or expenditure) for more estimation of confectioner. Producers ~ Product [tame 4 Aeon Value Added (2) Farmer = wheat (els to mill owner) 200 | | 2000 Fa. | mitt owner — flour (sells to baker) | _ 500 Baker — bread (sells to confectioner) 1100. oc fe 3000 400 coe 2100 | S100) [ees value added 4000" If for the purpose of calculation we take value of output as (2000 + 2500 + 3600 + 4000) = 12100, this will be double counting. In this, value of wheat has been included four times, flour for three times and bread for two times, whereas value of final product is £4000 only i.c., the value of bread (12100 - 8100 = 4000). : To avoid double counting, we should use the following : ‘Value added Method. By this method we take value added only i, value of output ~ Intermediate consumption i, 12100-8100 = 4000 or, Final output method. By this method we take value of final good only i, value of output (bread) i, 24,000 Let us practice numerical questions by output method : Remember, > Domestic income = NDP; and » National income = NNP,c Introductory MACROECONOMICS-XIl