National Income: Measurement— NBSE Class 12 Economics notes

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Here, you will find summaries, questions, answers, textbook solutions, pdf, extras etc. of (Nagaland Board) NBSE Class 12 (Arts/Commerce) Economics Chapter 4: National Income: Measurement. These solutions, however, should be only treated as references and can be modified/changed.

Introduction

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

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

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

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

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

Textual questions and answers

A. Very short-answer questions

1. Complete the following aggregates related to national product.

(i) National income = Domestic income ____________

Answer: + Net factor income from abroad

(ii) Private income = National income ____________

Answer: – Income accruing to Government sector

(iii) Personal income = Private income ____________

Answer: – Corporate tax – Undistributed profit

(iv) Personal disposable income = Personal income ____________

Answer: – Direct taxes

(v) Gross national disposable income = National income ____________

Answer: + Transfer payments

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

Answer: – Intermediate consumption

2. What is double counting?

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

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

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

7. What is operating surplus?

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

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

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

9. What all is included in compensation of employees?

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

3. Explain the problem of double counting.

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

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

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

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

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

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

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

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

1. Explain the product method of estimating national income.

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

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

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

3. Explain the expenditure method of estimating national income.

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

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6. How is domestic income different from national income?

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

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

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

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

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

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

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

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

2. Give briefly an outline of income method.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

(iii) Purchase of goods by foreign tourists

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

(iv) Profits earned by foreign companies in India

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

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

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

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

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

Numerical on Value Added (Product) Method

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

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

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

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

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

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12. Find net value added at FC:

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

Also,

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

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

= 5 + 10 = 15 (lakhs)

Depreciation = 0

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

Substituting the values:

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

= (20 + 2) – 15 – 0 – 1

= 15 (lakhs)

Therefore, Net Value Added at Factor Cost = 15 lakhs