XII ( ECONOMICS)

Unit 5 National Income and Related Aggregates

Topic- Some basic concepts; consumption goods, capital goods, final goods, intermediate
goods; stock and flows; gross investment and depreciation.
Circular flow of income (two sector model); Methods of calculating National Income – Value
Added or Product Method, Expenditure Method, Income Method.
Aggregates related to National Income: GNP, NNP, GDP and NDP – at market price and
factor cost; Real and Nominal GDP; GDP and Welfare.
Circular Flow of Income

1. Circular Flow of Income:-It is 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.

Phases:-

a) Generation Phase:-In this phase firms produces goods and services with the help of
factor services.
b) Distribution Phase: - This phase involves the flow of factor income from firms to
households. (rent, wage, interest and profit)
c) Disposition Phase:-In this phase the income received by factors of production is spent on
the goods and services produced by the firms.
2. Stock and Flow:-

Stock Flow
The variable Which is measured at a The variable Which is measured over a
particular point of time. period of time.
It does not have a time dimension. It has a time dimension.
It is a static concept. It is a dynamic concept.
It is influenced by flow. It is influenced by Stock.
Example: - National wealth, Money Example:- National income, Number of
supply. Birth during 2016.
3. Types of Circular Flow:-

Real Flow Money Flow

It is flow of goods and services between It is flow of money between firms and
firms and households. households.
It is also known as physical flow. It is also known as NominaP flow.
It involves exchange of goods and It involves exchange of money.
services.
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4. Circular Flow of Income in Two Sector Economy:-

Households are the owners of factors of production and consumers of goods and services.
Firms produce goods and services and sell them to the households.
The outer loop of the diagram shows the real flow and the inner loop shows the money
flow.
It helps in estimating national income and shows interdependence of different sectors of
economy.

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Some Basic Concepts of Macroeconomics

1. Domestic Territory:-

a) Ships and aircrafts owned and operated by normal residents between two or more
countries.
b) Fishing vessels, oil and natural gas rigs and floating platforms operated by the residents
of a country in the international waters where they have exclusive rights of operation.
c) Embassies, consulates and military establishments of a country located abroad.
d) Political frontiers.
It does not include embassies, consulates and military establishments of a foreign country.
International organisations like UNO, WHO etc. located within the geographical boundaries.
Examples:-
a) Profits earned by a company in India which is owned by a non-resident – Yes it is
domestic income as profit are earned within domestic territory.
b) Rent paid by the embassy of Japan in India to a resident Indian – No it is not included in
the domestic income as Japanese embassy is not the part of domestic territory of India.
c) Consultancy fees paid to a foreign expert – It will be domestic income if foreign expert
stays in the domestic territory.
d) Broker’s commission on the sale of second hand car – It will be included in domestic
income because it is income received by the broker in return for rendering his productive
services.
e) Services rendered by housewife –No it is not included in domestic income as it is difficult
to find its market value.
2. Normal Residents:-Individual or institution who ordinarily resides in the country and
whose centre of economic interest also lies in that country.
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It does not includes,
a) Foreign tourist and visitors.
b) Foreign staff of embassies, consulates, diplomats and members of armed force.
c) Employees of International organisations like WHO, UNO etc.
d) Crew members of foreign vessels, commercial travellers and seasonal workers.
e) Border workers.
Examples:-
a) Increase in the price of stock lying with the trader - No it is not national income as it
does not amount to flow of goods.
b) Purchase by foreign tourist – Yes it is national income as it is same as export by
expenditure method.
c) Payment of fees to a lawyer engaged by a firm – No it is not national income because it
is intermediate consumption as it is purchase of service by one production unit from other
production unit.
d) Imputed rent of self-occupied house - Yes it is national income because people living in
such house enjoy house services similar to those in rented houses.
e) Expenditure by government in providing free education - Yes it is national income as it
is part of government final consumption expenditure.
g) Mineral wealth of a nation - No it is not national income but only that part is included in
national income which is extracted during the year by production method.
h) Interest paid by banks on deposits by individuals - Yes it is national income because
interest is taken on loan for productive purpose
i) Interest received on loan given to a friend for purchasing a car - No it is not national
income because loan is not used for productive purpose.
j) Payment of interest on borrowings by general government - No it is not national income
because general government borrows only for consumption purpose.

3. Factor Income and Transfer Income:-

Factor Income Transfer Income
It refers to income received by factors It refers to income received without
of production for rendering factor productive services in return.
services in the production process.
It is included in both National Income It is neither included in National Income
and Domestic Income. nor in Domestic Income.
It is an earning concept. It is a receipt concept.
It is received by factors of production. It is generally received by households and
government.
Example – Rent, wage, interest and Example – Scholarship, Old age pension.
profit.
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4. Intermediate Goods and Final Goods:-

Intermediate Goods Final Goods

Those goods which are used either for Those goods which are used either for
resale or for further production. consumption or for investment.
They are included neither in National They are included in both National Income
Income nor in Domestic Income. and Domestic Income.
They have derived demand as their They have a direct demand as they satisfy
demand depends on the demand for the wants directly.
final goods.
They are not ready for use. They are ready for use by their final users.
They have still within the production They have crossed the production
boundary. boundary.
Example – Milk purchased by dairy for Example – Milk purchased by household
further production. for consumption.
5. Consumption Goods and Capital Goods:-

Consumption Goods Capital Goods

These goods satisfy human wants directly. These goods satisfy human wants indirectly.
e.g. Milk e.g. Machine
They do not promote production capacity. They help in raising production capacity.
They have limited expected life. They have expected life of more than one
year.
6. Types of Consumption Goods:–

a) Durable Goods –Those goods which can be used again and again over a considerable
period of time. e.g. Television.
b) Semi- Durable Goods – Those goods which can be used for a limited period of time. e.g.
Clothes.
c) Non-Durable Goods – Those goods which are used in a single act of consumption. e. g.
Fruits.
d) Services –They are non- material goods which directly satisfy the human wants. e.g.
teachers.
7. Gross and Net Investment: -

a) Gross Investment – The total addition made to the capital stock of economy in a given
period.
b) Net Investment - The total addition made to the capital stock of economy in a given
period.
8. Depreciation –It is fall in the value of fixed assets due to normal wear and tear, passage
of time or expected obsolescence.

Gross Value = Net Value + Depreciation

9. Net Indirect Tax – It is difference between indirect taxes and subsidies.

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a) Indirect Tax –Those taxes which are imposed by the government on production and sale
of goods and services.
b) Subsidy –It is financial assistance given by the government to an enterprise on the
production of a certain commodity.
c) Factor Cost –It is amount paid to factor of production for their contribution in the
production process.
d) Market Price –It is the price at which product is actually sold in the market.

Net Indirect taxes = Indirect Taxes - Subsidies

10. Net Factor Income from Abroad (NFIA) – It is the difference between factor income
received from rest of the world and factor income paid to rest of the world.

Net Factor Income from Abroad = Factor Income from Abroad - Factor Income to Abroad

Components: - a) Net Compensation to Employee.

b) Net Income from Property and Entrepreneurship.
c) Net Retained Earnings.

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Measurement of National Income

1. Value Added Method: - It is also called as production method. It gives GVA at MP.

Steps:-
1. Identify and classify the production units.
2. Estimates GDP at MP.
3. Calculate Domestic Income by subtracting Depreciation and Net Indirect Tax.
4. Estimate NFIA and it to Domestic Income to get National Income.
Precautions:-
a) Intermediate goods are not to be included in national income.
b) Sale and purchase of second hand goods are not to be included in national income.
c) Production of Services for self-consumption is not included.
d) Production of goods for self-consumption will be included.
e) Impute value of owner-occupied house should be included.
f) Change in stock of Goods will be included.
Numericals:- GVA at MP = Value of Output – Intermediate Consumption

= Sales + Change in Stock - Intermediate Consumption

Q.1 Calculate Sales from the following data:-

I) NVA at factor cost = 300 ii) Net addition to stocks = (-)20
iii) Sales tax = 30 iv) Depreciation = 10
v) Intermediate Consumption = 100 vi) Subsidy =5

Answer. Sales = NVA at FC + Depreciation – NIT – Stocks + IC

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= 300 + 10 + (30 – 5) – (-)20 + 100 = 455
Q.2 Calculate GVA at FC
i) Units of output sold = 1,000 ii) Price per unit of output = 30
iii) Depreciation = 1,000 iv) Intermediate cost = 12,000
v) Closing stock = 3,000 vi) Opening stock = 2,000
vii) Excise = 2,500 viii) Sales tax = 3,500

Answer. GVA at FC = Price * Quantity + Stock – IC – NIT

= 30 * 1000 + (3000 – 2000) – 12000 – (2500 + 3500 -0) = 13,000
2. Problems of Double Accounting:-It is counting of an output more than once while
passing through various steps of production. There are two alternative ways of avoiding it.

a) Final Output Method – In this method, value of final goods should be added to
determine the national income. Value of bread (final output) = 1000.

b) Value Added Method – In this method sum total of the value added by each producing
unit should be taken in the national income. Value added (500 + 200 + 300) = 1000.

Output Value of Output Value of Input Value Added

Wheat 500 0 500
Flour 700 500 200
Bread 1000 700 300
3. Income Method:-

Steps:-
1. Identify and classify the production units.
2. Estimate the factor income paid by each sector.
3. Calculate domestic income NDP at FC.
4. Add NFIA to get NNP at FC.

Precautions:-
a) Transfer income not included.
b) Income from sale of second hand goods not included.
c) Income from sale of share, bonds and debentures are not included.
d) Windfall gains not included.
e) Imputed value of services provided by owners of production will be included.
f) Payments out of past savings and indirect tax not included.
Numericals:-

NDP at FC = Compensation of Employees + Operating Surplus + Mixed Income

Compensation of Employees = Wage and salary + Pension + Kind + Social Security

Operating Surplus = Rent and Royalty + Interest + Profit

Profit = Dividend + Retained Earnings + Corporation Tax

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Q.1 Calculate GDP at MP and FIFA from the following data:-
i) Profits = 500 ii) Exports = 40
iii) Compensation of Employees = 1,500 iv) GNP at FC = 2,800
v) Net current transfer from abroad = 90 vi) Rent = 300
vii) Interest = 400 viii) FITA = 120
ix) Net Domestic Capital Formation = 650 ix) Net indirect taxes = 250
xi) Gross Fixed capital Formation = 700 xii) Change in stock = 50
Answer. Depreciation = GfixedCF + Change in stock – NDCF = 700 + 50 – 650 = 100
NDP at FC = Compensation of Employees + Operating Surplus + Mixed Income
= 1500 + 300 + 400 + 500 = 2700
GDP at MP = NDP at FC + Depreciation + NIT = 2700 + 100 + 250 = 3050
GNP at FC = GDP at MP + (FIFA – FITA) – NIT
2800 = 3050 + FIFA -120 - 250
FIFA = 120
Q.2 Calculate National Income by Output Method and Income Method.
i) Value of output = 800 ii) Intermediate Consumption = 400
iii) Subsidies = 10 iv) Indirect taxes = 60
v) FIFA = 10 vi) FITA = 20
vii) Mixed Income = 120 viii) Rent and Royalty = 40
ix) Interest and Profit = 20 x) Wages and Salaries = 110
xi) Consumption of Fixed Capital = 50 xii) Employer’s contribution to SSS = 10

Answer. GVA at MP = Value of output – Intermediate consumption = 800 -400 = 400

NNP at FC = GVA at MP – Depreciation + NFIA –NIT = 400 – 50 + (10-20) - (60-10) = 290
NDP at FC = Compensation of Employees + Operating Surplus + Mixed Income
= 110 + 10 + 40 +20 + 120 = 300
NNP at FC = NDP at FC + NFIA = 300 - (10-20)= 290
4. Expenditure Method:-

Steps:-
1. Identify the economic units incurring final expenditure.
2. Classification of final expenditure.
3. Estimate GDP at MP by adding final expenditure, capital formation and net export.
4. Calculate Domestic Income by subtracting Depreciation and Net Indirect Tax.
5. Estimate NFIA and it to Domestic Income to get National Income.

Precautions:-
a) Intermediate goods are not to be included in national income.
b) Transfer payments are not included.
c) Sale and purchase of second hand goods are not to be included in national income.
d) Purchase of financial assets not included.
e) Expenditure on account of production will be included in the national income.
Numericals:-

GDP at MP = Final Consumption Exp. + Gross Domestic Capital Formation + Net Export
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Final Consumption Expenditure = (Government + Private) Final Consumption Expenditure

Gross Domestic Capital Formation = Net Fixed Capital Formation + Stock + Depreciation

Net Export = Export - Import

Q.1 Calculate GDP at FC by Income and Expenditure method.

i) Personal Consumption Expenditure = 730 ii) Profits = 100
iii) Wages and Salaries = 700 iv) Rent = 50
v) Employer’s contribution to SSS = 100 vi) Exports = 40
vii) Gross Residential Construction Investment = 60 viii) Interests = 50
ix) Government purchase of Goods and Services = 200 x) Imports = 20
xi) Gross public investment = 40 xii) Mixed Income = 100
xiii) Inventory Investment = 20 xiv) Depreciation = 20
xv) Gross business fixed investment = 60 xvi) Subsidies = 10
xvii) NFIA = (-)10 xviii) Indirect taxes = 20

Answer. NDP at FC = Compensation of Employees + Operating Surplus + Mixed Income

= 700 + 100 + 50 + 50 +100 + 100 = 1100
GDP at FC = NDP at FC + Depreciation = 1100 + 20 = 1120
GDP at MP = Final Consumption Expenditure + GDCF + Net Exports
= 730 + 200 + 60 + 60 + 40 + 20 + (40-20) = 1130
GDP at FC = GDP at MP – NIT = 1130 – (20-10) = 1120

5. National Income at Current Price and Constant Price:-

National Income at Current Price National Income at Constant Price

It refers to money value of final goods It refers to money value of final goods
and services produced by normal and services produced by normal
residents of a country in a year measured residents of a country in a year
at current year price. measured at price if base year.
It is not a good tool for measuring the It is a better tool for measuring the
economic growth of a country. economic growth of a country.
It is affected by both changes in price and It is affected by change in quantity only.
quantity.
It is also known as Nominal National It is also known as Real National
Income. Income.
It is not a suitable tool for comparing the It is generally used for comparing the
national income of different years. national income of different years.
6. GDP and Welfare:-

a) Distribution of GDP –It is possible that with rise in GDP, inequalities in the distribution of
income may also increases, i.e gap between rich and poor may increase. GDP does not take
into account change in inequalities in the distribution of the income. So, welfare of the
people may not rise as much as the rise in GDP.
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b) Change in Price – 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.

c) Non-monetary Exchanges-Many activates in an economy are not evaluated in monetary

terms. e.g. services of housewife are not included in GDP, due to non- availability of data.
However such activities influence the economic welfare.

d) Externalities –It is benefit or harm of an activity caused by a firm or an individual, for

which they are not paid or penalized. Activates which result in benefits to others are
termed as positive externalities e.g. public parks and activities which result in harms to
other are termed as negative externalities e.g. polluting industries.

e) Rate of Population Growth –GDP does not consider changes in the population of a
country. If the rate of population growth is higher than the rate of growth of GDP, then it
will decrease the per capita availability of goods and services, which will adversely affect
the economic welfare.

7. GDP Deflator – It measures the average level of prices of all the goods and services that
make up GDP. It is also called as price index.

GDP Deflator = Nominal GDP * 100/Real GDP

8. Green GDP – It measures output adjusted for the depletion of natural resources and
degradation for the environment.
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ECONOMICS
SIMPLIFIED
CLASS XII
AS PER LATEST SYLLABUS OF CBSE
(2017-18)

BY A LEARNER OF
ECONOMICS SRI
KESHAV
PGT (ECONOMICS)
Kendriya vidyalaya