National Income AccountingClass 12 Introductory Macroeconomics NCERT Solutions
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Q1Questions
What are the four factors of production and what are the remunerations to each of these called?
Solution
Based on the chapter, the four factors of production and their respective remunerations are:
- Human Labour: The remuneration for the contribution made by human labour is called wage.
- Capital: The remuneration for the contribution made by capital is called interest.
- Entrepreneurship: The remuneration for the contribution of entrepreneurship is called profit.
- Fixed Natural Resources (Land): The remuneration for the contribution made by fixed natural resources, referred to as 'land', is called rent.
Q2Questions
Why should the aggregate final expenditure of an economy be equal to the aggregate factor payments? Explain.
Solution
The aggregate final expenditure of an economy must be equal to the aggregate factor payments because of the circular flow of income in an economy. The fundamental idea is that the revenue earned by all the firms in an economy must be distributed among the factors of production that contributed to the production process.
Here is a step-by-step explanation:
- Production and Income Generation: Firms produce goods and services by employing factors of production (labour, capital, land, entrepreneurship) supplied by households.
- Factor Payments: In return for these services, firms make payments to the households in the form of wages, interest, rent, and profits. The sum of these payments is the aggregate factor income.
- Expenditure: The households then use this income to purchase the final goods and services produced by the firms. This spending is the aggregate final expenditure.
- Circular Flow: This expenditure becomes the revenue for the firms, which is then used again to pay the factors of production in the next cycle. Therefore, the money flows from firms to households as factor payments and then flows back from households to firms as expenditure. In a simple economy without leakages like savings, taxes, or imports, the total value of what is produced (Product Method), what is earned (Income Method), and what is spent (Expenditure Method) must be equal. The aggregate final expenditure is the total spending on final goods, which equals the total revenue of firms, which in turn equals the total income paid to factors.
Q3Questions
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.
Solution
Distinction between Stock and Flow:
- Stock: A stock is a variable that is measured at a particular point in time. It does not have a time dimension. Examples include the amount of money in a bank account on a specific date, or the total number of machines in a factory at a given moment.
- Flow: A flow is a variable that is measured over a period of time. It has a time dimension (per hour, per day, per year). Examples include income earned per month, or the amount of output produced in a year.
Net Investment and Capital:
- Capital is a stock. It refers to the total stock of machines, buildings, and other equipment that a firm or an economy possesses at a specific point in time.
- Net Investment is a flow. It represents the addition to the stock of capital over a specific period of time (e.g., a year). Net Investment = Gross Investment - Depreciation.
Comparison with Water in a Tank:
The relationship between capital and net investment can be compared to the water in a tank:
- The stock of capital is like the amount of water in the tank at a particular point in time (a stock concept).
- The flow of net investment is like the amount of water flowing into the tank from a tap per minute or per hour (a flow concept). This flow adds to the existing stock of water in the tank. Similarly, net investment adds to the existing stock of capital in the economy.
Q4Questions
What is the difference between planned and unplanned inventory accumulation? Write down the relation between change in inventories and value added of a firm.
Solution
Difference between Planned and Unplanned Inventory Accumulation:
Inventories are the stocks of unsold finished goods, semi-finished goods, or raw materials a firm carries. Change in inventory can be planned or unplanned.
- Planned Inventory Accumulation: This occurs when a firm intentionally increases its stock of inventories. For example, if a firm expects higher sales in the future or wants to increase its buffer stock, it might produce more than its expected current sales. If a firm expecting to sell 1,000 units wants to increase its inventory by 100 units, it will produce 1,100 units. This increase of 100 units is planned accumulation.
- Unplanned Inventory Accumulation: This occurs when a firm's actual sales are less than its expected sales, leading to an unexpected pile-up of unsold goods. For example, if a firm produces 1,000 units expecting to sell them all, but is only able to sell 600 units due to an unexpected fall in demand, the resulting increase in inventory of 400 units is unplanned accumulation.
Similarly, there can be planned or unplanned decumulation (decrease) of inventories.
Relation between Change in Inventories and Value Added:
The value added of a firm is the net contribution made by it to the production process. The relation between change in inventories and value added is derived from the definition of Gross Value Added (GVA).
The Gross Value Added of a firm is defined as:
- GVA ≡ Gross value of output produced - Value of intermediate goods used
Since the gross value of output produced is equal to the value of sales plus the value of change in inventories, we can write:
- GVA ≡ (Value of sales + Value of change in inventories) - Value of intermediate goods used
From this, we can also derive the relation for change in inventories:
- Change in inventories of a firm during a year ≡ Value added + Intermediate goods used by the firm - Sale of the firm during a year.
Q5Questions
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.
Solution
The three methods of calculating the Gross Domestic Product (GDP) of a country are the Product (or Value Added) Method, the Expenditure Method, and the Income Method. The identity showing their equivalence is:
Where:
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Product Method: GDP is the sum of gross value added of all firms in the economy.
GDP ≡ Σ GVAi(where GVAi is the Gross Value Added of firm i)
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Expenditure Method: GDP is the sum of all final expenditures in the economy.
GDP ≡ C + I + G + (X - M)- C = Final Consumption Expenditure
- I = Final Investment Expenditure
- G = Government Final Expenditure
- (X - M) = Net Exports (Exports - Imports)
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Income Method: GDP is the sum of all factor incomes earned within the domestic territory.
GDP ≡ W + P + In + R- W = Wages and Salaries
- P = Profits
- In = Interest
- R = Rent
Reason for Equivalence:
These three methods should give the same value of GDP because they are measuring the same economic activity at different points in the circular flow of income. The value of total production of final goods and services must be equal to the total income generated in the production process, which in turn must be equal to the total expenditure on these goods and services.
- The Product Method measures the value of what is produced.
- This production generates income for the factors of production (labour, capital, etc.). The Income Method measures this sum of factor incomes.
- This income is then used by households, firms, and the government to purchase the goods and services produced. The Expenditure Method measures this total spending.
Thus, the total value of production is distributed as income, and this income is used for expenditure on that production, completing the circle. Therefore, Production = Income = Expenditure.
Q6Questions
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 that country?
Solution
The concepts of budget deficit and trade deficit, and the macroeconomic identity required to solve the numerical problem, are not discussed in Chapter 2 of the provided source text. The chapter focuses on the fundamental concepts of national income accounting, such as the three methods of calculating GDP, related aggregates, and the difference between real and nominal GDP. Therefore, based on the content of this chapter alone, this question cannot be answered.
Q7Questions
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.
Solution
We are given the following information:
- GDP at market price (GDP_MP) = Rs 1,100 crores
- Net Factor Income from Abroad (NFIA) = Rs 100 crores
- Net Indirect Taxes (Indirect Taxes - Subsidies) = Rs 150 crores
- National Income (NI or NNP at factor cost, NNP_FC) = Rs 850 crores
We need to find the value of Depreciation.
Step 1: Calculate Gross National Product at Market Prices (GNP_MP)
- GNP_MP = GDP_MP + NFIA
- GNP_MP = 1,100 + 100 = Rs 1,200 crores
Step 2: Calculate Net National Product at Market Prices (NNP_MP)
National Income (NNP_FC) is related to NNP_MP as follows:
- NNP_FC = NNP_MP - Net Indirect Taxes
- 850 = NNP_MP - 150
- NNP_MP = 850 + 150 = Rs 1,000 crores
Step 3: Calculate Depreciation
Depreciation is the difference between Gross National Product (GNP) and Net National Product (NNP).
- Depreciation = GNP_MP - NNP_MP
- Depreciation = 1,200 - 1,000 = Rs 200 crores
The aggregate value of depreciation is Rs 200 crores.
Q8Questions
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?
Solution
We are given the following information:
- Net National Product at Factor Cost (NNP_FC or NI) = Rs 1,900 crores
- Personal Disposable Income (PDI) = Rs 1,200 crores
- Personal Income Taxes = Rs 600 crores
- Retained Earnings (Undistributed Profits + Corporate Tax) = Rs 200 crores
- Net interest payments made by households = 0
We need to find the value of Transfer Payments.
Step 1: Calculate Personal Income (PI)
Personal Disposable Income is related to Personal Income as follows:
- PDI = PI - Personal Income Taxes - Non-tax Payments
- Assuming Non-tax Payments are zero, PDI = PI - Personal Income Taxes
- 1,200 = PI - 600
- PI = 1,200 + 600 = Rs 1,800 crores
Step 2: Calculate Transfer Payments
Personal Income is related to National Income (NNP_FC) as follows:
- PI = NI - Undistributed Profits - Corporate Tax - Net interest payments made by households + Transfer Payments
We are given that 'retained earnings' (which includes Undistributed Profits and Corporate Tax) is Rs 200 crores, and net interest payments are zero. So the formula becomes:
- PI = NI - Retained Earnings + Transfer Payments
- 1,800 = 1,900 - 200 + Transfer Payments
- 1,800 = 1,700 + Transfer Payments
- Transfer Payments = 1,800 - 1,700 = Rs 100 crores
The value of transfer payments made by the government and firms to the households is Rs 100 crores.
Q9Questions
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
Solution
We need to calculate Personal Income (PI) and Personal Disposable Income (PDI) from the given data.
Step 1: Calculate National Income (NI)
National Income (NI) is Net National Product at Factor Cost (NNP_FC).
- NI = Net Domestic Product at factor cost (NDP_FC) + Net Factor Income from abroad (NFIA)
- NI = 8,000 + 200 = Rs 8,200 crores
Step 2: Calculate Net Interest Payments made by Households
- Net Interest Payments = Interest Paid by Households - Interest Received by Households
- Net Interest Payments = 1,200 - 1,500 = -Rs 300 crores
Step 3: Calculate Personal Income (PI)
The formula for PI is:
- PI = NI - Undisbursed Profit - Corporate Tax - Net Interest Payments made by Households + Transfer Income
- PI = 8,200 - 1,000 - 500 - (-300) + 300
- PI = 8,200 - 1,000 - 500 + 300 + 300
- PI = 7,200 - 500 + 600
- PI = 6,700 + 600
- PI = Rs 7,300 crores
Step 4: Calculate Personal Disposable Income (PDI)
The formula for PDI is:
- PDI = PI - Personal Tax
- PDI = 7,300 - 500
- PDI = Rs 6,800 crores
Therefore, Personal Income (PI) is Rs 7,300 crores and Personal Disposable Income (PDI) is Rs 6,800 crores.
Q10Questions
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.
Solution
Based on the information provided, we can calculate Raju's contribution to the various measures of income.
(a) Gross Domestic Product (GDP)
GDP is the market value of final goods and services produced. Raju's service (haircuts) is a final service. Assuming no intermediate inputs, his contribution to GDP at market price is the total revenue he collects.
- GDP = Rs 500
(b) NNP at market price
Net National Product (NNP) is calculated by subtracting depreciation from Gross National Product (GNP). Since this is a domestic activity with no information on factor income from abroad, we can assume GNP = GDP and NNP = NDP (Net Domestic Product).
- NNP at market price = GDP at market price - Depreciation
- NNP at market price = 500 - 50 = Rs 450
(c) NNP at factor cost
NNP at factor cost (or National Income) is NNP at market price minus net indirect taxes. The sales tax is an indirect tax.
- NNP at factor cost = NNP at market price - Indirect Taxes
- NNP at factor cost = 450 - 30 = Rs 420
(d) Personal Income (PI)
Personal Income is the income received by households. From the NNP at factor cost (Rs 420), we deduct the profits retained by the business (undistributed profits) to find the income that accrues to the household.
- PI = NNP at factor cost - Retained Earnings
- PI = 420 - 220 = Rs 200 (This also matches the amount Raju "takes home".)
(e) Personal Disposable Income (PDI)
Personal Disposable Income is Personal Income minus personal taxes.
- PDI = PI - Personal Income Tax
- PDI = 200 - 20 = Rs 180
Q11Questions
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?
Solution
We are given the following information:
- Nominal GNP = Rs 2,500 crores
- Real GNP (GNP at base year prices) = Rs 3,000 crores
Calculation of GNP Deflator:
The formula for the GNP deflator is:
- GNP Deflator = (Nominal GNP / Real GNP) × 100
- GNP Deflator = (2,500 / 3,000) × 100
- GNP Deflator = (5 / 6) × 100
- GNP Deflator = 83.33
The value of the GNP deflator for the year is 83.33%.
Change in Price Level:
The base year's deflator is always 100. Since the GNP deflator for the year under consideration (83.33) is less than 100, it indicates that the general price level has fallen between the base year and the year under consideration.
Q12Questions
Write down some of the limitations of using GDP as an index of welfare of a country.
Solution
While a higher GDP often corresponds to a higher standard of living, it is not a perfect measure of the welfare of a country's people. Some key limitations are:
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Distribution of GDP: An increase in the total GDP does not reveal how that income is distributed among the population. If the rise in GDP is concentrated in the hands of a very small portion of the population, the majority of people may actually be worse off. Thus, a rising GDP can hide growing inequality, and the welfare of the entire country cannot be said to have increased.
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Non-Monetary Exchanges: Many productive activities in an economy are not evaluated in monetary terms and are therefore excluded from GDP calculations. For example, the services of a homemaker, care for the elderly at home, and barter exchanges in the informal sector are not counted. In many developing countries, these non-monetary exchanges form a significant part of economic activity. This leads to an underestimation of the actual productive activity and well-being of the people.
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Externalities: Externalities are the positive or negative impacts of an economic activity on others, for which no price is paid or penalty is imposed.
- Negative Externalities: For example, a factory might pollute a river while producing goods. The value of the goods is added to GDP, but the harm caused by pollution (e.g., to public health or fishermen's livelihoods) is not subtracted. In this case, GDP overestimates the actual welfare.
- Positive Externalities: Conversely, if someone creates a beautiful public garden, it benefits the community, but this benefit is not added to GDP. In such cases, GDP underestimates welfare.