ch-2 National Income Accounting

Economics by Pratham Singh 1
Macro - Economics
For
GE, B.Com (H/P), BA (H/P),
BBE, BA (Eco), B.Sc (GE)
CHAPTER – 2
National Income Accounting
Topic 1 - Circular Flow of Income
The circular flow of income and product is the flow of goods and services among different sectors
of the economy. (Household sector, Producing sector, Government Sector & Foreign Sector).
When we talk about only Household and producing sector, it is called TWO SECTOR economy
Model. Also called Private closed economy model.
Household Sector + Producing Sector = Two Sector economy
Household Sector + Producing Sector + Govt. Sector = Three Sector economy Or closed Economy
Household Sector + Producing Sector + Govt. Sector + Rest of the World = Three Sector economy
Or Open Economy
There is a flow of Income & Expenditure among these, Which is called ‘Circular Flow of Income’.
Circular Flow of Income in TWO sector Economy

It is a model of private closed economy. Circular flow of income in a two sector economy consists
following assumption :-
1. There are only two sectors, i.e., household sector and firm sector in the economy.
2. Household sector is the owner of all the factors of production (Land, Labour, Capital &
Entrepreneur).
3. Firm sector hire factor services from household for the production of goods and services.
4. Households sector spends entire income on consumption.
5. Firm sector sell all the products to household sectors.
6. There is no interference of government sector and external sector.
Working of this model

All factors of production are owned by household sector. Therefore, firm sector hire factor services
from households for the production of goods and services. As a reward of factor services from
household, firm sector makes payment in the form of rent, wages, interest and profit to household
which is called their factor income. This income is used by household on the purchase of goods
and services. In exchange, firm sector sells whatever it produces to household sector for their
consumption.
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Households and firms interact in two types of markets.

In the markets for goods and services, households are buyers, and firms are sellers. In particular,
households buy the output of goods and services that firms produce.
In the markets for the factors of production, households are sellers, and firms are buyers. In these
markets, households provide the inputs that firms use to produce goods and services.
Circular Flow of Income in THREE sector Economy

It is the Model of Closed Economy. This model is more close to real life situation. In this model
economic activities of the government have also been accounted for. However, we continue to
assume that the economy is a closed economy. It means the circular flow of income is influenced
by the foreign sector at all.
Working of this model
1) Money flows from firms and households
sector to govt. in the form of taxes.
Government receives direct taxes from the
households and indirect taxes from the firm
sector.
2) Govt sector also provides subsidies (like
fertilizer subsidies) to the firm and transfer
payment (scholarship, old age pension etc.)
to household. Also money flow from govt. to
firm in the form of govt. expenditure on
goods and services.
3) A part of income earned by the government
is saved and invested into financial (capital
market). Govt also borrow money form capital market in the form of loan to meet current
expenditure (daily expenses) or development expenditure.
4) Household sectors are the owner of all factors of production. Household sector provide
factor services (L,Lb,K,Ent) only to firms and household received factor payment (Rent,
wages, Interest, profit) from firms.
Circular Flow of Income in FOUR sector Economy

Circular flow of income in four sector economy (Open Economy) consists of households, firms,
governments and Rest of the World.
1) The ROW sector receives income from the producing sector in return for the goods and
services imported by the firm. Thus, the money flows from producing sector to the ROW
sector. The ROW sector makes payment to the producing sector for the purchase of goods
and services exported by the firms. Thus, there is a flow of income from ROW sector to the
producing sector.
2) Household also provides services to the ROW sector and get payment in return. Also ROW
sector provides remittances or any transfer payment to the household sector.
3) Money flows from firms and households sector to govt. in the form of taxes. Government
receives direct taxes from the households and indirect taxes from the firm sector.
4) Govt sector also provides subsidies (like fertilizer subsidies) to the firm and transfer payment
(scholarship, old age pension etc.) to household. Also money flow from govt. to firm in the
form of govt. expenditure on goods and services.
5) A part of income earned by the government is saved and invested into financial (capital
market). Govt also borrow money form capital market in the form of loan to meet current
expenditure (daily expenses) or development expenditure.
6) Household sectors are the owner of all factors of production. Household sector provide
factor services (L,Lb,K,Ent) only to firms and household received factor payment (Rent,
wages, Interest, profit) from firms.
7) Household sector also spent amount on consumption of goods and service. Households do
not spent entire income on consumption, they saved a part of their income into capital
market. On the other hand, firms borrow this amount from capital market for their expa nsion
and growth. In this way flow of income continues between three sectors of economy.
Topic 2 – Classification of Goods

Types of Goods
Goods
Final goods Intermediate goods
Consumption goods Capital goods
Distinguish Between Final Goods and Intermediate Goods

Final goods Intermediate goods
These goods are not used as Raw materials These goods may be used as raw materials for
for the production of other goods during the the production of other goods during the
financial year. financial year.
Final goods are those goods which are Intermediate goods are those goods which are
available either for consumption or not available either for consumption or
investment for final users. investment for final users.
These are used by consumer and producer. These goods are used by the producer.
These are not meant for sale, so no value is These are meant for resale, so value is to added
to be added to these goods. to these goods.
They remain outside the production They remain inside the production boundary.
boundary.
Their value is included in national income. Their value is not included in national income.
Example: Milk bought by household for Example: Milk used in sweet shop for resale.
consumption.
CONSUMER GOODS, CAPITAL GOODS & PRODUCER GOODS

1. Cosumer goods
Consumer goods are those goods which are directly used for the satisfaction of human wants.
. These include:
a. Durable goods: It refers to those goods which can be used again and again over a period
of time. For example: car, television, radio etc.
b. Non-durable goods: Those goods which are used up in a single act of consumption. For
example: fruit, oil, milk, vegetables, service of doctor etc.
c. Semi durable goods: It refers to those goods which can be used for a period of one year
or slightly more. For example: crockery, books , cloth etc.
d. Services: Service are those non material goods which directly satisfy human wants. For
example : Services of doctor, lawyer, banks etc.
2. Capital goods
Capital goods are those final goods which help in production of other goods and services.
For example, Plant and Machinery, equipment, etc.
Note: The same good can be consumption good and also capital good. It depends on the
ultimate use of the good. Example, a machine purchased by a household is a consumption
good, whereas, if it is purchased by a firm for use in the business, then it is a capital good.
3. Producer Goods
Those goods which is used by producer for the production of other goods and services are
called Producer Goods.
These Goods are of two types:
Durable Producer goods : Those goods which can be used repeatedly in the production
process are called Durable producer goods. For example, machinery, tools, equipment etc.
These are also called Capital Goods.
Non – Durable Producer goods : Those goods which cannot be used repeatedly in the
production process. It is finished in a single act of production. For example, Raw material,
fertilizers, petrol etc. These are also known as Intermediate Goods.
Topic 3 – Concept of GDP

GDP is a macro concept. GDP refers to the market value of all final goods and services produced
by all the producing units located in the domestic territory of a country during a period of one year.
When we talk about GDP, it is always calculated on Market price (called GDPmp).
It includes depreciation, net indirect tax and value of output produced within the domestic territory
by all the producers (resident and non- resident).
Activities that are not included in GDP

1. Net Factor Income from Abroad (NFIA) : GDP is limited to Domestic territory of a
country and therefore it does not include Net Factor Income From Abroad (NFIA).
2. Goods produced in the previous year : GDP is a flow concept, i.e., flow of goods and
services produced during a year. It does not include goods produced in the previous year.
3. Value of intermediate consumption : GDP is not value of output because it excluded value
of intermediate consumption. GDP or GVA (Gross Value Added) is sum total of value added
by all the producing units in domestic territory of a country.
Value Added or GDP or GVA = value of output – Intermediate consumption
4. Transfer payments : GDP includes only factor payments, it does not include transfer
payments because these are unilateral transfer i.e., One side transfer.
5. Capital gain : GDP does not include capital gains. Capital gains refers to income from sale
of second hand goods (like old car) and financial assets (share, debenture bonds). Any
income arising from such transactions are not a factor income these are the transfer income
and these does not add to the current flow of goods and services in the economy.
6. Income from illegal activities: Income from illegal activities like smuggling, black
marketing, theft, dacoity, gambling etc. should not be included in national income. Income
earned by way of legal activities is included.
7. Sale of Shares and Bonds: Sale of Shares, Debentures, bonds etc. will not be included in
national income because such transaction do not contribute to current flow of goods and
services. These financial assets are only paper claims.
Components of GDP
1) Consumption Expenditure: It refers to expenditure incurred by households and non –
profit institutions serving goods and service to households.
2) Government Expenditure : It refers to the expenditure incurred by government on various
administrative service like defence, law and order, education etc.
3) Gross Investment: It refers to the sum of Gross fixed investment and Change in stock. It
includes:
a. Gross fixed capital formation : It includes expenditure on capital good and expenditure
on construction of roads, dams and bridges.
b. Change in stock (Inventory Investment) : It refer to the change in stock during the
year. It is estimated as the difference between ‘closing stock’ and ‘opening stock’ of the
year.
4) Net Exports: It refers to the difference between exports and imports of a country during a
period of one year.
Differences Between GNP and GDP

Gross National Product (GNP) Gross Domestic Product (GDP)
GNP is the sum of market value of final GDP is the sum of market value of goods and
goods and services produced by the normal services produced by all the producers in the
resident of a country in a year. domestic territory of a country in a year.
It is related to the normal resident of the It is related to the domestic territory of a
country. It includes the income earn inside country in a year. It includes the income earn
and outside the country. by normal resident of a country.
It includes the net factor income from It does not include net factor income form
abroad. So it is a broad concept. abroad.
It is based on citizenship. It is based on Location.
GNP = GDP – NFIA GDP = Consumption + Investment + Govt.

Spending + Net export
Topic 4 – Real GDP vs Nominal GDP

Real Income/GDP
It refers to market value of final goods and services produced by normal residents of country during
an accounting year, measured at price of base year. It is obtained by multiplying the goods and
services produced in the current year with the price fixed in the base year or constant year. Real
income or real national income is also termed as National income at constant price. Base year or
constant year is a stable year. It is carefully selected as one in which there were no natural calamities
like floods, earthquakes, drought or wars. The prices remain stable throughout the year. For
example, To estimates national income or NNP (Net national product) at constant price in 2021-
22. You have to multiply the value of all the final goods and services produced in the current year
(2021-22) with price fixed in 2011-12 (Base Year). Real National Income is very useful index to
measure the real or actual growth of output. A rise in real income implies rise in GDP and economic
growth.
Real Income = Base year price (P0) × Current year Quantity (Q1)
Nominal Income
It refers to market value of final goods and services produced by normal residents of country during
an accounting year, measured at current year price. It is obtained by multiplying the goods and
services produced in the current year with the price fixed in the current year. Nominal income or
Nominal national income is also termed as National income at current price or Monetary national
Income. Each and every country calculates national income at current prices. For example, To
estimate national at current price in 2021-22, You have to multiply the value of all the final goods
and services produced in the current year (2021-22) with price fixed in 2021-22. Nominal National
Income is very poor index to measure the growth of output/economy. It is not compulsory that a
rise in nominal income always implies rise in GDP and economic growth.
Nominal Income = Current year price(P1) × Current year quantity (Q1)
Difference between Real Income and Nominal Income

Basis National Income at Current Price National Income at Constant Price
Meaning It refers to market value of final goods It refers to market value of final
and services produced by normal goods and services produced by
residents of country during an normal residents of country during an
accounting year, measured at current accounting year, measured at price of
year price. base year.
Economic It is not a good tool for measuring the It is a better tool for measuring the
growth economic growth of a country. economic growth of country.
Causes of It is affected by change in both price and It is affected by change in the quantity
cganges quatity. only.
Calculation Current year price(P1) × Current year Base year price (P0) × Current year
quantity (Q1) Quantity (Q1)
Alternative Nominal GDP or Monetary GDP Real GDP
name
Limitations of Real GDP

Q. What are the limitation for GDP as a measure of welfare.
Q. Increase in national income an indicator of increase in social welfare?
Ans: In an economy, when the level of GDP increases, it is always considered that the economy is
getting economic welfare. Economic welfare is a situation in which the level of GDP increases with
the growth of living standard of people. But sometimes inspite of increase in GDP there is no
economic welfare in the economy.
GDP are of two types: (1)Nominal GDP (2)Real GDP.
The nominal GDP is influence by change in price and change in quantity. If there is rise in price
the nominal GDP will rise even there is no rise in the level of production. So, we can say that it is
not a good indicator of measuring economic welfare. On the other hand,Real GDP is influence by
change in Quantity only. Real GDP rise when the level of production rise in the economy. It is
considered a good indicator of economic welfare. But there are some limitations of real GDP as an
indicator of economic welfare.
1. Distribution of GDP/Income: A only rise in GDP (or National Income) may not shows
that there is rise in economic welfare. If there is unequal distribution of income with rise in
GDP, means Rich is getting rich and the poor is geeting poor, few rich have a large share
of National Income and many poor have a small share of National income i.e., there is wide
gap between poor and rich. Then there will be no effect on economic welfare with rise in
GDP. On the contraty, if there is equal distribution of income with rise in GDP then, we
can say that GDP is the true indicator of economic welfare.
2. Composition of GDP: Composition of GDP means what is the share of different types of
Goods in GDP. If in an economy, there is increase in production of war materials (like, taks,
guns, bomb etc.), dangerous goods (liquor, cigarrette, tobacco etc.), then these goods doesn’t
have any effect on economic welfare, it will not increase economic welfare. But if there are
more of consumer goods and capital goods which is needed by people, then there will be
economic welfare in the economy. Only then real GDP can be said the good indicator of
economic welfare.
3. Non – Monetary Exchange: In rural economies, barter exchange still prevails to some
extent. when goods are exchanged with goods its called barter exchange or non monetary
exchange. Example, payment for farm labour are often made in kind rather than cash. All
such transaction remain unrecorded. These transaction raise the economic welfare but not to
be included in estimation of national income. So, GDP is not a proper index of welfare.
4. Externalities : Externalities refer to good and bad impact of an economic activity without
paying the price or penalty for that. There are both positive and negative extarnalities. For
example, Mr. Mohan mainatins a beautiful garden and Mr. shyam (neghbour of Mr. Mohan)
enjoys it. It adds to welfare of Mr. Shyam but he does not pay for it, it is the example of
Positive Externalities. Similarly, Environmental pollution caused by industrial plants. It
causes a loss of social welfare. It is the example of Negative externalities. The GDP remains
unaffected by externalities. Hence, it is an inappropriate index of welfare.
Topic 5 – GDP Deflator (Implicit Deflator)

Q. Explain the concept of Implicit GDP deflator.
Ans: when we compute the GDP at current prices is referred to as nominal GDP or Monetary GDP
and when we compute the GDP at base year price or at constant price is called Real GDP. As we
have seen that, Nominal GDP is affected by both changes in price and physical output. On the
other hand, Real GDP is affected by change in physical output only. For example, if the output
of goods and services produced by an economy remain the same during a year and price rises, then
there will be an rise in GDP. However, this is an rise in Nominal GDP not in Real GDP. On the
other hand, if price remained constant, and there is an increase in production, real GDP will
increase. This means that there is economic growth in the economy.
To eliminate the effect of price changes and to determine the real change in physical output, we
can use Implicit GDP deflator. Implicit GDP Deflator measures the average level of prices of all
the goods and services that make GDP. It is measured by Following Formulae:
𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝐺𝐷𝑃
Implicit GDP Deflator (Implicit Price Index) = × 100
𝑅𝑒𝑎𝑙 𝐺𝐷𝑃
For Example: If nominal GDP is ₹15,000 crores and Real GDP is ₹12,000 crores, then
15,000
Implicit GDP Deflator = × 100
12,000
In the above example, we can also convert nominal GDP into real GDP with the help of Implicit
GDP Deflator. The conversion of Nominal GDP into Real GDP is known as Deflating.
𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝐺𝐷𝑃
Real GDP = × 100
𝐺𝐷𝑃 𝑑𝑒𝑓𝑙𝑎𝑡𝑜𝑟
15,000
= × 100
125
= ₹12,000.
Topic 6 – Methods of Measuring National Income

There are three Methods of Measuring National Income. These are :
a) Income Method
b) Expenditure Method
c) Product Method
Income Method
Q. Explain the Income method of measuring National Income. Discuss the difficulties
involved in this method.
Ans: According to this method, all the incomes that arise that accrue to the factors of production
by way of wages, profit, rent, interest etc. are summed up to obtain the national income. This
method is also known as factor payment method or distributed share method.
Steps involved in estimation of national income
Step 1- Identification and classification of producing enterprises
All the producing enterprises of an economy can be classified under three sectors:
- Primary sector or Agriculture related sectors
- Secondary Sector or Manufacturing sectors
- Tertiary Sector or service sector
Step 2 - Classification of factor income:
Factor income payments are classified into following groups:
1) Compensation of employees: Compensation of employees refers to amount paid to
employee by its employer. The income from include in this. It includes :
- Wages and salaries in cash: It includes all monetary benefit, like wages, salaries,
bonus, commission, dearness allowance etc.
- Wages and salaries in Kind: It includes all non monetary benefit like rent free
home, free car, free medical facilities, uniform etc.
- Employer’s contribution in any social security scheme. For example employer’s
contribution in provident fund.
- Pension on retirement: Pension to retired person also included in this
2) Operating surplus: It include income from property and income from entrepreneurship.
a. Rent : Income form rent or rental income is income derived from the land or building.
The owners of land and building receive rental income for allowing others to use their
for specified time.
b. Royalty : income from copyrights, patent rights etc.
c. Interest : interest include income earned on bank deposits, as well as loan to firms.
d. Profit: The income earned from entrepreneurship/corporation is known as profit. A
corporation does not distribute whole of the profit among the shareholders. A part of the
profit is distributed in the form of ‘Dividend’ while a part is retained by the company as
‘corporate saving.’ Also a part of the profit goes to the government by way of corporate
profit tax. Thus corporate profit has three component dividends, corporate profit tax and
undistributed profit or corporate savings or retained earnings.
3) Mixed income: It is the income of self employed person like farmers, barbers, doctors,
teachers, traders, small shopkeeper. Mixed income include income from work as well as
income from property and entrepreneurship.
Step 3- Calculate Domestic Income (NDPFC)

When factors income of all the sectors are summed up, we get Domestic Income(NDPFC).
In short NDPFC = Compensation of employee + Operating Surplus(Rent + Royalty +

Interest + profit) + Mixed Income.
Step 4 – Calculate National Income(NNPFC) by Adding NFIA in Domestic Income(NDPFC)

In order to calculate national income, NFIA (Net Factor Income from abroad) is added to
domestic income to arrive at National Income, i.e.,
(National Income)NNPFC = (Domestic Income)NDPFC + NFIA
Note: Net factor income form abroad is the difference between the income received from
abroad for rendering factor service, and the income paid by non resident in the domestic
territory of a country.
Precautions / Difficulties involved in Income method

Few precautions must be undertaken to have correct estimates.
1. Transfer Incomes: Transfer incomes like scholarship, Old age pension, gifts, pocket money
etc. should not be included in the national income because these are unilateral transfer i.e.,
One side transfer.
2. Domestic services: Domestic services provided out of love and affection are not included
in estimation of national income. Like service rendered by a housewife, parent teaching his
child etc. because it is difficult to calculate their market value. But if the same are provided
by the paid employed staff such as cooks, gardeners, guards, etc. they will included in the
national income.
3. Sale or purchase of Second hand goods: Sale and purchase of second hand goods like old
scooter, old house, old radio, bond, debentures etc. should not be included in national
income because they have already been in the year of their first time sale and purchase.
4. Income from illegal activities: Income from illegal activities like smuggling, black
marketing, theft, dacoity, gambling etc. should not be included in national income. Income
earned by way of legal activities is included.
5. Intermediate consumption expenditure: Intermediate consumption expenditure like
purchase of raw material, purchase of vegetables by restaurant etc. should not be included
in national income because such expenditure are already included in final expenditure.
6. Windfall gains: windfall gains like income from lotteries, horse race, etc. are not included
as there is no productive activity connected with them.
7. Include free services provided by the owners of the production unit: owner work in their
own unit but do not charge any salary. Owners provide finance but do not charge any
interest. Owners do production in their own building but do not charge rent. The imputed
value of these must be included in national income.
8. Corporation Tax: Since corporation tax is a part of profit, it should not be separately
included in the national income. Instead, profit ( before deduction of corporation tax) have
to be included.
9. Imputed value of owner self occupied house: People, who live in their own house, do not
pay any rent. But, they enjoy housing services similar to those people who stayed in rented
house. Therefore, value of such housing services is estimated according to market rent of
similar accommodation. Such an estimated rent is known as imputed rent.
Expenditure Method
Q. Explain the Expenditure method of measuring National Income. Discuss the difficulties
involved in this method.
Ans: According to this method, national income is measured in terms of expenditure on purchase
of final goods and services produced in the economy during an accounting year.
Steps involved in calculation of National Income

Step 1 - Identification of economic units incurring Final expenditure:
There are four categories of economic unit which incur final expenditure within the domestic
territiory of a country. They are:
a. Household sector c. Production sector
b. Government sectorRest of the world sector d. Rest of the World
Step 2 - Classification of final expenditure

The final expenditure is classified into four kinds:
1) Private Final Consumption Expenditure: It refers to expenditure incurred by
households and non – profit institutions serving goods and service to households.
2) Government Final Consumption Expenditure : It refers to the expenditure incurred
by government on various administrative service like defence, law and order,
education etc.
3) Gross Domestic capital formation or Gross Investment: It refers to the sum of
Gross fixed investment and Change in stock. It includes:
c. Gross fixed capital formation : It includes expenditure on capital good and
expenditure on construction of roads, dams and bridges.
d. Change in stock (Inventory Investment) : It refer to the change in stock during
the year. It is estimated as the difference between ‘closing stock’ and ‘opening
stock’ of the year.
4) Net Exports: It refers to the difference between exports and imports of a country
during a period of one year.
Step-3 Estimation of National Income

The Sum total of four components of final Expenditure gives GDP MP (gross domestic
product at market price). To find the Net National Product at Factor Cost (NNP FC) we
have to subtract Depreciation and Net Indirect Tax and add the Net factor Income from
Abroad.
GDPMP = private final consumption expenditure

+ government final consumption expenditure
+ gross domestic capital formation
+ net exports
NNPFC (National income) = GDPMP – depreciation – Net indirect Tax+ NFIA
Precautions / Difficulties involved in Expenditure method

1. Expenditure on Intermediate goods will not be included in National Income:
Expenditure in Intermediate goods like purchase of raw materials, vegetables purchase by
Restaurant etc. is not to included in the National Income.
2. Final Expenditure: Only final expenditure is to be included to avoid double counting. Final
expenditure is expenditure on Consumption and Investment.
income because they have already been in the year of their first time sale and purchase.
4. Transfer Payments: Transfer payments like scholarship, Old age pension, gifts, pocket
money etc. should not be included in the national income because these are unilateral
transfer i.e., One side transfer.
5. Expenditure on Shares and Bonds: Expenditure on Shares, Debentures, bonds etc. will
not be included in national income because such transaction do not contribute to current
flow of goods and services. These financial assets are only paper claims.
7. Goods produced for self consumption are included in National Income: All the final
goods produced within the country are not necessarily sold in the market. A part of them is
kept by the producer for his own use and consumption. For example, farmers keeps a major
part of their produce for self consumption. Imputed value of such goods is included in
national income.
Value Added Method (Product Method)

Q. Explain the product method/Value added method of measuring National Income. Discuss
the difficulties involved in this method.
Ans: Product method or value added method is that method , which measure national income in
terms of value addition by each producing enterprises in the economy during an accounting year.
Steps involved in calculating national income by value added method

Step 1- Identification and classification of producing enterprises:
This is the first step in value added method. As in income method, producing enterprises are
classified into three heads:
i. Primary sector
ii. Secondary or manufacturing sector
iii. Tertiary or service sector
Step 2- Estimation of Gross Value Added
First we estimate value of output and value of intermediate consumption for each producing
unit of output. Value of output may be estimated as the sum of sale and change in stock.
Then value added can be find out by subtracting intermediate consumption from value of
output.
Gross Value Added (GVA) = value of output – intermediate consumption
= [sales + change in stock (i.e., closing stock-opening
stock)] – intermediate consumption
If intermediate consumption is not subtracted from the value of output, it would lead to problem of
double counting.
Step – 3 Estimation of National Income
Gross value added by all producing enterprises within the domestic territory of a country
during an accounting year is called GDPMP (Gross Value Added at market price). It means
Gross Value Added is equal to the GDPMP. To find out Net National Income at factor cost
we have to deduct Net indirect taxes and depreciation then added Net income from abroad to
GDP at MP.
NDPMP or NVAMP = GVAMP – Depreciation– Net Indirect Tax
NNPFC or National income = NDPFC + Net Factor Income from abroad
Precautions / Difficulties involved in Product method

The various precautions to be taken in Value added method are:
1. Double counting: While estimating national income by value added method, some times
the value of a product is counted more than once. It is called double counting. However,
the problem of double counting arise when value of intermediate goods is also included
along with value of final goods. It leads to over estimation of national income.
There are two alternatives method or ways to avoid double counting:
a) Value added method: According to this method, sum total of the value added by
each producing unit should be taken in the national income.
Value added = Value of Output – Intermediate consumption.
b) Final product method: According to this method, we should take the value of final
product only should be taken in the estimation of national Income.
2. Domestic services: Domestic services provided out of love and affection are not included
in estimation of national income. Like service rendered by a housewife, parent teaching his
child etc. because it is difficult to calculate their market value. But if the same are provided
by the paid employed staff such as cooks, gardeners, guards, etc. they will included in the
national income.
3. Intermediate goods: Intermediate goods like purchase of raw material, purchase of
vegetables by restaurant etc. should not be included in national income because such goods
are already included in final goods.
income because they have already been in the year of their first time sale and purchase..
5. Include free services provided by the owners of the production unit: owner work in their
own unit but do not charge any salary. Owners provide finance but do not charge any
interest. Owners do production in their own building but do not charge rent. The imputed
value of these must be included in national income.
7. Goods produced for self consumption are included in National Income: All the final
goods produced within the country are not necessarily sold in the market. A part of them is
kept by the producer for his own use and consumption. For example, farmers keeps a major
part of their produce for self consumption. Imputed value of such goods is included in
national income.
Topic 7 - National Income Aggregates

Difference between National Income & Domestic Income
National Income (NNPfc) Domestic Income (NDPfc)
National income is the sum of factor incomes Domestic income is the sum of factor income
earned by normal residents with in or outside generated within the domestic or economic
the economic territory in an accounting year. territory of a country by resident or non
resident during an accounting year.
Income is generated by resident. Income is generated within the domestic
territory of an economy.
It is a broad concept. It is a narrower concept than national income.
It includes net factor income from abroad. It does not include net factor income from
abroad.
National Concept
a) NNPfc : Net National Product at Factor Cost (or National Income) : It is defined as the Net
value of goods and service produced at factor cost by the Normal Resident of a Country during a
year.
b) NNPmp : Net National Product at Market Price : It is defined as the Net value of goods and
service produced at market price by the Normal Resident of a Country during a year.
c) GNPfc : Gross National Product at Factor Cost : It is defined as the Gross value of goods and
service produced at factor cost by the Normal Resident of a Country during a year.
d) GNPmp : Gross National Product at Market Price : It is defined as the Gross value of goods
and service produced at Market price by the Normal Resident of a Country during a year.
Domestic Concept
a) NDPfc : Net National Product at Factor Cost (or Domestic Income) : It is defined as the Net
value of goods and service produced at factor cost by the all the Resident in the domestic territory
of a country during a year.
b) NDPmp : Net National Product at Market Price : It is defined as the Net value of goods and
service produced at market price the all the Resident in the domestic territory of a country during
a year.
c) GDPfc : Gross National Product at Factor Cost : It is defined as the Gross value of goods and
service produced at factor cost by the all the Resident in the domestic territory of a country during
a year.
d) GDPmp : Gross National Product at Market Price : It is defined as the Gross value of goods
and service produced at Market price by the all the Resident in the domestic territory of a country
during a year.
Topic 8 – Some other Important Questions

Q1. Write a short note on
a. Operating Surplus
b. Personal Disposable Income
Ans:
Operating surplus
Operating Surplus refers to the income from property and income from entrepreneurship.
a. Rent : Income form rent or rental income is income derived from the land or building. The
owners of land and building receive rental income for allowing others to use their property
for specified time. Certain durable goods such as buses, tractors and machinery may also be
let out to others for a specific period of time. The income thus, received would be deemed
as rental income. It may be noted that rent of self occupied house, that is imputed rent, is
also a part of rental income and therefore, included in national income.
b. Royalty : rental income also include royalties received by persons from copyrights, patent
rights and rights to natural resources like mine.
c. Interest : interest include income earned on bank deposits, as well as loan to firms.
Important it is to note that interest paid by the governments and by the consumer is not
included in national income because these are not regarded as payments for current
economic production.
d. Profit: The income earned from entrepreneurship/ is known as profit. Entrepreneurship here
means a corporation. An entrepreneur or corporation does not distribute whole of the profit
among the shareholders. A part of the profit is distributed in the form of ‘Dividend’ while
a part is retained by the company as ‘corporate saving.’ Also a part of the profit goes to the
government by way of corporate profit tax. Thus corporate profit has three component :
(i) Dividends: It is that part of the profit which is distributed among the shareholders.
The dividend income of the shareholders depends upon profitability of the firm. Only
distributed profits are called dividends.
(ii) Corporate savings: This refers to undistributed profits of the firms, briefly called
theie ‘retained earnings’.
(iii) Corporate Profit Tax: It refers to the tax paid by the firms or corporations on their
profit to the government.
Personal Disposable Income

Personal disposable income is the personal income minus personal income taxes and property tax
and miscellaneous receipts of government administrative departments (fees and fines). It is the
amount which the household can spend or dispose of as they like. Disposable income is indicative
of the purchasing power of the households.
Personal Disposable Income = Saving + consumption
In the words of Peterson, “Disposable income is the income remaining with individuals after
deduction of the taxes levied against their income and property by the government”
Personal Disposable Income = Personal income – direct personal taxes(Income tax and property
tax) - miscellaneous receipts of the government administrative
Department (fees, fines etc.)
• Personal Income : Personal income is the sum total of income actually received by a
person from all sources in the form of current transfer payments and factor incomes. It is a
receipt concept. Personal income includes factor income as well as transfer income.
Corporate savings and corporation tax are not a part of personal income because it is not
distributed among shareholders. Personal income does not include income of corporation
and companies.
Personal Income = Private Income – Corporate tax – Corporate savings
• Private Income: Private income is the income of private sector obtained from any source,
productive or otherwise. It include both the factor income of the private sector as well as
transfer income.
Private Income = Factor income from domestic product accruing to the private
sectors + NFIA + Transfer payments from government + Interest on
National Debt + Current transfer from aborad.
Q2. Explain the meaning of depreciation. Why it is important to compute depreciation?

Ans: It means loss of value or fall in the value of fixed assets due to normal wear and tear in the
process of production and expected obsolescence. It is also called consumption of fixed capital.
It does not include accidental damages or unexpected obsolescence. when there is loss in the value
of assets due to unexpected obsolescence, natural calamities, thefts, accident etc. it is called capital
loss.
Depreciation of assets is mainly due to three reasons:
(i) Normal Wear and Tear: Continuous use of fixed assets in production process decrease
their productive capacity and value.
(ii) Passage of Time: Value of fixed assets also decreases with passage of time, even if they
are not being put to use in the business.
(iii) Expected obsolescence : Value of Fixed assets decrease due to expected obsolescence
(i.e loss in the value of assets due to change in technology or change in demand for
goods and services.)
Calculation of Amount of Depreciation : Depreciation is also called consumption of fixed

capital. It refers to that value of fixed capital or fixed assets which is consumed or used up in the
process of production. Because of depreciation fixed assets need to be replaced from time to time.
Replacement of fixed assets requires funds. Provision for the funds is made on annual basis. To
illustrate , if a machine is purchased for ₹10,00,000 and its expected lifetime to use is 10 year, then
the annual provision for funds (to replace the machine after 10 years) is ₹1,00,000 (= ₹10,00,000
÷ 10). Therefore, depreciation is also called ‘Current Repalcement cost’.
Importance of Depreciation
It is important to compute the depreciation for the following reasons:
(1) These estimates tell us how much of the capital stock has been used up and hence how
much is left and how long it will last.
(2) The corporate sector measures profit before depreciation because it is charge against profit
which arises from the current year’s production. An overestimation of depreciation are
linked with tax laws.
(3) It is important to know depreciation to make distinction between gross and net measures.
Gross investment minus depreciation (or replacement investment) is net investment.
Positive net investment increases the economy’s total stock of capital, while replacement
investment shows what has been used up or worn out.
Depreciation helps to differentiate between gross and net.
Net investment is the difference of gross investment and depreciation. It cause net
addition to stock of capital goods.
Net investment = Gross investment – depreciation

Gross investment = Net investment + depreciation
Q3. What do you know about withdrawals and injections? How are these related to circular
flow of national income?
Ans:
Leakages/Withdrawl: Leakages refers to withdrwal of Money from circular flow. When
households or firm save a part of their incomes, it leads to a leakage from the circular flow of
income.
Leakages are part of national income that are not used by household to buy domestic consumer
goods. It refers to that portion of income which does not flow to domestic product sector. It cause
a decrease in the process of production.
For example :
a. Saving : It flows from the household sector to the financial sector rather to the product
market.
b. Government tax : It flows to the government rather then to the product market.
c. Import: it flows to foreign market rather than to domestic product market.
Leakages reduce the volume of the circular flow.
Injections : Injections refers to the introduction of income into the circular flow. When households
and firms borrow money from external sources like financial institutions, it leads to injection in
circular flow of income. It cause an increase in the process of production.
For example:
a. Investment: It is total expenditure in new capital goods and inventories. It flows to the
product market.
b. Govt. Expenditure : It is the total expenditure by the government on goods and services
as well as on subsidies or transfer payments. It flows to the product market.
c. Exports: It is total expenditure by the foreigners on domestically produced goods. It also
flows to the domestic product market.
Injection rises the volume of the circular flow.
Relation of Injection and leakage with circular flow

a. Leakages reduce the volume of the circular flow.
b. Injection rises the volume of the circular flow.
c. The circular flow of income remains stable if ‘leakage’ are exactly equal to ‘Injection.

ch-2 National Income Accounting

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ch-2 National Income Accounting

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Economics by Pratham Singh 1

Circular Flow of Income in TWO sector Economy

Working of this model

Households and firms interact in two types of markets.

Circular Flow of Income in THREE sector Economy

Circular Flow of Income in FOUR sector Economy

Topic 2 – Classification of Goods

Final goods Intermediate goods

Consumption goods Capital goods

Distinguish Between Final Goods and Intermediate Goods

CONSUMER GOODS, CAPITAL GOODS & PRODUCER GOODS

Topic 3 – Concept of GDP

Activities that are not included in GDP

Differences Between GNP and GDP

GNP = GDP – NFIA GDP = Consumption + Investment + Govt.

Topic 4 – Real GDP vs Nominal GDP

Difference between Real Income and Nominal Income

Limitations of Real GDP

Topic 5 – GDP Deflator (Implicit Deflator)

Topic 6 – Methods of Measuring National Income

Step 3- Calculate Domestic Income (NDPFC)

In short NDPFC = Compensation of employee + Operating Surplus(Rent + Royalty +

Step 4 – Calculate National Income(NNPFC) by Adding NFIA in Domestic Income(NDPFC)

Precautions / Difficulties involved in Income method

Steps involved in calculation of National Income

Step 2 - Classification of final expenditure

Step-3 Estimation of National Income

GDPMP = private final consumption expenditure

Precautions / Difficulties involved in Expenditure method

Value Added Method (Product Method)

Steps involved in calculating national income by value added method

Precautions / Difficulties involved in Product method

Topic 7 - National Income Aggregates

Topic 8 – Some other Important Questions

Personal Disposable Income

Q2. Explain the meaning of depreciation. Why it is important to compute depreciation?

Calculation of Amount of Depreciation : Depreciation is also called consumption of fixed

Net investment = Gross investment – depreciation

Relation of Injection and leakage with circular flow

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