National Income: Measurement— NBSE Class 12 Economics notes

Introduction

Understanding the intricacies of national income and its various components is crucial for both economists and policy makers. National income provides a comprehensive measure of a nation’s economic activity, including the production of goods and services and the income earned by citizens. It is calculated by adding up the factor income – the incomes that are paid to factors of production, namely rent, wages, interest, and profit.

One of the key components of national income is the compensation of employees, which includes wages and salaries, as well as social security contributions by employers. Another important component is rent and royalty, which is the income earned from lending services of land, buildings, and sub-soil assets. Interest, the price for borrowed funds, is also a significant part of national income.

Profit, the residual factor payment to owners of production units, is another crucial component of national income. It is the reward that business owners receive for taking on the risks associated with running a business. The profit of a corporation is used mainly for three purposes – corporate tax, dividends, and undistributed profit.

In addition to these components, national income also includes mixed income, which is the income of self-employed persons and unincorporated enterprises who use their own resources like land, labour, and funds.

The calculation of national income also involves several precautions. For instance, it is important to avoid double counting, which can inflate the value of national income. It is also necessary to distinguish between final and intermediate goods to ensure accurate calculation.

Textual questions and answers

A. Very short-answer questions

1. Complete the following aggregates related to national product.

(i) National income = Domestic income ____________

Answer: + Net factor income from abroad

(ii) Private income = National income ____________

Answer: – Income accruing to Government sector

(iii) Personal income = Private income ____________

Answer: – Corporate tax – Undistributed profit

(iv) Personal disposable income = Personal income ____________

Answer: – Direct taxes

(v) Gross national disposable income = National income ____________

Answer: + Transfer payments

(vi) Net value added at FC = Gross output ____________

Answer: – Intermediate consumption

2. What is double counting?

Answer: Double counting means counting of the value of the same product (or expenditure) more than once in calculating national income.

3. Define the value of output.

Answer: The value of output is the market value of all the goods and services produced by an enterprise during an accounting year.

4. What is NVA at MP?

Answer: Net Value Added at Market Price (NVA at MP) is the value of the total output produced by an enterprise less the value of intermediate goods and depreciation, plus net indirect taxes.

5. State the factors of production.

Answer: The factors of production are land, labour, capital and enterprise.

6. What are the remunerations given to the various factors of production?

Answer: The remunerations given to the various factors of production are rent, wages, interest, and profit.

7. What is operating surplus?

Answer: Operating surplus consists of rent, interest and profit.

8. “Sale of a second-hand car”. Will it be included in the calculation of national income?

Answer: The sale of a second-hand car is not included in the calculation of national income because it is not a part of the production of the current year.

9. What all is included in compensation of employees?

Answer: Compensation of employees includes wages and salaries paid both in cash and kind, and the employer’s contribution to social security schemes

B. Short-answer questions-I

1. “National income exceeds domestic income only when exports are greater than imports”. Comment.

Answer: National income is the total income of the residents of the country, both from domestic and foreign sources. Domestic income, on the other hand, is the total income generated within the domestic territory of a country. When a country’s exports exceed its imports, it earns income from abroad, which adds to the domestic income, thereby making the national income exceed the domestic income.

2. “Cash transfer of subsidy on LPG raises annual income of the household”. Does it imply a rise in the domestic income?

Answer: Yes, it does imply a rise in the domestic income. The cash transfer of subsidy on LPG increases the disposable income of households. As the disposable income of households increases, it leads to an increase in the consumption expenditure, which in turn increases the domestic income.

3. Ram purchased a scooter for 70,000 to commute between his office and home. Should this be treated as an intermediate consumption?

Answer: No, this should not be treated as intermediate consumption. Intermediate consumption refers to the goods and services consumed in the process of production. Ram’s scooter is a final good, purchased for personal use and not for further production. Therefore, it is not an intermediate consumption.

4. How would the following be treated in calculation of national income?

(i) Subsidy on the rice produced

Answer: Subsidy on the rice produced would be treated as a transfer payment from the government to the producers. It does not directly contribute to the national income because it is not a payment for goods or services. However, it reduces the production cost for the producers, which could indirectly affect the national income.

(ii) Contribution to PPF by the employee

Answer: Contribution to PPF (Public Provident Fund) by the employee is a form of savings. It does not directly contribute to the national income as it is not a payment for goods or services. However, it forms a part of the national wealth.

(iii) Expenditure incurred on adding a new machinery in the firm.

Answer: Expenditure incurred on adding a new machinery in the firm is considered as an investment. This is a part of the Gross Domestic Product (GDP) and hence, contributes to the national income.

5. How are corporate taxes and undistributed profits treated in the calculation of national income?

Answer: Corporate tax is a direct tax levied by the government on the profit of a company, and it is paid out of the company’s total profit. Undistributed profit, also known as corporate savings or retained income, is the balance kept by a company after paying profit tax and distributing dividends. Both corporate taxes and undistributed profits are earned by the company and hence, are part of the domestic income.

C. Short-answer questions-II

1. State any three precautions that are necessary while estimating national income by value added method.

Answer: Three precautions that are necessary while estimating national income by value added method are:

Only value added and not value of output by production units should be included (i.e., avoid double counting).
Imputed rent of owner occupied houses should be included.
Value of illegal activities like smuggling, gambling, etc. should be excluded.

2. What are the precautions taken while measuring national income by income method?

Answer: Some precautions taken while measuring national income by income method are:

Only factor incomes which are earned by rendering productive services are included. All types of transfer income like old-age pensions, unemployment allowance, scholarships, etc. are excluded.
Income from illegal activities like smuggling, black-marketeering, etc., as well as windfall gains (e.g., from lotteries), are not included.
Imputed rent of owner-occupied dwellings and value of production for self-consumption are included but the value of self-consumed services like those of housewives is not included.
Direct taxes like income tax are included but indirect taxes are excluded.

3. Explain the problem of double counting.

Answer: Double counting arises when the value of intermediate goods (like raw materials) gets included along with the value of final goods, while estimating national income by the output method. This results in counting the value of the same goods more than once, leading to over-estimation of national income.

4. Why should final expenditure of an economy be equal to the aggregate of all the factor payments? Explain.

Answer: The final expenditure of an economy should be equal to the aggregate of all the factor payments because incomes which originate in production units ultimately come back to them by way of expenditure on goods and services by factor owners. This makes the circular flow of production, income, and expenditure complete. In short, production generates income, income creates expenditure, and expenditure, in turn, calls forth production

5. What are the four factors of production? What are the remunerations to each of these factors?

Answer: The four factors of production are land, labour, capital, and enterprise. The remunerations to each of these factors are as follows:

Land: The remuneration for land is rent.
Labor: The remuneration for labour is wages or compensation of employees.
Capital: The remuneration for capital interests. Interest is the price for the funds borrowed.
Enterprise: The remuneration for enterprise is profit.

6. How can the estimates of GDP, using the income and expenditure methods, be identical when households do not spend their entire income on the purchase of goods and services and a part of them remains unsold during the accounting year?

Answer: The estimates of GDP, using income and expenditure method, can be identical because the income generated by factors of production in the production process is spent by them on final goods. This is part of the circular flow of production, income, and expenditure. Even if households do not spend their entire income on the purchase of goods and services and a part of them remains unsold during the accounting year, the income and expenditure method still accounts for these factors, ensuring that the estimates of GDP are identical.

D. Long-answer questions-I

1. Explain the product method of estimating national income.

Answer: The product method, also known as the value-added method, involves calculating domestic income by totaling ‘net value added at FC’ by all the producing units during an accounting year within the domestic territory. This total is called Net Domestic Product at FC or Domestic Income. Then by adding net factor income from abroad to Domestic Income (NDP at FC), we get National Income (NNP at FC). The value-added method measures the contribution of each producing unit in the domestic economy avoiding any possibility of double counting. It is derived by subtracting intermediate consumption, depreciation, and net indirect taxes from the value of gross output.

2. How is national income calculated by the income method?

Answer: The Income Method measures national income from the side of payments made to the primary factors of production in the form of rent, wages, interest, and profit for their productive services in an accounting year. Thus, income is calculated by adding up factor incomes generated by all the producing units located within the domestic economy during a period of account. In the income method, national income is measured at the stage when factor incomes are paid out by enterprises to owners of factors of production-land, labor, capital, and enterprise.

3. Explain the expenditure method of estimating national income.

Answer: The expenditure method measures final expenditure on Gross Domestic Product at market price (GDP at MP) during a period of account. Since all domestically produced goods and services are purchased for final use either by consumers for consumption or by producers for investment, therefore, we take the sum of final expenditure on consumption and investment. This sum equals GDP at MP. Under the expenditure method, national income is calculated first by adding up all the items of final consumption expenditure and final investment expenditure within the domestic economy. The resulting total is called GDP at MP. By subtracting depreciation and net indirect taxes from GDP at MP and adding to it net factor income from abroad, we get NNP at FC or national income.

4. Explain the precautions required to be taken while measuring national income through income and expenditure method.

Answer: The precautions required to be taken while measuring national income through income and expenditure method are as follows:

To avoid double counting, expenditure on all intermediate goods and services is excluded. For example, purchase of vegetables by a restaurant, expenses on electricity by a factory, etc., are not included as they are for intermediate consumption.
Government expenditure on all transfer payments such as scholarships, unemployment allowance, old-age pension, etc., is excluded because no productive service is rendered by the recipients in exchange.
Expenditure on purchase of second-hand goods is excluded from national income because this type of expenditure is not on currently produced goods.
Expenditure on purchase of old shares/bonds or new shares/bonds, etc., is excluded because it is not payment for goods or services currently produced. It shows mere transfer of property from one person to another. Likewise, gifts from abroad which bring transfer payment are not included.

5. What is the income of government sector?

Answer: The income of the government sector comprises of two components. The first is the ‘income from property and entrepreneurship accruing to government administrative departments’ which includes government administrative departments and departmental enterprises like Railways, Posts and Telegraphs. The second component is the ‘savings of non-departmental enterprises’ which includes non-departmental enterprises like HMT, LIC, FCI. The income from domestic product accruing to the government sector is derived by subtracting the income from domestic product accruing to the private sector from the domestic product.

6. How is domestic income different from national income?

Answer: Domestic income is the sum-total of factor incomes generated by all the production units located within the domestic territory of a country during an accounting year. It includes the income generated by both residents and non-residents within the domestic territory. On the other hand, national income is the sum-total of factor incomes earned by normal residents of a country during an accounting year. It includes factor incomes earned by normal residents both within and outside the country. The difference between the two is the net factor income from abroad, which is added to domestic income to get national income.

D. Long-answer questions-II

1. Explain the product/value added method of estimating national income.

Answer: The product or value added method measures national income from the production side by estimating the value generated by various production units in the economy.

First, all the enterprises are identified and classified into industrial sectors like primary, secondary and tertiary. Net value added at factor cost (NVAFC) is calculated for each enterprise by deducting intermediate consumption, depreciation and net indirect taxes from the gross value of output.

The NVAFC of all units in a sector are added to derive sectoral NVAFC. By summing up NVAFC of all sectors, we get the Net Domestic Product at factor cost (NDPFC) which is the domestic income.

Precautions are taken to include imputed rent, production for self-consumption, own account production of fixed assets etc. Activities like sale of second hand goods, illegal activities etc. are excluded.

Finally, net factor income from abroad is added to NDPFC to arrive at the Net National Product at factor cost (NNPFC) which gives the national income.

Thus, the product method provides a sector-wise breakup of value addition taking place in the economy avoiding the problem of double counting inherent in the output method.

2. Give briefly an outline of income method.

Answer: The Income Method measures national income from the side of payments made to the primary factors of production in the form of rent, wages, interest, and profit for their productive services in an accounting year. Thus, income is calculated by adding up factor incomes generated by all the producing units located within the domestic economy during a period of account. The Income Method is measured at the stage when factor incomes are paid out by enterprises to owners of factors of production – land, labour, capital, and enterprise.

The Income Method involves several steps and precautions. It starts with the measurement of national income from the side of payments made to the primary factors of production. These payments are in the form of rent for land, wages for labour, interest for capital, and profit for enterprise. These factor incomes are added up to calculate the total income generated by all the producing units located within the domestic economy during a period of account.

It is important to note that in the income method, national income is measured at the stage when factor incomes are paid out by enterprises to owners of factors of production. This means that the income method takes into account the income generated at the point when it is paid out to the owners of the factors of production, rather than when it is earned.

Precautions need to be taken to avoid double counting and to ensure that only factor incomes are included. Transfer payments, such as pensions and unemployment benefits, should not be included as they are not payments for productive services. Similarly, income from the sale of second-hand goods and financial transactions should also be excluded as they do not contribute to the production of goods and services in the current period.

3. Give briefly an outline of expenditure method. State precautions to be taken in expenditure method.

Answer: The expenditure method measures national income by calculating the sum of final consumption expenditure and final investment expenditure within the domestic economy. This sum equals GDP at Market Price (MP). By subtracting depreciation and net indirect taxes from GDP at MP, and adding net factor income from abroad, we get NNP at FC or national income.

The steps involved in the expenditure method include identifying economic units incurring final expenditure, classifying final aggregate expenditure into components like private final consumption expenditure, government final consumption expenditure, gross fixed capital formation, change in stocks, and net exports. The sum of these components gives GDP at MP.

Precautions to be taken in the expenditure method include avoiding double counting by excluding expenditure on all intermediate goods and services, excluding government expenditure on all transfer payments as no productive service is rendered by the recipients in exchange, excluding expenditure on purchase of second-hand goods as this type of expenditure is not on currently produced goods, and excluding expenditure on purchase of old shares/bonds or new shares/bonds, etc., because it is not payment for goods or services currently produced.

4. Why are exports treated as a part of domestic product?

Answer: Exports are a part of domestic product (GDP). As import implies expenditure by domestic residents on purchase of foreign goods produced abroad, therefore, they are not part of domestic product. Hence, value of exports is added and that of imports is deducted. Beware, export receipts are not ‘net factor income from abroad’.

5. How are the following treated in estimating national income/domestic income? Give reasons.

(i) Services of owner-occupied houses

Answer: The rent of owner-occupied houses is called imputed rent. When the owner of a house, instead of renting out to a tenant, himself stays in it, he is assumed to have paid rent to himself. Thus, market rent of self-occupied house is labelled as imputed rent which is included in national income.

(ii) Sale of shares

Answer: Sale and purchase of second-hand goods are excluded since they are not part of production of current year but commission paid on sale of second-hand goods is included as it is reward for rendering productive services. Likewise, sale proceeds of shares and bonds are not included.

(iii) Production for self consumption

Answer: Imputed value of goods and services produced for self-consumption or for free distribution are included in the estimation of national income.

(iv) Old-age pension

Answer: Old-age pension is a transfer payment and is excluded because no productive service is rendered by the recipients in exchange.

(v) Gift tax

Answer: Direct taxes such as income tax which are paid by the employees from their salaries and corporate tax, which is paid by the joint stock company from its profit, are included. But wealth tax and gift tax are excluded since they are deemed to be paid from past savings and wealth.

6. Giving reasons, explain how the following should be treated in estimation of national income:

(i) Expenditure by a firm on payment of fees to a chartered accountant

Answer: Expenditure by a firm on payment of fees to a chartered accountant is treated as a part of the firm’s operating expenses and is included in the estimation of national income. This is because it is a payment for a service that contributes to the production process of the firm.

(ii) Payment of corporate tax by a firm

(iii) Purchase of a refrigerator by a firm for own use

Answer: If the refrigerator is used in the production process or in the provision of services by the firm, its purchase could be considered a part of the firm’s operating expenses and thus included in the estimation of national income. If it is not used in the production process, it might not be included in the estimation of national income.

7. Giving reasons, explain how the following should be treated in estimation of national income:

(i) payment of interest by a firm to a bank

Answer: Interest paid on loan is included in national income (or domestic income) if the loan is used for productive purposes (value addition) but not included if it is used for consumption purposes. Accordingly, payment of interest by a firm to a bank is included in national income.

(ii) payment of interest by a bank to an individual

Answer: The interest income earned by an individual from the bank is a factor payment for lending funds to the bank. The individual provides capital to the bank through deposits. So this interest income accrues for productive services and must be included in national income.

(iii) payment of interest by an individual to a bank

Answer: When an individual borrows from a bank for personal consumption purposes, the interest payment represents final expenditure on consumption. Since it is not for any further value addition, this interest payment should be excluded from national income.

8. How will you treat the following while estimating domestic product of a country? Give reasons for your answer:

(i) Profits earned by branches of a country’s bank in other countries

Answer: The profits earned by foreign companies in India are included in the estimation of the domestic product of the country. This is because the domestic product is calculated based on the income generated within the domestic territory of a country, irrespective of whether the producers are residents or non-residents. Therefore, the income generated by foreign companies operating within India is considered part of India’s domestic income. This concept is territorial in nature, as it is defined with reference to the domestic territory.

(ii) Gifts given by an employer to his employees on independence day

Answer: Gifts given by an employer to his employees on Independence Day are not included in the estimation of the domestic product of a country. This is because these gifts are considered as transfer payments and do not contribute to the production process. They are not a part of the compensation of employees, which includes wages and salaries paid both in cash and kind, and the employer’s contribution to social security schemes.

(iii) Purchase of goods by foreign tourists

Answer: Domestic product is defined based on economic activities taking place within the domestic territory of a country. When foreign tourists purchase goods and services that are domestically produced, it adds to the demand for goods and services that are output of economic units located within the country. Hence, expenditure made by foreign tourists on domestically produced goods and services should be included within the domestic product.

(iv) Profits earned by foreign companies in India

(v) Salaries of Indians working in the Russian Embassy in India

Answer: Domestic product accounts for production taking place within the geographic borders of a country. It does not account for production by embassies of foreign countries located in the domestic territory. Salaries earned by Indian citizens working in the Russian Embassy accrue due to services provided to a foreign government on Indian territory. Hence, these salaries should not be counted as part of the domestic production and income of India.

(vi) Profits earned by a branch of State Bank of India in Japan

Answer: The profits earned by a branch of State Bank of India in Japan would be included in the estimation of the domestic product of India. This is because these profits are generated by a resident enterprise of India, even though the operations are conducted in a foreign country. The document states that “national income includes factor incomes earned by normal residents within and outside the country”. Therefore, the profits of the State Bank of India branch in Japan, being a resident enterprise of India, contribute to the national income of India.

Numerical on Value Added (Product) Method

1. From the following data about a firm ‘X’ for the year 1998-99, calculate gross value added at FC during the year.

Particulars	(Rs in lakh)
Sales	70
Intermediate consumption	40
Opening stock	15
Closing stock	10
Subsidies	5
Purchase of raw material	25
Depreciation	15
Wages and Salaries	10

Answer: Value of output = Sales + Change in stock = 70 (Sales) + (10 (Closing stock) – 15 (Opening stock)) = 65 lakh

Gross value added at market price (MP) = Value of output – Intermediate consumption = 65 (Value of output) – 40 (Intermediate consumption) = 25 lakh

Gross value added at FC = Gross value added at MP + Subsidies = 25 (Gross value added at MP) + 5 (Subsidies) = 30 lakh

So, the gross value added at FC for firm ‘X’ for the year 1998-99 is 30 lakh.

2. From the following data, calculate GDP at MP:

Particulars	Amount (in lakhs)
Value of output in primary sector	2,000
Intermediate consumption of secondary sector	800
Intermediate consumption of primary sector	1000
Net factor Income from abroad	(-)30
Net indirect taxes	300
Value of output in tertiary sector	1,400
Value of output of secondary sector	1,800
Intermediate consumption of tertiary sector	600

Answer: Gross value added in primary sector = Value of output in primary sector – Intermediate consumption of primary sector = 2000 – 1000 = 1000 lakh

Gross value added in secondary sector = Value of output in secondary sector – Intermediate consumption of secondary sector = 1800 – 800 = 1000 lakh

Gross value added in tertiary sector = Value of output in tertiary sector – Intermediate consumption of tertiary sector = 1400 – 600 = 800 lakh

GDP at MP = Sum of gross value added in all sectors + Net indirect taxes = (1000 + 1000 + 800) + 0 (since Net indirect taxes are not included in the calculation of GDP at MP) = 2800 lakh

So, the GDP at MP is indeed 2800 lakh.

3. Calculate gross value added at FC from the following data:

Particulars	Amount (in lakhs)
Consumption of fixed capital	5
Sales	100
Subsidies	2
Closing stock	10
Purchase of raw material	50
Opening stock	15
Indirect taxes	10

Ans. GVA at MP = 45 lakh; GVA at FC = 37 lakh

Answer: Value of output = Sales + Change in stock = 100 (Sales) + (10 (Closing stock) – 15 (Opening stock)) = 95 lakh

Gross value added at market price (MP) = Value of output – Intermediate consumption = 95 (Value of output) – 50 (Purchase of raw material) = 45 lakh

Gross value added at FC = Gross value added at MP – Indirect taxes + Subsidies = 45 (Gross value added at MP) – 10 (Indirect taxes) + 2 (Subsidies) = 37 lakh

So, the gross value added at FC is 37 lakh and the gross value added at MP is 45 lakh.

4. From the following data, calculate gross value added at FC.

Particulars	Amount (in lakhs)
(i) Sales	180
(ii) Rent	5
(iii) Subsidies	10
(iv) Change in stock	15
(v) Purchase of raw material	100
(vi) Profits	25

Answer: Value of output = Sales + Change in stock = 180 (Sales) + 15 (Change in stock) = 195 lakh

Gross value added at FC = Value of output – Intermediate consumption = 195 (Value of output) – 100 (Purchase of raw material) = 95 lakh

Gross value added at FC = Gross value added at FC + Subsidies = 95 (Gross value added at FC) + 10 (Subsidies) = 105 lakh

So, the gross value added at FC is 105 lakh.

5. Calculate Net Value Added at MP from the following data:

Particulars	Amount (in crores)
Depreciation	5
Sales	100
Opening stock	20
Intermediate consumption	70
Excise duty	10
Change in stocks	(-) 10

Answer: Value of output = Sales + Change in stock = 100 (Sales) + (-10) (Change in stock) = 90 crore

Gross Value Added at MP = Value of output – Intermediate consumption = 90 (Value of output) – 70 (Intermediate consumption) = 20 crore

Net Value Added at MP = Gross Value Added at MP – Depreciation = 20 (Gross Value Added at MP) – 5 (Depreciation) = 15 crore

So, the Net Value Added at MP is 15 crore.

6. From the following data relating to a firm, calculate net value added at FC:

Particulars	Amount (in crores)
Sales	40
Sales	800
Depreciation	30
Exports	100
Closing stock	20
Opening stock	50
Intermediate purchases	500

Answer: Value of output = Sales + Change in stock = 800 (Sales) + (20 (Closing stock) – 50 (Opening stock)) = 770 crore

Intermediate consumption = Purchase of raw material = 500 crore

Gross Value Added at FC = Value of output – Intermediate consumption = 770 (Value of output) – 500 (Intermediate consumption) = 270 crore

Net Value Added at FC = Gross Value Added at FC – Depreciation = 270 (Gross Value Added at FC) – 30 (Depreciation) = 240 crore

7. Calculate value of output from the following data:

Particulars	Amount (in lakhs)
Net value added at FC	100
Intermediate consumption	75
Excise duty	20
Subsidy	5
Depreciation	10

Answer: Gross Value Added at FC = Net Value Added at FC + Depreciation = 100 (Net Value Added at FC) + 10 (Depreciation) = 110 lakh

Gross Value Added at MP = Gross Value Added at FC + Excise Duty – Subsidy = 110 (Gross Value Added at FC) + 20 (Excise Duty) – 5 (Subsidy) = 125 lakh

Value of output = Gross Value Added at MP + Intermediate consumption = 125 (Gross Value Added at MP) + 75 (Intermediate consumption) = 200 lakh

So, the value of output is indeed 200 lakh.

8. Calculate intermediate consumption from the following data:

Particulars	Amount (in lakhs)
Value of output	200
Net value added at FC	80
Sale tax	15
Subsidy	5
Depreciation	20

Answer: Gross Value Added at FC = Net Value Added at FC + Depreciation = 80 (Net Value Added at FC) + 20 (Depreciation) = 100 lakh

Gross Value Added at MP = Gross Value Added at FC + Excise Duty – Subsidy = 100 (Gross Value Added at FC) + 15 (Excise Duty) – 5 (Subsidy) = 110 lakh

Intermediate consumption = Value of output – Gross Value Added at MP = 200 (Value of output) – 110 (Gross Value Added at MP) = 90 lakh

So, the intermediate consumption is indeed 90 lakh.

9. From the following data, calculate “net value added at factor cost”:

Particulars	Amount (in crores)
Purchase of intermediate goods	500
Sales	750
Import of raw material	50
Depreciation	60
Net indirect taxes	100
Change in stock	(-) 30
Exports	20

Answer: Value of output = Sales + Change in stock = 750 (Sales) + (-30) (Change in stock) = 720 crore

Gross Value Added at MP = Value of output – Intermediate consumption = 720 (Value of output) – 500 (Intermediate consumption) = 220 crore

Gross Value Added at FC = Gross Value Added at MP – Net indirect taxes + Subsidy = 220 (Gross Value Added at MP) – 100 (Net indirect taxes) + 0 (since no subsidy is mentioned) = 120 crore

Net Value Added at FC = Gross Value Added at FC – Depreciation = 120 (Gross Value Added at FC) – 60 (Depreciation) = 60 crore

So, the Net Value Added at FC is indeed 60 crore.

10. Calculate Gross Value added at FC:

Particulars	Amount (in lakhs)
Units of output sold (units)	1,000
Price per unit of output	30
Depreciation	1,000
Intermediate cost	12,000
Closing Stock	3,000
Opening stock	2,000
Excise	2,500
Sales Tax	3500

Answer: Gross Output = 1,000 units * Rs 30 per unit = Rs 30,000 lakhs.

Change in Stock = Rs 3,000 lakhs – Rs 2,000 lakhs = Rs 1,000 lakhs.

Gross Value Added at Market Price (MP) = Rs 30,000 lakhs + Rs 1,000 lakhs – Rs 12,000 lakhs = Rs 19,000 lakhs.

Gross Value Added at Factor Cost (FC) = Rs 19,000 lakhs – (Rs 2,500 lakhs + Rs 3,500 lakhs) = Rs 13,000 lakhs.

So, the Gross Value Added at FC is Rs 13,000 lakhs.

11. Calculate sales from the following data:

Particulars	Amount (in lakhs)
Net value added at factor cost	560
Depreciation	60
Change in stock	(-)30
Intermediate cost	1,000
Exports	200
Indirect taxes	60

Answer: We know:

Value of Output = Sales + Change in Stock

Also,

Value of Output = Intermediate Cost + Net Value Added at FC + Depreciation + Indirect Taxes

Substituting the values:

⇒ S + (-30) = 1,000 + 560 + 60 + 60

⇒ S – 30 = 1,680

⇒ S = 1,680 + 30 = 1,710 (lakhs)

Therefore, the value of Sales is 1,710 lakhs.

12. Find net value added at FC:

Particulars	Amount (in lakhs)
Durable use producers goods with a life span of 10 years	10
Single use producer goods	5
Unsold output produced during the year	2
Taxes on production	1
Sales	20

Answer: We know:

Value of Output = Sales + Change in Stock = Sales + Unsold Output

Also,

NVA at FC = Value of Output – Intermediate Consumption – Depreciation – Net Indirect Taxes

Here, Intermediate Consumption = Single use producer goods + Durable use producer goods

= 5 + 10 = 15 (lakhs)

Depreciation = 0

Net Indirect Taxes = Taxes on production = 1 (lakh)

Substituting the values:

⇒ NVA at FC = (Sales + Unsold Output) – Intermediate Consumption – Depreciation – Net Indirect Taxes

= (20 + 2) – 15 – 0 – 1

= 15 (lakhs)

Therefore, Net Value Added at Factor Cost = 15 lakhs

Additional/extra questions and answers

1. What are the three phases in the circular flow of national income?

Answer: There are three different phases in the circular flow of national income: production, income, and expenditure. They represent three related aspects: production (generation of income), distribution (of income), and disposition (of income, i.e., expenditure).

2. How does the production phase generate income?

Answer: Production of goods and services is the result of the combined efforts of factors of production, which are land, labour, capital, and enterprise. The net output that emerges from the production process gets distributed as remuneration in the form of money income like rent, wages, interest, and profit among these factors of production for rendering productive service. In this way, production generates income.

3. How does income create expenditure in the circular flow?

Answer: With the income they receive, the factors of production purchase goods and services for final consumption and investment. This way, income creates expenditure, or the income flow gives rise to the expenditure flow.

4. Explain the relationship between production, income, and expenditure.

Answer: The relationship between production, income, and expenditure is circular. Production generates income, income creates expenditure, and expenditure, in turn, calls for more production. The incomes that originate in production units ultimately come back to them through the expenditure on goods and services by factor owners. This completes the circular flow. This flow does not end, because expenditure, in turn, gives rise to further production.

5. What are the three methods of measuring national income?

Answer: Corresponding to the three phases in the circular flow of national income, there are three methods of measuring it:

Value Added Method (Traditionally called Production Method)
Income Method
Expenditure Method

6. Why should the totals from the three methods of measurement be equal?

Answer: The three methods of measurement are only different viewpoints of the same flow of goods and services. Therefore, the totals from each method should be equal to one another.

7. What is the Value Added Method of measuring national income?

Answer: Under the Value Added Method, national income is measured at the stage of production or addition of value. Domestic income is first calculated by totaling the ‘net value added at FC’ by all the producing units during an accounting year within the domestic territory.

8. How is Net Domestic Product at FC calculated using the value-added method?

Answer: Under the value-added method, domestic income is calculated by totaling the ‘net value added at FC’ by all the producing units during an accounting year within the domestic territory. This total is called Net Domestic Product at FC or Domestic Income.

9. How is Net Value Added at FC derived from the value of gross output?

Answer: Net Value Added at FC is derived by subtracting intermediate consumption, depreciation, and net indirect taxes from the value of gross output.

Symbolically: Net value added at FC = Gross output – Intermediate consumption – Depreciation – Net indirect taxes.

10. What is the main significance of the value-added method?

Answer: The significance of the value-added method is that it avoids the problem of double counting, which arises when the Final Product (output) method is used.

11. What are the three industrial sectors used for classifying producing units?

Answer: The three industrial sectors used for classifying producing units are the primary, secondary, and tertiary sectors.

12. Define the primary sector. Give two examples of its activities.

Answer: The primary sector produces goods by exploiting natural resources. Examples of its activities include fishing and mining.

13. Define the secondary sector. Give two examples of its activities.

Answer: The secondary sector produces manufactured goods by transforming one type of commodity into another. Examples of its activities include construction and electricity generation.

14. Define the tertiary sector. Give two examples of its activities.

Answer: The tertiary sector renders services. Examples of its activities include educational and medical services.

15. What is meant by the value of output? How is it calculated?

Answer: Value of output implies gross output and is always at Market Price (MP). It is calculated as:

Value of output = Sales + Change in stock

16. How is ‘value added’ different from ‘value of output’?

Answer: ‘Value added’ is derived from the ‘value of output’. It is calculated by subtracting the value of intermediate goods from the value of output.

Value added = Value of output – Value of intermediate goods

17. State any two items that should be included while calculating national income by the value-added method.

Answer: Two items that should be included while calculating national income by the value-added method are:

(i) Imputed rent of owner-occupied houses.
(ii) Imputed value of goods and services produced for self-consumption or for free distribution.

18. Why is the sale of second-hand goods not included in national income?

Answer: The sale of second-hand goods is not included in national income because they are not a fresh production activity. They are not part of the production of the current year, and their value had already been included in the national income of the year in which they were produced.

19. Why is the commission on the sale of second-hand goods included in national income?

Answer: The brokerage or commission paid to facilitate the sale of second-hand goods is included because it is a fresh production activity. If the transaction is made through a broker, his commission is included because he has rendered a productive service.

20. Why is the sale of bonds and shares excluded from national income estimates?

Answer: The sale of bonds and shares by a company is excluded from national income estimates because this is merely a financial transaction that does not contribute directly to the flow of goods and services.

21. Why are services for self-consumption by a housewife not included in national income?

Answer: Services for self-consumption by a housewife are not included in national income because it is difficult to estimate their market value.

22. How does the value-added approach solve the problem of double counting?

Answer: The value-added method measures the contribution of each producing unit in the domestic economy, thereby avoiding any possibility of double counting. It avoids this problem because it considers only the value added at each stage of production, not the total value of the output, which includes the cost of intermediate goods.

23. What is the Income Method of measuring national income?

Answer: The Income Method measures national income from the side of payments made to the primary factors of production in the form of rent, wages, interest, and profit for their productive services in an accounting year. In this method, national income is measured at the stage when factor incomes are paid out by enterprises to the owners of factors of production—land, labour, capital, and enterprise.

24. What is Domestic Income or Net Domestic Product at FC (NDPFC)?

Answer: Domestic Income, or Net Domestic Product at FC (NDPFC), is the sum-total of factor incomes generated by all the production units located within the domestic territory of a country during a period of account.

25. State any two precautions for the correct computation of national income by the income method.

Answer: Two precautions for the correct computation of national income by the income method are:

(i) Only factor incomes which are earned by rendering productive services are included. All types of transfer income like old-age pension, unemployment allowance, and scholarship are excluded.
(ii) Income from illegal activities like smuggling and black-marketeering, as well as windfall gains like from lotteries, are not included.

26. Why are transfer incomes excluded from national income?

Answer: Only factor incomes earned by rendering productive services are included in national income. Transfer incomes are excluded because no productive service is rendered by the recipients in exchange for them.

27. Why are direct taxes like income tax included in national income calculation?

Answer: Direct taxes such as income tax, which are paid by employees from their salaries, and corporate tax, which is paid by a joint stock company from its profit, are included in the calculation of national income.

28. What are the main components of domestic income?

Answer: The components of domestic income (NDPFC) are: Compensation of employees, Operating surplus (Rent + Interest + Profit), and Mixed income.

29. Distinguish between remuneration in cash and remuneration in kind.

Answer: Remuneration in cash includes wages and salaries, dearness allowance, bonus, city compensatory allowance, house rent allowance, and leave travelling allowance. Remuneration in kind is in the form of goods and services and includes a rent-free quarter, free water and electricity, a free uniform, free services of vehicles, and the amount of interest on interest-free loans.

30. What is the difference between old-age pension and retirement pension?

Answer: The difference is that an old-age pension is a transfer payment, whereas a retirement pension is a part of the compensation of employees.

31. Define rent and royalty. How are they treated in national income?

Answer: Rent is a factor income earned from lending the services of land and buildings. Royalty is income earned by a landlord from granting leasing rights of sub-soil assets. In national income, domestic income includes both rent and imputed rent. Royalty is treated as a part of rent if not mentioned separately.

32. What is imputed rent? Why is it included in national income?

Answer: The rent of owner-occupied houses is called imputed rent. When the owner of a house stays in it instead of renting it out, he is assumed to have paid rent to himself. This market rent of a self-occupied house is labelled as imputed rent and is included in national income.

33. When is interest paid on a loan included in national income?

Answer: Interest paid on a loan is included in national income if the loan is used for productive purposes (value addition). It is not included if the loan is used for consumption purposes.

34. What are the three components of profit for a corporation?

Answer: The profit of a corporation is used for three main purposes, which are its components: corporate (or profit) tax, dividend, and undistributed profit.

35. What is a corporate tax? Is it a part of domestic income?

Answer: Corporate tax is the direct tax levied by the government on the profit of a company. It is a part of domestic income because it is actually earned by the company before being paid out as tax.

36. What is a dividend? Why is it considered a part of domestic income?

Answer: A dividend is that part of the profit of a corporate enterprise which it pays to its shareholders. It is considered a part of domestic income because it is paid by the company out of its total profit.

37. What is undistributed profit? What is its other name?

Answer: Undistributed profit is the balance of a company’s total profit that it keeps as a reserve fund after paying profit tax and distributing dividends. Its other names are corporate savings or retained income.

38. What is mixed income of the self-employed? Why is it termed ‘mixed’?

Answer: Mixed income is the income of self-employed persons like farmers and doctors, and unincorporated enterprises like small shopkeepers. It is termed ‘mixed’ because it is difficult to classify their income distinctly among rent, wages, interest, and profit, as they use their own resources. Therefore, such income is treated as a mixture of rent, wages, interest, and profit.

39. What is the income of the public (government) sector? What are its two components?

Answer: The income of the public sector has two components. The income of government administrative departments and departmental enterprises is called ‘income from property and entrepreneurship accruing to government administrative departments’. The income of non-departmental enterprises is called ‘savings of non-departmental enterprises’.

40. How is income from domestic product accruing to the private sector calculated?

Answer: Income from domestic product accruing to the private sector is calculated by deducting the surplus of the public sector from the domestic product.

Symbolically:
Income from Domestic Product accruing to Private Sector = Domestic Product – Surplus of public sector.

41. What is Personal Disposable Income? What is it used for?

Answer: Personal disposable income is the total amount of money available for an individual or population to spend or save after taxes have been paid. It is used to calculate the household savings and spending rates of a particular area for a given period of time.

42. What is the Expenditure Method of measuring national income?

Answer: The expenditure method measures the final expenditure on Gross Domestic Product at market price (GDP at MP) during a period of account. Under this method, national income is calculated first by adding up all the items of final consumption expenditure and final investment expenditure within the domestic economy.

43. What aggregate is calculated first using the expenditure method?

Answer: Using the expenditure method, the first aggregate calculated is the sum of all items of final consumption and investment expenditure within the domestic economy. This resulting total is called GDP at MP.

44. State any two precautions for the correct estimation of national income by the expenditure method.

Answer: Two precautions for the correct estimation of national income by the expenditure method are:

(i) To avoid double counting, expenditure on all intermediate goods and services is excluded.
(ii) Expenditure on the purchase of second-hand goods is excluded from national income because this type of expenditure is not on currently produced goods.

45. Why is government expenditure on transfer payments excluded from national income?

Answer: Government expenditure on transfer payments such as scholarships, unemployment allowance, and old-age pensions is excluded because no productive service is rendered by the recipients in exchange.

46. Why is expenditure on the purchase of old shares or bonds excluded?

Answer: Expenditure on the purchase of old shares or bonds is excluded because it is not a payment for goods or services that are currently produced. It shows a mere transfer of property from one person to another.

47. What are the main components of final expenditure on GDP?

Answer: The main components of final expenditure on GDP are:

Private final consumption expenditure.
Government final consumption expenditure.
Gross fixed capital formation.
Change in stocks.
Net exports.

48. What is private final consumption expenditure?

Answer: Private final consumption expenditure refers to the expenditure on the purchase of goods and services by households and non-profit institutions for current use during a time period.

49. What is government final consumption expenditure?

Answer: Government final consumption expenditure is defined as the “Current expenditure on goods and services incurred in providing services of government administrative departments less sales.”

50. What does ‘change in stocks’ refer to? How is it measured?

Answer: ‘Change in stocks’ refers to the physical change in stocks of inventories like raw material, semi-finished goods, and finished goods lying with producers. It is measured by subtracting the opening stock from the closing stock.

51. What are net exports? How are they calculated for GDP?

Answer: Net exports are exports less imports. It is the difference between the exports (X) and imports (M) of a country during a particular time period. For calculating GDP, the value of exports is added because it represents expenditure by foreigners on domestically produced goods, while the value of imports is deducted because it represents expenditure by domestic residents on foreign goods.

52. Explain the circular flow of production, income, and expenditure in an economy.

Production of goods and services is the result of the combined efforts of factors of production (land, labour, capital, and enterprise). The net output emerging from the production process gets distributed as remuneration in the form of money income (rent, wages, interest, and profit) among factors of production. Thus, production generates income. Production flow gives rise to income flow. With this income, factors of production purchase goods and services for final consumption and investment. In this way, income creates expenditure, or income flow gives rise to expenditure flow.

In short, production generates income, income creates expenditure, and expenditure, in turn, calls forth production. Thus, incomes which originate in production units ultimately come back to them by way of expenditure on goods and services by factor owners. This makes the circular flow of production, income, and expenditure complete. The circular flow does not end here because expenditure, in turn, gives rise to further production.

53. Describe the steps involved in estimating national income using the Value Added Method.

Answer: The following steps are involved in estimating national income by the Value Added method (Product method):

Step 1 – Identify all the producing units in the domestic economy and classify them into three industrial sectors such as primary, secondary, and tertiary sectors on the basis of the similarity of their activities.
Step 2 – Estimate net value added at FC by each producing unit by deducting intermediate consumption, depreciation, and net indirect taxes from the value of output; we get net value added at FC.
Step 3 – Estimate the net value added of each industrial sector by summing up the net value added at FC of all producing units falling in each industrial sector.
Step 4 – Compute Domestic Income (NDP at FC) by adding up NVA at FC of all industrial sectors.
Step 5 – Estimate net factor income from abroad which is added to Domestic Income for deriving National Income (NNP at FC).

54. Explain any four precautions that must be taken while calculating national income using the Value Added Method.

Answer: While calculating national income by the value added method, the following precautions should be taken:

(i) The imputed rent of owner-occupied houses should be included.
(ii) The sale of second-hand goods should not be included because they are not fresh production activity. However, brokerage or commission paid to facilitate the sale is included as it is a fresh production activity.
(iii) Services for self-consumption by a housewife are not included as it is difficult to estimate their market value.
(iv) The income of a smuggler is an illegal activity, and all illegal activities (like smuggling, gambling, black-marketeering, etc.) are excluded from the national income.

55. What is the problem of double counting? How can this problem be avoided?

Answer: Double counting means counting the value of the same product (or expenditure) more than once in calculating national income. In the Final Product (Output) Method, the problem of double counting arises. In actual practice, while taking the value of final goods, the value of intermediate goods also gets included separately because every producer treats the commodity he sells as a final product. In this way, certain items are counted more than once, resulting in an over-estimation of the national product.

The significance of the value added method is that it avoids the problem of double counting which arises when the Final Product (output) method is used. Under the value added method, only the value added by each production unit is included, not the total value of output, which avoids double counting.

56. Explain the Income Method for measuring national income. What are the main steps involved in this method?

Answer: The Income Method measures national income from the side of payments made to the primary factors of production in the form of rent, wages, interest, and profit for their productive services in an accounting year. Thus, income is calculated by adding up factor incomes generated by all the producing units located within the domestic economy during a period of account. The resulting total is called Domestic Income or Net Domestic Product at FC (NDPFC). By adding net factor income from abroad to domestic income, we get National Income (NNPFC).

The main steps involved in estimating national income by the income method are:

Step 1 – Identify enterprises which employ factors of production (land, labour, capital, and enterprise).
Step 2 – Classify factor payments into various categories like rent, wages, interest, profit, and mixed income (or classify factor payments into compensation of employees, mixed income, and operating surplus).
Step 3 – Estimate the amount of factor payments made by each enterprise.
Step 4 – Sum up all factor payments made within the domestic territory to get Domestic Income (NDP at FC).
Step 5 – Estimate net factor income from abroad which is added to Domestic Income to derive National Income.

57. What is ‘Compensation of Employees’? Explain its components with suitable examples.

Answer: Compensation of Employees (traditionally called Wages) is the reward or compensation paid to employees (labour) for rendering productive services. It includes:

(i) Wages and salaries paid both in cash and kind and
(ii) Employer’s contribution to social security schemes.

Remuneration in cash includes wages and salaries, dearness allowance, bonus, city compensatory allowance, house rent allowance, leave travelling allowance, etc. Remuneration in kind (i.e., in the form of goods and services) includes a rent-free quarter, free water and electricity, a free uniform, free services of vehicles (car, scooter), and the amount of interest on interest-free loans, etc.

The employer’s contribution to social security schemes consists of contributions to life insurance, casualty insurance, provident fund, pension schemes, etc.

58. Explain the components of ‘Operating Surplus’ in the context of the income method.

Answer: In the context of the income method, Operating Surplus is a component of domestic income. Broadly, domestic income (NDPFC) consists of Compensation of employees, Operating surplus (Rent + Interest + Profit), and Mixed income.

The components of Operating Surplus are:

Rent and Royalty: Rent is a factor income earned from lending the services of land and buildings. Royalty is income earned from granting leasing rights of sub-soil assets.
Interest: Interest is the price for the funds borrowed. It is a factor income to the lender of funds.
Profit: Profit is the residual factor payment to the owners of production units for organising production and undertaking attendant risks. Profit itself has three components:
(i) Corporate (Profit) Tax: This is the direct tax levied by the government on the profit of a company.
(ii) Dividend: This is the part of the profit of a corporate enterprise which it pays to its shareholders.
(iii) Undistributed Profit (Savings of Corporate Sector): This is the balance of profit a company keeps as a reserve fund after paying profit tax and distributing dividends.

59. Distinguish between Domestic Income and National Income. How is one derived from the other?

Answer: Domestic Income (NDP at FC) is the sum-total of factor incomes generated by all the production units located within the domestic territory of a country during an accounting year. It does not matter whether the producer is a normal resident or a foreigner. Domestic income is a territorial concept.

National Income (NNP at FC) is the sum-total of factor incomes earned (generated) by normal residents of a country during an accounting year. National income includes factor incomes earned by normal residents within and outside the country. It is an economic concept.

Simply put, income generated by residents and non-residents within the domestic territory of a country is called domestic income, and income generated by normal residents within and outside the country is called national income. The difference between the two is net factor income from abroad, which is added to domestic income to get national income.

Symbolically: National Income = Domestic Income + Net factor income from abroad.

60. Explain the concept of ‘Income from Domestic Product accruing to Private Sector’. How is it derived from Domestic Product?

Answer: That part of Domestic Product which accrues to the private sector is called ‘Income from domestic product accruing to private sector’. Domestic product is sub-divided into two parts: the private sector and the government or public sector.

To derive the income from domestic product accruing to the private sector, we deduct the surplus of the public sector from the domestic product. The surplus of the public sector has two components: income from property and entrepreneurship accruing to government administrative departments, and savings of non-departmental enterprises.

Symbolically, it is derived as follows:
Income from Domestic Product accruing to Private Sector = Domestic Product – Income from property and entrepreneurship accruing to govt. administrative departments – Savings of non-departmental enterprises.
or
Income from Domestic Product accruing to Private Sector = Domestic Product – Surplus of public sector.

61. Differentiate between Private Income, Personal Income, and Personal Disposable Income with the help of formulas.

Answer: Private Income: Private income is the total of factor incomes received from all sources by the private sector, that is, private households and enterprises within and outside the country. It includes net factor income from abroad and also transfer incomes received by the private sector.
Private income = National income – Income from domestic product accruing to govt. sector + Transfer incomes.

Personal Income: Personal income is the sum of earned income and transfer income received by persons (households) from all sources within and outside the country. In personal income, we do not include corporate tax and undistributed profits because corporate tax goes to the government and undistributed profits are retained/reinvested by the company.
Personal Income = Private income – Corporate tax – Undistributed profits.

Personal Disposable Income: Personal disposable income is the total amount of money available for an individual or population to spend or save after taxes have been paid. It is the total personal income minus personal current taxes.
Personal Disposable Income = Personal income – Personal current taxes income.

62. Explain the Expenditure Method of measuring national income. What are the main steps involved?

Answer: The expenditure method measures final expenditure on Gross Domestic Product at market price (GDP at MP) during a period of account. Since all domestically produced goods and services are purchased for final use either by consumers for consumption or by producers for investment, we take the sum of final expenditure on consumption and investment. This sum equals GDP at MP. The resulting total is called GDP at MP. By subtracting depreciation and net indirect taxes from GDP at MP and adding to it net factor income from abroad, we get NNP at FC or national income.

The expenditure method involves the following steps:

Step 1 – Identification of economic units incurring final expenditure, e.g., household (or consuming) sector, firm (or producing) sector, and government sector.
Step 2 – Classification of final aggregate expenditure into components like private final consumption expenditure, government final consumption expenditure, gross fixed capital formation, change in stocks, and net exports. Summing up these components gives GDP at MP.
Step 3 – Measurement of final expenditure on the above components. The sum-total gives the value of GDP at MP. By deducting depreciation and net indirect taxes from GDP at MP, we get NDP at FC.
Step 4 – Estimation of net factor income from abroad which is added to NDP at FC (Domestic Income) to obtain NNP at FC (National Income).

63. Explain the components of ‘Final Consumption Expenditure’ in the expenditure method of calculating GDP.

Answer: Final Consumption Expenditure has two main components:

Private final consumption expenditure: It refers to expenditure on the purchase of goods and services by households and non-profit institutions for current use during a time period. This includes consumption expenditure by consumer households and private non-profit institutions serving households on all types of consumer goods (like clothes, cars, shoes, computers, T.V.-sets, milk, etc.) and services (like educational, medical, transport services).

Government final consumption expenditure: It is defined as “Current expenditure on goods and services incurred in providing services of government administrative departments less sales.” It is incurred by the government to satisfy the collective needs of the people. For example, government expenditure on health, education, general administration, law and order, etc., belongs to this category.

64. What is ‘Gross Domestic Capital Formation’? Explain its two main components, gross fixed capital formation and change in stocks.

Answer: Gross Domestic Capital Formation is a component of final investment expenditure in the expenditure method. It consists of two main components:

Gross fixed capital formation: This refers to the increase in the stock of fixed capital during a year, which includes depreciation. It includes expenditure on three items:
(i) Business fixed investment, which is the addition to machinery, factory buildings, and equipment.
(ii) Residential construction investment, which refers to the addition of housing facilities.
(iii) Public investment, which refers to capital formation by the government in the form of schools, hospitals, roads, canals, etc.

Change in stocks: This refers to the physical change in stocks of inventories like raw material, semi-finished goods, and finished goods lying with the producers for the smooth working of the production process. Change in stocks is measured by subtracting opening stock from closing stock.

65. Explain how exports and imports are treated in the estimation of national income through the expenditure method.

Answer: In the estimation of national income through the expenditure method, exports and imports are treated as ‘Net exports’, which is the difference between exports (X) and imports (M) of a country during a particular time period.

Since export implies expenditure by foreigners on the purchase of domestically produced goods, exports are a part of the domestic product (GDP).

Similarly, as import implies expenditure by domestic residents on the purchase of foreign goods produced abroad, they are not part of the domestic product.

Hence, the value of exports is added and that of imports is deducted when calculating GDP.

66. What is the Income Method of measuring national income? Explain in detail the various components of factor incomes used in this method.

Answer: The Income Method measures national income from the side of payments made to the primary factors of production in the form of rent, wages, interest and profit for their productive services in an accounting year. Thus, income is calculated by adding up factor incomes generated by all the producing units located within the domestic economy during a period of account. The resulting total is called Domestic Income or Net Domestic Product at FC (NDPFC).

Broadly speaking, components of domestic income (NDPFC) are: Compensation of employees, Operating surplus (Rent + Interest + Profit) and Mixed income. They are further sub-divided into the following individual factor incomes:

Compensation of Employees (traditionally called Wages): This is the reward or compensation paid to employees (labour) for rendering productive services. It includes (i) Wages and salaries paid both in cash and kind and (ii) Employer’s contribution to social security schemes.

Rent and Royalty: Rent is a factor income earned from lending the services of land and building, whereas royalty is income earned by the landlord from granting leasing rights of sub-soil assets. Domestic income includes not only rent but also imputed rent of owner-occupied houses.

Interest: Interest is the price for the funds borrowed. It is a factor income to the lender of funds. A production unit borrows money for making investment in business and pays interest in return.

Corporate (Profit) Tax: This is the direct tax levied by the government on the profit of a company. The company pays it out of its total profit. Profit tax, thus, is a part of domestic income since it is actually earned by the company.

Dividend: It is that part of the profit of a corporate enterprise which it pays to its shareholders in accordance with the number of shares held by the latter. Dividend is also a part of domestic income since it is paid by the company out of its total profit.

Undistributed Profit (Savings of Corporate Sector): A company, after paying profit tax and distributing dividend out of its total profit, keeps the balance as a reserve fund which is known as undistributed profit or corporate savings or retained income.

Mixed Income: This is the income of self-employed persons (like farmers, doctors) and unincorporated enterprises (like small shopkeepers) who use their own labour, capital, etc. It becomes difficult to classify their income distinctly among rent, wages, interest and profit, hence they are treated as mixed income.

67. Discuss the precautions that need to be taken while estimating national income using the Income Method. Provide reasons for each precaution.

Answer: For the correct computation of national income by the income method, the following precautions need to be taken:

(i) Only factor incomes which are earned by rendering productive services are included. All types of transfer income like old-age pension, unemployment allowance, and scholarship, are excluded because they are received without rendering any productive service.
(ii) Sale and purchase of second-hand goods are excluded since they are not part of the production of the current year. However, the commission paid on the sale of second-hand goods is included as it is a reward for rendering productive services. Likewise, sale proceeds of shares and bonds are not included as they are financial transactions.
(iii) Imputed rent of owner occupied dwellings and value of production for self-consumption are included. However, the value of self-consumed services like those of a housewife is not included because it is difficult to estimate their market value.
(iv) Income from illegal activities like smuggling, black-marketeering, etc., as well as windfall gains (e.g., from lotteries) are not included.
(v) Direct taxes such as income tax, which are paid by the employees from their salaries, and corporate tax, which is paid by the joint stock company from its profit, are included as they are part of factor income. But wealth tax and gift tax are excluded since they are deemed to be paid from past savings and wealth. Similarly, indirect taxes like sales tax and excise duties are not included as National Income is taken at Factor Cost (FC) and not at Market Price (MP).

68. Explain the Expenditure Method for estimating national income. Discuss its various components in detail.

Answer: The expenditure method measures final expenditure on Gross Domestic Product at market price (GDP at MP) during a period of account. Since all domestically produced goods and services are purchased for final use either by consumers for consumption or by producers for investment, we take the sum of final expenditure on consumption and investment. This sum equals GDP at MP. Under the expenditure method, national income is calculated first by adding up all the items of final consumption expenditure and final investment expenditure within the domestic economy.

The components of final aggregate expenditure are as follows:

Private final consumption expenditure: It refers to expenditure on the purchase of goods and services by households and non-profit institutions for current use during a time period. This includes expenditure on all types of consumer goods (like clothes, cars, milk) and services (like educational, medical, transport services).

Government final consumption expenditure: It is defined as “Current expenditure on goods and services incurred in providing services of government administrative departments less sales.” It is incurred by the government to satisfy the collective needs of the people, for example, expenditure on health, education, and law and order.

Gross fixed capital formation: This refers to the increase in the stock of fixed capital during a year, which includes depreciation. It includes expenditure on three items: (i) Business fixed investment, which is an addition to machinery and equipment; (ii) Residential construction investment, which refers to the addition of housing facilities; and (iii) Public investment, which is capital formation by the government in the form of schools, hospitals, roads, etc.

Change in stocks: This refers to the physical change in stocks of inventories like raw material, semi-finished goods and finished goods lying with the producers. It is measured by subtracting opening stock from closing stock.

Net exports (Exports less imports): This is the difference between exports (X) and imports (M) of a country during a particular time period. Since export implies expenditure by foreigners on the purchase of domestically produced goods, exports are a part of the domestic product. As import implies expenditure by domestic residents on the purchase of foreign goods, they are not part of the domestic product. Hence, the value of exports is added and that of imports is deducted.

69. Explain the inter-relationship among the different concepts of income: Domestic Income, National Income, Private Income, and Personal Income.

Answer: The inter-relationship among different types of income explains the steps for deriving one from another.

Domestic Income (NDP at FC): It is the sum-total of factor incomes generated by all the production units located within the domestic territory of a country during an accounting year. It is a territorial concept and does not include factor income earned from abroad.

National Income (NNP at FC): It is the sum-total of factor incomes earned by normal residents of a country during an accounting year. It includes factor incomes earned by normal residents both within and outside the country. The relationship between the two is:
National Income = Domestic Income + Net factor income from abroad.

Private Income: This is the total of factor incomes received from all sources by the private sector, that is, private households and enterprises, within and outside the country. It includes both earned incomes and transfer incomes received by the private sector. The relationship is:
Private income = National income – Income from domestic product accruing to govt. sector + Transfer incomes.

Personal Income: This is the sum of earned income and transfer income received by persons (households) from all sources within and outside the country. It is different from private income because it excludes the parts of private income that are not received by households, such as corporate tax and undistributed profits. The relationship is:
Personal Income = Private income – Corporate tax – Undistributed profits.

This shows a flow where we start with the income generated within a country’s territory (Domestic Income), adjust it for income from abroad to get the income of residents (National Income), then isolate the income of the private sector (Private Income), and finally determine the income actually received by households (Personal Income).

70. “All three methods of measuring national income—Value Added, Income, and Expenditure—should give the same result.” Explain this statement in the context of the circular flow of income.

The process begins with the production of goods and services, which is the result of the combined efforts of factors of production (land, labour, capital, and enterprise). This is the production phase.

The net output from the production process gets distributed as remuneration in the form of money income (rent, wages, interest, and profit) among the factors of production. Thus, production generates income. This is the income phase.

With this income, factors of production purchase goods and services for final consumption and investment. In this way, income creates expenditure. This is the expenditure phase.

In short, production generates income, income creates expenditure, and expenditure, in turn, calls forth production. This makes the circular flow of production, income, and expenditure complete. Since the three methods of measuring national income—Value Added (Production), Income, and Expenditure—are only different viewpoints of the same flow of goods and services, the totals from each method should, therefore, be equal to one another. We can look at national income as a flow of goods and services (Value Added Method), as a flow of income (Income Method), or as a flow of expenditure (Expenditure Method), and each should yield the same result.

Additional/extra MCQs

1: In the circular flow of national income, which phase follows the production phase?

A. Disposition
B. Expenditure
C. Distribution
D. Investment

Answer: C. Distribution

2: The Value Added Method of measuring national income is also traditionally known as:

A. Income Method
B. Expenditure Method
C. Product Method
D. Disposition Method

Answer: C. Product Method

3: What does “Value Added” refer to in the context of national income accounting?

A. Production of durable goods
B. Output minus intermediate consumption
C. Production of non-durable goods
D. Expenditure on intermediate goods

Answer: B. Output minus intermediate consumption

4: Which of the following is a component of “Compensation of Employees”?

A. Old-age pension
B. Employer’s contribution to social security schemes
C. Windfall gains
D. Corporate tax

Answer: B. Employer’s contribution to social security schemes

5: In which type of economy is domestic income equal to national income?

A. Open economy
B. Closed economy
C. Both (a) and (b)
D. Neither (a) nor (b)

Answer: B. Closed economy

6: The sum of factor incomes generated by all production units within the domestic territory of a country is known as:

A. National Income
B. Private Income
C. Personal Income
D. Domestic Income

Answer: D. Domestic Income

7: The expenditure method measures final expenditure on which aggregate?

A. Net National Product at Factor Cost (NNP at FC)
B. Gross Domestic Product at Market Price (GDP at MP)
C. Net Domestic Product at Factor Cost (NDP at FC)
D. Gross National Product at Market Price (GNP at MP)

Answer: B. Gross Domestic Product at Market Price (GDP at MP)

8: What is the term for the income earned by self-employed persons like farmers, doctors, and barbers?

A. Operating Surplus
B. Compensation of Employees
C. Mixed Income
D. Undistributed Profit

Answer: C. Mixed Income

9: Broker’s commission on the sale or purchase of second-hand goods is included in national income because:

A. it is part of gross capital formation
B. it is part of compensation of employees
C. it is income earned for rendering productive services
D. it is a transfer payment

Answer: C. it is income earned for rendering productive services

10: How is Net Domestic Product at Factor Cost (NDP at FC) derived from Gross Domestic Product at Market Price (GDP at MP)?

A. By adding depreciation and net indirect taxes
B. By subtracting depreciation and adding net indirect taxes
C. By adding depreciation and subtracting net indirect taxes
D. By subtracting depreciation and net indirect taxes

Answer: D. By subtracting depreciation and net indirect taxes

11: The difference between National Income and Domestic Income is:

A. Net indirect taxes
B. Depreciation
C. Net factor income from abroad
D. Net exports

Answer: C. Net factor income from abroad

12: Which of the following represents the formula for “Value of output”?

A. Sales – Change in stock
B. Sales + Intermediate consumption
C. Sales + Change in stock
D. Sales – Intermediate consumption

Answer: C. Sales + Change in stock

13: The part of a corporation’s profit that is paid to shareholders is called:

A. Corporate Tax
B. Undistributed Profit
C. Dividend
D. Retained Earnings

Answer: C. Dividend

14: Which sector produces goods by exploiting natural resources like fishing, mining, and logging?

A. Secondary sector
B. Tertiary sector
C. Primary sector
D. Service sector

Answer: C. Primary sector

15: Personal Disposable Income is defined as:

A. Personal Income + Personal current taxes
B. Personal Income – Personal current taxes
C. National Income – Corporate tax
D. Private Income – Undistributed profits

Answer: B. Personal Income – Personal current taxes

16: Which of the following is NOT a phase in the circular flow of national income?

A. Production
B. Income
C. Savings
D. Expenditure

Answer: C. Savings

17: Which of the following items should NOT be included while calculating national income by the value added method?

A. Imputed rent of owner-occupied houses
B. Sale of second-hand goods
C. Imputed value of goods for self-consumption
D. Brokerage on the sale of second-hand goods

Answer: B. Sale of second-hand goods

18: Which of the following is NOT a component of domestic income?

A. Operating Surplus
B. Compensation of employees
C. Net factor income from abroad
D. Mixed Income

Answer: C. Net factor income from abroad

19: Which of the following is NOT a component of final expenditure on GDP?

A. Private final consumption expenditure
B. Government final consumption expenditure
C. Expenditure on intermediate goods
D. Net exports

Answer: C. Expenditure on intermediate goods

20: Which of the following is NOT considered a factor income?

A. Rent
B. Wages
C. Interest
D. Scholarship

Answer: D. Scholarship

21: All of the following are components of profit EXCEPT:

A. Dividend
B. Corporate Tax
C. Interest
D. Undistributed Profit

Answer: C. Interest

22: When calculating national income using the expenditure method, which of the following is NOT excluded?

A. Expenditure on purchase of second-hand goods
B. Government expenditure on transfer payments
C. Expenditure on purchase of new shares/bonds
D. Expenditure on domestically produced goods by foreigners

Answer: D. Expenditure on domestically produced goods by foreigners

23: Which of the following is NOT included in the compensation of employees?

A. Wages and salaries in cash
B. Rent-free accommodation
C. Employee’s contribution to social security
D. Dearness allowance

Answer: C. Employee’s contribution to social security

24: Which of the following activities’ income is NOT excluded from the national income?

A. Smuggling
B. Gambling
C. Black-marketeering
D. Production for self-consumption

Answer: D. Production for self-consumption

25: Which of the following is NOT a part of private income?

A. Net factor income from abroad
B. Income from domestic product accruing to the government sector
C. Transfer incomes
D. Income from domestic product accruing to the private sector

Answer: B. Income from domestic product accruing to the government sector

26: Assertion (A): The value added method avoids the problem of double counting.
Reason (R): It subtracts the value of intermediate goods from the value of output at each stage of production.