CH-2 NATIONAL INCOME ACCOUNTING NOTES

1. What are the four factors of production, and what are the remunerations to each of
these called?
Land, Labour, Capital and Entrepreneurship are the four factors of production.
i) Land is a natural resource and the primary factor of production. Land rent is the
remuneration paid for the use of land.
ii) Labour is the physical or mental work done by an employee that is required for
production. The remuneration for labour is paid through wages or salary.
iii) Capital is the wealth or monetary investment that is essential for production. Capital can
also mean assisting tools, machinery and other means of production. The remuneration for
capital is called interest.
iv) Entrepreneurship refers to the task of the individual who brings all the factors of
production together and manages them. The remuneration or reward of the entrepreneur is the
profit that is gained after the product is sold.
2. Why should the aggregate final expenditure of an economy be equal to the aggregate
factor payments? Explain.
The aggregate final expenditure of an economy is the sum of all the spending in the economy.
In economics, factor payment denotes the wage, interest, rent and other payments done as a
remuneration for the factors or production. The income earned is either spent on goods on
services or saved. But, all savings can be counted as investments for future expenditure.
Therefore, the aggregate final expenditure of an economy should be equal to aggregate factor
payments.
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.
The difference between stock and flow are as follows

Stock Flow

Stocks are defined at a point in time Flows are defined over a period of time

Stocks are a static concept Flows are a dynamic concept

It does not have a time dimension It has a time dimension

Examples: Wealth, Money supply, etc. Examples: National Income, Investments,

 etc.

The difference between net investment and capital is explained below

Capital Net Investment

Capital is tied to liquidity Investment is tied to equity

Capital is a stock variable Net Investment is a flow variable

Capital is on the liabilities side of the balance Investment is on the assets side of the
sheet balance sheet

Since it is measured over a period of time, the flow of water in a tank can be compared to net
investment. The stock of water in a tank is measured at a point in time and can be compared
to capital.
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.
Planned inventory accumulation is the planned accumulation of inventories and stocks. Firms
often experience an accumulation in their inventories based on the expected fall in sales or
projected fall in demand from consumers. Unplanned inventory accumulation happens when
the inventories and stocks get accumulated due to an unexpected fall in sales and demand.
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.
The three methods of identifying the GDP of a nation are:
1. Expenditure Method
2. Income Method
3. Value-added Method or Product Method
Expenditure Method: In the expenditure method, national Income is calculated based on the
expenditure done on the purchase of final goods and services that are produced in the
economy.
The formulae for calculating GDP is
GDP = C + I + G + (X – M)
Where,
C=Consumer spending on goods and services
I=Investor spending on business capital goods
G=Government spending on public goods and services
X= Exports
M= Imports
Now,
GDP – Depreciation = Net Domestic Product
NDP – Net Indirect Tax – = NDP
NDP + NFIA = National Income
Where NDP= Net Domestic Product
NFIA = Net Factor Income from Abroad
Income Method: Income Method: This method is used to determine national income
generated from the factors of production like capital, labour, land and profits of an
organisation. Another factor added is mixed-income which is income generated from self-
employed persons, farming and sole proprietorship firms.
Therefore national income can be calculated as follows:
Net Domestic Income = Compensation +Interest + Rent + Profit + Mixed income
Net Domestic Income + NFIA (Net Factor Income from Abroad) = Net Domestic Income.
Product Method: In this method which is also known as the value-added method, the income
is measured as per value addition by the products of firms. It is calculated as the summation
of Gross Value Added in the primary, secondary and tertiary sectors.
Net Domestic Product = GDP – Depreciation
NDP at Factor Cost = NDPMP – Net Indirect Tax
NDP at factor cost + NFIA = National Income
Where NDP= Net Domestic Product
NFIA = Net Factor Income from Abroad
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
(−) Rs 1,500 crores. What was the volume of trade deficit of the country?
Budget Deficit
A budget deficit is referred to a situation when the expenditure by the government exceeds its
income.
Budget Deficit is mathematically represented as G − T
Where,
G is the expenditure by the government
T is the income earned by the government
Trade Deficit
When a country spends more on imports than on earning revenue through exports, such a
situation is referred to as a trade deficit
Trade Deficit is represented as M − X
Where,
M expenditure on imports
X revenue earned from exports
As per the question
I − S = Rs.2000 crores.
Budget Deficit
G – T = (−) Rs.1500 crores.
Therefore, the trade deficit can be calculated as
Trade deficit = [I − S] + [G − T]
= 2000 + [−1500]
= Rs.500 crores.
7. Suppose the GDP at market price of a country in a particular year was Rs 1,100
crores. Net Factor Income from Abroad was Rs 100 crores. The value of Indirect taxes −
Subsidies was Rs 150 crores and National Income was Rs 850 crores. Calculate the
aggregate value of depreciation.
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 Rs 1,200 crores. The personal income taxes paid
by them is Rs 600 crores and the value of retained earnings of the firms and government
is valued at Rs 200 crores. What is the value of transfer payments made by the
government and firms to the households?
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
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.
(i) Gross Domestic Product or GDP = Rs.500 (This is the earning by Raju in a day from
haircuts)
(ii) NNP at market price or NNPMP = GDP – Depreciation
Putting the values of GDP and depreciation, we get NNPMP
= 500 − 50
= Rs.450
(iii) NNP at factor cost or NNPFC = NNPMP − Sales tax
Here NNPMP = 450
Sales Tax= 30
Therefore NNPFC is
= 450 − 30
= Rs.420
(iv)Personal Income or PI = NNPFC − Retained earnings
Here NNPFC = 420
Retained earnings = 220
Therefore, Personal Income is
= 420 − 220
= Rs.200
(v) Personal Disposable Income or PDI = PI − Income tax
Putting values of PI and Income Tax we get PDI is
= 200 − 20
= Rs.180
11. The value of the nominal GNP of an economy was Rs 2,500 crores in a particular
year. The value of GNP of that country during the same year, evaluated at the prices of
same base year, was Rs 3,000 crores. Calculate the value of the GNP deflator of the year
in percentage terms. Has the price level risen between the base year and the year under
consideration?
12. Write down some of the limitations of using GDP as an index of welfare of a country.
There are various limitations to using GDP as a measure of the welfare of a country. GDP
(Gross Domestic Product) is the total aggregate value of all goods and services produced
within the boundaries of a country or an economy. GDP can be a good indicator of a
country’s economic size, growth and value. It is essentially a total measure of all the
economic activities taking place in the economy. The relationship between welfare and GDP
is contested and not conclusive. Here are some reasons why GDP cannot be a measure of
welfare in a country.
i) GDP gives us only a measure of the total income of an economy. It does not provide us
with any details about how the earned income is distributed between the people. In countries
with a high rate of inequality, growth in GDP disproportionately benefits the wealthy, leaving
the average person with fewer benefits.
ii) GDP does not take into account the environmental costs of production and development. A
factory causing environmental degradation and pollution might be contributing to the GDP,
but the long-term costs and consequences of these are not taken into account in the GDP
calculation. Therefore, the GDP value of an economy is not a reflection of environmental
welfare.
iii) Consumption and spending do not necessarily mean ‘well-being’ for the people. The
citizens of a country could be spending more and raising their income, but other factors like
access to healthcare and education are essential for their well-being. GDP does not speak for
the average citizen’s Standard of living and Quality of Life.
iv) There are several socioeconomic factors like gender development, literacy, freedom and
equality which play a part in the overall welfare of society. GDP ignores these factors of
social progress and human development.
  NUMERICALS
 Question 1
 Calculate the domestic income or NDP at FC.

Particulars ₹ in crores

GNP at MP 6,000
200
Subsidies
100
Depreciation
400
Net Factor income from abroad
300
Indirect Tax

 Solution:
 NDP at FC
 = GNP at MP- Depreciation-Net Factor income from abroad- (Indirect tax-Subsidies)
 = 6,000-100-400- (300-200)
 = ₹ 5,400 crores
 Question 2
 Calculate GNP at MP

Particulars ₹ in crores

Domestic Income or NDP at FC 3,200

400
Depreciation
70
Indirect Taxes
50
Net Factor income to abroad

 Solution:
 GNP at MP
 = NDP at FC + Depreciation – Net Factor income from abroad + Indirect tax
 =3,200 + 400-50 + 70
 = ₹3,620 crores
 Question 3
  Calculate national income or NNP at FC

Particulars ₹ in crores

GDP at MP 5,500
300
Consumption of fixed capital
120
Goods and services tax
150
Factor income from abroad
70
Subsidies
250
Factor income to abroad

 Solution:
 National Income or NNP at FC
 = GDP at MP -M Consumption of fixed capital + (Factor income from abroad – factor
income to abroad) – (Goods and Services tax – Subsidies)
 =5,500 – 300 + (150-250) – (120-70)
 = ₹ 5,050 crores
 Question 4
 Define domestic income.
 Ans: Domestic income is the net money value of all the final goods and services
produced within the domestic territory of a country during a period of one year.
 Question 5
 When will the GDP of an economy be equal to the GNP?
 Ans: GDP and GNP will be equal when the net factor income from abroad is zero
 Question 6
 In which type of economy will the domestic income be equal to the national
income?
 Ans: Closed economy