NCERT Solutions for class 12th Economics Part B Chapter 2 National Income Accounting

NCERT TEXTBOOK QUESTIONS SOLVED

Question 1. What are the four factors of production and what are the remunerations to each of these called?

Ans. There are four main factors of production:
(a) Land: All natural resources are included in land in Economics. Remuneration to land is called rent.
(b) Labour: Any kind of physical or mental work done with a view to earning money is called labour. Labour gets wages and salaries and other benefits from employer which together called compensation of employees.
(c) Capital: All man made goods which are used in production are called capital. Capital gets interest as its remuneration.
(d) Entrepreneur: It is called organization. It refers to one who organizes all other factors of productionland, labour and capital and bears the risk of production. He gets profit in return.

Question 2. Why should the aggregate final expenditure of an economy be equal to the aggregate factor payments? Explain.

Ans. There is a principle of economics which is the base of entire macroeconomics. It is “one man’s expenditure is other man’s income.” For example, when a student pays his tuition fees, it is an expenditure for him but income for the tutor. Suppose tutor spends it for buying clothes. It is expenditure for tutor but income for cloth shop. Cloth shop owner buys grocery items from it. It is expenditure for him but income for grocery shop and the cycle goes on. Therefore, aggregate final expenditure must be equal to aggregate factor payments. It is clear from the following diagram:

If we measure national income at distribution stage, it is called income method. If we measure national income at production stage, it is called production method and if we measure national income at distribution stage,it is called expenditure method. Therefore, all the three methods give us same level of national income.
Symbolically,
National Income ≡ National Product ≡ National expenditure

Question 3. Distinguish between stock and flow. Between net investment and capital which is a stock and which is a flow? Compare net investment and capital with flow of water into a tank.

Ans. Difference between stock & flow:

Net investment is a flow and capital is a stock. Net investment is like water stream in a water tank which is getting added to water tank per unit of time. However capital is like total water in a tank. If flow of water is more then certainly total water in tank will also be more i.e. a high net investment will lead to increase in capital and vice versa.

Question 4. What is the difference between planned and unplanned inventory accumulation? Write down the relation between change in inventories and value added of a firm.

Ans. Planned inventory accumulation is one which is planned before starting of the financial year. Unplanned inventory accumulation occurs due to sudden fall in demand.value added will be more if change in inventories is positive and vice versa. It is clear from the following formula.
value added= value of output-Intermediate consumption
And value of output= sales +change in stock

Question 5. Write down the three identities of calculating the GDP of a country by the three methods. Also briefly explain why each of these should give us the same value of GDP.

Ans. INCOME METHOD
According to this method, NI is measured in terms of payments made to primary factors of production. All the incomes that accrue to the factors of production by way of wages, profits, rent, interest etc. are added to obtain the national income. Income method is also called factor payment method or distribution method. According to Income method, national income is calculated by adding:
Compensation of Employees
Operating Surplus
Mixed income of self employed
Net Factor Income from Abroad
NNPfc = 1+2+3+4

Compensation of employees:

It includes: Wages in cash (Basic Salary, Dearness Allowance, House Rent Allowance, Bonus, Conveyance Allowance, Commission, Overtime Allowance, Medical Allowance etc.)
Wages in Kind (Free food, Free uniform, Free accommodation, Free Education, Interest free loans, Free conveyance etc.) Employers’ contribution to Social security benefits such as Provident Fund (PF), Pension, Life insurance etc.
It does not include: Traveling Allowance, Employees’ contribution to Social Security benefits.

Operating Surplus:

It is income from property (Rent, Royalty, and Interest) and entrepreneurship (Profit = Dividend + Corporation tax + Undistributed profits/Retained Earnings).
Rent: Amount payable in cash or in kind for the use of land for production. It includes both actual as well as imputed rent of self-occupied properties.

Royalty: Amount payable for granting the leasing rights of subsoil assets only. For example: owners of mineral deposits like coal, iron ore, natural gas etc. can earn income by giving rights of mining to contractors.

Interest: Amount payable by a production unit for the use of money borrowed.Interest income includes interest on loans taken for productive services only. It includes both actual as well as imputed interest.
Interest income does not include
Interest paid by govt. on public debt and interest paid by consumers as such interest is paid on loans taken for consumption purposes.
Interest paid by one firm to another firm as it is already included in their profits.

Profit: Amount payable to the owner of production unit for his entrepreneurial abilities. It is used for three purposes:
Corporate tax
Dividend
Undistributed profit

Mixed Income of self-employed:

It is mixed in the sense that it is not possible to classify it into rent, wages, profit or interest. It is generated by own-account workers and unincorporated enterprises. It arises in the case of enterprises like sole proprietorship, small partnership, farmers, barbers etc.

Precautions Involved In Estimating National Income by Income Method:

Transfer payments are not to be included in national income.
Income through illegal activities is not to be included. Income from the sale of Second Hand Goods is not to be included.

Corporation tax is a part of profit hence if profit is given; it is not to be included separately.
Sale of shares or securities is not to be included as there is no corresponding production of goods and services. But commission paid to the broker is to be included.
Windfall gains are unearned income, hence not included in national income.
Goods produced for self consumption are included but services produced for self consumption are not included.

Rent of owner occupied building is to be calculated on market price and is to be included.
Death duties, Wealth Tax, Gift tax etc. are paid out of past savings, hence not to be included in national income

VALUE ADDED METHOD OR PRODUCTION OR OUTPUT METHOD

It is a method which measures national income by estimating the contribution of each enterprise to the production in the domestic territory of the country plus NFIA. This method is used to measure national income in different phases of production in circular flow. It shows the contribution i.e. value added of each producing unit in the production process. In the computation of NI, value added by different enterprises is included and value of output is not included.

Value of output : it refers to market value of all goods & services produced during a year. It includes NIT as it is calculated at the market price. value of output can be measured in the following ways:
value of output = Sales, if the entire output of the year is sold
value of output = sales + change in stock
Where, Change in stock = Closing stock – Opening stock

Value added : It refers to the addition of value to the raw material or intermediate goods by a firm through its productive activities.
value Added = value of Output – Intermediate consumption
GDPmp or GvAmp = value of Output – intermediate consumption
National Income or NNPfc = GDPmp – depreciation – NIT + NFIA
Precautions Involved In Estimating National Income by

Product Method:
The value of intermediate goods is not to be included as it will lead to double counting.
Leisure time/voluntary activities are not to be included as these are non economic activities. Sales include exports also unless expressed otherwise. Purchases include imports also unless expressed otherwise.
Sale & purchase of second hand goods is not included but commission or brokerage paid for that is included. value of goods retained for self consumption is included in NI.

EXPENDITURE METHOD

It is a method which measures the final expenditure on purchase of new goods and services at market price in an accounting year. This total final expenditure is equal to gross domestic product at market price. It measures national income as the sum of final expenditures incurred by households, business firms, foreigners and government.
According to expenditure method, GDPmp is the aggregate of all the final expenditure in an economy in a year, i.e.
Y = C+I+G+(X-M)
Where,
Y is national income
C = Private Final Consumption Expenditure: It includes final consumption expenditure of households, and private non-profit institutions serving households on goods & services.
I = Final investment expenditure or Gross Domestic

Capital formation: It includes two components:
Gross domestic fixed capital formation: it refers to purchase of fixed assets. It involves:
Business Fixed Investment i.e. expenditure on purchase of new plants, machinery etc.
Residential Investment by households like purchase of new house, major repairs or alterations of old buildings.
Government Fixed Investment i.e. expenditure on construction of flyovers, roads, bridge etc. Inventory Investment i.e. change in stock
G = Government Final Consumption Expenditure:
Total expenditure incurred by the government for producing various services to satisfy collective wants like compensation paid to employees, goods & services purchased from domestic markets etc. It includes:compensation of employees paid by the government goods & services purchased by the government from domestic market for intermediate consumption.
Purchases from abroad
X – M is net exports i.e. exports minus imports

Precautions Involved In Estimating National Income by Expenditure Method:

Financial investment i.e. expenditure on purchase of shares and debentures is not included because it is not a production activity as financial assets are neither good nor services.
Expenditure on purchase of second hand goods is not included.
Expenditure on transfer payments is not included.
Only final expenditure is included & intermediate expenditure is not included.

NNPfc = GDPmp – depreciation – NIT + NFIA
All the three methods give same answer because of the fact that one man’s expenditure is another man’s income and income is generated through production process.
Therefore,
National expenditure = National Income = National
Production.

Question 6. Define budget deficit and trade deficit. The excess of private investment over saving of a country in a particular year was rs. 2,000 crores. The amount of budget deficit was (–) ` 1500 crores. What was the volume of trade deficit of that country?

Ans. Budget Deficit : The difference between Government expenditure and taxes is called budget deficit.
Trade Deficit : The difference between exports and imports is called trade deficit.
For national income identity, leakages must be equal to injections. Therefore,
(Investment – Saving) + (Government expenditure- Taxes)

(Exports-Imports) = 0
2000-1500 + (exports – Imports) = 0
Exports – Imports = – 500
Trade deficit = (–) 500 crores.

Question 7. Suppose the GDP at market price of a country in a particular year was rs. 1,100 crores. Net factor income from abroad was rs. 100 crores. The value of indirect taxes- subsidies was rs. 150 crores and national income was rs. 850 crores. Calculate the aggregate value of depreciation.

Ans. National Income refers to Net national Product at factor cost.
GDPmp = 100 crores
NFIFA = 100 crores
Net Indirect tax = 150
NNPfc = 850
Depreciation = ?
NNPfc = GDPmp+NFIFA-NIT-depreciation
On putting values,
850 = 1100 + 150 – 100 – deperication
Depreciation = 1050 – 850
Depreciation = 200 crores.

Question 8. Net National product at Factor Cost of a particular country in a year is rs.1,900 crores. There are no interest payments made by the households to the firms/government or by the firms/government to the households. The personal disposable income of the households is 1,200 crores. The personal income taxes paid by them is 600 crores and the value of retained earnings of the firms and government is valued at ` 200 crores. What is the value of transfer payments made by the government and firms to the households?

Ans. (in crores)
NNPfc =1900
Interest payments = 0
Personal Disposable Income = 1200
Personal Income taxes = 600
value of Retained earnings = 200
Transfer payments = ?
Personal Income = Personal
Disposable Income + Personal Income Taxes = 1200 + 600 = 1800crores
Personal Income = National Income – retained earningsnet interest payments made by households-corporation tax + transfer payments to the households by government and firms
On putting values,
1800 = 1900 – 200 – 0 – 0 + transfer Payments to the households by firms and government
Transfer Payments to the households by firms and government = 1800 – 1700
Transfer Payments to the households by firms and government = 100 crores

Question 9.From the following data, calculate personal income and personal disposable income. rs. (crore)
(a) Net Domestic Product at factor cost 8,000
(b) Net Factor Income from abroad 200
(c) Undisbursed Profit 1,000
(d) Corporate Tax 500
(e) Interest Received by Households 1,500
(f) Interest Paid by Households 1,200
(g) Transfer Income 300
(h) Personal Tax 500

Ans. Personal Income = NDPfc + NFIFA – retained earnings net interest payments made by households-corporation tax + transfer payments to the households by government and firms
On putting values,
Personal Income = 8000 + 200 – 1000 – (1200 – 1500)– 500 +300
Personal Income = 8800 – 1500
Personal Income = 7300 crores.
Personal Disposable Income = Personal Income – Personal Tax
PDI = 7300 – 500
PDI = 6800 crores.

Question 10. In a single day Raju, the barber, collects rs.500 from haircuts; over this day, his equipment depreciates in value by rs. 50. Of the remaining rs. 450, Raju pays sales tax worth Rs 30, takes home rs. 200 and retains rs.220 for improvement and buying of new equipment. He further pays rs.20 as income tax from his income. Based on this information, complete Raju’s contribution to the following measures of income

(a) Gross domestic Product (b) NNP at market price (c) NNP at factor cost (d) Personal income (e) Personal disposable income.

Ans. Raju’s Contribution to GDPmp = 500
Raju’s Contribution toGDPfc = 500 – 30 = 470
Raju’s Contribution to NNPmp = 500 – 50 = 450
Raju’s Contribution to NNPfc = 450 – 30 = 420
Raju’s Contribution to Personal Income = 420 – 220 =200
Raju’s Contribution to Personal disposable Income = 200 – 20 = 180

Question 11. The value of the nominal GNP of an economy was rs. 2,500 crores in a particular year. The value of GNP of that country during the same year, evaluated at the prices of same base year, was ` 3,000 crores. Calculate the value of the GNP deflator of the year in percentage terms. Has the price level risen between the base year and the year under consideration?

Ans. GNP deflator = GNP at current prices/GNP at constant prices
GNP deflator = 2500/3000
0.833
GNP deflator in Percentage terms = GNP at current
prices/GNP at constant prices*100
2500/3000 × 100
83.33%.
Prices have fallen between the base year and the year under consideration.

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

Ans. When an economy experiences an increase in national income in real terms, it is said that economic growth has taken place. When an economy experiences rise in welfare it implies social growth. The term welfare can be categorized into economic welfare and social welfare. If welfare is affected only by economic factors then it is economic welfare but when welfare is affected by economic as well as non-economic factors then it is called as social welfare. It means that social welfare means the total welfare of the society as a whole. Environmental pollution, land degradation, law & order situation etc. comes under non-economic factors. GDP at best can indicate economic welfare. For example, industrial growth increases GDP and consequently the economic welfare. But industrial growth may also lead to increase in pollution and consequently decrease the welfare.
Hence it can be concluded that per capital real GDP is not an adequate indicator of economic welfare due to the following reasons:

1. Composition of GDP: Composition of GDP may not be welfare oriented even when the level of GDP tends to rise. If the product mix has more of explosives, guns, bombs then destruction will increase and welfare will reduce. Similarly it is also possible that there is increase in national income because of an increase in the production of goods which are socially undesirable like drugs. This will, surely not enhance economic welfare of the people. Therefore economic welfare depends not only on the volume of goods but also on the type of goods and services.

2. Non-Monetary exchange: In national income only those transactions are recorded which are monetary in nature. There are many goods and services which are not included in the estimation of National Income because of their non-monetary nature. Non-monetary transactions are quite evident in rural areas where payments for farm labour are often made in kind rather than cash. There are other examples also like services of housewives, family members etc. which are not included. To this extent, GDP remains underestimated and therefore not a proper index of welfare.

3. Externalities: It refers to good & bad impact of an activity without paying the price or penalty for that. For example: Positive externalities occur when a beautiful garden maintained by Mr. X raises the welfare of Mr. Y even when Mr. Y is not paying for it. So there is no valuation of it in our estimation of GDP. Negative Externalities occur when smoke omitted by factories cause air pollution. But nobody is penalized for it and there is no valuation of it in GDP. There is either underestimation or overestimation of welfare.

4. Distribution of GDP: High National Income of a country may be due to large contributions made by a few industrialists. Due to this these exceptional few enjoy a high standard of living. In other words, it can be said that there is unequal distribution of income.The gulf between haves and have-nots may increase in which situation the bulk of population may have even lesser goods than before even when the overall level of GDP has tended to raise. India is facing almost a similar situation at present.

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