Chapter – 2: National Income and Related Aggregates (10 Marks)
Short and Long Answer Type Questions
1. What is circular flow of income? Mention its two principles.
Ans: In a macro economy, every economic decision of a sector is in response to that of another. The system of interrelationship between the major sectors of economic activity is called circular flow of income and product.
Circular flow of income involves two basic principles:
- In any exchange process, the seller (or producer) receives the same amount that the buyer or consumer spends and
- Goods and services flow in one direction and money payments to get these goods and services flow in the return direction. Thereby causing a circular flow.
2. What are three phases of circular flow of income?
Ans: There are three phases in circular flow of income:
a) Production Phase: In this phase, goods and services are produced by the producing sectors.
b) Distribution phase: In this phase, income flows in the forms of rent, wages, interest and profit from producing sector to household sector.
c) Expenditure or disposition phase: In this phase, there is disposition (i.e. spending) of income on the purchase of goods and services by the households and the other sectors.
3. Explain the circular flow of income is simplified economy with two sectors – households and firms (Relationship). 2012, 2014, 2016
Ans: Circular flow of income forms the basis for measurement of Macro economics activities. It helps to know the functioning of an economy. Circular flow of income is a two sector economy is presented in the form of a household sector and firm sector. Factors of production are required for producing goods. The households (owners of factor inputs) supply factor services to the firms; which pay them a price for these services in form of wage, rent, interest and profit. Households make use of this income to purchase different goods and services produced by the firms. Thus, households depend on firms for factor payments and firms depend on households for sales revenue. The circular flow of income in a two sector economy is presented in the form of a figure given below:
4. Explain the role of government in circular flow of income.
Ans: The role of government is important. It acts as regulator and as an agent of promoting public welfare in the country. The relationships between households and the government and between firms and government can be explained in the following way. The government receives taxes from households and firms which are withdrawals or leakages from the circular flow of income. Government also purchases goods and services from households and firms. These government purchases are injections into the circular flow of income. Apart from purchases, government also makes transfer payments. Transfers payments to households are in the form of unemployment allowance, old age pension, scholarship etc. Government also provides subsidies to the firms.
5. What is importance of study of circular flow of income models?
Ans: The study of circular flow of income is important in the following ways:
- Circular flow models help us to understand the mutual interdependence among different sectors of the economy namely household sector, producing sector and government sector.
- They also help in identifying various types of leakages and infections in the economy.
- Circular flow of income facilitates the estimation of national income. There are three phases in circular flow of income viz. production phase, income phase and expenditure phase.
6. Income is flow and flow of income is circular. Explain.
Ans: Income is a flow concept as it is estimated per unit of time period. For example, national income is measured per year; income of a household is measured per month etc. Flow of income is circular. It flows in a circular way across the different sectors of the economy. In a two sector economy, income received by the owners of factors of production (that is households) is spent by them on the purchase of goods. Thus flow of income is circular.
7. Explain the concept of double counting with the help of suitable examples. How it can be avoided. 2016
Ans: The counting of the value of commodity more than once is called double counting. This leads to over estimation of the value of goods and services produced. Thus, the importance of avoiding double counting lies in avoiding over estimating the value of domestic product, e.g. a farmer produces one tonne of wheat and sells it for Rs.400 in the market to a flour mill. The flour mill sells it for Rs. 600 to the baker. The baker sells the bread to the shopkeeper for Rs. 800. The shopkeeper sells the entire bread to the final consumer’s for Rs.900. Thus, Value of Output = Rs. (400 + 600 + 800 + 900) = Rs.2700.
Double counting can be avoided by:
- Taking the value of final goods
- Add value added method of each firm
8. What is depreciation? Mention its main causes and significance. 2017
Ans: Depreciation refers to a fall in the value of fixed assets due to normal wear and tear, passage of time and expected obsolescence (change in technology).
Cause of Depreciation: Depreciation is mainly caused by the following:
a) Normal wear and tear: Constant use of fixed assets in factors in the process of production decreases their value.
b) Passage of time: Value of fixed assets also falls with the passage of time, even if they are not being put to use in the business. Natural factors like rain, winds weather, etc. contribute to this fall.
c) Expected obsolescence: Value of fixed assets also falls due to change in technology and change in demand for goods and services.
Significance of the concept of depreciation
The concept of depreciation assumes a great significance in national income accounting. It is used to differentiate between gross variables and net variables. Gross variables like GDP, gross profit, gross investment are inclusive of depreciation. When we deduct depreciation from a gross variable, we obtain a net variable. For example, when we deduct depreciation from GDP, we get NDP.
9. What are the uses of national income accounting?
Ans: National income is a monetary measure. It is a set of rules and definitions for measuring economic activity in the economy. Following are the uses of national accounting –
- National income accounting shows as to how the national income is distributed among the factors of production.
- It is a record of economic function that is production, consumption, savings and capital formation.
- It indicates the specific contribution of individual sectors as well as the growth of these sectors.
- It indicates the changes in the sectoral composition of national output and it gives the knowledge of the structural changes in the economy.
- Government was these accounts for the economic policies in the country.
- Comparison is possible in the field of income, consumption and capital formation, among the different countries and regions.
10. Explain product method of measurement of National income. 2014
Ans: This approach is also called output method or inventory method as it measures income from the output side. In this approach, we add up the specific value of the flows of output arising from each sector of the economy. As per this method, the economy is divided into different industrial sectors to show the contribution made by each sector to GDP. Then, the national income is calculated by adding the value of final goods from all the sectors that have taken place during a year. Final goods are those goods which are directly consumed and not used in further production process. In order to avoid the problem of double counting, there are two methods for calculating national income viz; final product method and value-added method.
Final product Method: In this method in estimating GDP, the only final value of goods and services are computed ignoring all intermediate transaction, Intermediate goods are those which are further processed to produce final goods. In this approach, national income is calculated by finding the market value of all final goods and services produced within the country during the time period of one year. Thus, GDP = market value of all final goods and services produced within the country.
Value added method: This is also the another method of avoiding double counting in calculating national income in which the country’s income is measured by adding the differences between the values of inputs and output at each stage of production. As per this method, income is the sum of value added by different producing units of a country in their production process. Hence, Value added = Value of output – Cost of production For the purpose of estimating value added, the following steps are generally applied:
- Identifying the production units and classifying them under different industrial activities.
- Estimating net value added by each production unit in an industrial sector.
- Adding up the total value added of each final product to calculate GDP.
This method is considered very useful as it helps to get some very important information about the contribution made by each of the different production sectors of the economy to the value of GDP. It also gives us an idea about the current structure of national income and changes in the structure over the period of time.
Precautions: The following precautions should be taken while measuring national income of a country through value added method:
- Imputed rent values of self-occupied houses should be included in the value of output. Though these payments are not made to others, their values can be easily estimated from prevailing values in the market.
- Sale and purchase of second-hand goods should not be included in measuring value of output of a year because their values were counted in the year of output of the year of their production. Of course, commission or brokerage earned in their sale and purchase has to be included because this is a new service rendered in the current year.
- Value of services of housewives are not included because it is not easy to find out correctly the value of their services.
- Value of intermediate goods must not be counted while measuring value added because this will amount to double counting.
11. Explain income method of measurement of National income. 2012, 2013, 2015, 2017
Ans: The income method of calculating national income is also called the factor income method or factor share method. This method measures national income from distribution side i.e. the national income is measured after it has been distributed and appears as income earned by individuals in the country. To estimate the national income by this approach, the total sum of the factor payments received during a given period is estimated. The factors of production are classified as land, labor, capital and organization. Accordingly, the national income is calculated as the sum of various factor payments like rent, wages, interest and profits plus depreciation.
Thus, National income = Rent + Wages + Interest + Profits + Depreciation
This method of estimating national income is of great advantage as it shows the distribution of national income among different income groups such as landlords, capitalists, workers, etc. It is therefore called national income by distributive shares.
Precautions: While estimating national income through income method the following precautions should be taken:
- Transfer payments are not included in estimating national income through this method.
- Imputed rent of self-occupied houses are included in national income as these houses provide services to those who occupy them and its value can be easily estimated from the market value data.
- Illegal money such as hawala money, money earned through smuggling etc. are not included as they cannot be easily estimated.
- Windfall gains such as prizes won, lotteries are also not included.
12. Explain Expenditure method of measurement of National income. 2016, 2019
Ans: The expenditure method is also known as the final product method, which measures the national income at the final expenditure stage. In other words, it measures national income as the aggregate of all final expenditure on Gross Domestic Product in an economy within a year. Hence, expenditure method measured the disposal of GDP. This method calculates national income by adding up all the expenditures made on goods and services during a year. Income can be spent either on consumer goods or investment goods. Hence, the national income is calculated by adding consumption expenditure and investment expenditure made by individuals as well as government during a period of one year. National income is calculated by adding:
- Personal consumption expenditure(C): It is the household sector’s purchases of currently produced goods and services. Consumption can be broken down into consumer goods (automobiles, televisions) , non-durable goods (foods, beverages) and consumer goods (medical services, haircuts).
- Gross domestic investment (I): It consists of expenditure of private business on replacement, renewals and new investment.
- Government expenditure (G): It refers to the government purchases of goods and services. Government transfer payments to individuals and government interest payments are examples of government expenditure.
- Net export(X): Net export equal total exports minus imports. It represents the contribution of foreign sector in the national economy.
Hence, GDP = C + I + G + X
Precautions: While calculating National Income by expenditure method, the following precautions are necessary:
- We should not include expenditure on the purchase of second hand goods as the expenditure on these goods has been included when they are bought for the first time.
- For avoid double counting only including the expenditure of final products.
- Expenditure on gifts, donation, taxes, scholarships etc. is not the expenditure on final products. There are transfer payments (or transfer expenditure) and should not be included in final expenditure.
- Expenditure on intermediate goods such as fertilisers and seeds by the farmers and wool, cotton and yarn by manufacturers of garments should also be excluded. This is because we have to avoid double counting. Therefore, for estimating Gross Domestic Product we have to include only expenditure on final goods and services.
- Expenditure on purchase of old shares and bonds from other people and from business enterprises should not be included while estimating Gross Domestic Product through expenditure method. This is because bonds and shares are mere financial claims and do not represent expenditure on currently produced goods and services.
13. What is Goods? Distinguish between Public Goods and Private Goods. 2015
Ans: Goods are something which we all use in our daily lives and the moment we wake up till we sleep we are using one or another product. However goods can public or private which are differentiated as below:
- Public goods are those which are free to use and therefore there is no cost involved in usage of such products whereas for private product one has to pay in order to use them.
- Examples of public goods are air, roads, street lights and so on whereas examples of private goods are cars, cloths, furniture and so on.
- Public goods are either provided by nature or government whereas private goods are provided or manufactured by entrepreneurs who make them in order to earn profit.
- Public goods are non-rivalrous and non-excludable in consumption. Whereas, Private goods are rivalrous and excludable in consumption.
14. What are the differences between Consumer Goods and Capital Goods? 2014, 2015
Ans: The main differences between consumer goods and capital goods are as follows:
|Consumer Goods||Capital Goods|
|These goods are used by their ultimate consumers.||These are final goods used by the producers in the production process.|
|These goods directly satisfy human wants. Thus they have direct demand.||These goods indirectly satisfy human wants. Thus they have derived demand.|
|These goods may be consumer durables (i.e. TV set, car), Semi-durables like clothing and single use goods such as milk, good etc.||Capital goods are the producer durables of high value.|
|The wear and tear of consumer durables, when put in use, is not taken into account while measuring national income.||These goods undergo wear and tear and hence are gradually replaced over time. Their cost of wear and tear is deducted to arrive at net national income.|
15. Differentiate between intermediate products and final products.
Ans: The differences between intermediate products and final products are given below:
- Final goods are meant for final use by consumers or firms, while intermediate goods (a) are used to produce other goods or (b) for resale in the same year.
- Final goods are not required to enter into further stages of production or resale, whereas, intermediate goods move from one stage of production to another.
- While measuring the final value of economic activity, only the value of final goods is taken. The value of intermediate goods is not entered into the final value of economic activity.
16. Distinguish between real flow and money flow.
Ans: The differences between real flow and money flow are as follows:
|Real Flow||Money Flow|
|Real flow is the exchange of goods and services between the major sectors of an economy.||Money flow is the exchange of money between the major sectors.|
|In real flow, factor services flow from household sector to firms. At the same time, firms supply goods and services to households.||In money flow, the households are rewarded for factor services rendered by them in money terms. They receive wage, rent, interest and profit.|
|It is called physical flow because actual goods and services flow between the sectors.||It is called nominal flow because it is thorough money that various transactions take place.|
17. Distinguish between Leakages and Injections of giving examples.
|Leakages refer to the withdrawals from circular flow of income||Injections refer to the additions to circular flow of income.|
|They have a negative impact on the process of production (or the process of income generation).||They have positive impact on the process of production or income generation.|
|Leakages (a) Reduce flow of income/production. (b) Reduce demand of goods and services.||Injections (a) Add to the production capacity of the economy. (b) Generate demand of goods and services.|
|Examples: Saving, taxation and imports.||Examples: investment, exports, consumption expenditure.|
18. Distinguish between Stock and Flow.
Ans: The differences between stock and flow are as follows:
|Stock relates to a point to time e.g. Stock in hand as on 31st Dec 2017.||Flow relates to the period of time e.g. income of a household or of a nation.|
|Stock has no time dimension.||Flow has time dimension.|
|Stock influences flow e.g. larger the stock of capital more will be the flow of goods and services.||Flow influences stock e.g. monthly increase in income of a household leads to growth in its wealth.|
19. Distinguish between Factor income (or payment) and Transfer Income (or payment). 2017
Ans: The differences between these two are given below:
|Factor Income (or Payment)||Transfer Income (or Payment)|
|It is received in return for rendering productive service.||It is received without providing any good or service in return.|
|It comprises rent, wages, interest and profit.||It comprises gifts, subsidies, donations, scholarships etc.|
|It is an earned income and hence, an earning concept.||It is an unearned income and hence a receipt concept.|
|It is included in national income.||It is not included in national income.|
20. Distinguish personal income from private income.
Ans: Following are the difference between personal income and private income:
- Personal income is the income actually received by the individuals during a particular period of time. On the other hand, private income is the income of the private sector that is factor incomes and transfer incomes received from all sources within and outside the country.
- Personal income is obtained by deducting two items from the private income that is undistributed profits and corporate taxes.
- The concept of private income is vast that the personal income.
21.Distinguish between gross value added and net value added.
Ans: Following are the differences between gross value added and net value added.
- Gross value added means the value of final goods and services are measured by each enterprise in the production process including the value of depreciation also. On the other hand, net value added means the value of those output which are receives after deducting intermediate consumption depreciation and net indirect taxes.
- The area of gross value added is more than the net value added.
- The net value added is the part of the gross value added.
22. Explain the differences between National Income at Current Prices and National Income at Constant Prices.
Ans: Following are the differences between National Income at Current Prices and National Income at Constant Prices:
|National Income at Current Prices||National Income at Constant Prices|
|National Income at current prices is affected by (a) change in price and (b) change in physical output of goods and services.||National Income at constant prices is affected only by change in physical output.|
|It is not a true indicator of economic growth of a country.||It is a true indicator of economic progress of a country.|
|It cannot be compared with base year national income.||It is comparable with the base year national income.|
23 Distinguish between GDPMP and GNPMP.
Ans: The differences between the two are as given below:
|GDP is the money value of all the final goods and services produced within the domestic territory of a country.||1||GNP is the money value of all the final goods and services produced by the normal residents of a country.|
|GDP is a geographical concept as it related to the domestic territory.||2||GNP is a national concept as it related to the normal residents.|
|GDP does not include net factor income from abroad.||3||GNP includes net factor income from abroad.|
24. Distinguish between Net Domestic Product at Market Price and Net National Product at Market Price.
Ans: The differences between Net Domestic Product at Market Price and Net National Product at Market Price are as follows:
|Net Domestic Product at Market Price||Net National Product at Market Price|
|It implies the market value of all final goods and services within the domestic territory of a country.||It signifies the market value of final goods and services produced by the normal residents of a country.|
|It is a domestic concept, as it excludes net factor income from abroad.||It is a national concept as it includes net factor income from abroad.|
|NDPMP=GMPMP – Depreciation
NDPMP =NNPMP – NFIA
|NNPMP=GNPMP – Depreciation
NNPMP =NDPMP + NFIA
25. Distinguish between National Income and Domestic Factor Income.
Ans: The differences between National Income and Domestic Factor Income are as follows:
|National Income (NNPFC)||Domestic Factor Income (NDPFC)|
|It includes income generated by residents both within and outside the country.||It includes income generated by residents as well non-residents within the domestic territory of the country.|
|It includes net factor income earned from abroad and hence is a national concept.||It excludes net factor income earned from abroad. So, it is domestic concept.|
|National income = Domestic Income + Net factor income earned from abroad.||Domestic income = National income – Net factor income earned from abroad.|
26. Distinguish between Private Income and National Income.
Ans: Private Income can be also distinguished from National Income as under:
- Private income includes only income of the private sector while national income includes income generated both in the private as well as public sector.
- Private income includes both factor incomes as well as transfer incomes while national income includes only factor incomes.
- Interest on national debt is included in private income but national income excludes it.
27. Distinguish between Personal Income and National Income.
Ans. Personal Income can be distinguished from National Income in the following ways:
- Personal income is the income of the households from all sources factor incomes and transfer incomes both whereas national income included only factor incomes. Thus personal income is related to receipts of income while national income relates to generation of income.
- Personal income excludes undistributed profits and corporation tax but national income includes them.
- Personal income excludes income from domestic product accruing to public sector while national income includes it.
28. Distinguish between NDPMP and NDPFC.
Ans: The differences between the two are given below:
|It refers to the market value of all final goods and services produced within the domestic territory of a country in an accounting year.||It is the income received by the factors of production while working within the domestic territory of a country in a year.|
|It is estimated at market price.||It is estimated at factor cost.|
|NDPMP = NDPFC + Indirect Taxes – Subsidies||NDPFC = NDPMP – Indirect Taxes + Subsidies|
29. Distinguish between Nominal GDP and Real GDP.
Ans: The differences between Nominal GDP and Real GDP are as follows:
|Nominal GDP||Real GDP|
|Nominal GDP is affected by (a) change in prices and (b) change in physical output of goods and services.||Real GDP is affected only by change in physical output.|
|It cannot be compared with base year GDP||It is comparable with the base year GDP.|
AHSEC CLASS 12 CHAPTER-WISE NOTES
Part A: Introductory Macro Economics
- INTRODUCTION TO MICRO ECONOMICS
- NATIONAL INCOME AND RELATED AGGREGATES
- MONEY AND BANKING
- GOVERNMENT BUDGET AND THE ECONOMY
- BALANCE OF PAYMENTS