NATIONAL INCOME AND RELATED AGGREGATES

PHASES OF CIRCULAR FLOW

There are three phases of circular flow
● Generation: Production of goods and services by the firms with the
help of factor services.
● Distribution : Flow of factor income from firms to households
● Disposition: Consumption expenditure by household on the goods
and services produced by firms.
In this way income generated in production units reaches
back to production units and makes the circular flow
complete.

CIRCULAR FLOW OF INCOME IN TWO SECTOR

ECONOMY
Meaning:

It refers to cycle of generation of income in the production process, its

distribution among the factors of production and finally, its circulation
from households to firms in the form of consumption expenditure on
goods and services produced by them.

Assumption:
● There are only two sector in the economy , namely Household and Firm
● Household is the sole consumer and receive factor income for their
services and spend the amount on consumption of goods and services and
Firm is the sole producer in the economy and sell the entire output to the
households.
● Household sector supplies factor services only to firms and the firms hire
factor services only from households.
● There are no leakages and injections in the economy

Basic principles:
 ● In any exchange process the seller or producer receives the same
amount that the buyer or consumer spends
● Goods and services flow in in direction (Real Flow) and money payment to
acquire these flow in the return direction, thereby causing a circular flow.

In the upper loop of the diagram

● Householdsprovide factor services like land , labour , capital an d

enterprise to the firms
● By using these the firm produce goods and service and provides to
the households.

In the lower loop of the diagram

● The firms make payment for the factor service to the households in
the form of rent , wage
, interest and profits
● Households make payment to the firm in the form of consumption
expenditure

In this case the flow of goods and services and factor services are
called real flow and money payments and expenditure are called
Money flow.

Money Flow = Real Flow

Hence:
Total Production = total consumption
Factor Payment = Factor Receipts
Consumption expenditure = Factor Income
Real Flow = Money Flow
Leakage : It is the amount of money which is withdrawn from circular flow of income.
For eg. Taxes, Savings and Import. It reduces aggregate demand and the level of
income.
Injection : It is the amount of money which is added to the circular flow of income.
For e.g. Govt. Exp., investment and exports. It increases the aggregate demand and
the level of income.

Real flow And money flow

REAL FLOW MONEY FLOW

Real flow is the exchange of goods and Money flow is the monetary exchange
services between household and firms between two sectors.
real flow household sector supplies raw In money flow, firm sector gives
material, land, labour, capital and remuneration in the form of money to
enterprise to firms and in return firms household sector a wages and salaries,
sector provides finished goods and rent, interest etc.
services to household sector.
Difficulties of barter system for the There is no such difficulty or
exchange of goods and factor services inconvenience arise in money flow.
between households and firms sector in
real flow.
It is also known as physical flow. It is also known as nominal flow.

STOCKS AND FLOWS

Stocks:
Meaning: Those variables which are measured at a point of time are
called stock variables Example: The population of India as on 31 st
March 2017
Flows:
Meaning : Those variables which are measured over a period of time
are called flow variables Example: the population of India during the
year 2017

Difference between stock and flow variable

Basi Stock variable Flow

s varia
ble
Meaning Those variable which are Those variables which are
measured at a point of time measured over a period of
time
Nature Static Dynamic
Time It does not have any time It has time dimension
dimensio dimension
n
Example Capital , National wealth Capital formation, National
Income, savings
 DOMESTIC TERRITORY (ECONOMIC TERRITORY)

Domestic territory is a geographical territory administered by a government within

which persons, goods and capital circulate freely.
Scope identified as
*Political frontiers including territorial waters and air space.
*Embassies, consulates, military bases etc. located abroad but including those
locates within the political frontiers. *Ships, aircrafts etc., operated by the residents
between two or more countries.
*Fishing vessels, oil and natural gas rigs etc. operated by the residents in the
international waters or other areas over which the country enjoys the exclusive
rights or jurisdiction.

RESIDENT

Resident (normal resident):- Normal resident is a person or an institution who

ordinarily resides in that country and whose center of economic interest lies in that
country.
(The Centre of economic interest implies :-
(1) the resident lives or is located within the economic territory.
(2) The resident carries out the basic economic activities of earnings, spending and
accumulation from that location
3. His center of interest lies in that country.

Exceptions:-

(a) Diplomats and officials of foreign embassy.

(b) Commercial travellers, tourists students etc.
(c) People working in international organizations like WHO, IMF, UNESCO etc. are
treated as normal residents of the country to which they belong.

CITIZEN AND RESIDENT

CITIZENSHIP IS A LEGAL CONCEPT BASED ON THE PLACE OPF BIRTH OF THE

PERSON OR SOME LEGAL PROVISIONS ALLOWING A PERSON TO BECOME A
CITIZEN.

RESIDENT
IT IS AN ECONOMIC CONCEPT BASED ON THE BASIC ECONMIC ACTIVITIES
PERFORMED BY A PERSON.

Relation between national product and Domestic product

Domestic product concept is based on the production units located within domestic
(economic) territory, operated both by residents and non-residents.

National product concept based on resident and includes their contribution to

production both within and outside the economic territory.

National product = Domestic product + Residents contribution to production

outside the economic territory
 (Factor income from abroad) - Non- resident contribution to
production inside the
economic territory (Factor income to abroad)

FACTOR INCOME AND TRANSFER INCOME

FACTOR INCOME TRANSFER INCOME

Payment received in exchange for The one received without providing any
rendering productive service is factor service (or good) in return is transfer
income income.
It is included in both national income It is neither included in national income
and domestic income. nor in domestic income.
It is received by factors of production. It id generally received by households
and government.
Rent, wages, interest and profit Scholarship, old age pension,
unemployment allowances.

FINAL AND INTERMEDIATE GOODS

FINAL GOODS INTERMEDIATE GOODS

Are those goods, which are used either Intermediate goods are those goods,
for final consumption or for investment. which are used either for resale or for
further production.
They are ready for use by final users. They are not ready for use by final
So, no value is added to these goods. users. So, some value has to be added to
these goods.
It is included in both national income It is neither included in national income
and domestic income.. nor in domestic income.
They have crossed the production They are still within the production
boundary boundary
Milk purchased by household for Example for intermediate good is- milk
consumption. used by a tea shop for selling tea.

NOTE: CONSUMPTION GOODS AND CAPITAL GOODS ARE PARTS OF FINAL

GOODS.

CONSUMPTION GOODS CAPITAL GOODS

those which are bought by consumers as Capital goods – capital goods are those
final or ultimate goods to satisfy their final goods, which are used and help in
wants the process of production of other goods
and services.
Eg: Durable goods car, television, radio E.g.: plant, machinery etc
etc. Non-durable goods and services like
fruit, oil, milk, vegetable etc. Semi
durable goods such as crockery etc.

Investment: addition to the capital stock of an economy.

It can be in two forms: gross investment and net investment

Gross investment: addition to the capital stock before making allowance for
depreciation.
Net investment: It is the addition to capital stock in an economy
during a year excluding depreciation.
Net Investment = Gross Investment – Depreciation
Example:
Suppose a company has 5 machines and 20% of each machine is
depreciated annually. This year the company has purchased another 3
machines. So the Gross Investment is 3 machines. But actually 1 machine
is meant for replacing the existing machines. Hence net investment is 2
machines.

DEPRECIATION:

It refers to the annual allowance for normal wear and tear of a capital good
● It is calculated annually
● It is pre-determined. Hence it is always positive
● The other names are Consumption of Fixed Capital, Replacement
Investment, Capital Consumption Allowances etc.
CAPITAL LOSS:
It refers to the loss in valuae of the fixed asset due to unforeseen obsolescence.
Natural calamities, thefts, accidents etc.

Goods: In economics a goods is defined as any physical object, manmade, that could
command a price in the market and these are the materials that satisfy human wants
and provide utility

Net indirect taxes:

Difference between indirect taxes and subsidies.

NIT = IT - SUBSIDIES

Indirect taxes: taxes which are imposed by government on production and sale of
goods and services. For example: GST

Subsidies are economic assistance given by the government to the households with
the motive of general welfare.
Factor cost: amount paid by factors of production for theior contribution in the
production process.
Market price: price at which product is initially sold in the market.

MP = FC + NIT
FC = MP – NIT

NET FACTOR INCOME FROM ABROAD: difference between factor income

received from the rest of the world and factor income paid to the rest of the world.

Factor income from abroad: income earned by normal resident of a country from
the ROW in the form of wages and salaries, rent, interest, dividend and retained
earnings.
Factor income paid to abroad is factor income paid to normal resident of other
countries for their factor services within the economic territory.

National Income: Domestic Income + NFIA

NFIA can be Positive, Negative or Zero
● NFIA is Positive when income earned from abroad is more than income paid to
abroad.
● NFIA is Negative when income earned from abroad is less than income.
● NFIA is Zero when income earned from abroad paid to abroad. is equal to
income paid to abroad.
●
Components of NFIA

There are three main components of NFIA:

1. Net Compensation to Employees: It refers to difference between income from

work received by resident workers living or employed abroad for less than one year
and similar payments made to non-resident workers staying or employed within the
domestic territory of the country for less than one year.

2. Net Income from property and entrepreneurship: It refers to difference

between income from property and entrepreneurship (in the form of rent, interest
and dividend) received by residents of the country and similar payments made to the
non-residents.

3. Net Retained Earnings: It refers to difference between retained earnings of

resident companies located abroad and retained earnings of non-resident companies
located within the domestic territory of the country.

4. Retained Earnings refer to that part of profits which is kept as reserve after
paying the corporate tax and dividends.

The related aggregates of national income are:-

i. Gross Domestic Product at Market price (GDPMP)

ii. Gross Domestic Product at Factor Cost (GDPFC)
iii. Net Domestic Product at Market Price (NDPMP)
iv. Net Domestic Product at FC or (NDPFC)
v. Net National Product at FC or National Income (NNPFC)
 vi. Gross National Product at FC (GNPFC)
vii. Net National. Product at MP (NNPMP)
viii. Gross National Product at MP (GNPMP)

Gross Domestic Product at Market Price : It is the money value of all the final
goods and services produced within the domestic territory of a country during an
accounting year.
GDPMP = Net domestic product at FC (NDPFC) + Depreciation + Net Indirect
tax.

Gross Domestic Product at FC: It is the value of all final goods and services
produced within domestic territory of a country which does not include net indirect
tax.
GDPFC = GDPMP – Indirect tax + Subsidy or GDPFC = GDPMP – NIT

Net Domestic Product at Market Price : It is the money value of all final goods
and services produced within domestic territory of a country during an accounting
year and does not include depreciation.
NDPMP = GDPMP – Depreciation

Net Domestic Product at FC : It is the value of all final goods and services which
does not include depreciation charges and net indirect tax. Thus it is equal to the
sum of all factor incomes (compensation of employees, rent, interest, profit and
mixed income of self employed) generated in the domestic territory of the country.
NDPFC = GDPMP – Depreciation – Indirect tax + Subsidy

Net National Product at FC (National Income) : It is the sum total of factor

incomes (compensation of employees + rent + interest + profit) earned by normal
residents of a country in an accounting year
NNPFC = NDPFC + Factor income earned by normal residents from abroad -
factor payments made to abroad.

Gross National Product at FC: It is the sum total of factor incomes earned by
normal residents of a country along with depreciation, during an accounting year.
GNPFC = NNPFC + Depreciation OR GNPFC = GDPFC + NFIA

Net National Product at MP : It is the sum total of factor incomes earned by the
normal residents of a country during an accounting year including net indirect taxes.
NNPMP = NNPFC + Indirect tax – Subsidy

Gross National Product at MP : It is the sum total of factor incomes earned by

normal residents of a country during an accounting year including depreciation and
net indirect taxes.
GNPMP = NNPFC + Dep + NIT

DOMESTIC AGGREGATES

Gross domestic Product at Market Price is the market value of all the final goods
and services produced by all producing units located in the domestic territory of a
country during an accounting year.
It includes the value of depreciation or consumption of fixed capital.

Net Domestic Product at Market Price. It is the market value of final goods and
services produced within the domestic territory of the country during a year
exclusive of depreciation. It is the factor income accruing to owners of factors of
production for supplying factor services with in domestic territory during an
accounting year.

NATIONAL AGGREGATES

Gross National Product at Market Price is the market value of all the final goods
and services produced by normal residents (in the domestic territory and abroad) of
a country during an accounting year.

National Income :It is the sum total of all factors incomes which are earned by
normal residents of a country in the form of wages. rent, interest and profit during
an accounting year.

METHODS OF CALCULATING NATIONALINCOME:

Value of Output: Market value of all goods and services produced by an enterprise
during an accounting year.
Value added: It is the difference between value of output of a firm and value of
inputs bought from the other firms during a particular period of time.

(a) Value Added Method

GVAMP = Value of Output – Intermediate cost
Value of output = Sales +
Change in stock Change in stock
= Closing stock – Opening Stock
**Intermediate Cost is the Non factor input cost
(a) Value Added Method:
Step-1: Identify various sectors of the economy as
Primary, secondary and tertiary Step-2: Calculate GVAMP
in all sectors by
GVAMP = Sales + Change in Stock –
Intermediate cost Step-3: Subtract the value of
depreciation from GVAMP and find NVAMP
NVAMP = GVAMP – Depreciation
Step-4:Add the value of NFIA with
NVAMP and get NNPMP NNPMP
= NVAMP + NFIA
Step-5 : Subtract the value of Net Indirect Taxes from
NNPMP and get NNPFC or the National Income
National Income/NNPFC = NNPMP – NIT
 Step-6: Add the National income of all sectors and find the
National Income of the economy

PROBLEM OF DOUBLE COUNTING:

Meaning:
Problem of double counting refers to adding the value of one output more
than once while estimating National Income.
Problem: Due to this the National Income is over estimated

While estimating national income as the market value of final goods produced in the
economy, one is likely to encounter the problem of double counting. The problem
arises when the value of certain goods is counted more than once. This happens
when we fail to draw the distinction between final goods (or final sales) and
intermediate goods
Let us understand this with the help of an example.

● Suppose, a farmer produces one tonne of wheat and sells it for Rs. 400 in the
market to a flour mill. As far as the farmer is concerned, the sale of wheat is a
final sale and he gets Rs. 400 for it. If he does not have to incur any
expenditure on the cultivation of wheat, 7 400 becomes the value of his
contribution to GDP or value added by him.

● The purchase of wheat by the flour mill is an intermediate good. It converts

wheat into flour and sells it for Rs. 600 to a baker. The four mill treats the
flour as a final good.

● But the baker uses it as an intermediate good and manufactures bread. The
baker sells the bread to the shopkeeper for Rs. 800. For the baker, the bread
is a final good.

● But for the shopkeeper, it is an intermediate good. The shopkeeper sells the
entire stock of bread to the final consumers for Rs. 900.

● In this the entire chain of production activity, if we overlook the fact that
output of one producer is used as raw material by the other, GDP estimation
would be grossly overrated, We might estimate it as equal to Rs. 400 + Rs. 600
+ Rs. 800 + Rs.900= 2,700.
● But the fact of the matter is that only final goods are to be included in the
estimation of GDP. And, in this example, market value of the bread sold by
shopkeeper to its final users should be included.

● Implying that GDP is Rs. 900 and not Rs. 2700.

Methods of avoiding:

This can be avoided by two methods

(a) Final Output Method
● In this method only the value of final output are included

● The value of intermediate cost are not included

 ● In the above example the value of bread is only included as the
value of wheat , flour are include in it

(b) Value Added Method:

● In this method the value added in various stages of
production are taken in to account ting while estimating
National Income instead of adding value of output in each
stage
● The value of the final ,output is equal to the sum of the
value added in various stages of production
● Value of Final Output = ∑ Value Added

Precautions while calculating national income using value added

method:

● Avoid double counting : Only value of final goods to be

included and thje value of intermediate goods are to be
excluded to avoid double counting
● Sale of Second hand goods not to be included: Sale of
Second hand goods is not a production activity. Its value
have already been included in the year it produced
● Self-consumed output to be included; As these are
produced through economic activities. (Self-services not to
be included)
● Own account production of goods of production units is to
be included as these are like those produced for the
market.
● Change of stock to be included; As these are a part of capital
formation
● Imputed value of own occupied house to be included :
These have values in the market
● Value of intermediate goods not to be included.
● Service for self-consumption are not included as their
market value is difficult to be estimated.

INCOME METHOD:
Income method, also known as factor income method, is used to calculate all
income accrued to the basic factors of production used in producing national
product. Traditionally, there are four factors of production, namely land, labor,
capital, and organization. Accordingly there are four factor payments, namely rent,
compensation of employees, interest, and profit. There is another category of factor
payment called mixed income.
These factor payments are explained as follows:

(a) Rent:
Refers to the amount payable in cash or in kind by a tenant to the landlord for using
land. In national income accounting, the term rent is restricted to land and not to
other goods, such as machinery.

In addition to rent, royalty is also included in national income which is defined as the
amount payable to landlord for granting the leasing rights of assets that can be
extracted from land, for example, coal and natural gas.

(b) Compensation of Employees:

Refer to the remuneration paid to employees in exchange of services rendered by
them for producing goods and services.

Compensation of employees is divided into two parts, which are as follows:

(i) Wages and salaries:Include remuneration given in the form of cash to
employees on a daily, weekly, or monthly basis. It includes allowances, such as
conveyance allowance, bonuses, commissions, rent-free accommodation, loans on
low interest rates, and medical and educational expenses.
(ii) Social security contribution:
Includes remuneration provided to employers in the form of social security schemes
such as insurance, pensions, and provident fund.

(c) Interest:
Refers to the amount payable by the production unit for using the borrowed money.
Generally, production units borrow for making investment and households borrow
for meeting consumption expenditure.

In national income accounting, interest is restricted to the payment by production

units. If production units use their own savings, then the interest is payable to them
in the form of imputed interest.
(d) Profits:Refers to the amount of money earned by the owner of a production unit
for his/her entrepreneurial abilities. The profits are distributed by the production
unit under three heads. First is by paying income tax, called corporate profit tax.
Second is by paying dividend to shareholder. Third is the retained earnings called
undistributed profits. Thus, profit Is the sum total of corporate profit tax, dividend,
and retained earnings.

(e) Mixed Income:

Refers to earnings from farming enterprises, sole proprietorships, and other
professions, such as medical and legal practices. In these professions, owners
themselves assume the role of an entrepreneur, financier, worker and landlords.
Mixed income also takes into account the income of those individuals who earn from
different sources, such as wages rents on own property, and interests on own
money.

Therefore,

National Income Rent + Wages + Interest + Profit + Mixed Income

These steps are as follows:

1. Classifying the production units into primary, secondary, and tertiary sectors.

2. Estimating Net Value Added (NVAfc) of each sector. The sum total of the factor
payments
equals NVAfc.
3. Taking the sum of NVAfc of all the industrial sectors of the economy. This will
give NDPfc.
ΣNVAfc = NDPfc
4. Estimating NFIA and adding it to NDPfc, which gives NNPfc (national income).
NDPfc + NFIA = National Income (NNPfc)

The following are the precautions that should be taken into consideration
while calculating national income using the income method:
a. Including the imputed value of factor services rendered by the owners of
production units themselves. For example, if production units use their own savings
for production, then the interest is payable to them in the form of imputed interest.
This imputed interest should be added in the calculation of national income.

b. Avoiding the inclusion of transfer payments, such as gifts, donations and taxes.

c. Excluding the gains that arise from the sales of pre-owned goods. These gains are
called capital gains.

d. Excluding the income arising from sale of financial assets, such as shares and
debentures. This is not related to the production of goods and services. However,
national income includes the value of services rendered by the agents in selling
these financial assets.

EXPENDITURE METHOD:
the total sum of expenditures on the purchase of final goods and services produced during
an accounting year within an economy is estimated to obtain the value of domestic income.

Final Expenditure It is the expenditure on the purchase of final goods and services during
an accounting year. It is broadly classified into four categories:

(i) Private final consumption expenditure: Expenditures incurred by household and private
nonprofit institutions serving households on all type of consumer goods.
(ii) Government final consumption expenditure: Expenditres incurred by government on
various administrative services like defence, law and order etc.
(iii)Investment expenditure or gross domestic capital formation: Addition to capital stock of
the economy. It represents the expenditure incurred on acquiring goods for investment by
the production units located within the domestic territory. The two components of GDKF are
:
(i) Gross Fixed Capital Formation: It refers to the expenditure incurred on
purchase of fixed assets. This expenditure is generally divided into three sub-
categories:
(a) Gross Business Fixed Investment: It includes expenditure on the
purchase of new plants, machinery, equipments, etc.

(b) Gross Residential Construction Investment. It includes expenditure

on purchase or construction of new houses by the households.

(c) Gross Public Investment: It includes expenditure on construction of

flyovers, roads, bridges etc. by the government.

(ii)Inventory Investment (Change in Stock): It refers to the physical change in

the stock of raw material, semi-finished goods and finished goods lying with
the producers. It is included as an investment item because it represents the
goods produced but not used for current
(iv) Net exports, i.e. difference between exports and imports during an accounting year.

Precautions While Using Expenditure Method

(i) Only final expenditure is to be taken into account to avoid error of double
counting.
(ii) Expenditure on second hand goods is not to be included.

(iii) Expenditure on transfer payments by the government is not to be included.

(iv) Imputed value of expenditure on goods produced for self consumption should be
taken into account.
(v) Expenditure on shares and bonds is not to be included in Total Expenditure.

NATIONAL INCOME AT CONSTANT PRICE

It is the money value of all final goods and services produced by normal residents of
a country in a year, measured at the current year’s price.
It is also known as 'Nominal National Income..
It does not show the true picture of economic growth as any increase in nominal
national income may be due to rise in price level without any change in physical
output.

NATIONAL INCOME AT CONSTANT PRICE

It is the money value of all final goods and services produced by normal residents of
a country in a year, measured at the base year’s price.
It is also known as 'Real National Income'.

It shows the true picture of economic growth as any increase in real national income
is due to increase in output only.

Why do we measure National Income at the prices of the Base Year?

The need for estimating national income at constant price arises because national
income at current price may give a misleading picture of economic performance if
the prices are continuously rising or falling.

Which is better: Nominal GDP or Real GDP?

Real GDP is better as compared to Nominal GDP because of following reasons:

1. Real GDP helps in determining the effect of increased production of goods and
services as it is affected by change in physical output only. On the other hand,
Nominal GDP can increase even without any increase in physical output as it is
affected by change in prices also.

2. Real GDP is a better measure to make periodic comparison in the physical output
of goods and services over different years.
3. Real GDP facilitates international comparison of economic performance across the
countries.

Therefore, Real GDP is better than Nominal GDP as it truly reflects the growth of an
Economy.

Real GDP= Nominal GDP/Price Index *100

GDP Deflator: It measures the average level of prices of all the goods and services
that make up GDP.

GDP Deflator = Nominal GDP/Real GDP * 100

Green GDP = It measures the national income or output adjusted for the depletion
of natural resources and degradation of the environment.

GDP AND WELFARE

Welfare mean material well being of the people. It depends on many economic factors like
national income, consumption level quality of goods etc and non-economic factor like
environmental pollution, law and order etc. the welfare which depends on economic factors
is called economic welfare and the welfare which depends on non-economic factor is called
non-economic welfare. The sum total of economic and non-economic welfare is called social
welfare.

Thus GDP and welfare directly related with each other but this relation is incomplete
because of the following reasons.

1. Distribution of GDP: It is possible that with rise in GDP, inequalities in the

distribution of income may also increase, i.e. the gap between rich and poor
increases. GDP does not
take into account changes in inequalities in the distribution of income. So, welfare of
the
people may not rise as much as the rise in GDP.

2. Change in prices: If increase in GDP is due to rise in prices and not due to
increase in physical output, then it will not be a reliable index of economic welfare.

3. Non-monetary exchanges: Many activities in an economy are not evaluated in

monetary terms. For example, non-market transactions like services of housewife,
kitchen gardening, leisure time activities, etc. are not included in GDP, due to non-
availability of data. However, such activities influence the economic welfare.

4. Externalities: Externalities refer to benefits or harms of an activity caused by a

firm or an individual, for which they are not paid or penalized. Activities which result
in benefits to others are termed as positive externalities and activities which result
in harm to others are termed as negative externalities.

• Example and Impact of Negative Externality: Environmental Pollution caused by

industrial plants. Such pollution reduces the welfare through negative effect on
health.

• Example and Impact of Positive Externality: Use of public parks by the people for
pleasure

for which no payments are made by the public. It increases welfare through positive
effect on health.

Such external effects do not form part of market transactions. GDP does not take
into account externalities, positive or negative.

5. Rate of population growth: GDP does not consider the changes in the population
of a
country. If rate of population growth is higher than the rate of growth of GDP, then
it will decrease the per capita availability of goods and services, which will adversely
affect the
economic welfare.

it can be concluded that GDP may not be taken as a satisfactory measure of

economic welfare, yet it does reflect some index of economic welfare.

SHORT ANSWER QUESTIONS

 1. Define intermediate goods.
Ans : Intermediate goods are those goods which are within the boundary line of production
and not ready for use by their final users. These goods are purchase for further sale or
are to be use as raw material by the producers.
2. What is meant by producer goods?
Ans. Producer goods are those goods which are used for further production. These may be
used either as raw material(like wood used in making chair) or as fixed assets (like a
tractor in farming).
3. What is meant by capital goods?
Ans. Capital goods are those goods which are used in the process of production for
several years and which are of high value. These goods are fixed assets of the
producers.
4. What is fixed investment?
Ans. Fixed investment refers to increase in the stock of fixed assets or capital goods (like
plant and machinery) of the producers during an accounting year.
5. What do you mean by inventory investment?
Ans. Change in inventory stock during the year is called inventory investment of the producer.
6. What is meant by consumption of fixed capital?
Ans. Consumption of fixed capital or depreciation refers to loss of value of fixed assets in use
on account of: 1. Normal wear and tear; 2. Normal rate of accidental damage, and 3.
Expected or foreseen obsolescence.
7. Define depreciation reserve fund?
Ans. Depreciation reserve fund is a provision of funds to cope with depreciation losses. These
fund are used for the replacement of fixed assets when these are worm-out or when
these become obsolete/outdated.
 1. Define real flow.
Ans. Real flow refers to the flow of factor services from the household sector to the producing
and the corresponding flow of goods and services from the producing sector to the
household sector.
2. Define money flow.
Ans. Money flow refers to the flow of money (in term of receipts and payment) across
different sectors of the economy. It is called money flow because it involves the flow of
money value from one sector to the other. Thus, producers make sector payment to the
households and household make payment to the producers (for the purchase of goods
and services) in term of money.
3. Should purchase of wheat in the wholesale market be treated as the purchase of final
goods?
Ans. Purchase of wheat in the wholesale market is often done by the trader. Wheat is a
consumption goods and traders are not the final users of wheat. Therefore, purchase of
wheat in the wholesale market is to be treated as the purchase of intermediate goods.
However, sometimes the households buy wheat in bulk from wholesale market. In such
situation, purchase of wheat should be treated as purchase of final good.
4. What is national debt interest?
Ans. National debt interest refers to the interest payment accruing to residents of the country
on account of borrowings by the govt. The government borrows money from the people
(by issuing bond like National Saving Certificates in India).
5. What is meant by transfer payment?
Ans. Transfer payment (or transfer expenditure) are all those unilateral payment
corresponding to which there is no value addition in the economy.
6. What is meant by nominal GDP?
Ans. Nominal GDP refers to market value of the final goods and services produced
Q. How will you treat the following in the calculation of gross domestic product of
India? Give reasons for your answers.
(i) Profit earned by a branch of foreign Bank in India.
(ii) Salaries of Indian employees working in embassy of Japan in India
(iii) Salaries of residents of Japan working in Indian embassy of Japan
ANS. (i) Yes, it will be included in the gross domestic product of India as profits are
earned within the domestic territory of India.
(ii) No, it will be not included in the gross domestic product of the India as the embassy
of japan is not the part of domestic territory of India.
(iii)Yes, it will be included in the gross domestic product of India as the India embassy is
the part of domestic territory of India.
 Q. Classify the following expenditures as intermediates consumption
expenditures and finals consumption expenditures.
(i) Expenditure on research and development by TATA on Nano car.
(ii) Insurance premium paid by a firm to an insurance company.
(iii) Insurance premium paid by households to an
insurance company. (iv)Expenditure on repairs and
maintenance of plant and machinery.
(v) Expenditure incurred by a firm on purchase of equipment.
(vi)Advertising expenditure incurred by Airtel on promotion
of its product.
(vii) Business expenses of employees on tour and entertainment.
Ans: Intermediates consumption expenditure: (i), (ii), (iv), (vi), (vii); final
consumption expenditure: (iii), (v).
TRUE & FALSE
1. Nominal GDP can never be less than real GDP.
FALSE: nominal GDP can be less than the real GDP, if price in the
current year are less than the price in the base year.
2. Good produced for self-consumption will be included in
national income. TRUE: such goods contribute to the current
output and their imputed value will be included in national income.
3. Increase in stock of goods held by a consumer will contribute to
capital formation. FALSE: any increase in goods of stock held by
consumers does not contribute to capital formation as it is assumed that
such goods are consumed, the moment are purchased.
4. Gross domestic capital formation is always greater than
gross fixed capital formation.
FALSE: gross domestic capital formation can be less than gross fixed capital
formation if
change in stock is negative.
5. Productions of services for self-consumption are not included in
national income. TRUE: Such services are not included in national
income as it is difficult to ascertain their market value and they are not
rendered for earning income.