Preface UNIT 5: NATIONAL INCOME AND RELATED AGGREGATES 1. Circular Flow of Income 2. Basic Concepts of Macroeconomics 3. National Income and Related Aggregates 4. Measurement of National Income UNIT 6: MONEY AND BANKING 5. Money 6. Banking: Commercial Banks and The Central Bank UNIT 7: DETERMINATION OF INCOME AND EMPLOYMENT 7. Aggregate Demand and Related Concepts 8. Income Determination and Multiplier 9. Excess Demand and Deficient Demand UNIT 8: GOVERNMENT BUDGET AND THE ECONOMY 10. Government Budget and the Economy UNIT 9: BALANCE OF PAYMENTS 11. Foreign Exchange Rate 12. Balance of Payments REVISION SECTION * Scanner CBSE (2007-2016) * Important Questions * Value Based, Evaluation & Multi-Disciplinary Questions * CBSE Sample Paper 2016-17 (with Answers) * CBSE Examination Paper 2016 (Delhi) (with Marking Scheme) {All India) Question Paper Appendix-1: Demonetisation in India * CBSE Examination Paper 2016 Contents (i) 14-414 24 -2.20 3.1-3.57 41-4125 5.1 -5.20 6.1-6.22 741 8.1 - 8.46 9.1-9.19 10.1 - 10.33 14.1-11.20 12.1-12.18 Ra -R24 R25 -R.28 R.29-A.34 R35 - R38 R39- AAS R.46-R48 R49 - R52 ‘scannea witn vamscanner1 CIRCULAR FLOW OF INCOME LEARNING GBJECTIVES' INTRODUCTION 1,2. MEANING OF CIRCULAR FLOW OF INCOME 1.3, STOCK AND FLOW 1.4 TYPES OF CIRCULAR FLOW 1.5 CIRCULAR FLOW IN A SIMPLE ECONOMY (TWO-SECTOR ECONOMY) 1.1 INTRODUCTION The unlimited and recurring wants of human beings have made the production process, a continuous process. In this process, different factors of production: Land, Labour, Capital and Enterprise are combined together for production of goods and services. * Firms produce goods and services with collective efforts of factors of production supplied by the household sector * Firm makes payment to the factors of production in the form of rent, wages, interest and profit (known as factor incomes). * The household sector spends this money on the purchase of goods and services produced by the firms. Thus, income flows first from firms to households in the form of factor payments and then, from households) to firms in the form of consumption expenditure. Such a flow of money is known as the circular flow of income. 41.2 MEANING OF CIRCULAR FLOW OF INCOME It refers to cycle of generation of income in the production process, its distribution among the factors of production and finally, its circulation from households to firms in the form of consumption expenditure on goods and services produced by them, Phases of Circular Flow of Income There are 3 different phases (generation, distribution and disposition) in circular flow of income, as shown in the given diagram: Ww Sexe tgs cannes witn vamscannerae Introductory Macroeconomi 1, Generation Phase: In this phase, firms produce goods and services with the help of factor services. Distribution Phase: This phase involves the flow of factor income (rent, wages, interest and profit) from firms to the households. Production Phaso {Goneration of incor) r 3, Disposition Phase:In this phase, the income received by factors of production, is spent on the goods and services produced by firms. In this way, income generated in production units Fail reaches back to production units and makes the circular flow complete. Expenditure Phaso (Disposition of Income) 41.3 STOCK AND FLOW The concepts of stock and flow are used frequently in macroeconomics. Some of the macro is important to understand variables relate to stock, while others relate to flow. Therefore, it their meaning so that variables can be categorised as stock or flow. Stock Stock variable refers to that variable, which is measured at a particular point of time, For example stock of goods in the gadown as on 31* January, 2019, It means, stock variables are not time dimensional. Some more examples of stock variables are National wealth, National capital, Money supply etc. Flow Flow variable refers to that variable, which is measured over a period of time. For example, production of goods during the month of January 2019, birth rate in the year 2018, National Income in the year 2018 are flow variables. The ‘period of time’ could be a day, a week, a year, etc. It means, flow variables are time dimensional as they are measured for a period of time. Examples for Better Clarity + The amount of water in tank is the quantity of water in Ste of water ina tank the tank at a given point of time. On the other hand, water flowing into the tank from a tap is a flow of water being, added to the tank per unit of time. © The total number of houses as on December 31, 2018 is the stock concept, while the number of houses constructed during the year 2018 is a flow variable. Flow of wate from tank Seavey tgs cannes witn vamscannerCircular Flow of come Difference het Basis | 2 Stock and Flow Stock Meaning | Stock variable reters to that variable, | which is measured at a particular pein! oftime, “Flow Flow variable refers to that variable, Which is measured over a period of uno, Time Ndoes not have atime dimension. | it has a time dimension as iie| imension magnitude can be measured over a Period of time. Nature of Itls a static ‘concept. Itis a dynamic concept. concept Examples | 1. Population of india as on 31.03.18, |1. Nomberol births during 2018. 2. Total number of Maruti cars in Delhi. |2. Maruti cars manufactied during January, 2019, 3. Money supply (money in circulation). | 3. Exponditure or transactions in money. 4, National Wealth, 4, National Income. 5. Quantity of wheat stored, 5, Quantity of wheat produced, 1.4 TYPES OF CIRCULAR FLOW There are two types of circular lows: (i) Real flow; (i) Money Flow. Real Flow Real flow refers to the flow of factor services from households to firms and the correspondiny flow of goods and services from firms to households. As seen in the diagram, households provide factor services Factor Services ——_ to the firms which, in turn, provide goods and services to itand Labo Capt ar Crerprve) them as a reward for their productive services. Wousanoiae Ga * Itis also known as ‘Physical flow’. t * There is only exchange of goods and services between Goods and Services —! the two sectors without involvement of any money. Fig. 1.2 * Real flow determines the magnitude of growth process in an economy. For example, wher more factor services are offered to firms, then volume of production will be more and i speeds up the process of economic growth. Money Flow Money Flow refers to flow of factor payments from firms to cenungun households for their factor services and corresponding flow eae — of consumption expenditure from households to firms for purchase of goods and services produced by the firms. Househorde os As seen in the diagram, firms make factor payments to t - 7 i i ischolds spend this 12 —| households for their factor services and house reco Deyn tinction purchase of goods and services produced by the or om ae firms. cannes witn vamscanner4 Introductory Macroeconomics * Itis also known as ‘Nominal flow’. + Itinvolves exchange of money between the two sectors. Difference between Real Flow and Money Flow Basis Real Flow Money Flow Meaning |Ilis the flow of goods and services |Itis the flow of money between firms between firms and households. and households. Kind of {It involves exchange of goods and | It involves exchange of money. exchange _| services. Difficulty in There may be difficulties of barter There is no such difficulty in case of exchange _ | systemin exchange of goods and factor | money flow. services. Alternative | Itis also known as Physical Flow. Itis also known as Nominal Flow. Name 4.5 CIRCULAR FLOW IN A SIMPLE ECONOMY (TWO-SECTOR ECONOMY) —_ A simple economy assumes the existence of only two sectors, i.e. household sector and firm sector. * Households are the owners of factors of production and consumers of goods and services. * Firms produce goods and services and sell them to the households. Itis the simplest form of closed economy"*, in which there is no government sector and foreign trade. *Closed Economy san economy which has no economic relations with rest of the world. Qpen Economy Is an economy which has economic relations with rest of the world. In order to make our analysis simple, we take some assumptions: 1. There are only 2 sectors in the economy: Households and Firms. It means, there is no government and foreign sector. Household sector supplies factor goctor Services services only to firmsand the firms hire [e0P tm four Domestic concepts. The term (+) Dop nr ‘Domestic’ signilies that contribution of only those producers (whether resident (NOP MP (cop at Fc) or non-resident) is lo be included who are within the domestic territory of the country. (+) NIT (-)Dep Gross National Product at Market Price (GNP, up) 1 refers to gross market value ofall the final goods and services produced by the normal residents of country during a period of one year. GNP p= GDP yp + Net factor income from abroad Seamed tps cannes witn vamscannerNational Income and Related Aggregates 33 Mmust be noted that GNP, pcan be less than GDP, when NFIA is negative. However r, GNP, il be ‘more than GDP,» when NFIA is positive. ” ene "GNP Gross National Product at Factor Cost (GNP) It refers to gross money value of all the final goods and services produced by the normal residents of a country during a period of one year. GNP, = GNP\yp— Net Indirect Taxes Net National Product at Market Price (NNPyyp) I refers to net market value of all the final goods and services produced by the normal residents of a country during a period of one year. NNP\yp= GNPyyp~ Depreciation Net National Product at Factor Cost (NNP;c) It refers to net money value of all the final goods and services produced by the normal residents of a country during a period of one year. NNPro NP \yp~ Net Indirect Taxes - Depreciation itmust be noted that NNP,- is also known as National Income. Relationship Between Four National Concepts GNP yp GNP,c, NNPyp and NNP,c > (GHP ame}, are tour National concepts. The term (+) Dop (Nr ‘National’ signifies that production of ‘only normal residents of the country isto LNNP at MP GNP at FC be included even if they are outside the [, domestic territory of the country. (+) NIT (-) Dep Domestic Income (NDP, .) Vs National Income (NNP}.) Bas Domestic Income National Income i tudes itis a terntorial concept as it includes | It is a national concept as it incl | eae the value 1 final goods and services | the value of final goods and services produced within domestic territory of | praduced in the entire world. country, r iti it considers all producers who are of | It considers all producers within the | | I Paxducera domestic territory of the country. normal residents of the country. ; NFIA I does not include NFIA. Itincludes NFIA. Seamed TpSomeer cannes witn vamscanner3.4 Introductory Macroeconomic, DOMESTIC INCOME fl (NOP) | | (-) Not Factor income from abroad (+) Depreciation | () Net inarect Taxes, | NP at MP GDP at FC T T ] (-) Depreciation (+) Not Indirect Taxes, GNP at MP GDP at MP | (+) Net Indirect Taxes (-) Depreciation | 1 GNP at Fo) NOP at MP_ t T (+) Net Factorincome (+) Depreciation trom abroad (-) Net Indirect Taxes NATIONAL INCOME (NNP,<) Gross Domestic Product at Market Price Vs National Income, Basis Gross Domestic Product at | National Income (NNPpc) te Market Price (GDPyp) Nature of His aterntonal concept as includes Itis a national concept as it includes Concept value of final goods and services the value of final goods and services produced within domestic torntory of | produced in the entire world. a country + Catagory of | i considers all the producers within | It considers the producers who are Producers _| the domestic territory of the country. | normal residents of the country. Net Indirect | itis at market pice, .e includes net | Its at factor cost, 1. it excludes net taxes indirect taxes. indirect taxes Depreciation | It is inclusive of depreciation. Itdoes not include depreciation. Steps for Calculating Practicals of Basic Aggregates of National Income ight basic aggregates of National Income: | 4Domestic Concepts : GDPyp GDPp¢ NOPy» NOP ro ' 4National Concepts: GNPyp GNPpe NNPyp NNPre While solving practicals of National Income, we are often required to calculate one of the basi aggregate out of the other 7 aggregates. For better understanding of the steps, let us asad that we have to calculate NDPy¢ from GNPyyp? ‘The various steps are: Step 1. Formulate an equation by putting “Aggregate to be calculated on the left hand side’ and “Aggregate given on the right hand side’. Considering the given example, the equation will be: NDPr< = GNPyyp = Adjustments. Seamed tps cannes witn vamscannerNational income and Related Aggregates i Step 2. Identity the “Adjustments and calculate the answer, AS we have to calculate NOP, from GNPyp, there are thiee adjustments required * [Glin GNP yo signties Gross, ie. it includes depreciation. So, Depreciation will be subtracted fom GNP yp to arrive at NNPyp * Nin GNP yp signifies National, 1 @. includes Net Factor Income trom Abroad (NFIA). So, NFIA ‘ill be subtracted from NNPyp to arrive at NDP yp * MP" in GNP yp signifies Market Price. ie. it includes Net Indirect Taxes (NIT). So, NIT will be subtracted trom NDP yp to arnve at NDP. The equation will become: NDP,< = GNP» Depreciation - NFIA NIT. Alter putting the respective values of GNPyp, Depreciation, NFIA and NIT, we can calculate NDP... Let us understand this with the help of following illustrations: Illustration 1. Calculate NDP at FC. () GNP atMP (i) Depreciation (iii) Net Factor Income from Abroad (iv)_Net indirect taxes inthe gran question, NDP, is to be calculated from GNP,,.. It can be calculated through following steps: Step 1. Formulate an equation by putting 'NDP,.,on the left hand side’ and “GNPyp on the right hand side’. NDP, ¢ = GNPyp + Adjustments Step 2. Identity the Adjustments’ and calculate the answer. Depreciation, Net Factor Income from Abroad (NFIA) and Net indirect taxes (NIT) wilbe subtracted from GNP,» to arrive at NDP,<. NDP,, = GNPyp — Depreciation - NFIA - NIT = 8,000 - 600 - 300 - 700 NDP,< = 26,400 crores. Illustration 2. Calculate GDP at MP. () NNPat FC (ii) Depreciation (iii), Subsidies (iv) Factor Income from Abroad (v) Indirect Taxes (vi) Factor Income to Abroad Sexe tps scannea witn vamscannerIntroductory Macroeconomic, 3.6 Solution: inthe given question, GOP yp is to be calculated trom NNP,c. ltcan be calculated through following step, Step 1. Formulate an equation by putting GOPypon the Jetthand side’and'NNP,,on the right hand side. GDP yp = NNPre Adjustments Step 2. Identity the Adjustments’ and calculate the answer Depreciation and Net Indirect taxes (NIT) wil be addi (NFIA) willbe subtracted trom NNP,, to arrive al GDP yp GDP yp = NNP,, + Depreciation - NFIAY + NIT? = 2000 + 200 — ~ (110-50) + (180-70) GDP yp = 72,250 crores. ‘Note: NFIA* = Factor Income from Abroad - Factor Income to Abroad, NIT? = indirect Taxes ~ Subsidies ‘Solved Practicals’. led while Net Factor Income from Abroag For more practicals of Basic Aggregates of National Income, refer ‘Section 3.7: 3.3 SOLVED PRACTICALS _____———————————————————————————————— | Important Formulae ata Glance Net Indirect Taxes = Market Price - Factor Cost Depreciation = Gross Value - Net Value Net Factor Income from Abroad = National Value - Domestic Value GDP,¢ = GDP yp — Net Indirect Taxes NDPyp = GOPyp ~ Depreciation Domestic Income or NDP,- = GDP yp - Depreciation ~ Net Indirect Taxes GNPyp = GOP, + Net Factor Income from Abroad GNP ye = GNPyp~ Net Indirect Taxes NNPyp = GNP,» ~ Depreciation National Income or NP, = GNP,,»- Depreciation - Net Indirect Taxes Example 1. Calculate Domestic Income or NDP at FC Particulars Zin crores _| () GNP at MP 6,000 (i) Subsidies 200 (ii) Depreciation 100 (iv) Net Factor income from abroad 400 (v)_ Indirect tax 300 Solution: NDP at FC GNP at MP — Depreciation - Net Factor i i di enh oD pr a mone — income from abroad - (Indirect tax - Subsidies} Ans. NDP at FC = 75,400 crores Seamed tps cannes witn vamscannerNational Income and Related Aggregates 3? The Solution of Example 1 can also be presented as: i) — (ii) - ivy - 0) - (iy) 6,000 - 100 ~ 400 - 1300 - 200) = & 5,400 crores Ans. NDP at FC = Example 2. Calculate National Income or NNP at FC. 400 crores Particulars in crores (0 GOP at MP 5,500 (i) Consumption of Fixed Capital 300 (iil) Goods and Services Tax 120 (iv) Factor income from abroad 150 (v) Subsidies 70 (vi)_Factor income to abroad 250 Solution: National Income or NNP at FC = GDP at MP - Consumption of Fixed Capital + (Factor income from abroad - Factor income to abroad) - (Goods and Services Tax - Subsidies) = 5,500 ~ 300 + (150 - 250) - (120-70) = 5,050 crores Ans. NNP at MP = @ 5,050 crores Wwcrwo4aSorys Example 3. Calculate GNP at FC. NOP at MP Depreciation 4 (iii) Subsidies Factor income from abroad Factor income to the rest of the world Solution: Note: In the given example, only subsidies are (Add subsidies (as factor cost 1s to be calculated trom the market price): or taxes - Subsidies) and put value of indirect taxes as zero. given. There can be two ways to solve this: (ii) Write formula as: (Indirect GNP at FC / = NDP at MP + Depreciation + (Factor income from abroad — Factor income to the rest of the world) + Subsidies = 25,000 + 5,000 + (400 - 600) + 30 29,830 crores ‘The Solution of Example 2 can also be presented = NDP at MP + Depreciation + (Factor income of the world) - (Indirect tax - Subsidies) as: from abroad — Factor income to the rest Sexe tgs cannes witn vamscannerIntroquctory Macroeconomieg 25,000 + 5,000 + (400 - 600) - (0 - 30) = 729.830 crores Ans. GNP at FC= % 29,830 crores Example 4. Calculate GNP at MI" Particulars WW) Domestic Income or NDP at FC 3.200 (i) Dopreciation 400 (uy) Indirect Taxes 70 50 (iv)_Net Factor income to abroad Solution: NP at MP = NDP at FC + Depreciation - Net Factor income to abroad + Indirect Taxes | = 3,200 + 400 - 50 +70 Oey Phi EPEpome sep NOT © = % 3,620 crores Ans. GNP at MP = 23,620 crores reg eee 4300 Note: Net factor income to abroad means thal the pard amount is more than received amount. Example 5. Calculate Consumption of Fived Capital. !00 2 () National Income or NNP at FC (i), GOP at MP (ii) Net Indirect Tax (v)_Net Factor income from abroad Solution: GDP at MP = NNP at FC + Consumption of Fixed Capital - Net Factor income from abroad + Net Indirect Tax It means: Consumption of Fixed Capital = GDP at MP - Net Indirect Tax + Net Factor income from abroad - NNP at FC = 5,000 ~ 300 + 200 - 4,000 900 crores Ans. Consumption of Fixed Capital = % 900 crores Example 6. Calculate Net Indirect Tax. (i) GNP at MP (ii) Domestic income or NDP at FC. (ii), Depreciation (Wv)_Net Factor income from abroad Sexe tps cannes witn vamscannerNational Income and Re!atea Aggregates 3.9 Solution GNP at MP = NDPat FC + Deprec \ Tae, SHEE + Depreciation + Net Factor income from abroad + Net Indirect It means Net Indirect Tax GNP at MP ~ Depreciation - Net Factor income from abroad = NDP at FC 000 ~ 600 ~ (~) 400 ~ 6,200 = 2 600 crores Ans. Net Indirect Tay = 2 600 crores Example 7. Calculate Subsidies W) GNP at FC (i) Consumption of Fixed Capital (it) Indwect Taxes (iv) Factor income from abroad (v) NOP at MP Factor income to abroad Solution: GNP at FC = NDP at MP + Consumption of Fixed Capital + (Factor income from abroad ~ Factor income to abroad) - (Indirect Taxes - Subsidies) It means: Subsidies = GNP at FC - Consumption of Fixed Capital - (actor income from abroad - Factor income to abroad) + Indirect Taxes - NDP at MP 27,710 - 4,000 - (400 - 600) + 120 230 crores Subsidies = % 30 crores 24,000 An: Example 8. Calculate Factor Income to abroad. (i) GNP at MP 4,500 (ii) Replacement of Fixed Capital 100 (iii) Indirect Taxes 300 (iv) Subsidies 200 (v) Factor Income from abroad 700 (v)_NOP at FC 3,900 Solution: GNP at MP = NDP at FC + Replacement of Fixed Capital + (Factor Income from abroad ~ Factor Income to abroad) + (Indirect Taxes - Subsidies) It means: Factor Income to abroad ; = NDP at FC + Replacement of Fixed Capital + Factor Income from abroad + (Indirect Taxes - Subsidies) - GNP at MP Seamed TpSomens cannes witn vamscanner900 + 100 + 700 + (300 - 200) = 7300 crores 500 Ans. Factor Income to abroad = 2300 crores Note: Replacement of Fixed Capital 1s another name for Depreciation. Example 9. The net domestic product at market price of an economy is @ 4,500 crores. The capital stock is worth 34,000 crores and it depreciates at the 6 of 10% per annum, Indirect 2.20) crores, factor income from the rest of taxes amount to 7150 crores, subsidies amount to ores. Find aut the gross national the world is & 400 crores and to rest of the world is & 600 er product at factor cost. Solution: Gross National Product at Factor Cost (GNPy¢) = Net Domestic Product at Market Price + Depreciation income from abroad = 4,500 + 10's of 4,000 - (150 - 20) + (400 - 600) = 4,500 + 400 - 130 - 200 = & 4,570 crores ‘Ans. Gross National Product at Factor Cost (GNP gc) = & 4,570 crores —Net Indirect taxes + Net Factor Example 10. Calculate (a) Depreciation; (b) Subsidies: (¢) NDP at FC. GNP at FC Indirect Tax NOP at MP NNP at MP GNP al MP Solution: (a) Depreciation Pat MP - NNP at MP 07,000 ~ 1,00,000 7,000 crores (b) Subsidies = GNP at FC - GNP at MP + Indirect Tax = 95,000 - 1,07,000 + 14,000 = & 2,000 crores (c) NDP at FC = NDP at MP - (Indirect Tax - Subsidies) = 1,00,422 - (14,000 - 2,000) = % 88,422 crores Ans. (a) Depreciation = 8 7,000 crores; (b) Subsidies = 2 2,000 crores; (c) NDP at FC = % 88,422 crore Seamed tpSomees cannes witn vamscannerMEASUREMENT OF NATIONAL INCOME LEARNING OBJECTIVES 4.1. INTRODUCTION 4.2 VALUE ADDED METHOD 4.3 INCOME METHOD 4.4 EXPENDITURE METHOD. 4.5 RECONCILIATION OF THREE METHODS 4.6 TREATMENT OF DIFFERENT ITEMS IN NATIONAL INCOME 4.7 TREATMENT OF DIFFERENT ITEMS IN DOMESTIC INCOME 4.8 NATIONAL INCOME AT CURRENT PRICE AND CONSTANT PRICE 4.9 NOMINAL GDP AND REAL GDP 4.10 SOLVED PRACTICALS 4.1 INTRODUCTION National income s considered as the most comprehensive measure of the performance of an economy. However, its measurement is an extremely complicated task. * When the process of production takes place, then the factor incomes are paid to factors of production for their factor services. It means, there is an ‘Income Flow’ corresponding to the ‘Output loz". * Factors of production spend their income on purchase of goods and services by making consumption ‘Expenditure’. Thus, production gives rise to income, income results in expenditure, which in turn, generates income again. Similarly, National Income of a country can be measured by 3 different methods: 1. Value Added Method 2. Income Method 3. Expenditure Method. We have three different methods to measure the national income because production, income and expenditure are three different phases of circular flow of income. Use of a particular method depends on the availability of reliable data. the three methods give the same value of national income because they are sod ere te ame physical output at throe different phases. In india, the task of estimating ational income is entrusted with the Centra Statistical Organisation (CSO). 4A Seamed TpSomems cannes witn vamscanner42 Iniroductory Macroeconomicy 4.2 VALUE ADDED METHOD This method is used to measure national income in different phases of production in the circular flow. It shows the contribution (value added) of each producing unit in the production process, + Every individual enterprise adds certain value to the products, which it purchases from some other firm as intermediate goods. « When value added by each and every individual firm is summed up, we get the value of national income. Value added Method is also known as:()) Product Methods i) Inventory Method; il) Net Output Method, (iv) Industral Origin Method; and (v) Commodity Service Method. \ Concept of Value Added Value added refers to the addition of value to the raw material (intermediate goods) by a firm, by virtue of its productive activities. [tis the contribution of an enterprise to the current flow of goods and services. Its calculated asthe difference between value of output and value of intermediate consumption. Value Added = Value of Output - Intermediate Consumption Example of Concept of Value Added Suppose a baker needs only flour to produce bread. He purchases flour as inputs worth 2 500 from the miller and then by virtue of its productive activities, converts the flour into bread and sells the bread for & 700. In the given example: + Flour is an input (Intermediate goods) and its value of % 500 is termed as value of “Intermediate Consumption’. © Bread is the Output and its value of & 700 is termed as “Value of Output’. © Difference between the value of output and intermediate consumption is termed as ‘Value ‘Added!’ It means, that the baker has added a value of & 200 to the total flow of final goods and services in the economy « Value added by each producing enterprise is also known as the Gross Value Added at Market price (GVAxip) It means, value added by baker (8 200) can be termed either as Value added or GVA yp. * Sum total of GVAyp of all producing enterpris country during one year is equal to GDP yp (G LGVAyp= GDP yyy within the domestic territory of a ss Domestic Product at Market Price), i. Let us now understand ‘Intermediate Consumption’ and ‘Value of Output’ in detall. Intermediate Consumption and Final Consumption Intermediate Consumption refers to the expenditure incurred by a production unit on purchasing those goods and services from other production units, which are meant for resale or for using up completely (i.e. further production) during the same year. In the given example, expenditure on flour is intermediate consumption. Final Consumption refers to the expenditure on goods and services meant for final consumption and investment. In the given example, expenditure on bread is final consumption. Seavey rps cannes witn vamscannerNN Measurement of National Income 43 As discussed in the previous cha, merged with the value of tinal qo. inthe value of bread. However, apler. intormodiate goods include all those Inputs, whose valve is eds Foy exami, Hour an nermatate good as is valves merged any machinery purchased tor making bread is not an mermed ails value will not be included in the value of intermediate consump frmediare good fon. Imports are not Separately Included If value of intermediate consumption is given, then imparts are already incluted on th : not incluled separately as imports are " auc of intermediate consumption. However, if domestic purchases are specifically mentioned, then imports will also be included. Let us understand this through following cases: Calculate Intermediate Consumption in the following cases: Case 1: (i) Intermediate Consumption = & 1,200; (ii) Imports Ans. Intermediate Consumption = 2 1,200 ‘As imports are already included in the value of intermediate consumption. Case 2: (i) Purchase of raw material from domestic firm = % 500; ) Imports= @ 100 Ans. Intermediate Consumption = 2500 + 2100 = 7600 Imports are included as it is specifically mentioned that purchase of raw material is from domestic firm, Case 3: (i) Purchase of raw material = & 1,000; (ii) Imports= % 200 Ans. Intermediate Consumption = 71,000 Imports are not included as total purchase of raw material is given. Value of Output Value of output refers to market value of all goods and services produced during a period of one year. How to Measure the Value of Output? (i) When the entire output is sold in an accounting year, then: Value of Output = Sales (ii), When the entire output is not sold in an accounting year, then the unsold stock is added to les. Unsold stock is the excess of closing stock over opening stock and is the value of termed as ‘Change in Stock’. It means, Value of Output = Sales + Change in Stock Where, Change in stock = Closing stock - Opening stock One More way to Calculate Value of Output Itcan also be calculated as: Value of Output = (Quantity x Price) + Change in Stock Forexample, ifa firm manufactures 1,000 pairs of shoes annually and sells them @ 2 500 per pair {assuming change in stock is nil), then: Value of Output = 1,000 « 500 = 2 5,00,000 Exports are not Separately Included Like imports, exports are also not separatel sales are not specifically mentioned). In cas and exports. Let us understand this included in value of output if‘Sates’ are given (and domestic ofan open economy, sales include both domestic sales Seamed TpScmeer cannes witn vamscanner44 Introductory Macroeconome, Culalate Value of Output: Case 1: (i) Sales = % 2,000; (ii) Exports = = 400 Ans. Value of Output = % 2,000 As exports are already included in the value of sales. Case 2: (i) Domestic Sales = % 700; (ii) Exports= % 200 Ans. Value of Output = 7700 + £200 = * 900 Exports are included as domestic sales are specifically mentioned. Before we proceed with the steps needed to estimate national income, let us first group th, various production units into distinct industrial yroups or sectors. It is done because it is easier to estimate national income of a group of similar production units as compared to es for each production unit separately. mating (EP a ‘Allthe production unis of the economic torrtory are grouped into three broad groups: 1. Primary Sector: It ncludes production units explosting natural resources Vike land, water, clibsoll assets, ele. For example, farming, lishing. rnining, arumal husbandry. oresiry, ete itis primary as iis the source of basic raw materials lor the secondary sector. 2. Secondary Sector: It includes production units which are engaged 19 transforming one {ood into another good. Such an actly #8 called manulaciuring activity. These units sonvert raw materials into finished goods. For example, twms engaged in converting sugarcane into sugar, construction companies, power generation, ele Iis called Secondary because il depends on primary sector for raw materials. 3, Tertlary Sector:llincludes production units engaged in producing services. For example, transport, edueatan, nance. government administration, etc. This sector linds third place because is growth is primarily dependent on primary and secondary Sectors. Steps of Value Added Method The main steps for estimating national income by Value Added Method are: Step 1: Identify and classify the production units VALUE ADDED METHOD The first step is to identify and classify all the producing enterprises of an economy into primary, secondary and tertiary sectors. GVA,,p 01 Primary Sector (+) GVA,y» 0! Socondary Sector Step 2: Estimate Gross Domestic Product at Market Price Gross Domestic Product at Market Price (GOP) In the second step, Gross Value Added at Market Price (GVA) of each sector is calculated and sum total of GVA yp of all sectors give GDP yp. ie. LGVAgp= GDP aye {-) Depreciation (-) Net Indiroct Taxes Domestic Income (NOP) Step 3: Calculate Domestic Income (NDP) By subtracting the amount of depreciation and net indirect (+) NFIA, taxes from GDPyjp, we get domestic income, ie, NDP yc GDP yp — Depreciation ~ Net Indirect Taxes. sexe re scannea witn vamscannerMeasurement of National income 45 Step + Estimate net factor j income from abroad (NFIA\ i i / t In the final step, NFIA is added to domestic i vest Notation National Income (NNP,..) = NDP, + NEIA c re Precautions of Value Added Method The various precautions to be taken in V, 1, Intermediate Goods are not to be ncome to arrive at National Income. ‘alue Added Method are: included in the already included in the value of fin; double counting. Habional income: since such goods are al goods. If they are included again, it will lead to 2. Sale and Purchase of second-hand goods is not include. in which they were produced However, any comin «d:as they were included in the year and do not add to current flow of goods and service: : Sion or brokerage on sale or purchase of such goods will be included in the national income as it is a productive servi 3. Production of Services for self-consumption (Domestic Services) are nat included Domestic services like services of a housewife, kitchen gardening, etc. are not included in the national income since itis difficult (o measure their market value. These services are produced and consumed at home and never enter the market place and are termed as non-market transactions. ‘{t must be noted that paid services, like services of maids, drivers, private tutors, ate. should be included in the national income. 4, Production of Goods tor self-consumption will be included: in the national income as they contribute to the current output. Their value is to be estimated or imputed as they are not sold in the market. 5, Imputed value of owner-occupied houses should be included: People, who li houses, do not pay any rent. But, they enjoy housing services similar to those people who stay in rented houses. Therefore, value of such housing services is estimated according to market rent of similar accommodation. Such an estimated rent is known as imputed rent. 6. Change in stock of Goods (inventory) will be included: Net increase in the stock of inventories will be included in the national income as it is a part of capital formation. * Goods Produced for self-consumption are included in National Income: All the final goods produced within the country are nol necessanily sold in the market. A part of them is kep! by the producer for his own use and consumption. For example, farmers keep a major part of their produce for self-consumplion. Imputed value of such goods 1s included in national income. * Services Produced for self-consumption are not included in National income: Services like housewife working in her own house, doctor treating his own child or teacher teaching his own child will not be included in national income as itis difficull to ascertain their market value and such services are nol rendered for the purpose of earning income. in theirown Sexe tags cannes witn vamscanner46 Introductory Macroeconomics Problem of Double Counting In measu ng the National Income, the value of only final goods and services is to be included. However, the problem of double counting arises when value of intermediate goods is also included along with value of final goods. Double countin 6 of ant output more than once while pe sing trough varios s ages of production. A commodity passes through various stages of production before reaching the final stage, When value of the commodi likely to include the cost of inputs more than taken at each stage, i once. This leads to double counting. Let us understand this through the famous example of Farmer, Miller and Baker. IIs it for 8500 to miller (flour mill, for farmer to be zero, then © Farmer: Suppose, farmer produces 50) kg, of wheat and sel For farmer, wheat of 8 500 is a final product. (If intermediate cos is value added will be 8 500). © Miller: For miller, wheat is an intermediate good. Miller conv it for & 700 to a baker. Now, flour of & 700 is a final product fo miller = 700 - 500 = % 200) © Baker: For baker, flour is an intermediate good. B. sells the entire bread to final consumers for @ 1,000. Bre: the baker. (Value added by baker = 1,000 - 700 = % 300) Let us present the data in a chart Sells Bread FARMER [oO LER Sats eet, paKen = consumers | erts wheat into flour and sells the Miller. (Value added by aker manufactures bread from flour and .ad of & 1,000 is a final product for Yor 500 for 700 for 1,000 Output Whoat Flour Bread Value of Output %.500 2700 1,000 Value of input Zero ‘Wneat = % 500 Flour = ® 700 Value Added = 500 200 2300 In the given example, wheat is a final product for farmer, flour for miller and bread for bake Asa general practice, every producer treats his commodity as the final output. If means: Tot value of output = 500 + 700 + 1,000 = & 2,200. However, a careful examination reveals that each transaction contains the value of intermedia goods. © The value of wheat is included in the value of flour. © The value of flour is included in the value of bread. As a result, the values of wheat and flour are counted more than once. This causes t problem of double counting, It leads to over estimation of value of goods and services produc In order to know the correct value of national income, we must avoid this problem of dow! counting. Seamed TpSomen scannea witn vamscannerMeasurement of National Income How to Avoid Double Counting? ~ There are two alternative wa (i) Final Output Me s of avoiding double counting: thod: According to thi en Met Seco method, value of only final goods should be added. toate ational income. In the given example, value of bread of 8 1,000 sold to lal consumers should be taken in the national income. (i) Value - ; ded Method: Accordiny ig to this method, sum total of the value added by e: a Ls a alue added by each producing unit should be taken in the national income. In the given example, value added by farmer (® 500), miller (% 200) and baker ( 300) total of @ 1,000 should be included in the National Income. ‘Sum of Value Added = Sum of Factor Incomes Production means addition of value to the inputs through combined efforts of various factors Of production (land, labour, capital and enterprise). It means, value added (or NVA,c) is othing but the contribution made by diferent factors in the production process. So, every individual factor has a right to get back a share for the value added to the inputs. The producer distributes this NVA, among the owners ol factors of production as rent, wages. interest and proti So, it is rightly said that Sum of Value Added = Sum of Factor Incomes. (Refer solved example 24 and unsolved practical 21 and 22) 4.3 INCOME METHOD __ Income Method measures national income from the perspective of factor incomes. Under this method, incomes received by all the residents of a country for their productive services during a year are added up to obtain the national income. According to this method, all the incomes that accrue to the factors of production by way of wages, profits, rent, interest, etc. are summed up to obtain the national income. Income method is also known as ‘Distributive Share Method’ or Factor Payment Method’. Components of Factor Income The sum total of all the factor incomes earned within the domestic territory of acountry is known as ‘Domestic Income (NDP,,)’. System of National Accounts (SNA) 1993 (joint publication of United Nations and World Bank) has elaborated the following components of Income Method: 1. Compensation of Employees (COE): COE refers to amount paid to employees by employer for rendering productive services. It includes all the payments and benefits, which the ‘employees receive, directly or indirectly, from the employer. Compensation of Employees consists of 3 elements: (i) Wagesnd salaries in cast: It includesall monetary benefits like wages, salaries, bonus, dearness allowances, commission, etc, Any reimbursement of business expenses incurred by the employees will be excluded from COE as such expenses are part of intermediate consumption of business enterprises. Seavey tpScmeer cannes witn vamscanner8 Introductory Macroecononyes (ii) Wages anid salartes in kind: Itincludes all non-monetary benefits, Hike rent free home, free car, free medical and educational facilities, ete. An imputed value of these benefit, should be included in national income. However, it does not include any facilily which is necessary for work and in which employees do not have any discretion. For example, urvforms fo be worn during work only oF vehicles to be used for work only. Such payments are intermediate consumpiion of business enterprises, - It includes contributions made by (iii) Employers’ contribution to social security schemes employer for the social security of employees. For example, ete. The aim of such contributions is to ensure safety contribution to provident fund, gratuity, labour welfare funds, and security of life of the emptor Any contribution by third party (say. an insurance company) to an employee is not the part ‘Of COE as the insurance company is not the employer of injured worker. Any contribution by employees is also not included as such payments are made by the employees from GOE only, 2. Rent and Royalty: Rent is that part of national income which arises from ownership of land and building. Rental income includes both actual rent (rent of let out land) as well as wner occupied houses is imputed rent (rent of self-occupied properties). Imputed rent of ov calculated on the basis of market rental value of the house. Royalty refers to income received for granting leasing rights of sub-soil assets. For example, owners of mineral deposits like coal, iron ore, natural gas, etc. can earn income by giving rights of mining to the contractors. 3. Interest: Interest refers to amount received for lending funds to a production unit. Itincludes both actual interest as well as imputed interest of funds provided by the entrepreneur, ices only. “Interest income’ includes interest on loans taken for productive sei Interest income does not include: (i) Interest paid by government on public debt and interest paid by consumers as such interest is paid on loans taken for consumption purpos Gi) Interest paid by one firm to another firm. 4. Profit: Profit is the reward to the entrepreneur for his contribution to the production of goods and services. Itis the residual income, which an entrepreneur earns after payingall the other factors of production. The profit earned by an enterprise is used for 3 purposes: (i) Corporate Tax: Itis the direct tax paid by an enterprise to the government on the total profit earned by it. It is also known as Profit tax or Business tax. Seavey TpSomeer cannes witn vamscanner(i) Dividend: It refers to that part of Profit, which is paid to the shar of their shareholding. Itis also rs wcholdens on known as distributed profits. Git) Retained Earnings: It refers to that Part of profit, which is kept as reserve to m Spexprtel Contingencies or for business expansion. It is also known as Uh ofits or Savings of Private Sector or Reserves and Surplus. In short, Profit = Corporate Tax + Dividend + Retained Earnings Operating surplus is another term used in factor payments. It refers to total of income from property (rent + royalty + interest) and Income from entrepreneurship (prof) ‘So. Operating Surplus = Rent + Royalty + Interest + Profit] Operating surplus arises in both private and government enterprises. However, it does not arise in the general government sector as it works with the motive of social welfare. Its basic aim is to operate for the benefit of public. So, incomes like rent, interest and profit are nil in general government sector, 5. Mixed Income: It is the income generated by own-account workers (like farmers, barbers, etc.) and unincorporated enterprises (like retail traders, small shopkeepers, etc.). \tis the term used for any income th has elements of more than one type of factor income. Mixed income arises from productive services of self-employed persons, whose income includes wages, rent, interest and profit and these elements cannot be separated from each other. For example, income of a doctor running a clinic at his residence. * Incertain situations, accounts of most production units are not available to the estimators ‘of National Income. Moreover, due to different accounting practices, it is not possible for the estimators to clearly identity the components of different factor incomes. + So, when total factor payments can be estimated, but cannot be segregated into separate heads (COE, Rent and Royalty, Interest and Profits), hen an additional lactor payment, known as ‘Mixed Income’ is added. + This factor payment is also known as'Mixed Income of Self-Employed’ as this problem arises mainly in case of sell-employed people ike doctors, chartered accountants, consultants, etc. Seavey rapsomeer cannes witn vamscannery 4.10 Introductory Macroeconomics DOMESTIC INCOME (NDP,<) Rent and Royalty income | EOE ‘Compensation of Employees ‘Operating Surplus Steps of Income Method eps involved in estimating national income by Income Method are: INCOME METHOD The variou: Step 1: Identify and classify the production units. ing, Various factors of ‘Compensation of Employees. 4 Rent and Royalty + Interest + Profil + Mixed Income All the producing enterprises emplo: production are identified and classified into primary, secondary ctors. and tertia Step 2: Estimate the factor income paid by each sector. fied under the The factor incomes paid by each sector are class following heads: (i) Compensation of employees; (ii) Rent and Royalty; (iii) Interest; (iv) Profit; and (v) Mixed Income. (+) NFIA Step 3: Calculate Domestic Income (NDP,<) When factor incomes of all the sectors are summed up, we get domestic income (NDP,_). In short, NDP,c = Compensation of Employees + Rent and Royalty + hterest + Profit + Mixed Income ‘Domestic Income (NOP) Step 4: Estimate net factor income from abroad (NFIA) to arrive at National Income. ional Income (NNPj<), ie. In the final step, NFIA is added to domestic income to arrive at Na NNPye = NDP ye + Net factor income from abroad. Precautions of Income Method Following precautions are to be considered while estimating national income by Income Method: 1. Transfer Incomes (like scholars included in the National income because such receip! ips, donations, charity, old age pensions, etc.) are not re not connected zwith any productive no value addition. activity and there is 2. Income from sale of second-hand goods will not be included in national income as their original sale has already been counted. If they are included again, it would lead to double counting. However, any brokerage or commis ion agents on sale of such gous, will be included as it an income received for reuering productine service. ion received by brokers or comm Seamed TS cannes witn vamscannerMeasurement of National income ome from, do not contribute to current flan claims and involves However service. le of sh. 7 - bonds and debentures will not be of goads and sere 4 change of title only, + NY commission or broker included as sted finan nsactions These ial assets are mere paper On Stich financial as cls is included us it is a productive CRITI Capital gains i+ (come trom sa 3 (bonds, debentures, on eto Sale of Second-hand goods (say. old car) and tinancial assets those harrenctan C16) An iicome ansi tom such transactions is nla tater ncome te se tran 's are nol productive transactions and d o fansaclions. and do not add to the current tlow ot goods 4, Windfall gains (like income ‘ ( from lotteries, horse race, etc.) are not included as there is no productive activity connecte with them, 5. Imputed value of services Imputed value of owne consumption, ete. 0 and servic Provided by owners of production units will be included: T-occupied houses, interest on own capital, production for self- Ibe included as these are productite activities and add to the flow of goods 6. Payments out of past savings (like death duties, gift tax, interest tax, etc.) are not included in the National income because they are paid out of wealth or past savings and do not add to current flow of vods aud services. 4.4 EXPENDITURE METHOD Factor income carned by factors of production is spent in the form of expenditure on purchase of goods and services produced by firms * This method mea ures national income as sum total of final expenditures incurred by households, business firms, government and foreigner: © This total final expenditure is equal to gross dom E Final Expenditure = GDP yy © This method is also known as ‘Income Disposal Method’. Components of Final Expenditure ; Expenditure is undertaken by all the sectors of an economy: Households, Government, Firms tic product at market price, and the Foreign Sector. The various components of final expenditure are: COMPONENTS OF FINAL EXPENDITURE oo Prvaie Final) [Government Final] [ Grogs Domestic Consumption] } Consumption | |cartairormation| | Net Exports Expenditure Expenditure —— 4 £ ¥ Gross Fixod inventory | (Exporis],_ [imports capital Formation}‘*? | investment | | cx) || "ita Sava Taaer cannes witn vamscannera i TD al | 4.42 Introductory Macroeconong, 1. Private Final Consumption Expenditure (PECE): It refers to expenditure incurred households and private non-profit institutions serving households on all types of constane, Sous, ie. durable (except houses**), semi-durabl woods and services, © PECE = Household Final Consumption Expenditure + Private Non-Profit Institution, Serving Households Final Consumption Expenditure © PECE includes expenditures incurred by normal residents, whether in the domestic territory or abroad. So, any expenditure incurred by residents during their fore) tour/travel will be added in PFCE, However, any expenditure incurred by non-restdenty and foreign visitors in the domestic market will be ducted from PFC! “Note: The expenditure incurred on purchase or construction of owner-occupied houses Is treateg ‘as capital formation (included under Gross Residential Construction Investment) and not as durabje ‘consumption, Other costly consumer durables, like cars, air conditioners, washing machines, etc. arg included under PFCE. j E): It refers to the expenditure incurreg defence, law and order, im of social welfare 2. Government hin by general government on various administrative services lik education etc. Government produces goods and services with the ai out any intention of earning profits. Expenditure ( 1 Consumption TS ee ND GFCE is equal to cost of goods and services produced by government for collective use by the public These services are valued al their cost to the government as they are nol normally sold to the public It means, GFCE 1s calculated as: Government Final Consumption Expenditure = Intermediate Consumption of government + COE paid by government + Direct purchases Irom abroad for embassies and consulates located abroad - Sale ol goods and services produced by general government. 3. Gross Domestic Capital Formation (GDCE) or Gross Investment: It refers to the addition to capital stock of the economy. It represents the expenditure incurred on acquiring goods for investment by the production units located within the domestic territory. There are two components of GDCF: (i) Gross Fixed Capital Formation: It refers to the expenditure incurred on purchase of fixed ts, This expenditure is generally divided into three sub-categories: (a) Gross Business Fixed Investment: Iincludes expenditure on the purchase of new plants, machinery, equipments, etc (6) Gross Residential Construction Investment: It includes expenditure on purchast or construction of new houses by the households. (c) Gross Public Investment: It includes expenditure on construction of flyovers. roads, bridges etc. by the government. (i) Inventory hnvestment (Change in Stock): It refers to the physical change in the stock of ti material, semi-finished goods and finished goods lying with the producers. Itis included 8 an investment item because it represents the goods produced but not used for curred! Seed yYapScear cannes witn vamscanner‘Measurement of National Income consumption, It is calculated as the vg stock of the year, It means, GDCF = GDCF = difference between the closing stock and the opening Gross Fixed Capital Formation + Inver Gross Business Fixed Investment + + Gross Public Investment + Inve ntory Investment; or Gross Residential Construction Investment entory Investment. ‘Gross Domestic Capital Formation (or Gross Investment) Gross Fixed Capital Formation ‘richange instock)” " Closing Stock - Opening Stock Gross Business Gross Residenti ident r Fiedinvesiment - Constucten ‘este investment {tis important to understand that purchase of shares and debentures, either old or new, is not included in investment. For example. it | have purchased 500 shares of Reliance Industries. it may be an investment from my point of view, but for economy. itis simply a transfer of purchasing power and not an investment. Ge a da ead + Any Increase in stock of consumer goods with households is excluded from inventory investments its assumed thal such goods are consumed, the moment they are purchased. + Purchase of shares and debentures (either old or new) 1s not included in GCF as itis simply a transter of purchasing power and there 1s no addition to flow of goods and services. * Purchase o! second hand goods (like old house or old machinery) 's also not included in GDCF as such goods have been already included in the year of original purchase. 4. Net Exports (X - M): It refers to the difference between exports and imports of a country during a period of one year. «+ Exports (X) refer to expenditure by foreigners on purchase of domestic products. The exported have been produced within the country’s domestic territory. So, they are goods included in output of an economy. + Imports (M) ig the expenditure by residents on foreign products. Imports are deducted to obtain domestic product as they are not produced within the domestic territory. ad of treating exports and imports separately, the difference between the two is « Inste taken and is termed as Net Exports. Seamed tps cannes witn vamscanner414 Introductory Macroeconone, Caleulate Net Exports in the following cases: Case 1: (i) Exports = 2500; (ii) Imports = % 300 Ans Net Exports = £ 500 - 7300 = ¢ 200 Case 2: (i) Exports = © 600; (ii) Imports = 7700 Ans Net Exports = 2 600 ~ ¢ 700 = ~% 100 2200 Case 3: (i) Exports = 0; (ii) Import Ans Net Exports = 0 - £200 = - 200 ¢ 4: (i) Net Exports = 2 500; (ii) Imports = % 200 Ans. Net Exports = % 500 {As Net Exports are given, we will ignore imports 5: (i) Net Imports = % 200 ‘Ans Nel Exports = -% 200 {As Net Imports is positive, it means that Exports are less than Imports, 7350 {As Net Imports is negative, it means that Exports are more than Impons) Case 6: (i) Net Imports ‘Ans. Net Exports = % 350 Comparison Between Net Exports and Net Factor Income tram Abroad Basis I Net Exports ‘Net Factor Income from Abroad Meaning lt relers to difference between Itrelers to difference between factor income received from abroad and exporls and imports of goods and services. factor income paid abroad. Itis a national concept. Concept Itis a domestic concept. Factor/Non-Factor| it ncludes non-factor services. | It includes lactor services. Services Steps of Expenditure Method The steps involved in calculating National Income by Expenditure Method are: Step 1: Identify the Economic Units incurring Final Expenditure which incur final expenditure within the domestic territory, are classified ) Producing sector; (iv) Rest All the economic uni under 4 groups: (i) Household sector; i) Government sector; of the world sector. Step 2: Classification of Final Expenditure Final expenditures incurred by the above mentioned economic units are estimated and classified under the following heads: © Private Final Consumption Expenditure (PFCE) Government Final Consumption Expenditure (GFCE) Gross Domestic Capital Formation (GDCF) Net Exports (X-M). . Seamed TpSomens scannea witn vamscannerMeasurement of Naponal Income Thesum totalot tour comporne S16 ents of finalexpenditure gives Gross Domestic Product at Market Price (GDP yi). ie. GDP = PECE 6 GCE « GDcr +(X-M EXPENDITURE METHOD Step 3 Calculate Domestic Income (NDP,.) ‘ By subtracting the amount of depreciation and net indirect tayes trom GDP. we yet domestic income, ie. NDP,o = GDP yy ~ Depreciation — Net Indi (1 Depreciation Taxes (1 Not in Step 4 Estimate net factor income from abroad (NFIA) to arrive at National Income Domeste Income (NOP, ) In the final step. NFIA is added to domestic income [ane to arrive at National Income. National Income (NNP,.) = NDP). +NFIA Precautions of Expenditure Method The various precautions to be aken while using the Expenditure Method are: 1. Expenditure on Intermediate Goods will not be included in the nabonal income as it is already included in the value of final expeni counting of expenditures. ture. Ititis included again, it will lead to double 2. Transter Payments are not included as such payments are not connected with any productive activity and there ts no value addition. 3. Purchase of second-hand goods will not be included as such expenditure has already been included when thew were originally purchased. Such goods do not affect the current flow of ieier, any commission or brokerage on such goods is ineluded as at 1s a goods and services. Ho payment made for productive service. 4, Purchase of financial assets (shares, debentures, bonds etc.) will not be included as such transactions do not contribute to current flow of yoods and services. These financial assets are: mere paper claims and involv ange of title only. However, any commission or brokerage on such financial a included as it is a productive service 5. Expenditure on own account production (like production for self-consumption, imputed value of owner occupied houses, free services from general government and private non- profit institutions serving households) will be included in the national income since these are productive services. 4.5 RECONCILIATION OF THREE METHODS Since all the three methods are used to measure the value of the will provide the same National Income. The following chart shows the reconciliation of three methods used for calculating National Income. same physical output, they Seavey reer scannea witn vamscannerIntroductory Macroeconomics RECONCILIATION OF 3 METHODS Value Added Method woadacae Exponditure Method at Mi {-) Depreciation (+) Net Indirect Taxes GVAy,» of Pamary Sector (+) GVA,,, ol Secondary Sector (+) GVAy, of Tertiary Sector Gross Domestic Product et Price (GDPyp) ‘Compensation of Employoos Rent and Royally Interest Protit Mixed Income Domestic income (NOPrc) (1 NFIA Domestic Income (NOP) From the follor T (+) NFIA National Income (NNPpc) oer Prwate Final Consumphion Exponditor + Govornitiont Final Consumption Exper + Gross Domestic Capital Formation Not Exports Gross Domestic Product, at Market Price (GOP ys) (-) Depreciation (2) Net indirect Taxes Domestic Income (NOP yc) i (4) NFIA National Income (NNPyc) Example for Reconciliation of Three Methods data, calculate national income Method; and (c) Expenditure Method. by (a) Value Added Method; (b) Income Particulars [_fincrores (i) Gross value added by Primary Sector 1,600, (li) Gross value added by Secondary Sector 2,500 (ii) Gross value added by Tertiary Sector 1,200 (v)_ Compensation of employees 1,500 (v) Rent and Royalty 1,000 (vi) Interest 450 (vii), Mixed Income 600 (viliy Profit 550 (ix). Private final consumption expenditure 3,500 (x) Government final consumption expenditure 650 (xi) Gross domestic capital formation 1,300 (xii) Net Exports (9150 (xii) Net Indirect taxes 700 (xiv) Depreciation 500 (xv) Net Factor income trom abroad 400 se eee cannes witn vamscannertI Se aa Measurement of National income 437 NATIONAL INCOME BY 3 METHODS Value Added Methog Income i Income Method Expenditur 1.600 (GVA, of Primary Secon T00 eo penaiie Method fs) 2800 (GvA0% of Secontay Seca Comes or 3500 (Piva Fa! Comuaton (4) 1.200 (GVA of Tertiary Sector + 1.000 (Ret ae ya ~ ! + 450 (Interest) rom S00 |GOR 3608 tee nee) 500 (Depreciation) a ~ 700 (Wet indvoct Taxes) Nr . u 500 (Depreciation aqoo NOR 100 (NFIAY 00 (Deprecaron) + 100 (NIA) ‘4200 (NP) Too Wel deel Tes) £200 (NP, + 100 nFUA) aaa 7 4.6 TREATMENT OF DIFFERENT ITEMS IN NATIONAL INCOME National Income includ come earned (i.e. only factor income, not transfer income) by normal residents of the country as a reward for their productive services in the current year, 'tmeans, transfer payments, financial transactions, income trom sale and purchase of second-hand goods, non-market activities, windfall gains, etc. are not included in the National Income. Let first discuss the various items ‘not welded’ in the Nati al Income. No. | Items not Included in National Income Reason 1.| Transfer Incomes and Payments Iike| They are no! connected with any productive scholarship. old age pension, unemployment | activity and there is no value addition. allowance, gifts, expenditure on birthday dmarriage, pocket money. Remittances trom abroad, financial help to victims of natural calamity, meals to beggars, compensation Qiven to accident victims etc 2.| Compulsory Transfer Payments like interest | They are transfer payments and government tax, capital gains tax and indirect taxes. does not make any promise of providing services in return, tions do not contribute to current . le and purchase of financial assets like | Such transact r . shaves ponds debentures etc. flow of goods and services. These financial . " assels are mere paper claims and involves a change of title only. L 4, ‘¢ winning from lottery, horse | There is no productive activity involved with innit lottery, fs no . | Windfall Gains lik herg is no p race, contests etc. cannes witn vamscanner