Class 12th Macroeconomics National Income Accounting Notees

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Class 12th - Economics
National Income Accounting
Full Chapter Explanation
MACROECONOMICS
Class 12th - Macroeconomics - National Income Accounting
Overview:
➢ Basic concepts of Macroeconomics
➢ Stock & Flow
➢ Circular flow of Income
➢ Types of Circular Flow
➢ National Income and Related Aggregates
➢ Measurement of National Income
➢ Value Added Method
➢ Income Method
➢ Expenditure Method
Basic concepts of Macroeconomics:
● Domestic territory
● Normal residents
● Citizenship & Residentship
● Factor income & Transfer income
● Final goods & Intermediate goods
● Consumption goods & Capital goods
● Net Indirect tax
● Depreciation & Capital Loss
● Investment
Domestic Territory:
● In layman’s language, domestic territory means the political
frontiers of a country.
However, for the purpose of national income accounting, it is

used in wider sense.
Domestic Territory:
In addition to political frontiers, domestic territory also includes:
● Ships and aircrafts owned by normal residents between two or

more countries.
● Fishing vessels, oil and natural gas rigs and floating platforms
operated by the residents of a country in international waters
where they have exclusive rights of operation.
● Embassies, consulates and military establishments of a country

located abroad.
Domestic Territory:
Domestic territory does not includes:
● Embassies, consulates and military establishments of a foreign

country.
● International organisations like UNO, WHO, etc located within

the geographical boundaries of a country.
Normal Residents:
● Normal residents of a country refers to an individual or an
institution who ordinarily resides in the country and whose
centre of economic interest also lies in that country.
● Normal residents include both, individuals and institutions.
‘Centre of Economic Interest’ implies two things:
1. The resident lives or is located within the Domestic Territory;
2. The residents carries out basic economic activities of earnings,

spending and accumulation from that location.
Normal Residents:
Following are not included under the category of Normal residents:
1. Foreign tourists and visitors.
2. Foreign staff of Embassies, officials, diplomats and members of the armed

forces of a foreign country, located in the given country.
3. International organisations like UNO, WHO, etc. are not considered as normal
residents of the country in which they operate.
4. Employees of international organisations.
5. Crew members of foreign vessels, commercial travellers and seasonal workers.
6. Border workers.
Citizenship And Residentship:

Citizenship
A legal concept, indian citizenship can arise in two ways:
I. When a person is born in india, he acquires automatic citizenship of india.

II. A person born outside india applies for citizenship and indian law allows him to
become indian citizen.
Residentship
➢ An economic concept
➢ An individual is a normal resident of a country if he ordinarily resides in the country

for a period more than one year and his centre of economic interest also lies in that
country.
Factor Income and Transfer Income:

Factor income:
➢ Factor income refers to income received by factors of production for

rendering factor services in the production process.
➢ It is received for providing factor services of land, labour, capital and

enterprise.
➢ Factor income of normal residents of a country is included in the national

income.
➢ Examples: rent, wages, interest and profit.
➢ Factors of Production are primary inputs, which are needed to produce

goods and services.
Factor Income and Transfer Income:

Factor income:
➢ They are broadly categorised under four heads:
i. Land
ii. Labour
iii. Capital
iv. Entrepreneur
Factor Income And Transfer income:

Transfer income:
➢ Transfer income refers to income received without rendering any

productive service in return.
➢ It is a unilateral (one-sided) concept.
➢ It is not included in national income as it does not reflect any

production of goods and services.
➢ It can be received either within the domestic territory of a

country or from abroad.
➢ Examples: old age pension, scholarship, unemployment

allowance, pocket money, etc.
Factor Income And Transfer income:

Transfer income:
➢ Taxes received by government are the transfer incomes of the

government as they are received without providing any productive
service in return.
➢ Similarly, subsidies paid by the government are the transfer payments of

government.
Final Goods and Intermediate Goods:

Final goods-
➢ Final goods refer to those goods which are used either for
consumption or for investment.
➢ Final goods include:
I. Goods purchased by consumer households as they are meant

for final consumption.
II. Goods purchased by firms for capital formation or investment


Final goods-
➢ Expenditure on final goods purchased by households is called ‘consumption

expenditure’
➢ Expenditure on final goods purchased by the producers is called ‘investment

expenditure’
➢ Expenditure on final goods= consumption expenditure + investment expenditure.


Intermediate goods-
➢ Intermediate goods refer to those goods which are used either for resale or for
further production in the same year.
➢ Intermediate goods include:
I. Goods purchased for resales
II. Goods used for further production

Important Points about Intermediate Goods:

➢ Intermediate goods remain within the production boundary.
➢ They have ‘Derived demand’ as their demand depends on demand for

final goods.
➢ Durable goods (like trucks, aircrafts, vehicles, etc) purchased by

government for military purposes are included under the category of
intermediate goods as they are used to produce defense services and not
for market sale.
➢ Value of intermediate goods is merged with the value of final goods.

Production Boundary:
➢ As long as goods remain within the production
boundary, they are intermediate goods and Farmer A produces Cotton
when a good comes out of this boundary, it worth ₹ 2000 and sells it to B
becomes a final good.
B produces Thread worth ₹

3000 and sells it to C
C produces Cloth worth ₹

Final Good
Consumer 4500 and sells it to
Cloth Consumers
How to Classify Goods as Intermediate Goods and Final goods:
➢ The distinction between intermediate goods and final goods is made on
the basis of the use of product and not on the basis of product itself.
➢ A commodity can be an intermediate good as well as a final good,

depending upon its nature of use.
➢ For example: Sugar is an intermediate good when it is used by sweet

shop for making sweets. However, if it is by the consumers, then it
becomes a final good.
➢ Intermediate goods are used up in the same year. If they remain for
more than one year, then they are treated as final goods.
Consumption Goods:
➢ Consumption goods refer to those goods which satisfy the wants of the
consumers directly. For example, bread, butter, shirt, pens, television,
furniture,etc.
Consumption goods can further be subdivided into following categories:
1. Durable goods
2. Semi durable goods
3. Non-durable goods
4. Services
Capital Goods:
➢ Capital goods are those final goods which help in production of other
goods and services. For example, plant and machinery, equipments, etc.
Capital Goods:
Some points about capital goods-
I. They are used in future for productive purposes and have expected
lifetime of several years.
II. They need repairs or replacement over time as they depreciate over a
period of time.
III. They have derived demand as their demand is derived from the demand
for other good which they help to produce.
IV. Capital goods are durable use consumer good for household.
All Producer Goods Are Not Capital Goods:

It must be noted that all goods used by producer (known as
producer goods) are not capital goods. Producer goods include two
types of goods:
1. Single-use producer goods: it includes raw material like coal,

wood, etc. they are not capital goods as they cannot be
repeatedly used in the production process.
2. Capital goods: it includes fixed assets like plant and machinery,

which can be repeatedly used in the production process.
So, it can be said that all capital goods are producer goods, but all
producer goods are not capital goods.
Gross Investment, Net Investment and Depreciation:
➢ Investment or capital formation refers to addition to the capital
stock of an economy.
➢ For example, construction of building, purchase of machinery.
➢ In economics, capital stock refers to all the assets that help with
production.
➢ Investment can be in two forms:

I. Gross investment
II. Net investment


Gross investment-
➢ Gross investment is addition to the stock of capital before making

allowance for depreciation.
➢ These may be machines, tools and implements; buildings, office spaces,

storehouses or infrastructure like roads, bridges.All the capital goods
produced in a year do not constitute an addition to the capital stock
already existing.
➢ A significant part of current output of capital goods goes in maintaining or

replacing part of the existing stock of capital goods. Therefore, gross
investment does not indicate the actual change in economy’s stock of
productive assets for a given year.

Net investment-
➢ The actual addition made to the capital stock of economy in a given period is
termed as net investment.
Net investment = Gross Investment - Depreciation


Depreciation (consumption of fixed capital)-
➢ Depreciation refers to a fall in the value of fixed assets due to normal

wear and tear, passage of time or expected obsolescence.
Gross Value = Net Value + Depreciation
➢ Also known as:
I. Current replacement cost;
II. Replacement cost of fixed capital;
III. Capital consumption allowance.


Depreciation of assets is mainly due to 3 reasons:
I. Normal wear and tear: continuous use of fixed assets in production process
decreases their productive capacity and value.
II. Passage of time: Value of fixed assets also decreases with the passage of time,
even if they are not being put to use in the business. Natural factors like rain,
wind, weather, etc. contribute to fall in their value.
III. Expected obsolescence: Value of fixed assets also decreases due to expected
obsolescence (i.e. loss in value due to change in technology or change in
demand for goods and services).
Expected and Unexpected Obsolescence:

➢ Expected obsolescence occurs due to change in technology or change in
demand for goods and services. As expected obsolescence is an
expected loss, it is managed by making provision for depreciation
reserve fund.
➢ Unexpected obsolescence occurs due to nature calamities like

earthquake, floods, etc. or due to thefts, accidents, etc. loss of value of
fixed assets due to unexpected obsolescence is termed as ‘capital loss’.
Net Indirect Tax (NIT):
➢ Net indirect tax refers to the difference between indirect taxes and
subsidies.
Net indirect tax = Indirect taxes - Subsidies

Factor Cost Vs Market Price:
A. Factor cost (FC): It refers to amount paid to factors of production for
their contribution in the production process.
B. Market price (MP): it refers to the price at which product is actually sold
in the market.
Market Price = Factor Cost + Net Indirect Taxes

Net Factor Income From Abroad (NFIA):
➢ It refers to the difference between factor income received from the rest
of the world and factor income paid to the rest of the world.
NFIA = Factor income earned from abroad - Factor income paid abroad
➢ NFIA can be positive, negative or zero

Net Factor Income From Abroad (NFIA):

Components of NFIA
There are three main components of NFIA:
1. Net compensation to employees.
2. Net income from property and entrepreneurship.
3. Net retained earnings.
Net factor income from abroad = net compensation of employees + net income from property and
entrepreneurship + net retained earnings.

Stock and Flow:
Stock-
● Stock variables are defined as any quantity, which is measured at

a particular point of time, e.g. number of machines in plant,
amount in the bank account on a specific date, population of India
at a 31st of March, 2014, etc.
Flow-
● Flow variables are defined any quantity which is measured over a

period of time. Flows are changes in stock, which can be
measured over specific time period. E.g. population of India
during the month of March 2014, money in bank account during
August 2014, etc.
Meaning and Phases of Circular Flow of Income:
● It refers to cycle of generation of income in the production
process, its distribution among the factors of production and
finally, its circulation from households to firms in the form of
consumption expenditure on goods and services produced by
them.
Circular Flow of Income:
Phases of circular flow of income
1. Generation phase: in this phase, firms produce

goods and services with the help of factor services.
2. Distribution phase: this phase involves the flow of
factor income (rent, wages, interest and profit)
from firm to the households.
3. Disposition phase: in this phase, the income
received by factor of production, is spent on the
goods and services produced by firm.
Sectors involved in Circular Flow:
1. Household sector: It is engaged in the consumption of goods and
services and is also the provider of factors services.
2. Producing sector: It is engaged in the production of goods and

services. It is also referred to as ‘firms’.
3. Government sector: It is engaged in such activities which are

related to taxation and subsidies as well as consumption and
production.
4. Rest of the world: It engaged in exports and imports.

Type of Circular Flow:
Real flow -
● Real flow refers to the flow of factor services from

household to firms and the corresponding flow of
goods and services from firms to households. Also
known as ‘physical flow’.
Type of Circular Flow:
Money flow -
● Money flow refers to flow of factor payments from

firms to household for their factor services and
corresponding flow of consumption expenditure
form households to firms for purchase of goods and
services produced by the firms.
● It is also known as ‘normal flow’.

Circular Flow In A Simple Economy (Two-Sector Economy):
A simple economy assumes the exercise of only two sector,i.e.Household sector
and Firms sector.
● Households are the owners of factor of production and consumers of

goods and services.
● Firms produce goods and services and sell them to the households.
● It is the simplest form of closed economy, in which there is no government

sector and foreign trade.
In order to make our analysis simple, we take some assumptions:
1. There are only 2 sectors in the economy: households and firms. It means,
there is no government and foreign sector.
2. Household sector supplies factor services only to firms and the firms hire
factor services only from households.
3. Firms produce goods and services and sell their entire output to the
households.
4. Households receive factor income for their services and spend the entire
amount on consumption of goods and services.
5. There are no savings in the economy, i.e. neither the household save from
their incomes,nor the firms save from their profits.
Conclusions of circular flow in a simple economy-
● Total production = total consumption
● Factor payment = factor income
● Consumption expenditure = factor income
● Real flow = money flow

Significance of Circular Flow of Income:
1. It helps us to understand the mutual interdependence among
different sectors of the economy.
2. It shows the equilibrium position of the economy.
3. It helps in identifying various types of leakages and injections in

the economy.
4. It helps in estimation of national income.

National Income Aggregates:
● Gross Domestic Product at Market Price (GDPMP)
DOMESTIC:
● Gross Domestic Product at Factor Cost (GDPFC) ● GDPMP
● Net Domestic Product at Market Price (NDPMP) ● NDPMP
● Net Domestic Product at Factor Cost (NDPFC) ● GDPFC

● NDPFC
● Gross National Product at Market Price (GNPMP)
● Gross National Product at Factor Cost (GNPFC) NATIONAL:

● Net National Product at Market Price (NNPMP) ● GNPMP
● Net National Product at Factor Cost (NNPFC) ● NNPMP
● GNPFC
● Domestic Income (NDPFC)
● NDPFC
● National Income (NNPFC)
How to Remember Definition of all Aggregates:
Keywords to remember:
● Domestic Product Domestic territory
● National Product Normal residents
● Market Price Market Value
● Factor cost Money value
● G Gross
● N Net
How to Remember Definition of all Aggregates:
● GDPMP:
➢ It refers to gross market value of all final goods and

services produced within the domestic territory of a
country during a period of one year.
● NNPFC:
➢ It refers to the net money value of the final goods and

services produced by the normal residents of a country
during a period of one year.
Relationship Between Four Domestic Concepts:
GDP at MP
(+) Dep (-) NIT
NDP at MP GDP at FC
(+) NIT (-) Dep

NDP at FC
Relationship Between Four National Concepts:
GNP at MP
(+) Dep (-) NIT
NNP at MP GNP at FC
(+) NIT (-) Dep

NNP at FC
Categorisation of Domestic Income:
● The domestic income (NDPFC) of a country is earned by both private
sector and public sector. So it is divided into two sub parts:
1. Income from domestic product accruing to Private Sector: It refers

to that part of domestic income which accrues only to private
sector.
2. Income from domestic product accruing to Public Sector: It refers to that
part of domestic income which accrues to the public or government
sector.
It is further divided into two components:
(i) Income from property and entrepreneurship accruing to government

administrative departments
(ii) Savings of non- departmental enterprise.

Income from Domestic Product accruing to Private Sector:
= NDPFC - Income from Property and Entrepreneurship accruing to Government

Administrative Departments - Savings of Non - Departmental Enterprises.
Private Income:
● Private income refers to the income which accrues to private
sector from all the sources within and outside the country.
● It includes both earned (factor income) and unearned income

(transfer income) received by private sector (Private enterprises
+ Households).
Private Income:
Factor Income (Earned Income)
● There are two sources of factor income for the private sector:
➢ Income earned within the domestic territory known as

Income from domestic product accruing to private sector.
➢ Income earned outside the domestic territory known as

Net factor income from abroad.
Private Income:
Transfer Income (Unearned Income)
● There are two sources of transfer income:
➢ Income received within the domestic territory. It includes

National debt interest and current transfers from
government.
➢ Income received from outside the domestic territory

known as net current transfers from the rest of the world.
Transfer Incomes under Private Income:
(i) Interest on National Debt
(ii) Current transfers from Government
(iii) Net Current transfers from rest of the world.
Private income = Income from Domestic Product Accruing to Private

Sector + Net Factor income from abroad (NFIA) + Interest on National
Debt + current transfers from government + Net Current transfer from
ROW.
Personal Income:
● Personal income is the sum total of all the incomes that are
actually received by households from all the sources.
● It includes both factor and transfer incomes.

Personal Income does not include ‘Corporate Tax’ and ‘Retained Earnings’:
● Private income belongs to both private enterprises and the households.
However, Personal Income refers to that part of private income, which is
received by the households only.
● Personal Income does not include ‘Corporate Tax’ as such taxes are paid
by the private enterprises to the Government and are not received by
the households.
● Personal Income does not include ‘Retained Earnings’ also as they are
retained by private enterprises for their future expansion and
unforeseen events.
Personal Income = Private Income - Corporate Tax - Retained Earnings.

Disposable Income:
Disposable income is the amount of money that individuals and families
have available for spending or saving after they have paid their direct
taxes and received any state welfare benefits
Types of disposable income:
● Personal disposable income
● National Disposable Income

Personal Disposable Income:
● Personal disposable income (PDY) refers to that part of personal
income which is actually available at the disposal of households.
● PDY does not include ‘Personal Taxes’ as households need to pay

direct taxes like income tax, house tax, etc, to the government.
● PDY does not include ‘Miscellaneous Receipts of Government’ as

these ar, fine small compulsory payments made by households to
the government in the form of fees, fines, etc.
Personal Disposable Income = Personal Income - Personal taxes -

Miscellaneous receipts of government.
National Disposable Income (Net and Gross):
● National Disposable Income (NDY) refers to the income which is
available to the whole country for disposable.
● It includes both factor income and transfer income.
● It is also known as ‘Net National Disposable Income’.

NDY includes ‘Net Indirect Taxes’ and ‘Net Current Transfers from ROW’
● NDY includes ‘Net Indirect Taxes’ as it is the transfer income of

government and is free to use , the way it likes.
● NDY also includes ‘Net Current Transfers from ROW’ as it is the

transfer income of the government received from abroad.
Net Disposable Income = National Income + Net indirect taxes + Net

current transfers from the rest of the world.
NDY = National Consumption Expenditure + National Savings

● When depreciation is added to the the net National Disposable
Income, we get Gross National Disposable Income.
Gross National disposable Income = Net National disposable Income

+ Depreciation
Measurement of National Income:
● National Income of a country can be measured by three
different methods:
1. Value Added Method
2. Income Method
3. Expenditure Method
Value Added Method:
● Value added refers to the addition of value to the raw material
(intermediate goods) by a firm, by virtue of its production activities.
● It is the contribution of an enterprise to the current flow of goods and
services.
Value Added = Value of Output - Intermediate Consumption
● We get GVAMP i.e. by GDPMP value added method.

Value Added Method:
Value of Output-
● Value of output refers to market value of all goods and services

produced during period of one year.
Value of Output = Sales + Change in Stock
Value of Output = (Quantity x Price) + Change in Stock

Value Added Method:
Steps of Value Added Method-
Step 1: Identify and classify the production units.
Step 2: Estimate the Gross Domestic Product at Market Price.
Step 3: Calculate Domestic Income (NDPFC).
Step 4: Estimate net factor income from abroad (NFIA) to arrive at National
Income
National Income (NNPFC) = NDPFC + NFIA

Value Added Method:
GVAMP of Primary Sector
(+) GVAMP of Secondary Sector
(+) GVAMP of Tertiary Sector
Gross Domestic Product at

Market Price (GDPMP)
(-) Depreciation
(-) Net Indirect Taxes
Domestic Income (NDPFC)
(+) NFIA
National Income (NNPFC)

Value Added Method:
Precautions of Value Added Method-
1. Intermediate Goods are not to be included in the national income.
2. Sale and Purchase of second- hand goods is not included.
3. Production of Services for Self- consumption are not included.
4. Production of Goods for self- consumption will be included.
5. Imputed value of owner- occupied houses should be included.
6. Change in the stock of Goods (inventory) will be included.

Value Added Method:
Problem of Double Counting-
● Double counting refers to counting of an input more than once while

passing through various stages of production.
sells sells sells

wheat flour bread
FARMER MILLER BAKER CONSUMERS
for ₹ 500 for ₹ 700 for ₹ 1,000
A careful examination reveals that each transaction contains the value of

intermediate goods:
● The value of wheat is included in the value of flour.

● The value of flour is included in the value of bread.
Value Added Method:
How to Avoid Double Counting-
1. Final output Method: According to this method, value of only final

goods should be added to determine the national income.
2. Value Added Method: According to this method, sum total of the value
added by each production unit should be taken in the national income.
Income Method:
● According to this method, all the incomes that accrue to the factors
of production by way of wages, profits, rent, interest, etc. are
summed up to obtain the national income.
Income Method:
Components of Factor Income:
1. Compensation of Employees (COE): It refers to amount paid to employees

by employer for rendering productive services.
It consists of 3 elements:
➢ Wages and salaries in cash: It includes all monetary benefits, like

wages, salaries, bonus, dearness allowances, commission,etc.
➢ Wages and salaries in kind: It includes all non- monetary benefits like
rent free home, free car, free medical and educational facilities, etc.
An imputed value of these benefits should be included in national
income.
➢ Employers contribution to social security schemes: It includes

contributions made by employer for social security of employees.
Income Method:
2. Rent and Royalty: Rent is that part of national income which arises from
ownership of land and building.
It includes both actual rent as well as imputed rent.
Imputed rent of owner occupied houses is calculated on the basis of market

rental value of the house.
Royalty refers to income received for granting or leasing rights to use

intellectual property or physical asset .
Income Method:
3. Interest: Refers to amount received for lending funds to a production unit. It

includes interest on loans taken for productive service only.
Interest income does not include:
(i) Interest paid by government on public debt and interest paid by consumers
as such interest is paid on loans taken for consumption purposes.
(ii) Interest paid by one firm to another firm

Income Method:
4. Profit: Profit is the reward to the entrepreneur for his contribution to the
production of goods and services.
It is the residual income, which an entrepreneur earns after paying all the other
factors of production.
The profit earned by an enterprise is used for 3 purposes:
(i) Corporate Tax
(ii) Dividend
(iii) Retained Earnings

Income Method:
Profit:
(i) Corporate Tax: It is the direct tax paid by an enterprise to the government on the
total profit earned by it. It is also known as Profit tax or Business tax.
(ii) Dividend: It refers to that part of profit, which is paid to the shareholders in the
ratio of their shareholding. It is also known as distributed profits.
(iii) Retained Earnings: It refers to that part of profit, which is kept as reserve to meet
unexpected contingencies or for business expansion. It is also known as Undistributed
Profits or Savings of Private Sector or Reserves and Surplus.
Profit = Corporate Tax + Dividend + Retained Earnings

Income Method:
5. Mixed Income: It is the income generated by own-account workers (like

farmers, barbers, etc).
Mixed income arises from productive services of self-employed persons, whose

income includes wages, rent, interest and profit and these elements cannot be
separated from each other.
For example, income of a doctor running a clinic at his residence.

Income Method:
Steps of Income Method:
Step 1: Identify and classify the production units.
Step 2: Estimate the factor income paid by each sector.
The factor incomes paid by each sector are classified under the following heads:
(i) Compensation of employees;
(ii) Rent and Royalty;
(iii) Interest;
(iv) Profit;
(v) Mixed Income.

Income Method:
Step 3: Calculate Domestic Income (NDPFC).
When factor incomes of all the sectors are summed up, we get domestic income
(NDPFC).
NDPFC = Compensation of Employees + Rent and Royalty + Interest + Profit + Mixed

Income
Income Method:
Step 4: Estimate net factor income from abroad (NFIA) to arrive at National
Income
In the final step, NFIA is added to domestic income to arrive at National Income
NNPFC = NDPFC + Net factor income from abroad.
Income Method:
Compensation of Employees
+ Rent and Royalty
+ Interest
+ Profit
+ Mixed Income
Domestic Income (NDPFC)
(+) NFIA
National Income (NNPFC)

Income Method:
Precautions of Income Method:
1. Transfer Incomes are not included in the National income because such
receipts are not connected with any productive activity and there is no
value addition.
2. Income from sale of second-hand goods will not be included in national
income as their original sale has already been counted.
However, and brokerage or commission received by brokers or commission

agents on sale of such goods, will be included as it is an income received
for rendering productive service.
Income Method:
Precautions of Income Method:
3. Income from sale of shares, bonds and debentures will not be included as
such transactions do not contribute to current flow of good and services.
However, any commission or brokerage on such financial assets is included

as it is a productive service.
4. Windfall gains are not included as there is no productive activity

connected with them.
5. Imputed value of services provided by owners of production units will be
included as these are productive activities and add to the flow of goods
and services.
Expenditure Method:
Factor income earned by factors of production is spent in the form of
expenditure on purchase of goods and services produced by firms.
● This method measures national income as sum total of final

expenditures incurred by household, business firms, government and
foreigners.
● This total final expenditure is equal to gross domestic product at
market price,
Σ Final expenditure is equal = GDPMP.
● Also known as ‘income disposal method’.

Expenditure Method:
Components of final expenditure-
1. Private final consumption expenditure (PFCE): it refers to expenditure

incurred by household and private non-profit institutions serving
households on all types of consumer goods, i.e. durable, semi-durable,
non-durable goods and services.
Private final consumption expenditure (PFCE) =
Household final consumption expenditure + private non-profit institutions

serving households final consumption expenditure
● Any expenditure incurred by residents during their foreign tour/travel will

be added in PFCE. any expenditure incurred by non-residents and foreign
visitors in the domestic market will be deducted from PFCE.
Expenditure Method:
2. Government final consumption expenditure (GFCE): It refers to the
expenditure incurred by general government on various
administrative services like defence, law and order, education etc.
government produces goods and services with the aim of social
welfare without any intention of earning profits.
Government final consumption expenditure =
intermediate consumption of government + COE paid by government

+ direct purchase from abroad for embassies and consulates located
abroad - sale of goods and services produced by general government.
Expenditure Method:
3. Gross domestic capital formation (GDPF) or gross investment: It refers
to the addition to capital stock of the economy.
There are two components of GDCF:
I. Gross fixed capital formation

II. Inventory investment (change in stock)
Expenditure Method:
I. Gross fixed capital formation: it refers to the expenditure incurred on
purchase of fixed assets. This expenditure is generally divided into
three sub-categories:
a. Gross business fixed investment: It includes expenditure on the

purchase of new plants, machinery, equipments, etc.
b. Gross residential construction investment: It includes

expenditure on purchase or construction of new houses by the
households.
c. Gross public investment: It includes expenditure on

construction of flyovers, roads, bridges etc. by the government.
Expenditure Method:
II. Inventory investment (change in stock): It refers to the physical
change in the stock of raw material, semi-finished goods finished
goods lying with the producers. It is calculated as the difference
between the closing stock and the opening stock of the year.
GDCF = gross fixed capital formation + investment; or
GDCF = gross business fixed investment + gross residential

construction investment + gross public investment + inventory
investment.
Expenditure Method:
4. Net exports (X-M): It refers to the difference between exports and
imports of a country during a period of one year.
● Exports(X) refer to expenditure by foreigners on purchase of

domestic products.
● Import(M) is the expenditure by residents on foreign products.

Expenditure Method:
Step of expenditure method
The steps involved in calculating national income by expenditure method

are:
Step 1: Identify the economics units incurring final expenditure
Step 2: Classification of final expenditure
Final expenditures incurred are estimated and classified under the following
heads:
● Private final consumption expenditure (PFCE)
● Government final consumption expenditure (GFCE)
● Gross domestic capital formation (GDCF)
● Net exports (X-M).

Expenditure Method:
The sum total of four components of final expenditure gives gross domestic
product at market price (GDPmp), i.e. GDPmp= PFCE + GFCE + GDCF + (X-M)
Step 3: Calculate domestic income (NDPfc)
NDPfc= GDPmp- depreciation - net indirect taxes.
Step 4: Estimate net factor income from abroad (NFIA) to arrive at national
income.
National income (NNPfc) = NDPfc + NFIA

Reconciliation of All Three Methods:
Reconciliation of 3 Methods
GDP And Welfare:
Welfare means sense of material well being among the people. Higher GDP
is generally taken as greater welfare of people.
However, this generalization may not be correct due to following limitations

or reasons:
1. Distribution of GDP: GDP does not take into account changes in

inequalities in the distribution of income. So, welfare of the people
may not rise as much as the rise in GDP.
2. Change in prices: If increase in GDP is due to rise in prices and not due
to increase in physical output, then it will not be a reliable index of
economic welfare.
3. Non-monetary exchanges.
GDP And Welfare:
3. Non-monetary exchanges.
4. Externalities: Externalities refer to benefits or harms of an activity
caused by a firm or an individual, for which they are not paid or
penalised.
Activities which result in benefits to others are termed as positive

externalities activities which result in harm to others are termed as
negative externalities.
GDP And Welfare:
● Example and impact of negative externality: Environmental pollution
caused by industrial plants. Such pollution reduces the welfare
through negative effect on health.
● Example and impact of positive externality: Use of public parks by the

people for pleasure for which no payments are made by the public. It
increases welfare through positive effect on health.
5. Rate of population growth.

National Income at Current Price and Constant Price:
National income at current price:
● It is the money value of final goods and services produced by

normal residents of a country in a year, measured at the prices of
the current year.
● It is also known as ‘nominal national income’.
● It does not show the true picture of economic growth of a

country.
National Income at Constant Price:
● It is the money value of final goods and services produced by

normal residents of a country in a year, measured at base year
price.
● Base year is a normal year which is free from price fluctuations.
● Presently , 2011- 12 is taken as the base year in India.
● It is also known as ‘Real National Income’.
● It shows the true picture of economic growth of a country.
● So, in order to eliminate the effect of price changes, national

income is calculated at a constant price.
Conversion of National Income at Current Price into Constant Price:
● This can be done by eliminating the effects of price change on

national income with the help of a suitable ‘price index’.
● Price index is an index number which shows the change in price

level between two different time periods.
Nominal GDP and Real GDP:
1. Nominal GDP or GDP at current price: When GDP of a given year
is estimated on the basis of price of the same year, it is called
nominal GDP.
2. Real GDP or GDP at constant price: When GDP of a given year is

estimated on basis of price of base year, it is called real GDP.
Which is better: National GDP or real GDP ?
Real GDP is better as compared to nominal GDP because of following

reasons:
1. Real GDP helps in determining the effect of increased production of

goods and services. Nominal GDP can increase even without any
increase in physical output as it is affected by change in prices also.
2. Real GDP is a better measure to make periodic comparison in the

physical output of goods and services over different years.
3. Real GDP facilitates international comparison of economic

performance across the countries.
GDP deflator (or price index):
● GDP deflator measures the average level of prices of all the goods
and services that make up GDP.
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➢ Basic concepts of Macroeconomics

➢ Stock & Flow

➢ Circular flow of Income

➢ Types of Circular Flow

➢ National Income and Related Aggregates

➢ Measurement of National Income

➢ Value Added Method

● Citizenship & Residentship

● Factor income & Transfer income

● Final goods & Intermediate goods

● Consumption goods & Capital goods

● Net Indirect tax

● Depreciation & Capital Loss

However, for the purpose of national income accounting, it is

● Ships and aircrafts owned by normal residents between two or

● Embassies, consulates and military establishments of a country

● Embassies, consulates and military establishments of a foreign

● International organisations like UNO, WHO, etc located within

● Normal residents include both, individuals and institutions.

‘Centre of Economic Interest’ implies two things:

1. The resident lives or is located within the Domestic Territory;

2. The residents carries out basic economic activities of earnings,

1. Foreign tourists and visitors.

2. Foreign staff of Embassies, officials, diplomats and members of the armed

4. Employees of international organisations.

5. Crew members of foreign vessels, commercial travellers and seasonal workers.

Citizenship And Residentship:

A legal concept, indian citizenship can arise in two ways:

I. When a person is born in india, he acquires automatic citizenship of india.

➢ An individual is a normal resident of a country if he ordinarily resides in the country

Factor Income and Transfer Income:

➢ Factor income refers to income received by factors of production for

➢ It is received for providing factor services of land, labour, capital and

➢ Factor income of normal residents of a country is included in the national

➢ Examples: rent, wages, interest and profit.

➢ Factors of Production are primary inputs, which are needed to produce

Factor Income and Transfer Income:

➢ They are broadly categorised under four heads:

Factor Income And Transfer income:

➢ Transfer income refers to income received without rendering any

➢ It is a unilateral (one-sided) concept.

➢ It is not included in national income as it does not reflect any

➢ It can be received either within the domestic territory of a

➢ Examples: old age pension, scholarship, unemployment

Factor Income And Transfer income:

➢ Taxes received by government are the transfer incomes of the

➢ Similarly, subsidies paid by the government are the transfer payments of

Final Goods and Intermediate Goods:

➢ Final goods include:

I. Goods purchased by consumer households as they are meant

II. Goods purchased by firms for capital formation or investment

Final Goods and Intermediate Goods:

➢ Expenditure on final goods purchased by households is called ‘consumption

➢ Expenditure on final goods purchased by the producers is called ‘investment

➢ Expenditure on final goods= consumption expenditure + investment expenditure.

Final Goods and Intermediate Goods:

➢ Intermediate goods include:

I. Goods purchased for resales

II. Goods used for further production

Important Points about Intermediate Goods: