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CHAPTER 6 Determination of National Income ™ Unit 1: National Income Accounting ™ Unit 2: Keynesian Theory  UNIT 1 National Income Accounting MEANING OF NATIONAL INCOME ‰ National Income is def...

CHAPTER 6 Determination of National Income ™ Unit 1: National Income Accounting ™ Unit 2: Keynesian Theory  UNIT 1 National Income Accounting MEANING OF NATIONAL INCOME ‰ National Income is defined as the net value of all economic goods & services produced within the domestic territory of a country in an accounting year plus the net factor income from abroad. ‰ According to the Central Statistical Organisation (CSO) ‘National income is the sum total of factor incomes generated by the normal residents of a country in the form of wages, rent, interest & profit in an accounting year’ National Income Accounting Limitations and Different concepts of Measurement of Challenges of National National Income National Income in India Income Computation NATIONAL INCOME ACCOUNTING National Income Accounting, pioneered by the Nobel prize-winning economists Simon Kuznets and Richard Stone, is the system of macro-economic accounts from the stage of production of goods and services to the stage of their final disposal. Like any other accounting system, the national income accounts first define concepts and then construct measures corresponding to these concepts. The Central Statistical Organisation (CSO) in the Ministry of Statistics and Programme Implementation (MoSP & I) is responsible for the compilation of National accounts statistics. At the State level, State Directorates of Economics and Statistics (DESs) have the responsibility of compiling their State Domestic Product and other aggregates. USEFULNESS OF NATIONAL INCOME ESTIMATES 1. National income accounts are fundamental aggregate statistics in macro economic analysis and it is more useful for emerging and transition economy. 2. National income estimates helps business to forecast the future demand for their products. 3. The estimates of national income show the composition and structure of national income in terms of different sectors of the economy, the periodical variations in them and the broad sectoral shifts in an economy over time.  4. Using national income estimates , the government can fix various sector-specific development targets for different sectors of the economy and formulate suitable development plans & policies to increase growth rates. 5. National Income statistics also provide a quantitative basis for macroeconomic modeling and analysis, for assessing and choosing economic policies and for objective statement as well as evaluation of governments economic policies. 6. National income estimates throw light on income distribution and the possible inequality in the distribution among different categories of income earners. It is also possible make comparisons of structural statistics, such as ratios of investment, taxes or government expenditures to GDP: 7. International comparisons in respect of incomes and living standards assist in determining eligibility for loans, and or other funds or conditions on which suh loans, and / or funds are made available. The national income data are also useful to determine the share of nation’s contributions to various international bodies 8. Combined with financial and monetary data, national income data provide a guide to make policies for growth and inflation. GROSS DOMESTIC PRODUCT (GDP) GDP refers to the money value of all goods & services produced within the domestic boundary of a country during a period of time.It includes value of the goods produced like mobile phone, T.V , furniture etc. and value of services like banking , insurance etc. Real GDP Nominal GDP 1. It refers to the GDP calculated at the 1. It refers to the GDP calculated at a base year price level. current year price level. 2. It is also known as GDP at constant 2. It is also known as GDP at current prices. prices. 3. Real GDP = Qty. of output × Base year 3. Nominal GDP = Qty. of Output × current Price level year price level 4. It is better and more reliable index of the 4. Comparatively, it is not a good index of welfare of an economy. the welfare of an economy. Real GDP is better index of the growth and welfare of an economy because real GDP changes due to change in only physical quantity and output. Hence, real GDP truly reflects the level of growth. GDP AND WELFARE Can the GDP of a country be taken as an index of the welfare of people in that country? There are many reasons to dispute the validity of GDP as a perfect measure of well-being. In fact, GDP measures our ability to obtain many requirements to make our life better; yet leave out many important aspects which ensure good quality of life for all. GDP measures exclude the following which are critical for the overall wellbeing of citizens. 268 Business Economics PW  1. Income distributions and, therefore, GDP per capita is a completely inadequate measure of welfare. Countries may have significantly different income distributions and, consequently, different levels of overall well-being for the same level of per capita income. 2. Quality improvements in systems and processes due to technological as well as managerial innovations which reflect true growth in output from year to year. 3. Productions hidden from government authorities, either because those engaged in it are evading taxes or because it is illegal (drugs, gambling etc.). 4. Nonmarket production (with a few exceptions) and Non-economic contributors to well- being for example: health of a country's citizens, education levels, political participation, or other social and political factors that may significantly affect well- being levels. 5. The disutility of loss of leisure time. We know that, other things remaining the same, a country's GDP rises if the total hours of work increase. 6. Economic 'bads' for example: crime, pollution, traffic congestion etc which make us worse off. 7. The volunteer work and services rendered without remuneration undertaken in the economy, even though such work contribute to social well-being as much as paid work. 8. Many things that contribute to our economic welfare such as, leisure time, fairness, gender equality, security of community feeling etc., 9. Both positive and negative externalities which are external effects that do not form part of market transactions 10. The distinction between production that makes us better off and production that only prevents us from becoming worse off, for e.g. defence expenditures such as on police protection. Increased expenditure on police due to increase in crimes may increase GDP but these expenses only prevent us from becoming worse off. However, no reflection is made in national income of the negative impacts of higher crime rates. As another example, automobile accidents result in production of repairs, output of medical services, insurance, and legal services all of which are production included in GDP just as any other production. GDP DEFLATOR GDP deflator refers to the ratio of Nominal GDP and Real GDP multiplied by 100. It is also known as the Price index. Formula Nominal GDP GDP deflator = × 100 Real GDP 1. GDP deflator indicates change in general price level. 2. It is a price index used to convert nominal GDP to real GDP. 3. Since nominal GDP and real GDP must be the same in the base year, the deflator for the base year is always 100. Determination of National Income 269 Determination of Nominal GDP and Real GDP Nominal GDP and real GDP can be determined in the following manner: Nominal GDP       = Real GDP × 100 Price Index Real GDP × Price Index Or,  Nominal GDP = 100 For example, if nominal GDP is ` 15,000 crores and real GDP is ` 12,000 crores, then 15, 000     GDP Deflator = × 100 = ` 125 12, 000 In the above example, we can also convert nominal GDP into real GDP with the help of GDP deflator: Nominal GDP 15, 000       Real GDP = × 100 = × 100 = ` 12, 000 GDP Deflator 125 Example. If real GDP = 600 and nominal GDP = 660, find GDP deflator (price index). Nominal GDP 660 Sol. GDP Deflator (Price Index) = × 100 = × 100 = 110 Real GDP 600 It shows increase in the general price level by 10%. If the real GDP is ` 520 and Nominal GDP is ` 650, calculate the price index Nominal GDP 650 Price Index = × 100 = × 100 = 125 Real GDP 520 Price Index = 125. Suppose nominal GDP of a country in year 2010 is given at ` 600 Crores and price index is given as base year 2010 is 100. Now let the nominal GDP increases to ` 1200 Crores in year 2018 and price index rises to 110, find out real GDP? Real GDP = (Nominal GDP / GDP Deflator) x 100 Real GDP = (1200 / 110) x 100 i.e. 1090.9 The deflator measures the current level of prices relative to the level of prices in the base year. Since nominal GDP and real GDP must be the same in the base year, the deflator for the base year is always 100. As you know, inflation is a closely monitored aspect of macroeconomic performance and a significant variable guiding macroeconomic policy. Using the GDP deflator, the inflation rate between two consecutive years can be compute using the following procedure: GDP deflator in year 2 − GDP deflator in year 1 Inflation rate in year 2 × 100 GDP deflator in year 1 270 Business Economics PW TRY YOUR UNDERSTANDING 6.1.1 1. Gross Domestic Product (GDP) of any nation (a) excludes capital consumption and intermediate consumption (b) is inclusive of capital consumption or depreciation (c) is inclusive of indirect taxes but excludes subsidies (d) None of the above Answer Key 1. (b) FACTOR INCOME AND TRANSFER INCOME Transfer Income Factor Income It is the income obtained without providing It is the income earned by providing factor any factor input. input. It is a one-sided income i.e. unilateral concept. It is two-sided income i.e. bilateral concept. It is an unearned income It is earned income. It is not included in the calcualtion of national It is included in the calculation of national. income. Examples: Gifts, Pocket Money etc. Examples: Rent, Interest etc. TRY YOUR UNDERSTANDING 6.1.2 1. Which of the following is an example of transfer payment? (a) Old age pensions and family pensions (b) Scholarships given to deserving diligent students. (c) Compensation given for loss of property due to floods (d) All the above Answer Key 1. (d) CIRCULAR FLOW OF INCOME ‰ Circular flow of income refers to the continuous circulation of production, income generation and expenditure involving different sectors of the economy. ‰ There are 3 different interlinked phases in a circular flow of income, namely: production, distribution & disposition as can be seen from the following figure. ‰ In the production phase, firms produce goods & services with the help of factor services. ‰ In the income or distribution phase, the flow of factor incomes in the form of rent, wages, interest and profits from firms to the households occurs. Determination of National Income 271  Production of Goods & Services Distribution as Disposition factor incomes Consumption/ (Rent, Wages, Investment Interest, Profit) ‰ In the expenditure or disposition phase, the income received by different factors of production is spent on consumption goods & services and investment goods. This expenditure leads to further production of goods & services & sustains the circular flow. Particulars Method 1 Method 2 Method 3 Phase of Production / Output Income Generation Income Disposition Measurement Names of Method ‰ Production ‰ Income Method, ‰ Expenditure Method, or or Method, or ‰ Product Method, ‰ Factor Income ‰ Disposable or Method, or Method, or ‰ Value added ‰ Factor Payment ‰ Income method, or Method, or Disposable ‰ Industrial origin ‰ Distributed Method Method, or Net Shares method output method National Income is a Flow of Production Flow of Production Flow of Production Broad Concept Approaches National Approaches National Approaches National income from the income from the income from the output side Distribution side Expenditure side National Income = Sum of value added Sum of Factor Sum of all by Producers Incomes expenditures INTERMEDIATE GOODS ‰ Intermediate goods refer to those goods which are used either for resale or for further production in the same year. They do not end up in final consumption, and are not capital goods either. ‰ They have derived demand. Intermediate goods are used up in the same year; if they remain for more than one year, then they are treated as final goods. 272 Business Economics PW ‰ Intermediate consumption consists of the value of the goods and services consumed as inputs by a process of production, excluding fixed assets whose consumption is recorded as consumption of fixed capital. ‰ Intermediate goods used to produce other goods rather than being sold to final purchasers are not counted as it would involve double counting. The intermediate goods or services may be either transformed or used up by the production process. ‰ For example, the value of flour used in making bread would not be counted as it will be included while bread is counted. This is because flour is an intermediate good in bread making process. Similarly, if we include the value of an automobile in GDP, we should not be including the value of the tyres separately. FINAL GOODS ‰ Final goods ref er to those goods which are used either for consumption or for investment. They are neither resold nor undergo further transformation in the process of production. ‰ The distinction between intermediate goods and final goods is made on the basis of end use: if the good is for consumption or investment, then it is a final good By ‘value added’ we mean the difference between value of output and purchase of intermediate goods. Value added represents the contribution of labour and capital to the production process THERE ARE 2 TYPES OF FINAL GOODS & SERVICES 1. Consumer Goods: Where the goods and services are used for final consumption by the consumer, it is called as Consumer Goods and services. E.g. Sugar used in making tea @ home, Television installed @ home, car used for personal use etc. 2. Producer Goods: Where the final goods and services are used in production of other goods and services are termed as Producers goods. E.g. Sugar used in making tea @ Restaurant, Television installed @ Restaurant, car used for passenger transportation etc. Goods & Services Free Goods Economic Goods ‰ Some goods which are free or having zero ‰ Economic goods are scarce in relation to prices Le we need not make any payment their demand and have an opportunity for them. Example: air, sunlight etc. cost. ‰ Free goods being abundant in supply do ‰ Unlike free goods, they are exchangeable not have scarcity and need no cost to in the market and command a price. obtain them. ‰ Value of free goods is not considered in ‰ Value of economic goods is considered in GDP. GDP. Determination of National Income 273  Type of Activities Economic Activity Non-Economic Activity ‰ All human activities which create goods ‰ These activities produce goods and and services that are exchanged in a services, but since these are not exchanged market and valued at market price in a market transaction they do not command any market value; ‰ The motive or the intent behind economic ‰ For eg hobbies, housekeeping and services activity is to earn a living. (livelihood of family members that are done out of motive) love and affection. TRY YOUR UNDERSTANDING 6.1.3 1. Non-economic activities are (a) those activities whose value is excluded from national income calculation as it will involve double counting (b) those which produce goods and services, but since these are not exchanged in a market transaction they do not command any market value (c) those which do not involve production of goods and services as they are meant to provide hobbies and leisure time activities (d) those which result in production for self consumption and therefore not included in national income calculation Normal resident Answer Key 1. (b) NORMAL RESIDENT ‰ Normal resident of a country refers to an individual or an institution who ordinarily resides in the country and whose center of economic interest also lies in that country. ‰ Normal residents include both, individuals and Institutions. ‘Centre of Economic Interest’ implies two things: 1. The resident lives or is located within the Domestic Territory; and 2. The resident carries out basic economic activities of earnings, spending and accumulation from that location. Following are not included under the category of Normal residents: 1. Foreign tourists and visitors who visit a country for recreation, holidays, medical treatment, study, sports, conferences, etc. 2. Foreign staff of Embassies, officials, diplomats and members of the armed forces of a foreign country, located in the given country. 3. International organisations like UNO, WHO, etc. are not considered as normal residents of the country in which they operate. They are treated as the normal residents of international area. 274 Business Economics PW  4. Employees of international organisations are considered as residents of the countries to which they belong and not of the international area. For example, an American working in UNO office located in India will be treated as normal resident of America. However, if the employees are working for more than one year in such International Institutions, then they become the normal resident a country in which such institutions are located. It means, in the given example, if the American is working in UNO office in India for more than one year, then he will be treated as normal resident of India. 5. Crew members of foreign vessels, commercial travellers and seasonal workers, provided their stay is less than one year. 6. Border workers who live near the international border and cross the border on a regular basis to work in the other country. They are treated as normal residents of the country where they live, and not where they work. TRY YOUR UNDERSTANDING 6.1.4 1. The concept of 'resident unit' involved in the definition of GDP denotes (a) A business enterprise which belongs to a citizen of India with production units solely situated in India. (b) The unit having predominant economic interest in the economic territory of the country for one year or more irrespective of the nationality or legal status. (c) A citizen household which had been living in India during the accounting year and one whose economic interests are solely in India. (d) Households and business enterprises composed of citizens of India alone living in India during the accounting year. 2. Identify the following as Normal Residents of India: (a) Indian officials working in the Indian Embassy in USA. (b) A Japanese tourist who stays in India for 2 months. (c) Indians going to Pakistan for watching the cricket match. (d) Indians working in the UNO office, located in America for less than 1 year. (e) Indian employees working in WHO, located in India. (f) Foreign tourists visiting India for a month to see the Taj Mahal. (h) Indian Muslims going for the Haj pilgrimage. Answer Key 1. (b) 2. (a), (c), (d), (e), (g) DOMESTIC TERRITORY ‰ Domestic territory refers to geographical or political boundary of country. ‰ It excludes- international institutional (United nations, WHO, WTO) and foreign embassies located within geographical territory but includes embassies of this country located outside its geographical territory ‰ Indian Ship and Indian aircrafts performing operations outside country is also included in domestic territory. Determination of National Income 275 TRY YOUR UNDERSTANDING 6.1.5 1. Which of the following are covered under the domestic territory of India? (a) An Indian Company in London. (b) Microsoft Office in India. (c) Company in India owned by a Japanese. (d) Office of Reliance Industries in New York. (e) Branch of Foreign Bank in India. (f) Indian Embassy in Japan. (g) Branch of State Bank of India in China. (h) Russian Embassy in India. (i) Tata rented its building to Google in America. Answer Key 1. (b), (c), (e), (h) NATIONAL INCOME DOES NOT INCLUDE ‰ Purchase and sale of second hand goods as their money value has already been included in the national income of the year in which they were originally produced. ‰ Purchase and sale of securities, as it is just a transfer of ownership title. [However services provided by agent in regards to purchase and sale of second hand goods and securities for commission is included in national income as it amounts to provision of new service.] ‰ Transfer payments, as it is just shifting of purchasing power and no economic activity is involved. Eg. Pocket money provided by parents to their children, pension to senior citizen by government etc. It can be received either within the domestic territory of a country or from abroad. Examples: Old age pension, scholarship, unemployment allowance, pocket money, etc. Taxes received by the government are the transfer incomes of the government as they are received without providing any productive service in return. Similarly, subsidies paid by the government are transfer payments of the government. CURRENT TRANSFER vs CAPITAL TRANSFERS Transfer receipts are of two types: ‰ Current Transfer; ‰ Capital Transfer. 1. Current transfers are made out of income, whereas, capital transfers are made out of the wealth of the payer. 2. Current transfers are generally regular in nature, whereas, capital transfers are irregular. 276 Business Economics PW  3. Current transfers are meant for consumption purposes, whereas, capital transfers are meant for capital formation. 4. Examples of Current transfers: Old age pension, gifts, unemployment allowance, etc. Examples of Capital transfers: Investment grant, capital gains tax, war damages, etc. GROSS INVESTMENT, NET INVESTMENT AND DEPRECIATION Investment or capital formation refers to addition to the capital stock of an economy. For example, construction of building, purchase of machinery, addition to inventories of goods, etc. Investment can be looked up in two forms: ‰ Gross Investment ‰ Net Investment ‰ Depreciation (Consumption of Fixed Capital) 1. Gross Investment: Gross Investment is addition to the stock of capital before making allowance for depreciation. Capital stock consists of fixed assets and unsold stock. So, gross investment is the expenditure on purchase of fixed assets and unsold stock during the accounting year. However, gross investment does not indicate the actual change in economy’s stock of productive assets for a given year. During the production process, some amount of fixed capital is used up. This loss of fixed capital is known as depreciation. By subtracting depreciation from gross investment, we get Net Investment. 2. Net Investment: The actual addition made to the capital stock of economy in a given period is termed as Net Investment. Net Investment = Gross Investment – Depreciation 3. Depreciation (Consumption of Fixed Capital): Depreciation refers to a fall in the value of fixed assets due to normal wear and tear, passage of time or expected obsolescence (change in technology). The concept of depreciation is very important to differentiate between Gross value and the Net value. ‘Gross’ is inclusive of depreciation, whereas, ‘net’ excludes it. [Gross Value = Net Value + Depreciation] NET INDIRECT TAX (NIT) Net indirect tax refers to the difference between indirect taxes and subsidies. Indirect Taxes ‰ Indirect taxes refers to those taxes which are imposed by the government on production and sale of goods and services. For example, Goods and Services Tax (GST). ‰ Indirect tax increases the price of the product in the market. For example, if cost of producing one set of Chairs is ` 500 and Government levies GST of 12%, then price of chairs will increase to ` 560 due to indirect taxes. Determination of National Income 277 Subsidies ‰ Subsidies are the ‘economic assistance’ given by the government to the firms and households, with a motive of general welfare. In India, LPG cylinder is sold at subsidized rates. ‰ They are often granted to promote exports or to encourage firms for setting up the industries in the backward areas. ‰ Subsidies are opposite to indirect taxes as they reduce the market price of the commodity. In the example of chairs, if the Government grants a subsidy of ` 10, then price of chairs will fall to ` 540 due to subsidies. ‰ Subsidies may also be referred as ‘Economic Assistance’ or ‘Financial Assistance’. NET FACTOR INCOME FROM ABROAD (NFIA) It refers to the difference between factor income received from the rest of the world and factor income paid to the rest of the world. NFIA = Factor income earned from abroad - Factor income paid abroad 1. ‘Factor income from abroad’ is the income earned by the normal residents of a country from the rest of the world (ROW) in the form of wages and salaries, rent, interest, dividend and retained earnings. 2. ‘Factor income to abroad’ is the factor income paid to the normal residents of other countries (i.e. non-residents) for their factor services within the economic territory. NFIA is significant to differentiate between ‘Domestic Income’ and ‘National Income’. In practical estimates, domestic income is estimated first and then, National Income is derived from Domestic Income in the following manner: National Income = Domestic Income + NFIA FACTOR COST vs MARKET PRICE FACTOR COST vs BASIC PRICE vs MARKET PRICE At this stage, we need to clearly understand the difference between the concepts: 'market price' and 'factor cost and Basic Price GDP at Basic Price excludes any taxes on products the producer receives from the purchaser and passes on to the government (Eg: GST or Sales Tax or Services Tax) but includes any subsidies the producer receives from the government and uses to lower the prices charged to purchasers. In simple terms, the basic price is the subsidised price without tax. Basic price = factor cost + Production taxes - Production subsidy Relationship between Factor Cost and Basic Price: Factor cost + production tax - production subsidies = Basic prices. Relationship between Basic Price and Market Price: Basic Price + Product tax - Product Subsidy = Market Price. Note: Thus, market price includes both product tax as well as production tax while excluding both product and production subsidies. 278 Business Economics PW TRY YOUR UNDERSTANDING 6.1.6 1. The basis of distinction between market price and factor cost is (a) net factor income from abroad (b) net indirect taxes (i.e., Indirect taxes - Subsidies) (c) net indirect taxes (i.e., Indirect taxes + Subsidies) (d) depreciation (consumption of fixed capital) 2. If net factor income from abroad is positive, then (a) national income will be greater than domestic factor incomes. (b) national income will be less than domestic factor incomes. (c) net exports will be negative (d) domestic factor incomes will be greater than national income Answer Key 1. (b) 2. (a) NATIONAL INCOME AGGREGATES 1. Gross Domestic Product at Market Price GDPMP: GDP at Market price is the gross market value of all final goods and services produced within the domestic territory of a country by residents and non residents during a year. 2. Gross National Product at Market Price GNPMP: GNP at Market price is defined as gross market value of all final goods and services produced by normal residents during a year. [GNPMP = GDPMP + NFIA] 3. Net Domestic Product at Market Price NDPMP: NDP at Market price is the net market value of all final goods and services produced within the domestic territory of a country by residents and non residents during a year. [NDPMP = GDPMP - Depreciation] 4. Net National Product at Market Price NNPMP: NNP at Market price is defined as Net market value of all final goods and services produced by normal residents during a year. [NNPMP = GDPMP + NFIA - Depreciation] 5. Gross Domestic product at Factor cost GDPFC: It refers to gross money value of all the final goods and services produced within the domestic territory of a country by residents and non residents during a period of one year. [GDPFC = GDPMP - Net Indirect Taxes*] *Net Indirect Taxes = Indirect Taxes – Subsidies 6. Gross National product at Factor cost GNPFCIt 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. [GNPFC = GDPMP - Net Indirect Taxes + NFIA] Determination of National Income 279  7. Net Domestic product at Factor cost NDPFC It refers to net money value of all the final goods and services produced within the domestic territory of a country by residents and non residents during a period of one year. [NDPFC = GDPMP - Net Indirect Taxes - Depreciation] 8. Net National product at Factor cost NNPFC (National Income) Net 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. [NNPFC = GDPMP - Depreciation + NFIA - Net Indirect Taxes] Why NNP at Factor Cost is better than NNP at Market Price ‰ NNP at Market price includes the impact of Net indirect taxes. ‰ If there is change in tax rate and subsidy then NNP at market price figure will change accordingly without actual increase in Factor cost. ‰ Also, different countries have different tax rate and thus for international comparison of relative income level. TRY YOUR UNDERSTANDING 6.1.7 1. Gross National Product at market prices GNP MP is (a) GDPMP + Net Factor Income from Abroad (b) GDPMP + Net Factor Income from Abroad (c) GDPMP + Depreciation (d) GDPMP + Net Indirect Taxes 2. Choose the correct statement (a) GNP includes earnings of Indian corporations overseas and Indian residents working overseas; but GDP does not include these (b) NNPFC = National Income = FID (factor income earned in domestic territory) - NFIA. (c) Capital goods and inventory investment are excluded from computation of GDP (d) NDPMP = GDPMP + Depreciation 3. Market price refers to the __________ of all final goods and services. (a) Market value (b) Intermediate value (c) Final value (d) None of the above 4. NDPFC represets __________ (a) Domestic income (b) Normal income (c) Both (a) and (b) (d) International income 5. GNP exceeds NNP by (a) Subsidy (b) Depreciation (c) Both (a) and (b) (d) None of the above 280 Business Economics PW  6. NDP exceeds NNP by __________. (a) NFIA (b) FIFA (c) FITA (d) None of the above Answer Key 1. (a) 2. (a) 3. (a) 4. (a) 5. (b) 6. (a) MEASUREMENT OF NATIONAL INCOME National income is 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 Flow’. ‰ 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. It must be noted that all the three methods give the same value of national income because they are used to measure the same physical output at three different phases VALUE ADDED METHOD Value added refers to the addition of value to the raw material (intermediate goods) by a firm, by virtue of its productive activities. It is the contribution of an enterprise to the current flow of goods and services. It is calculated as the difference between value of output and value of intermediate consumption. Value Added = Value of Output - Intermediate Consumption Value of output refers to market value of all goods and services produced during a period of one year. Value of Output = Sales + Change in Stock ‰ 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 Gross Domestic Product @ Market Price (GDPmp). Value added Method is also known as: (a) Product Method (b) Inventory Method; (c) Net Output Method; (d) Industrial Origin Method; and (d) Commodity Service Method. Determination of National Income 281 All the production units of the economic territory are grouped into three broad groups: 1. Primary Sector: It includes production units exploiting natural resources like land, water, subsoil assets, etc. For example, farming, fishing, mining, animal husbandry, forestry, etc. It is primary as it is the source of basic raw materials for the secondary sector. 2. Secondary Sector: It includes production units which are engaged in transforming one good into another good. Such an activity is called manufacturing activity. These units convert raw materials into finished goods. For example, firms engaged in converting sugarcane into sugar, construction companies, power generation, etc. It is called secondary because it depends on primary sector for raw materials. 3. Tertiary Sector: It includes production units engaged in producing services. For example, transport, education, finance, government administration, etc. This sector finds third place because its growth is primarily dependent on primary and secondary sectors. Computation of National Income Gross Value Added By Primary Sector - + Gross Value Added By Secondary Sector - + Gross Value Added By Tertiary Sector - Gross Domestic Product @ Market Price (GDPmp) - (-) Depreciation (-) (-) Net Indirect Tax (-) + Net Factor Income From Abroad - National Income - Remember 1. Imports are not Separately Included: If value of intermediate consumption is given, then imports are not included separately as imports are already included in the value of intermediate Consumption. However, if domestic purchases are specifically mentioned, then imports will also be included. 2. Exports are not Separately Included: Like imports, exports are also not separately included in value of output if ‘Sales’ are given (and domestic sales are not specifically mentioned). In case of an open economy, sales include both domestic sales and exports. The various precautions to be taken m Value Added Method are: 1. Intermediate Goods are not to be included in the national income: since such goods are already included in the value of final goods. If they are included again, it will lead to double counting. 2. Sale and Purchase of second-hand goods is not included: as they were included in the year in which they were produced and do not add to current flow of goods and services. However, any commission or brokerage on sale or purchase of such goods will be included in the national income as it is a productive service. 282 Business Economics PW  3. Production of Services for self-consumption (Domestic Services) are not included: Domestic services like services of a housewife, kitchen gardening, etc. are not included in the national income since it is difficult to 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. It must be noted that paid services, like services of maids, drivers, private tutors, etc. should be included in the national income. 4. Production of Goods for 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 live in their own 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. PRODUCTION FOR SELF CONSUMPTION 1. Goods Produced for self-consumption are included in National Income: All the final goods produced within the country are not necessarily sold in the market. A part of them is kept by the producer for his own use and consumption. For example, farmers keep a major part of their produce for self-consumption. Imputed value of such goods is included in national income. 2. 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 it is difficult to ascertain their market value and such services are not rendered for the purpose of earning income. Example 1. Calculate National Income by Value Added Method with the help of following data (Figures in Crores) Sales 700; Opening stock 500; Intermediate Consumption 350; Closing Stock 400; Net FactorIncome from Abroad 30; Depreciation 150; Excise Tax 110; Subsidies 50. Sol. NVA(FC) = GDP (MP) – Depreciation + NFIA - Net Indirect Tax Where GVA(MP) = Value of output- intermediate consumption Value of Output = Sales+ change in stock = 700+ (400-500)           = 600 GVA(MP) = 600 – 350= 250 Therefore NI = 250 - 150 + 30 - (110 - 50) = 70 Crores Example 2. Calculate national income by value added method (Figures in Crores) Value of output in primary sector 2000; Intermediate consumption of primary sector 200; Value of output of secondary sector 2800; Intermediate consumption of secondary sector 800; Value of output of tertiary sector 1600; Intermediate consumption of tertiary sector 600; Net factor income from abroad -30; Net indirect taxes 300; Depreciation 470. Determination of National Income 283 Sol. GDPMP = (Value of output in primary sector - intermediate consumption of primary sector) + (value of output in secondary sector - intermediate consumption of secondary sector) + (value of output in tertiary sector - intermediate consumption of tertiary sector)     = (2,000 – 200) + (2,800 – 800) + (1,600 – 600) = 4,800 NNPFC = GDPMP + NFIA -NIT-Depreciation NNPFC = 4,800 + (-)30 – 300 – 470 i.e. 4000 Crores Example 3. Calculate Net Value Added by Factor Cost from the following data (Figures in Crores) Purchase of materials 85; Sales 450; Depreciation 30; Opening stock 40; Closing stock 30; Excise tax 45; Intermediate consumption 200; Subsidies 15. Sol. GVAMP = (Sales - Intermediate consumption) + change in stock GVAMP      = (450 – 200) + (30-40) = 240Crores NVAMP = GVAMP – Depreciation NVAMP = 240-30 = 210 Crores   NVAFC = NVAMP – (indirect tax - subsidies) NVAFC = 210 – (45 -15) = 180Crores 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 a country is known as “Domestic Income (NDPFC)”. 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: (a) Wages and salaries in cash: It includes all 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. (b) Wages and salaries in kind: It includes all non-monetary benefits, like rent free home, free car, free medical and educational facilities, etc. An imputed value of these benefits should be included in national income. 284 Business Economics PW  However, it does not include any facility which is necessary for work and in which employees do not have any discretion. For example, uniforms to be worn during work only or vehicles to be used for work only. Such payments are intermediate consumption of business enterprises. (c) Employers’ contribution to social security schemes: It includes contributions made by employer for the social security of employees. For example, contribution to provident fund, gratuity, labour welfare funds, etc. The aim of such contributions is to ensure safety and security of life of the employees. 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 COE only. 2. Operating surplus is another term used in factor payments: It refers to sum total of income from property (rent + royalty + interest) and income from entrepreneurship (profit). Income From Property: (a) 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 imputed rent(rent of self-occupied properties). Imputed rent of owner occupied houses is 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. (b) Interest: Interest refers to amount received for lending funds to a production unit. It includes both actual interest as well as imputed interest of funds provided by the entrepreneur. ‘Interest income’ includes interest on loans taken for productive services only. 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 purposes. (ii) Interest paid by one firm to another firm. Income From Entrepreneurship: Profit Profit is the reward to the entrepreneur for his contribution to the production of goods and services. It is the residual income, which an entrepreneur earns after paying all the other factors of production. The profit earned by an enterprise is used for 3 purposes: (a) Corporate Tax: It is 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. (b) Dividend: It refers to that part of profit, which is paid to the shareholders in the ratio of their shareholding. It is also known as distributed profits. (c) Retained Earnings: It refers to that part of profit, which is kept as reserve to meet unexpected contingencies or for business expansion. It is also known as Undistributed Profits or Savings of Private Sector or Reserves and Surplus. Determination of National Income 285  In short, Profit = Corporate Tax + Dividend + Retained Earnings Operating Surplus Operating Surplus Income from property Income from property (Rent + Royality + Interest) (Rent + Royality + Interest) 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. 3. Mixed Income: It is the income generated by own-account workers (like farmers, barbers, etc.) and unincorporated enterprises (like retail traders, small shopkeepers, etc.). It is the term used for any income that has elements of more than one type of factor income. Mixed income arises from productive service 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. Reason for Concept of Mixed Income In certain 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 identify 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), then an additional factor 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 self-employed people like doctors, chartered accountants, consultants, etc. Calculation of National Income by Income Method Particulars Amount Compensation Of Employee - + Operating Surplus - + Mixed Income - NDPFC - + NFIA - National Income (NNPFC) 286 Business Economics PW  Precautions of Income Method Following precautions are to be considered while estimating national income by Income Method: (a) Transfer Incomes (like scholarships, donations, charity, old age pensions, etc.) are not included in the National income because such receipts are not connected with any productive activity and there is no value addition. (b) 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 commission received by brokers or commission agents on sale of such goods, will be included as it is an income received for rendering productive service. (c) Income from sale of shares, bonds and debentures will not be included as such transactions do not contribute to current flow of goods and services. These financial assets are mere paper claims and involves a change of title only. However, any commission or brokerage on such financial assets is included as it is a productive service. Capital gains refer to income from sale of second-hand goods (say, old car) and financial assets (bonds, debentures, etc.). Any income arising from such transactions is not a factor income as these transactions are not productive transactions and do not add to the current flow of goods and services in the economy. (d) Windfall gains (like income from lotteries, horse race, etc.) are not included as there is no productive activity connected with them. (e) Imputed value of services provided by owners of production units will be included: Imputed value of owner-occupied houses, interest on own capital, production for self- consumption, etc. will be included as these are productive activities and add to the flow of goods and services. (f) 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 goods and services. Example 4. Calculate NI with the help of income method with the help of following data (Figures In Crores). (i) Compensation of employees = 1,200 (ii) Net factor income from Abroad = 20 (iii) Net indirect taxes = 120 (iv) Profit = 800 (v) Private final consumption expenditure = 2,000 (vi) Net domestic capital formation = 770 (vii) Consumption of fixed capital = 130 (viii) Rent = 400 (ix) Interest = 620 (x) Mixed income of self-employed = 700 (xi) Net export = 30 Determination of National Income 287  (xii) Govt. final consumption expenditure = 1100 (xiii) Operating surplus = 1820 (xiv) Employer’s contribution to social security scheme = 300 Sol. NNPFC = COE + Operating Surplus + Mixed Income + NFI NNPFC = 1200 + 1820 + 700 + 20 NNPFC = 3740 Crores EXPENDITURE METHOD Factor income earned by factors of production is spent in the form of expenditure on purchase of goods and services produced by firms. ‰ This method measures national income as sum total of final expenditures incurred by households, business firms, government and foreigners. ‰ This total final expenditure is equal to gross domestic product at market price. ‰ 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 and the Foreign Sector. The various components of final expenditure are: 1. Private Final Consumption Expenditure (PFCE): It refers to expenditure incurred by households and private non-profit institutions serving households on all types of consumer goods, i.e. durable (except houses), semi-durable, non-durable goods and services.  PFCE = Household Final Consumption Expenditure + Private Non-Profit Institutions Serving Households Final Consumption Expenditure  PFCE includes expenditures incurred by normal residents, whether in the domestic territory or abroad. So, any expenditure incurred by residents during their foreign tour/travel will be added in PFCE. However, any expenditure incurred by non‑residents and foreign visitors in the domestic market will be deducted from PFCE. Note: The expenditure incurred on purchase or construction of owner-occupied houses is treated as capital formation (included under Gross Residential Construction Investment) and not as durable consumption. Other costly consumer durables, like cars, air conditioners, washing machines, etc. are included under PFCE. 2. Government Final Consumption Expenditure (GFCE): It refers to the expenditure incurred by general government on various administrative services like defence, law and order, education etc. Government produces goods and services with the aim of social welfare without any intention of earning profits. GFCE is equal to cost of goods and services produced by government for collective use by the public. These services are valued at their cost to the government as they are not normally sold to the public. It means, GFCE is calculated as: Government Final Consumption Expenditure = Intermediate Consumption of government + COE paid by government + Direct purchases from abroad for embassies and consulates located abroad - Sale of goods and services produced by general government. 288 Business Economics PW  3. Gross Domestic Capital Formation (GDCF) 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: (a) Gross Fixed Capital Formation: It refers to the expenditure incurred on purchase of fixed assets. This expenditure is generally divided into three sub-categories: (i) Gross Business Fixed Investment: It includes expenditure on the purchase of new plants, machinery, equipments, etc. (ii) Gross Residential Construction Investment: It includes expenditure on purchase or construction of new houses by the households. (iii) Gross Public Investment: It includes expenditure on construction of flyovers, roads, bridges etc. by the government. (b) Inventory Investment (Change in Stock): It refers to the physical change in the stock of raw material, semi-finished goods and finished goods lying with the producers. It is included as an investment item because it represents the goods produced but not used for current consumption. It is calculated as the difference between the closing stock and the opening stock of the year. It means, GDCF = Gross Fixed Capital Formation + Inventory Investment; or GDCF = G  ross Business Fixed Investment + Gross Residential Construction Investment + Gross Public Investment + Inventory Investment. Gross Domestic Capital Formation (or Gross Investment) Gross Fixed Capital Formation Inventory Investment (Change in Stock) Gross Business Gross Public Closing Stock- Opening Stock Fixed Investment Investment Gross Residential Construction Investment Some Important Points About GDCF ‰ Any Increase in stock of consumer goods with households is excluded from inventory investment as it is assumed that such goods are consumed, the moment they are purchased. ‰ Purchase of shares and debentures (either old or new) is not included in GDCF as it is simply a transfer of purchasing power and there is no addition to flow of goods and services. ‰ Purchase of second hand goods (like old house or old machinery) is also not included in GDCF as such goods have been already included in the year of original purchase. Determination of National Income 289  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 goods have been produced within the country’s domestic territory. So, they are included in output of an economy.  Imports (M) is the expenditure by residents on foreign products. Imports are deducted to obtain domestic product as they are not produced within the domestic territory.  Instead of treating exports and imports separately, the difference between the two is taken and is termed as Net Exports. Components of Final Expenditure Private final Government final Gross domestic consumption consumption Net Exports Capital formation expenditure expenditure Gross fixed Inventory Exports Imports (+) (–) Capital formation investment (X) (X) Calculation of National Income by Expenditure Method Private Final Consumption Expenditure (PFCE) - + Government Final Consumption Expenditure (GFCE) - + Gross Domestic Capital Formation (GDCF) - + Net Exports (X-M) - Gross Domestic Product @ Market Price GDPMP - (-) Depreciation (-) + NFIA - (-) NIT - National Income (NNPFC) - 290 Business Economics PW  Expenditure Method Private Final Consumption Expenditure  Government Final Consumption Expenditure  Gross Domestic Capital Formation  Net Exports Gross Domestic Product at Market Price (GDPMP) (–) Depreciation (–) Net Indirect Taxes Domestic Income (NDPFC) (+) NFIA National Income (NNPFC) Example 5. Calculate NI with the help of Expenditure method with the help of following data (Figures In Crores) (i) Compensation of employees = 1,200 (ii) Net factor income from Abroad = 20 (iii) Net indirect taxes = 120 (iv) Profit = 800 (v) Private final consumption expenditure = 2,000 (vi) Net domestic capital formation = 770 (vii) Consumption of fixed capital = 130 (viii) Rent = 400 (ix) Interest = 620 (x) Mixed income of self-employed = 700 (xi) Net export = 30 (xii) Govt. final consumption expenditure = 1100 (xiii) Operating surplus = 1820 (xiv) Employer’s contribution to social security scheme = 300 Sol. NDPMp = PFCE + GFCE + NDCF + (X-M) NDPMp = 2000 + 1100 + 770 + 30 NDPMp = 3900 NNPFC = NDPMp + NFIA – NIT NNPFC = 3900 + 20 – 120 i.e. 3800 crores Determination of National Income 291 Example 6. Calculate NNP at FC by expenditure method with the help of following information (Figures In Crore) Private final consumption expenditure 10; Net Import 20; Public final consumption expenditure 05; Gross domestic fixed capital formation 350; Depreciation 30; Subsidy 100; Income paid to abroad 20; Change in stock 30; Net acquisition of valuables 10 Sol. GDPMp = PFCE + GFCE + GDCF + (X - M) GDPMp = 10 + 5 +(350 + 30 + 10) + (-)20 GDPMp = 385 crore NNPFC = GDPMp – Dep – NIT + NFIA NNPFC = 385 – 30 – (0 -100) + (-) 20 NNPFC = 435 crores PRACTICE QUESTIONS 1. From the following data about a firm ‘X’ for the year 2000-01, calculate the net value added at market price during that year: Particulars in crores (i) Sales 90 (ii) Closing stock 25 (iii) Opening stock 15 (iv) Indirect taxes 10 (v) Depreciation 20 (vi) Intermediate consumption 40 (vii) Purchase of raw materials 15 (viii) Rent 5 Sol. Net Value Added at Market Price = Sales + (Closing stock - Opening stock) - Intermediate consumption - Depreciation = 90 + (25 - 15 ) - 40 - 20 = Rs. 40 crores Note: ‘Purchase of raw materials ‘is not included separately as it is already included in Intermediate Consumption. 2. From the following data about firm ‘X’ calculate gross value added at factor cost by it: Particulars in thousands (i) Sales 500 (ii) Opening stock 30 (iii) Closing stock 20 (iv) Purchase of intermediate products 300 (v) Purchase of machinery 150 (vi) Subsidy 40 292 Business Economics PW Sol. Gross Value Added at Factor Cost = Sales + (Closing stock - Opening stock) - Purchase of intermediate products + Subsidy = 500+ ( 20- 30)- 300 + 40 = Rs. 230 thousands Note: ‘Purchase of machinery’ is not considered as it is not a part of intermediate consumption. 3. From the following data, calculate “gross value added at factor cost: Particulars in crores (i) Sales 180 (ii) Rent 5 (iii) Subsidies 10 (iv) Change in stock 15 (v) Purchase of raw materials 100 (vi) Profits 25 Sol. Gross Value Added at Factor Cost = Sales + Change in stock - Purchase of raw materials + Subsidies = 180 + 15 -100 + 10 = ` 105 crores 4. From the following data relating to a firm, calculate its net value added at factor cost Particulars in Lakhs (i) Subsidy 40 (ii) Sales 800 (iii) Depreciation 30 (iv) Exports 100 (v) Closing stock 20 (vi) Opening stock 50 (vii) Intermediate purchases 500 (viii) Purchase of machinery for own use 200 (ix) Import of raw material 60 Sol. Net Value Added at Factor Cost = (ii) + (v) - (vi) - (vii) - (iii) + (i) = 800 + 20 - 50 - 500 - 30 + 40 = Rs. 280 Lakhs Note: ‰ It is assumed that exports are already included in Sales. ‰ Import of raw materials is not included separately as it is a part of Intermediate Purchases. ‰ Subsidy is added as indirect taxes are not given. Determination of National Income 293  5. Calculate Gross Value Added at Factor Cost Particulars (i) Units of output sold (units) 1,000 (ii) Price per unit of output 30 (iii) Depreciation 1,000 (iv) Intermediate cost 12,000 (v) Closing stock 3,000 (vi) Opening stock 2,000 (vii) Goods and Services Tax or GST 6,000 Sol. Gross Value Added at Factor Cost = (i x ii) + v - vi - iv - vii = (1,000 X 30) + 3,000 - 2,000 - 12,000 - 6,000 = ` 13,000 6. From the following data, calculate Net value added at factor cost. Particulars in Crores (i) Total Sales 1,000 (ii) Decrease in Stock 70 (iii) Production for Self Consumption 120 (iv) Purchase of raw materials 300 (v) Exports 150 (vi) Electricity Charges 50 (vii) Income Tax 20 (viii) Goods and Services Tax (GST) 70 (ix) Subsidy 40 Sol. Net Value Added at Factor Cost =T  otal Sales + Production for Self Consumption - Decrease in Stock - Purchase of raw materials - Electricity Charges - (GST - Subsidy) = 1,000 + 120 - 70 - 300 - 50 - (70 - 40) = ` 670 Crores Note: ‰ Exports will not be taken separately as it is a part of Total Sales. ‰ Income Tax is not taken in calculations as it is a direct tax. ‰ Production for Self Consumption will be separately included in value of output as it also adds to current flow of goods and services and is not included in total sales. ‰ Intermediate Consumption is calculated as sum of (iv) and (vi) item. 294 Business Economics PW  7. From the following data, calculate: (a) Value of output; (b) Intermediate Consumption; (c) Net value added at factor cost. Particulars in Crores (i) Purchase of raw materials from domestic market 400 (ii) Increase in the unsold stock 60 (iii) Import of raw material 120 (iv) Domestic Sales 1,200 (v) Replacement of Fixed Capital 50 (vi) Power Charges 20 (vii) Exports 200 (viii) Import of Machinery 40 (ix) Goods and Services Tax (GST) 10 (x) Subsidy 30 (xi) Goods used for self Consumption 10 Sol. (a) Value of Output =D  omestic Sales + Exports + Increase in the unsold stock + Goods used for self Consumption = 1,200 + 200 + 60 + 10 = Rs. 1,470 Crores Note: ‰ Exports will be included as domestic sales are given. ‰ Goods used for self Consumption will also be included as it adds to current flow of goods and services. (b) Intermediate Consumption = P  urchase of raw material from domestic market + Import of raw material + Power Charges = 400 + 120 + 20 = ` 540 Crores (c) Net value added at factor cost = V  alue of Output - Intermediate Consumption - (Goods and Services Tax - Subsidy) - Replacement of Fixed Capital = 1,470-540-(10-30)-50 = ` 900 Crores Note: Replacement of Fixed Capital is another name for depreciation. Determination of National Income 295  8. From the following data, calculate Net Domestic Product at factor cost. in Crores Particulars Primary Sector Secondary Sector Tertiary Sector (i) Sales 1,000 1,500 700 (ii) Net Indirect Taxes 50 30 — (iii) Opening Stock 50 40 20 (iv) Intermediate Consumption 300 750 250 (v) Consumption of Fixed Capital 10 80 60 Sol. Net Domestic Product at factor cost =S  ales of all sectors - Opening Stock of all sectors - Intermediate Consumption of all sectors - Consumption of Fixed Capital of all sectors - Net Indirect Taxes of all sectors = (1,000 + 1,500 + 700) - (50 + 40 + 20) - (300 + 750 + 250) - (10 + 80 + 60) - (50 + 30 + 0) = ` 1,560 Crores. 9. Calculate NDP at FC. Particulars in Crores (i) Rent 400 (ii) Royalty 200 (iii) Interest 500 (iv) Compensation of Employees 1,000 (v) Profit 500 (vi) Mixed Income 1,000 Sol. NDP at FC = Rent + Royalty + Interest + Compensation of Employees + Profit + Mixed income = 400 + 200 + 500 + 1,000 + 500 + 1,000 = Rs. 3,600 crores 10. Calculate GNP at MP from the following data: Particulars in Crores (i) Net indirect tax 900 (ii) Depreciation 400 (iii) Net Factor income from abroad -20 (iv) Rent 1,000 (v) Dividend 500 (vi) Mixed Income 200 (vii) Saving of private corporate sector 400 (viii) Interest 200 (ix) Compensation of employees 100 296 Business Economics PW Sol GNP at MP = R  ent + Dividend + Mixed income + Saving of private corporate sector + Interest + Compensation of employees + Net indirect tax + Depreciation + Net Factor income from abroad = 1,000 + 500 + 200 + 400 + 200 + 1001- 900 + 400 + (-) 20 = ` 3,680 crores 11. From the following data, calculate National Income. Particulars in Crores (i) Compensation of employees 800 (ii) Rent 200 (iii) Wages and salaries 750 (iv) Net exports (-) 30 (v) Net Factor income from abroad (-) 20 (vi) Profit 300 (vii) Interest 100 (viii) Depreciation 50 Sol. National Income (NNPFC) = Compensation of Employees + Rent+Profit + Interest+Net factor Income from Abroad = 800 + 200 + 300 + 100 + (- 20) = 1,400 - 20 = ` 1,380 crores 12. Calculate the Operating Surplus. Particulars in Crores (i) Value of output 70,000 (ii) Purchase of raw material 18,000 (iii) Net indirect tax 3,000 (iv) Wages and salaries 25,000 Sol. Operating Surplus = Value of output - Purchase of raw material - Net indirect tax - Wages and Salaries = 70,000 - 18,000 - 3,000 - 25,000 = ` 24,000 crores 13. Calculate GDP at MP Particulars in crores (i) Private Final Consumption Expenditure 1,200 (ii) Government Final Consumption Expenditure 200 (iii) Gross Fixed Capital formation 300 (iv) Change in stock 400 (v) Imports 500 (vi) Exports 600 Determination of National Income 297 Sol. GDP at MP = P  rivate Final Consumption Expenditure + Government Final Consumption Expenditure + Gross Fixed Capital formation + Change in stock + (Exports - Imports) = 1,200 + 200 + 300 + 400 + (600 - 500) = ` 2,200 crores 14. Calculate GNP at FC: Particulars in crores (i) Net domestic fixed capital formation 350 (ii) Closing stock 100 (iii) Government final consumption expenditure 200 (iv) Net indirect taxes 40 (v) Opening stock 60 (vi) Consumption of fixed capital 50 (vii) Net exports (-)10 (viii) Private final consumption expenditure 1,500 (ix) Imports 20 (x) Net factor income from abroad (-) 30 Sol. GNP at FC = (i) + {(ii) - (v)} + (iii) + (viii) + (vii) + (vi) - (iv) + (x) = 350 + {100 - 60} + 200 + 1,500 + (-) 10 + 50 - 40 + (-) 30 = ` 2,060 crores 15. Calculate ‘Gross Domestic Product of Factor Cost’ from the following data: Particulars in crores (i) Private final consumption expenditure 800 (ii) Net domestic capital formation 150 (iii) Change in stock 30 (iv) Net factor income from abroad (-) 20 (v) Net indirect tax 120 (vi) Government final consumption expenditure 450 (vii) Net Exports (-) 30 (viii) Consumption of fixed capital 50 Sol. Gross Domestic Product at Factor Cost (GDPFC) = (i) + (vi) + (ii) + (vii) + (viii) - (v) = 800 + 450 + 150 + (-30) + 50 - 120 = ` 1,300 crores 298 Business Economics PW 16. Calculate National Income by Income and Expenditure method. Particulars in crores (i) Final Consumption Expenditure  Private Sector 350  Government Sector 100 (ii) Mixed income of self employed 35 (iii) Gross domestic fixed capital formation 70 (iv) Opening stock 15 (v) Compensation of employees 250 (vi) Closing stock 25 (vii) Imports 20 (viii) Rent 75 (ix) Consumption of fixed capital 10 (x) Net indirect taxes 25 (xi) Interest 25 (xii) Net factor income from abroad –5 (xiii) Exports 10 (xiv) Profit 100 Sol. National Income by Income method = M  ixed income of self employed + Compensation of employees + Rent + Interest + Profit + Net factor income from abroad = 35 + 250 + 75 + 25 + 100 + (-5) = ` 480 crores National Income by Expenditure method = F  inal consumption expenditure of Private sector+ Final consumption expenditure of Government sector + Gross domestic fixed capital formation + (Closing stock — Opening stock) + Net Exports - Consumption of fixed capital + Net Factor Income from abroad - Net Indirect tax = 350 + 100 + 70 + (25 - 15) + (10 - 20) - 10 + (- 5) - 25 = ` 480 crores 17. From the following data, calculate National Income by (a) Income method and (b) Expenditure method: Determination of National Income 299  In Crores (i) Private final consumption expenditure 2,000 (ii) Net capital formation 400 (iii) Change in stock 50 (iv) Compensation of employees 1,900 (v) Rent 200 (vi) Interest 150 (vii) Operating surplus 720 (viii) Net indirect tax 400 (ix) Employers’ contribution to social security schemes 100 (x) Net exports 20 (xi) Net factor income from abroad (-) 20 (xii) Government final consumption expenditure 600 (xiii) Consumption of fixed capital 100 Sol. National Income (NNP at FC) by Income method = (iv) + (vii) + (xi) = 1,900 + 720 + (-) 20 = ` 2,600 crores National Income (NNPfc) by Expenditure method = (i) + (ii) + (x) + (xii) - (viii) + (xi) = 2,000 + 400 + 20 + 600 - 400 + (-)20 = ` 2,600 crores 18. Calculate GNP at FC by Income and Expenditure method. Particulars in crores (i) Compensation of employees 1,000 (ii) Operating surplus 500 (iii) Employers’ contribution to social security schemes 120 (iv) Net exports (-)30 (v) Net indirect taxes 40 (vi) Mixed income of the self employed 600 (vii) Net factor income to abroad 20 (viii) Consumption of fixed capital 40 (ix) Private final consumption expenditure 1,440 (x) Govt, final consumption expenditure 490 (xi) Gross fixed capital formation 250 (xii) Change in stock 30 (xiii) Interest on national debt 25 300 Business Economics PW Sol. GNP at FC by Income method = (i) + (ii) + (vi) - (vii) + (viii) = 1,000 + 500 + 600 -20 + 40 = ` 2,120 Note Net factor income to abroad means that the paid amount is more than received amount. GNP at FC by Expenditure method = (ix) + (x) + (xi) + (xii) + (iv) - (v) - (vii) = 1,440 + 490 + 250 + 30 + (-30) - 40 - 20 = ` 2,120 crores 19. Calculate NDP at FC by expenditure method and GDP at MP by income method. Particulars in crores (i) Gross fixed capital formation 130 (ii) Private final consumption expenditure 510 (iii) Mixed income of the self employed 280 (iv) Net factor income from ROW (-)5 (v) Exports 50 (vi) Imports 60 (vii) Compensation of employees 240 (viii) Government final consumption expenditure 70 (ix) Consumption of fixed capital 40 (x) Indirect tax 90 (xi) Subsidies 10 (xii) Rent, interest and profit 90 (xiii) Change in stock 30 (xiv) Interest on national debt 10 Sol. NDP at FC by Expenditure method = (i) + (xiii) + (ii) + {(v) - (vi)} + (viii) - (ix) - {(x) - (xi)} = 130 + 30 + 510 + {50 - 60} + 70 - 40 - {90 - 10} = ` 610 crores GDP at MP by Income method = (iii) + (vii) + (xii) + (ix) + {(x) - (xi)} = 280 + 240 + 90 + 40 + {90 - 10} = ` 730 crores. LIMITATIONS AND CHALLENGES OF NATIONAL INCOME COMPUTATION There are innumerable limitations and challenges in the computation of national income. The task is more complex in underdeveloped and developing countries. Following are the general dilemmas in measurement of national income. There are many conceptual difficulties related to measurement which are difficult to resolve, such as: Determination of National Income 301  1. lack of an agreed definition of national income, 2. accurate distinction between final goods and intermediate goods, 3. issue of transfer payments, 4. services of durable goods, 5. difficulty of incorporating distribution of income, 6. valuation of a new good at constant prices, and 7. valuation of government services Other challenges relate to: 1. Inadequacy of data and lack of reliability of available data, 2. presence of non-monetised sector, 3. production for self-consumption, 4. absence of recording of incomes due to illiteracy and ignorance, 5. lack of proper occupational classification, and 6. accurate estimation of consumption of fixed capital PER CAPITA INCOME The GDP per capita is a measure of a country's economic output per person. It is obtained by dividing the country's gross domestic product, adjusted by inflation, by the total population. It serves as an indicator of the standard of living of a country. Similarily, the per capita income is obtained by dividing the national income by the population. PRIVATE INCOME Private income refers to the income which accrues to private sector from all the sources within and outside the country. It includes both earned income (factor income) and unearned income (transfer income) received by private sector (Private enterprises + Households). It means, it consists of two kinds of incomes: 1. Factor Income (Earned Income): There are two sources of factor income for the Private sector: (a) Income earned within the domestic territory known as Income from domestic product accruing to private sector. (b) Income earned outside the domestic territory known as Net factor income from abroad. 2. Transfer Income (Unearned Income): The transfer income is also received from two sources: (a) Income received within the domestic territory. It includes National debt interest and current transfers from government. 302 Business Economics PW  (b) Income received from outside the domestic territory known as net current transfers from the rest of the world. It must be noted that Net factor income from abroad (NFIA) accrues to both Private and Government sectors. However, due to lack of data for the Government sector, it is assumed that NFIA is attributed to the Private Sector only. TRANSFER INCOMES UNDER PRIVATE INCOME 1. Interest on National Debt: Sometimes, the government borrows funds from the public (by issuing bonds like National Saving Certificates, Saving Bonds, etc.) in order to meet its rising expenditure. Such debts are generally used by the government for consumption purposes. Hence, interest paid on such debts is treated as a transfer income for private enterprises. 2. Current transfers from Government: It includes all transfer receipts from government in the form of scholarships, unemployment allowances, subsidies, etc. Such transfers are always positive as they are one-sided, i.e., they flow from Government to the private sector. 3. Net Current transfers from rest of the world: It refers to net gifts and remittances received from abroad. It is positive when transfers received from abroad are more than transfers paid abroad. However, if transfers paid abroad are more than transfers received, then it is negative. NNPFC - Less: Income from Property and Entrepreneurship accruing to Government - Administrative Departments (Railways, Post Office etc) Less: Savings of Non-departmental Enterprises. - Income From Domestic Product Accruing To Private Sector - Add: National Debt Interest - Add: Current Transfers from Government - Add: Net Current Transfers from rest of the world. - Private Income - PERSONAL INCOME ‰ Personal income is a measure of actual current income receipts of households from all sources which may or may not be earned from productive activities during a given period of time. ‰ In other words, it is the income ‘actually paid out’ to the household sector, but not necessarily earned. ‰ Personal income excludes retained earnings, indirect business taxes, corporate income taxes and contributions towards social security. Determination of National Income 303  Private Income - Less: Undistributed profits (-) Less: Corporate Tax (-) Personal Income - DISPOSABLE PERSONAL INCOME (DI) Disposable personal income is a measure of amount of money in the hands of the individuals that is available for their consumption or savings i.e. it shows the purchasing power of the households It is calculated as follows: Personal Income - Less: Personal taxation (-) Less: Non tax payments i.e. fees, penalty, fines to government (-) NATIONAL DISPOSABLE INCOME (NET AND GROSS) National Disposable Income (NDY) refers to the income which is available to the whole country for disposal. It includes both factor income and transfer income. It is also known as ‘Net National Disposable Income’. NDY includes ‘Net Indirect Taxes’ and ‘Net Current Transfers from ROW’ NDY = NNPFC + Net indirect taxes + Net current transfers from the rest of the world GROSS NATIONAL DISPOSABLE INCOME When depreciation is added to the net National Disposable Income, we get Gross National Disposable Income. Gross National Disposable Income = Net National Disposable Income + Depreciation TRY YOUR UNDERSTANDING 6.1.8 1. Which of the following is added to national income while calculating personal income? (a) Transfer payments to individuals (b) Undistributed profits of corporate (c) Transfer payments made to foreigners (d) Mixed income of self employed 2. The GDP per capita is (a) a measure of a country's economic output per person (b) actual current income receipts of persons (c) national income divided by population (d) (a) and (c) above 304 Business Economics PW  3. Domestic income is: (a) GDPMP (b) NDPFC (c) NNPMP (d) GNPFC 4. National income is: (a) GDPMP (b) NDPMP (c) NNPFC (d) GNPFC 5. The difference between gross and net is: (a) Depreciation (b) NFIA (c) Net Indirect Tax (d) Subsidies 6. How is GDPMP different from NNOfc? (a) NFIA (b) Net Indirect Tax (c) Depreciation (d) All of the above 7. Market price includes: (a) NFIA (b) Depreciation (c) Net Indirect Tax (d) None of the above 8. The word national in national income means: (a) Goods produced by normal resident (b) Goods produced in domestic territory (c) Services produced by normal resident (d) Both (a) and (c) 9. The word gross means: (a) Inclusive of NFIA (b) Inclusive of indirect tax (c) Exclusive of depreciation (d) Inclusive of depreciation 10. Which of the following is a domestic concept? (a) NDPMP (b) NDPFC (c) GDPMP (d) All of the above 11. Which of the following is not a nation concept? (a) GDPFC (b) NNPMP (c) GNPFC (d) NNPFC 12. Depreciation can never be: (a) Zero (b) Positive (c) Negative (d) None of the above. 13. Value added method is also known as: (a) Product method (b) Inventory method (c) Net output method (d) All of the above 14. Which of the following is not a component of operating surplus? (a) Profit (b) Intermediate consumption (c) Rent and royalty (d) Interest 15. Net exports is (a) Export – Import (b) Import – Export (c) Export + Import (d) None of the above Determination of National Income 305 16. The output at current year price is called: (a) Nominal GDP (b) Real GDP (c) National GDP (d) None of the above 17. Real GDP shows: (a) Change in price only (b) Change in output only (c) Change in both price and output (d) None of the above 18. Nominal GDP shows: (a) Change in price only (b) Change in output only (c) Change in both price and output (d) None of the above 19. Which of the following is included in national income? (a) Brokerage on sale of financial assets (b) Sale of financial assets (c) Intermediate goods (d) Transfer payments 20. Which of the following is not included in national income? (a) Windfall gains (b) National debt interest (c) Purchase of second hand goods (d) All of the above Answer Key 1. (a) 2. (d) 3. (b) 4. (c) 5. (a) 6. (?) 7. (?) 8. (d) 9. (d) 10. (d) 11. (a) 12. (c) 13. (d) 14. (b) 15. (a) 16. (a) 17. (b) 18. (?) 19. (a) 20. (d)  306 Business Economics PW  UNIT 2 Keynesian Theory The Keynesian Theory of Determination of National Income The Two-Sector Determination The Determination of Model for National of Equilibrium