National Income Accounting – Class 12 Economics Chapter 2 Part – A

National Income Accounting – Class 12 Economics Chapter 2 Part – A ” Introductory Macroeconomics”

Chapter 2: National Income Accounting

Concept of National Income:
National Income Accounting is a fundamental concept in macroeconomics. It is a method for measuring the aggregate economic activity of a country. It provides a comprehensive picture of a nation’s total production, income, and expenditure.

Basic Concepts of the Economy:

• Final Goods: These are goods and services that are not used for further production and are meant for final consumption or investment. They include consumption goods (food, clothes) and capital goods (machinery).
• Intermediate Goods: These are goods used as raw materials or inputs for the production of other goods. For example, flour used to make bread.
• Stocks and Flows: A stock is a quantity measured at a particular point in time (e.g., capital stock). A flow is a quantity measured over a period of time (e.g., national income, investment).
• Depreciation: This refers to the wear and tear or loss in the value of capital goods (like machinery) due to their use in the production process. It is also known as the consumption of fixed capital.

Circular Flow of Income:
In a simple economy, firms produce goods and services using factors of production (land, labour, capital) provided by households. In return, firms make factor payments (rent, wages, interest, profit) to households. Households then spend this income on the goods and services produced by the firms. This flow of income and expenditure circulates continuously within the economy.

Methods of Calculating National Income:
There are three primary methods to calculate national income, and all three methods yield the same result.

1. Product Method or Value Added Method: This method calculates the sum of the market value of all final goods and services produced within the domestic territory of a country during a financial year. To avoid the problem of double counting, it sums up the value added by each production unit, where Value Added = Value of Output – Value of Intermediate Consumption.
2. Expenditure Method: This method measures the total final expenditure incurred in the economy during a financial year. Its components are: Private Final Consumption Expenditure (C), Gross Domestic Capital Formation (Investment, I), Government Final Consumption Expenditure (G), and Net Exports (X-M).
   GDP = C + I + G + (X – M)
3. Income Method: This method sums up all the factor incomes (wages, rent, interest, and profit) earned by the factors of production within the domestic territory of a country in a financial year.

Various Concepts of National Income:

• Gross Domestic Product (GDP): The market value of all final goods and services produced within the domestic territory of a country in a financial year.
• Gross National Product (GNP): GDP plus Net Factor Income from Abroad (NFIA). GNP = GDP + NFIA.
• Net National Product (NNP): GNP minus Depreciation. NNP = GNP – Depreciation.
• Net National Product at Factor Cost (NNP at FC) or National Income (NI): NNP at Market Price minus Net Indirect Taxes (Indirect Taxes – Subsidies).
• Personal Income (PI) and Personal Disposable Income (PDI): The part of national income received by households is Personal Income. After paying personal taxes from PI, the remaining amount is Personal Disposable Income.

Nominal and Real GDP:

• Nominal GDP: When GDP is calculated at current year’s prices.
• Real GDP: When GDP is calculated at the constant prices of a base year. It is a better measure of economic growth as it reflects the change in the quantity of output.
• GDP Deflator: It is the ratio of Nominal GDP to Real GDP. It measures the change in the price level.

GDP and Welfare:
GDP is often used as an indicator of the welfare of a country, but it has limitations. It does not account for the distribution of income, non-monetary exchanges, and externalities (positive or negative side-effects of economic activities).

National Income Accounting Class 12

Textual Question Answers (Exercise)

1. What are the four factors of production and what are the remunerations to each of these called?
Answer: The four factors of production and their remunerations are:

• Land: Rent
• Labour: Wages
• Capital: Interest
• Entrepreneurship: Profit

2. Why should the aggregate final expenditure of an economy be equal to the aggregate factor payments?
Answer: According to the circular flow of income, the total value of final goods and services produced in an economy (aggregate production) is distributed among the factors of production as income (aggregate factor payments). This income is then used by the households to purchase the final goods and services (aggregate final expenditure). Therefore, in a simple economy, the aggregate final expenditure must equal the aggregate factor payments because the money flows in a circle: Production generates Income, and Income is used for Expenditure.

3. Distinguish between stocks and flows. Between net investment and capital which is a stock and which is a flow?
Answer:

• Capital: It is a stock variable because it is measured at a particular point in time.
• Net Investment: It is a flow variable because it represents the addition to the stock of capital during a period of time (e.g., a year).

4. What is the difference between planned and unplanned inventory accumulation?
Answer:

• Planned Inventory Accumulation: This occurs when a firm intentionally increases its stock of unsold goods in anticipation of future demand or to meet future production needs.
• Unplanned Inventory Accumulation: This occurs when a firm’s sales are unexpectedly low, leading to an unintended pile-up of unsold goods. It is a result of a sudden fall in market demand.

5. Write down the three identities of calculating the GDP of a country by the three methods. Also, briefly explain why the three methods give the same value of GDP.
Answer: The three identities are:

1. Product Method: GDP ≡ Sum of Gross Value Added (GVA) of all firms in the economy.
2. Expenditure Method: GDP ≡ C + I + G + (X – M)
3. Income Method: GDP ≡ W + P + In + R (Wages + Profit + Interest + Rent)

The three methods give the same value because they are three different ways of looking at the same thing: the total economic activity in a year. The total value of production (Product Method) must be paid out as income to the factors of production (Income Method), and this income is then spent on purchasing the goods and services (Expenditure Method). Thus, Aggregate Production ≡ Aggregate Income ≡ Aggregate Expenditure.

6. Suppose the budget deficit was Rs 2,000 crores greater than the trade deficit of a country in a particular year. The value of private investment was Rs (-) 1,500 crores. What was the value of the country’s private savings?

Answer:
This question is based on the savings-investment identity in an open economy with a government sector. The identity is:
S = I + (G – T) + (X – M)

Where:

• S = Private Savings
• I = Private Investment
• (G – T) = Government Budget Deficit (Government Expenditure – Taxes)
• (X – M) = Trade Deficit (Exports – Imports). Note: A trade deficit means M > X, so (X-M) is negative.

Let’s denote:

• Budget Deficit (BD) = G – T
• Trade Deficit (TD) = M – X = – (X – M)

From the question, we are given:

• Budget Deficit (BD) = Trade Deficit (TD) + Rs 2,000 crores
  • (G – T) = (M – X) + 2000
• Private Investment (I) = Rs 1,500 crores

Now, let’s rearrange the main identity:
S = I + (G – T) + (X – M)
S – I = (G – T) + (X – M)

We know that (G – T) = (M – X) + 2000. Let’s substitute this into the equation:
S – I = [(M – X) + 2000] + (X – M)
S – I = (M – X) + 2000 – (M – X)
S – I = 2000

Now, substitute the value of Investment (I):
S – 1500 = 2000
S = 2000 + 1500
S = 3500

Therefore, the value of the country’s private savings was Rs 3,500 crores.

7. Suppose the GDP at market price of a country in a particular year was Rs 1,100 crores. Net Factor Income from Abroad was Rs 100 crores. The value of Net Indirect Taxes was Rs 150 crores and National Income was Rs 850 crores. Calculate the aggregate value of depreciation.

Answer:
Given:

• GDP at Market Price (GDP_MP) = Rs 1,100 crores
• Net Factor Income from Abroad (NFIA) = Rs 100 crores
• Net Indirect Taxes (NIT) = Rs 150 crores
• National Income (NI or NNP_FC) = Rs 850 crores

We need to find Depreciation. Let’s work backward from National Income (NNP_FC).

Step 1: Calculate NNP at Market Price (NNP_MP)
We know that: NI (NNP_FC) = NNP_MP – Net Indirect Taxes
850 = NNP_MP – 150
NNP_MP = 850 + 150
NNP_MP = Rs 1,000 crores

Step 2: Calculate GNP at Market Price (GNP_MP)
We know that: GNP_MP = GDP_MP + NFIA
GNP_MP = 1100 + 100
GNP_MP = Rs 1,200 crores

Step 3: Calculate Depreciation
We know that: NNP_MP = GNP_MP – Depreciation
1000 = 1200 – Depreciation
Depreciation = 1200 – 1000
Depreciation = Rs 200 crores

Therefore, the aggregate value of depreciation is Rs 200 crores.

8. In a particular year, an economy has its Net National Product at factor cost at Rs 1,900 crores. There were no interest payments made by the households to the firms/government, or by the firms/government to the households. The Personal Disposable Income of the households was Rs 1,200 crores. The personal income taxes paid by them was Rs 600 crores and the value of retained earnings of the firms and government was Rs 200 crores. What was the value of transfer payments made by the government and firms to the households?

Answer:
Given:

• National Income (NNP_FC) = Rs 1,900 crores
• Net Interest Payments by Households = 0
• Personal Disposable Income (PDI) = Rs 1,200 crores
• Personal Income Taxes = Rs 600 crores
• Retained Earnings (Undistributed Profits) = Rs 200 crores

We need to find Transfer Payments (Tr).

Step 1: Calculate Personal Income (PI)
We know that: PDI = PI – Personal Income Taxes
1200 = PI – 600
PI = 1200 + 600
PI = Rs 1,800 crores

Step 2: Calculate Transfer Payments (Tr)
The formula for Personal Income is:
PI = National Income – Undistributed Profits – Corporate Tax + Transfer Payments
(Note: The question does not mention Corporate Tax, so we assume it to be zero or included in the retained earnings figure for simplicity. It also states net interest payments are zero.)

Let’s plug in the values:
1800 = 1900 – 200 + Tr
1800 = 1700 + Tr
Tr = 1800 – 1700
Tr = 100

Therefore, the value of transfer payments was Rs 100 crores.

9. From the following data, calculate Personal Income and Personal Disposable Income.
(in Rs crores)
(a) Net Domestic Product at factor cost: 8,000
(b) Net Factor Income from abroad: 200
(c) Undistributed Profit: 1,000
(d) Corporate Tax: 500
(e) Interest Received by Households: 1,500
(f) Interest Paid by Households: 1,200
(g) Transfer Income: 300
(h) Personal Tax: 500

Answer:

Step 1: Calculate National Income (NI or NNP_FC)
NI = Net Domestic Product at factor cost (NDP_FC) + Net Factor Income from Abroad (NFIA)
NI = 8,000 + 200 = Rs 8,200 crores

Step 2: Calculate Personal Income (PI)
PI = NI – Undistributed Profit – Corporate Tax + (Interest Received by Households – Interest Paid by Households) + Transfer Income
PI = 8,200 – 1,000 – 500 + (1,500 – 1,200) + 300
PI = 8,200 – 1,500 + 300 + 300
PI = 6,700 + 600
PI = Rs 7,300 crores

Step 3: Calculate Personal Disposable Income (PDI)
PDI = Personal Income (PI) – Personal Tax
PDI = 7,300 – 500
PDI = Rs 6,800 crores

10. A barber, Raju, collects Rs 500 from haircuts in a day. During this day he incurs a depreciation of his equipment of Rs 50. Of the remaining Rs 450, Raju pays sales tax worth Rs 30, takes Rs 200 home, and retains Rs 220 for improvement and buying of new equipment. He further pays Rs 20 as income tax from his income. Based on this information, complete Raju’s contribution to the following measures of income (a) GDP (b) NNP at market price (c) NNP at factor cost (d) Personal Income (e) Personal Disposable Income.

Answer:
Let’s calculate Raju’s contribution to each measure.

(a) GDP at Market Price (Contribution to GDP_MP):
This is the total market value of the final service produced.
GDP_MP = Value of service (haircuts) = Rs 500

(b) NNP at Market Price (Contribution to NNP_MP):
NNP_MP = GDP_MP – Depreciation
NNP_MP = 500 – 50 = Rs 450

(c) NNP at Factor Cost (Contribution to NNP_FC or National Income):
NNP_FC = NNP_MP – Net Indirect Taxes (Here, Sales Tax)
NNP_FC = 450 – 30 = Rs 420

(d) Personal Income (PI):
This is the income that accrues to the individual before paying personal taxes. It is the NNP_FC minus any part of the income that is not received by the household (like retained earnings).
PI = NNP_FC – Retained Earnings (Undistributed Profit)
PI = 420 – 220 (retained for improvement) = Rs 200
(This matches the Rs 200 he takes home, which is his personal income before personal tax).

(e) Personal Disposable Income (PDI):
PDI = Personal Income (PI) – Personal Income Tax
PDI = 200 – 20 = Rs 180

11. The value of the nominal GNP of an economy was Rs 2,500 crores in a particular year. The value of GNP of that country during the same year, evaluated at the prices of some base year, was Rs 3,000 crores. Calculate the value of the GNP deflator of the year in percentage terms. Has the price level risen or fallen?

Answer: This is the same as question 6.
Given:

• Nominal GNP = Rs 2,500 crores
• Real GNP = Rs 3,000 crores

GNP Deflator = (Nominal GNP / Real GNP) × 100
GNP Deflator = (2500 / 3000) × 100 = 83.33%

Since the GNP deflator is less than 100, it indicates that the price level has fallen compared to the base year.

12. Write down some of the limitations of using GDP as an index of the welfare of a country.

Answer: This is the same as question 7. The limitations are:

1. Distribution of GDP: GDP does not show how income is distributed. High inequality can mean low welfare for the majority.
2. Non-Monetary Exchanges: Services not paid for, like those of a homemaker, are not included in GDP, understating true welfare.
3. Externalities: GDP ignores negative externalities like pollution, which decrease welfare, and positive externalities that increase it.
4. Composition of GDP: GDP does not distinguish between goods that enhance welfare (like food and medicine) and those that do not (like weapons).
5. Rate of Population Growth: If GDP growth is less than population growth, the per capita availability of goods and services will fall, reducing welfare.

National Income Accounting Class 12

Previous Years’ AHSEC Question Answers (2015-2025)

Long Questions:

1. Explain the income method of calculating National Income. (AHSEC 2015, 2018)
   Answer: The income method measures national income by summing up all the factor incomes earned by the factors of production within the domestic territory of a country in a financial year. The main components are:
   1. Compensation of Employees: Includes wages, salaries, and other benefits.
   1. Operating Surplus: Includes profit, rent, and interest.
   1. Mixed Income: The income of self-employed individuals where factor incomes cannot be separated.
      The sum of these three gives Net Domestic Product at Factor Cost (NDP at FC). By adding Net Factor Income from Abroad (NFIA) to it, we get National Income (NNP at FC).
2. Explain the expenditure method of calculating National Income. (AHSEC 2016, 2020)
   Answer: The expenditure method measures national income by summing up all the final expenditures incurred in the economy during a financial year. The main components are:
   1. Private Final Consumption Expenditure (C): Expenditure by households.
   1. Government Final Consumption Expenditure (G): Expenditure by the government.
   1. Gross Domestic Capital Formation (I): Investment expenditure.
   1. Net Exports (X-M): The difference between exports and imports.
      The sum of these gives Gross Domestic Product at Market Price (GDP at MP).
3. Explain the value-added method of calculating National Income. (AHSEC 2017, 2022)
   Answer: This method measures national income by estimating the contribution of each producing enterprise to production in a financial year. It calculates the sum of the value added by all firms. Value added is the difference between the value of output and the value of intermediate consumption.
   Value Added = Value of Output – Intermediate Consumption
   Summing up the value added by all firms gives Gross Domestic Product at Market Price (GDP at MP). This method avoids the problem of double counting.

Short Questions:

1. Distinguish between final goods and intermediate goods. (AHSEC 2015, 2019, 2023)
   Answer: Final goods are those goods which are used for final consumption or investment. Intermediate goods are those goods which are used as raw materials for producing other goods.
2. Distinguish between stock and flow. (AHSEC 2016, 2020)
   Answer: A stock is a variable measured at a specific point in time (e.g., capital), while a flow is a variable measured over a period of time (e.g., income).
3. What is National Income? (AHSEC 2017)
   Answer: National Income is the sum total of factor incomes earned by the normal residents of a country during a financial year. It is equal to NNP at Factor Cost.
4. What is Personal Income? (AHSEC 2018)
   Answer: Personal Income is the total income received by the households of a country from all sources in a year.
5. Write the formula for GDP Deflator. (AHSEC 2022)
   Answer: GDP Deflator = (Nominal GDP / Real GDP) × 100.
6. What is the problem of double counting?
   Answer: It is the problem of counting the value of a commodity more than once when calculating national income.
7. What is an externality?
   Answer: An externality is the positive or negative impact of an economic activity on a third party who is not involved in that activity, without any payment being made.
8. What are non-monetary exchanges?
   Answer: These are transactions involving the exchange of goods for goods (barter system) without the use of money.
9. What is the circular flow of income?
   Answer: It is the continuous flow of production, income, and expenditure in an economy.
10. State one limitation of GDP as an index of welfare.
    Answer: GDP does not reflect the distribution of income among the people.

National Income Accounting Class 12

Additional Most Important Question Answers

1. What is Net Investment?
   Answer: Gross Investment minus Depreciation.
2. Why are only final goods included in the estimation of National Income?
   Answer: To avoid the problem of double counting.
3. Who calculates National Income in India?
   Answer: The National Statistical Office (NSO).
4. What are the four sectors of an economy?
   Answer: Households, Firms, Government, and the External Sector.
5. If a country’s exports are greater than its imports, what will be its net exports?
   Answer: Positive.
6. How is Personal Disposable Income (PDI) calculated?
   Answer: By deducting personal taxes from Personal Income.
7. Is a car a final good or an intermediate good?
   Answer: It depends on its use. If used by a household, it is a final consumption good. If used as a taxi, it is a final capital good.
8. What are subsidies?
   Answer: Financial assistance given by the government to producers, which reduces the market price of a commodity.
9. How is Net Factor Income from Abroad (NFIA) calculated?
   Answer: By subtracting the factor income earned by foreigners in the domestic country from the factor income earned by the country’s residents from abroad.
10. What is the main difference between GDP and GNP?
    Answer: GDP measures production within a country’s geographical boundaries, while GNP measures production by a country’s citizens, regardless of where they are located.