NATIONAL INCOME AND RELATED AGGREGATES

TO DO:-
❖ 3.1 Introduction: Concept of National Income
❖ 3.2 Concept of Open/Closed Economy
❖ 3.3 Concept of NFIA: Domestic and National Concepts of Income
❖ 3.4 Concept of Domestic Territory
❖ 3.5 Concept of Stock and Flow
❖ 3.6 Concept of Depreciation: Gross and Net Concepts of Domestic Product
❖ 3.7 Concept of Net Indirect Tax: Domestic Product at Market Price & Factor Cost
❖ 3.8 Concept of Normal Resident
❖ 3.9 Concept of :
1. Nominal National Income/National Income at Current Price
2. Real National Income/National Income at Constant Price
❖ 3.10 GDP and Welfare
❖ 3.11 Basic Relationships in National Income Accounting (Golden rules on
National Income Accounting)
❖ 3.12 Difference between goods and services
❖ 3.13 Types of Goods produced in the Economy
1. Intermediate Good and Final Good
2. Consumer Good and Capital Good
❖ 3.14 Three different phases of circular flow of Income indicating three different
methods of calculating National Income
1. Product Method or Value Added Method (with reference to the problem
of Double Counting)
2. Income Method (with reference to the concept of Operating Surplus)
3. Expenditure Method (with reference to classification of final expenditure
as Consumption expenditure and Investment Expenditure)
❖ 3.15 Distinguish between Factor Income and Transfer Income
❖ 3.16 Distinguish between Domestic Income and National Income
❖ 3.17 Important rules for national income accounting

3.1 Introduction

National Income is the sum total of factor incomes earned by the normal residents of a
country during a particular period of time (normally the period is one year). Rent, interest,
profit and wages are the factor incomes. So National Income is the sum total of rent,
interest, profit and wages earned by the normal residents during an accounting year.

SOME IMPORTANT CONCEPTS:-

3.2 Concept of Open/Closed Economy

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The existence of the external sector and economic relationship with the rest of the world help to
categories economies as open or closed.

Closed economy- Which has no relations with the rest of the world
Open economy- Which has economic relations with the rest of the world. Realistically, there is
no economy that is actually closed.

Possible economic relationships-

1) Buying and selling of goods and services
2) Investment in bonds and shares etc.
3) Labour movement
4) Borrowing and lending
5) Donations/aid- transfer payment

Significance of knowing whether an economy is open or closed-

To analyze the relationship between GDP and GNP
• In an open economy, GDP is not equal to GNP. GDP can be greater or lesser than GNP.
• In a closed economy, GDP=GNP

3.3 Concept of NFIA (Net Factor Income From Abroad)

NFIA is the difference between factor income (rent, interest, profit and wages) received from the
rest of the world and factor income paid to the rest of the world
OR
It is the income attributable to the factor services rendered by the normal residents to the rest of
the world less factor services rendered to them by the rest of the world.

GDP+NFIA=GNP

In a closed economy, NFIA is 0

Therefore, GDP=GNP

In an open economy, NFIA is not equal to 0

Therefore, GDP>GNP or GDP<GNP
GDP is not equal to GNP
The difference between GDP and GNP can be significant or insignificant

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 COMPONENTS OF NFIA-

NET FACTOR INCOME FROM ABROAD

Net Net Income from Net Retained

Compensation Property and Earnings of
of Employees Entrepreneurship Resident
Companies
Abroad

a) Net compensation of employees- It is the difference between the wages andsalaries

received from the rest of the world and similar payments made to the rest of the world.

b) Net income from property and entrepreneurship- It is equal to the

differencebetweenthe income received by way of rent, interest and profit by the
residents and similar payments made to the rest of the world

c) Net retained earning of resident companies abroad- Undistributed profits or part of

the profit kept as reserve for future use is retained earnings. It is kept in capital market as
savings. The difference between the retained earnings of resident companies located
abroad and the retained earnings of foreign companies within the domestic territory
is known as net retained earnings from abroad.

Given the meaning of factor income to abroad and factor income from abroad. Also give an example of
each, (AI 2009)

3.4 Concept of Domestic Territory

Domestic territory is perceived as the area within the country but in economic terms, it means
much more. Domestic territory includes-

a) Land mass lying within political border including territorial waters

b) Ships and air crafts owned and operated by the residents of the country
c) Floating platform, fishing vessels and oil rigs operated by residents of the country in the
international waters.
d) Embassies consulates, military establishments, tourist offices, scientific establishments,
immigration offices etc. located abroad.

3.5 Concept of Stock and Flow

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 STOCK FLOW
1) Stock is any variable measured at a 1) Flow is any variable measured over a
particular point of time period of time.
2) For e.g. wealth of a person, distance 2) For e.g. income, savings, investment,
between 2 places, water level in a speed of a car, water in a river,
reservoir, population etc. (Example: on birth/death rates etc.(Example: you may
January 1, 2009 there may be Rs 1000 be getting Rs 150 per month as pocket
in your bank account. On January 10, money, you may be spending Rs5
2009 there may be Rs 5000 in your everyday in the canteen, you may be
bank account. All these values are stock getting 5%annual interest on your bank
values as they are measured at a deposits. All these values are flows as
specific point of time) they are measured over a period of
time, which can be per day, per month,
an year etc)
3) There is no time dimension 3) It has a time dimension
4) Static concept 4) Dynamic concept
5) Stock influences the flow. Greater the 5) Flow influences the stock. For example,
stock of capital, greater is the flow of monthly increase in the supply of
goods and services. money leads to an increase in the
quantity of money

Few examples of stock and flow variables

Stock Flow
1) Distance 1) Speed
2) Water in a tank 2) Water in a river
3) Capital 3) Capital formation
4) Wealth 4) Income
5) Reserve of coal 5) Coal production
6) Population 6) Birth rate/ Death rate
7) Amount of money 7) Spending of money
8) Number of people employed in the 8)Number of people getting employment
country
9) Inventory( Inventory is treated as capital 9) Change in Inventory (Production of a
so it is a stock concept) firm during a year – Sale of a firm during
a year)

NOTE – Some concepts of economics do not have their stock aspect such as imports and
exports. Imports and exports are used only as flow concepts.
There are certain stock variables which have the flow aspect as well. For example capital at a
point of time is a stock but addition to the stock of capital i.e. capital formation during a year is a
flow.
1) Distinguish between stocks and flows. Give an example of each. (Foreign 2010)
2) Define flow variables. (Delhi 2011, AI 2012, Foreign 2012)
3) Define stock variable. (AI 2011, Delhi 2012)
4) Capital formation is a flow. State whether it is true or False giving reasons. (Sample Paper 2012)

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 Are the following stocks or flows

1) Investment – Flow concept because it is measured over a period of time. It has a time
dimension and is a dynamic concept
2) Monetary expenditure- Flow concept because it is measured over a period of time.It has a
time dimension and is a dynamic concept
3) A family’s consumption of sugar -Flow concept because it is measured over a period of
time.It has a time dimension and is a dynamic concept
4) Production of cement -Flow concept because it is measured over a period of time.It has a
time dimension and is a dynamic concept
5) A hundred rupee note – Stock concept because it is a variable measured at a particular point
of time. There is no time dimension involved here. It is a static concept
6) Machinery of a sugar mill -Stock concept because it is a variable measured at a particular
point of time. There is no time dimension involved here. It is a static concept
7) Services of a tutor -Flow concept because it is measured over a period of time.It has a time
dimension and is a dynamic concept

Question: Distinguish between Net Investment and Capital. Which is Stock and which is
Flow? Compare Net Investment and Capital with flow of water into a tank.

Capital Net Investment

1) It is a factor of production which has 1) It is addition to the capital stock. Unlike
itself been produced and which is not Gross Investment it does not include the
generally entirely consumed in the replacement for the depletion of capital
production process stock
2) It is a variable measured at a particular 2) It takes place over a period of time
point of time
3) It has no time dimension 3) It has time dimension
4) It is a static concept so it is a stock 4) It is a dynamic concept so it is a flow

Example of flow of water into a tank- Suppose a tank is being filled with water coming from a
tank. The amount of water which is flowing into the tank from the tap per minute is a flow. It is
an addition to the water in the tank. Similarly Net Investment is a flow as it is addition to the
capital stock.

But how much water there is in the tank at a particular point of time is a stock concept. Similarly
Capital is measured at a particular point of time therefore it is a stock concept.

3.6 Concept of Depreciation/ Consumption of Fixed Capital/ Capital Consumption

Allowance

Depreciation is also called as consumption of fixed capital. It refers to the loss of value of fixed
assets (IN USE)

Depreciation is on account of –

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 1) Normal Wear and Tear- Fixed assets are used in production. Due to continued usage
they suffer wear and tear

2) Expected Obsolescence- Another aspect of fixed assets is expected obsolescence. When

we use a technology, it is definite that at some point or the other it will become obsolete.
It is when a newer technology is developed.

Depreciation is an expected cost for the firm. We know the rate at which a fixed asset is
depreciated. It is pre-determined. The firm thus charges it from the customers by way of higher
price and creates a reserve. When the period expires the asset can be replaced.

Depreciation is hence a decline in the value of fixed assets on account of- wear and tear,
expected obsolescence or changes in demand/tastes.
Unexpected obsolescence is damage of fixed assets due to natural calamities (fire, earthquakes,
accidents, volcanoes etc.) These can not be foreseen but there is a possibility that such things
may occur. So we try to cover up such losses by taking insurance. (While estimating
depreciations unexpected obsolescence is not to be considered)

Purpose/ Significance of studying Depreciation-

• The difference between the Gross and Net value of anything is always Depreciation or
Consumption of Fixed Capital.
• Gross is inclusive of Depreciation whereas Net excludes Depreciation.
• For e.g.-
GDP – Depreciation = NDP
GNP – Depreciation = NNP
Gross Capital Formation – Depreciation=Net Capital Formation
Define depreciation. (AI 2011)

3.7 Concept of Net Indirect Tax (NIT)

It is the difference between Indirect Tax and Subsidies

NIT = Indirect Tax – Subsidies

Indirect Taxes –
1. They are imposed on commodities.
2. Burden of tax can be shifted.
3. They are ultimately paid by the consumers.
4. Indirect taxes increase the prices of commodities.

Subsidies –
1. They are financial grants given by the government to the producing enterprise to
encourage production of certain goods.
2. It is given to cover the operating loss due to government policies.

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 3. Subsidies lower the prices of commodities.

Purpose/ Significance of studying NIT-

Net Indirect Taxes are calculated to differentiate between Market Price and Factor Cost

Market Price – When price of a commodity includes Indirect Tax, it is said to be Market Price.
It is the price at which a commodity is sold in the market.
Market Price = Factor Cost + NIT (Indirect Tax – Subsidies)
Or
Market Price = Factor Cost + Indirect Tax – Subsidies

Factor Cost – It is the expenditure incurred by the producer on factors of production. It includes
only factor payments (rent +wages +interest +profits) It does not include Net Indirect Tax
Factor Cost = Market Price – NIT (Indirect Tax – Subsidies)
Or
Factor Cost = Market Price – Indirect Tax +Subsidies

3.8 Concept of Normal Resident

National Income is the income attributable to the Normal Residents of the country. You can be a
citizen of any country while also being a resident of another country

Following points have to be kept in mind while dealing with the concept of normal resident –

1) Normal Residents include both citizens and non-citizens

2) The concept of Normal Resident is applicable to individuals as well as institutions
3) A Normal Resident should normally reside in the country where his centre of interest
(economic interest i.e. income) lies.
4) The period of stay considered is 1 year.

The people who satisfy the above criteria automatically become the residents of the country.
Normal Residents of India = Nationals living in India + Non Nationals living in India

Non Residents –

Normal Residents will not include the following –

a) Diplomats – They may live in a country but their economic interest lies in their own
country because they are paid by the government of their own country. These people are
the residents of the country that they are citizens of. For e.g. Ambassadors.
b) Military forces stationed elsewhere
c) Border workers
d) Tourists
e) People undergoing treatment
f) Conference attendees

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 g) Sports persons
h) Crew members of air lines/ ships etc.
i) People employed for construction, installing machinery etc.
j) Seasonal workers
k) Members of International Organizations like UNO, ILO, WB, IMF etc.
l) Exceptional categories – students, patients
The period of stay of most of the above categories is generally less than 1 year and their centre of
interest does not lie in the country where they are staying during the period.

Purpose/ Significance of studying the concept of Normal Residents-

The concept of Normal Residency tells us whose incomes should be included in the calculation
of National Income and whose should not be included.

Question Bank
A. Are the following Residents of India or not –

1) USA ambassador in India

2) Foreigners working in WHO office in Delhi
3) Local people working in the office of IMF in India
4) Ambassador of India in USA
5) Indians working in foreign embassies in India
6) Foreign citizen working in India for a period of more than 1 year
7) Indian working in WHO located in India
8) Indian worker employed in Nepal on daily wages and crossing into Indian territory every
week
9) Indian working in USA laboratory in India
10) Indian going abroad for medical treatment
11) Foreigners in Indian embassy

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B. Will the following be a part of Domestic Factor Income of India. Give reasons for your
answer –
1) Salaries to Indian residents working in Russian Embassy in India.
2) Profits earned by a company owned by a non-resident, operating in India.
3) Profits earned by a foreign bank from its branches in India.
4) Scholarships given by government of India.
5) Profits earned by a resident of India from his company in Singapore
6) Salaries received by Indians working in American Embassy in India.
7) Financial help given to flood victims
8) Profits earned by an Indian bank from its branches abroad
9) Salaries paid to non-resident Indians working in Indian embassy in America
10) Profits earned by a branch of State Bank of India in England
11) Profits earned by a foreign company in India.
12) Money received from sale of shares
13) Money received from sale of old house
14) Remittances from abroad
15) Rent received by a resident Indian from his property in Singapore
16) Salaries paid to Koreans working in Indian embassy in Korea.
17) Salaries to Indians working in Japanese embassy in India.

C. Will the following be a part of National Income of India. Give reasons for your answer –
1) Salaries to Indian residents working in Russian Embassy in India.
2) Profits earned by a company owned by a non resident, operating in India.
3) Profits earned by a foreign bank from its branches in India.
4) Scholarships given by government of India.
5) Profits earned by a resident of India from his company in Singapore
6) Salaries received by Indians working in American Embassy in India.
7) Financial help given to flood victims
8) Profits earned by an Indian bank from its branches abroad
9) Salaries paid to non resident Indians working in Indian embassy in America
10) Profits earned by a branch of State Bank of India in England
11) Profits earned by a foreign company in India.
12) Money received from sale of shares
13) Money received from sale of old house
14) Remittances from abroad
15) Rent received by a resident Indian from his property in Singapore
16) Salaries paid to Koreans working in Indian embassy in Korea.
17) Salaries to Indians working in Japanese embassy in India.

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3.9 Concept of Nominal National Income/National Income at Current Price and Real
National Income/National Income at Constant Price

Economic growth is associated with the growth of national income in real terms. To find out
changes in real income we have to convert national income at current prices into national income
at constant prices.

3.9.1 National Income at current price/Nominal National Income- is the money value of
final goods and services produced in an economy during an accounting year estimated on the
basis of the prevailing prices in the market

National Income at Current Prices = Quantity of goods and services produced during an
accounting year x Prices of goods and services prevailing during the accounting year
Or
Y=QxP

The above equation shows that the Income can increase when there is an increase in Q or P. If Y
increases because of increase in Q alone (P remaining constant), it is called real increase in
income. On the other hand, if Y increases because of increase in P alone (Q remaining constant),
it is called as monetary increase in income. Monetary increase in income is of no significance. It
shows inflation in an economy. It does not cause any increase in the flow of goods and services.

3.9.2 National Income at constant price/ Real National Income- is the money value of final
goods and services produced in an economy during an accounting year estimated on the basis
of prices of a previous year which is a normal year

Since the prices of commodities change every year a valid comparison of real output in different
years can be made only by eliminating the influence of inflation in the economy. A comparison
of national income of 1 year with that of another would enable us to know whether there was a
real growth or not. If prices remain same and there is a continuous increase in national
income it means that there is economicgrowth in real terms. A real growth of the economy
reflects on the quantity of goods and services produced.

National income at current price can be converted into national income at constant price using
the following formula

National income at constant price= National income at current price/ price index of a
current year x 100

Numerical Example –
Question:Given real income to be 400 and price index be 100. Find nominal income.

GDP deflator= {nominal income/real income}*100

100= {nominal income/400}*100
Real income=400

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Question: If in 2001, National Income is Rs 100 Crores and in 2008 it is Rs 200 Crores at the
current price, and if the price index rises from 100 to 400 within the same period then what will
be the real national income/national income at constant prices?

Year National Income at Index National Income at

Current Prices Number/Current Constant Prices/Base
(Rs in Crores) Price Index Year Prices
(Rs in Crores)
2008 200 400 200/400 x 100 = 50

From the above example it is clear that although national income at current prices in 2008 is
double than that of 2001, yet national income at constant prices or real national income has
halved. It is because prices in the current year have increased four times.

Distinguish between nominal National income and real national income

National Income at current prices/ National Income at Constant prices/
Nominal National Income Real National Income
1)It is value of all the goods and services in 1) It is value of all the goods and services
a country where they are valued at prices in a country where they are valued at prices
prevailing in the current year prevailing in the base year
Or Or
When the output produced in a particular When the output produced in a particular
year is valued at prices prevailing in the year is valued at prices prevailing in the
same year base year
2) It is affected by changes in both prices 2) It is affected only by the change in
and quantity produced quantity produced
3) It is also called the Money National 3) It is also called the Real National
Income Income
4) It is not a good indicator of economic 4) It is a better indicator of economic
growth growth

Significance of Real GDP/GDP at Constant Prices

1) It shows the change in the availability of goods and service to the people of the country.
Any change in real GDP implies corresponding change in the flow of goods and services
in the economy
2) It shows a change in the level of economic activity in the country. Increase in real GDP
implies an increase in the level of production.
3) It facilitates inter-regional and international comparisons regarding the level of
production. This is not possible through Nominal GDP.

3.10 GDP and Welfare

GDP is considered as an index of the welfare of the people. Increase in real GDP means an
increase in the level of welfare of the people. When real GDP rises, flow of goods and services

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 tends to rise this means greater availability of goods and services per person. But there can be
exceptions to this generalization, which can be discussed as follows-

1) Distribution of GDP should be equal – If the distribution of GDP is unequal then fewer
people tend to benefit from it. The gap between the rich and poor will increase and the bulk
of the population will have fewer goods than before even when the overall level of GDP
tends to increase.
2) Composition of GDP should be welfare oriented – There is no direct increase in the
welfare of the masses if GDP has risen mainly due to the increase in the production of
defence goods. Though defence indirectly contributes to the welfare of the economy by
maintaining a peaceful atmosphere
3) Non-monetary exchanges underestimate the GDP – Non monetary exchanges or barter
system is very common in rural areas of India. Such transactions are not recorded as they are
outside the monetary system of exchange. In such economies GDP remains under estimated
and is not a proper index of welfare.

4) Impact of externalities is not accounted for in GDP – Externalities refer to good and bad
impact of an activity without paying the price or penalty for that. For example, negative
externalities occur when factories cause air pollution. This pollution causes a loss of social
welfare. But nobody is penalized for it and there is no estimation of it in GDP. Similarly
positive externalities occur when people enjoy a beautiful park maintained by the
government without paying for it. But there is no estimation of it in GDP. Therefore GDP
either underestimates or overestimates the level of welfare.

1) Explain how distribution of gross domestic product is its limitation as a measure of economic
welfare. (Delhi 2010)
2) Explain how distribution of gross domestic product is a limitation in taking gross domestic product
as an index of welfare. (Delhi 2011)
3) Distinguish between real and nominal gross domestic product. Can gross domestic product be used
an index of welfare of the people? Give 2 reasons. (Delhi 2010, AI 2010, Foreign 2010)
4) What is nominal gross domestic product? (Delhi 2011)
5) Explain how ‘non-monetary exchanges’ are a limitation in taking gross domestic product as an
index of welfare .(AI 2011)
6) Define real gross domestic product. (Foreign 2011)
7) Explain how ‘externalities’ are a limitation of taking gross domestic product as an index of
welfare. (Foreign 2011)
8) State whether the following statement is true or false giving reasons- Nominal GDP can never be
less than real GDP. (Sample paper 2012)

3.11 Basic Relationships in National Income Accounting(Golden rules on National Income

Accounting)

1) Depreciation (Gross Vs Net)

• Gross value – Depreciation= net value

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 • Net Value + Depreciation= Gross Value
a) GNP(MP)-depreciation=NNP(MP)
b) NDP(FC)+depreciation=GDP(FC)

2) NFIA (Domestic Vs. National)

• National-NFIA=domestic
• Domestic+NFIA=national
a) GNP (MP)-NFIA=GDP (MP)
b) NDP (FC) +NFIA=NNP (FC)

3) NIT (Market price vs. Factor Cost)

• Market price-NIT=factor cost
• Factor cost+NIT=MP
a) GNP (MP)-NIT=GNP (FC)
b) NNP (FC) +NIT=NNP (MP)

Question Bank
1) Convert GDP(MP) to NNP(FC)
2) Convert NNP (FC) to GNP (MP)
3) Convert GDP (FC) to NNP (MP)
4) Calculate NNP (FC) from the followings-
• GDP (MP)=7500
• Depreciation = 700
• Indirect tax=400
• Subsidies= 200
• NFIA=300
5) Convert NDP(MP) to GNP(FC)
6) Convert National Income (NNP(FC)) to GDP(MP)
7) Calculate GNP(FC) from the following
• Consumption of fixed capital /Depreciation=500
• Indirect tax=600
• Subsidies=250
• NFIA=(-)700
• NDP(MP)=12500
8) Calculate GDP(MP) from the following
• Factor income paid to the Rest of the world= 700
• Depreciation=250
• Indirect tax=800
• Subsidies=300
• Factor income received from the rest of the world= 300
• National Income (NNP (FC)) = 7800
9) Calculate NNP(MP) from the following-
• GDP(FC)=8800
• Consumption of fixed capital (depreciation) =950
• Factor income received from rest of the world=1100

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 • Indirect tax=780
• Subsidies=650
• Factor income paid to the rest of the world=1600
10) Convert-
a) GNP(MP) to NDP(FC)
b) NNP(FC) to GDP(MP)
c) NDP(MP) to GNP(FC)
d) Estimate NNP(MP) from the following-
• Consumption of fixed capital= 500
• NFIA= (-) 400
• Indirect tax=300
• Subsidies=200
• GDP (FC) =7200
e) Calculate NNP(FC) from the following-
• GDP (MP) =25000
• Consumption of fixed capital=500
• Indirect tax=800
• Subsidies=300
• NFIA= (-) 110
3.12 Difference between Goods and Services:

Goods Services
They are tangible They are intangible and have no physical
form
Production and consumption may have a Production and consumption take place
time gap simultaneously
Goods can have a derived demand Services have direct demand
They can be stored They cannot be stored
They can be transported They cannot be transported
E.g.- soaps, trucks, iron and steel etc. E.g.- hospital services, teaching etc.

• Goods can be classified as:

1. Durable – can be used more than once e.g. car
2. Non-durable- can be used only once. They lose their utility after one use. They are
also called single use goods.
• Goods can also be classified as:
1. Consumer goods- used for consumption
2. Capital goods- used from further production
• These in turn can be durable or non-durable
1. Durable consumer goods- refrigerator
2. Non-durable consumer goods- food, water
3. Durable capital goods- Trucks, machinery
4. Non-durable capital goods- Dye, water, coal
• The classification of goods depends on the utility and end purpose
• The same goods can be consumer/ capital

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 3.13 Basic Concepts of Macroeconomics: Types of Goods

3.13.1 Final and Intermediate Goods

INTERMEDIATE GOODS FINAL GOODS

These goods may be reused as raw materials These goods are not used as raw materials for the
for the production of other goods during the production of other goods during the accounting year
accounting year
These goods may be resold by the firms to These goods are not resold by the firms to make
make profits during the accounting year profits during the accounting year
These goods remain within the boundary line These goods are outside the boundary line of
of the production function and are not ready production and are ready for use by their final
for use by their final users. users. Final goods therefore do not enter into further
stages of production to change their form or content.
Value is yet to be added to these goods Value is not to be added to these goods
These goods are not included in the These goods are included in the estimation of
estimation of national product ornational national product or national income
income
Examples of intermediate goods – Shirts Final users can be (i) consumers (ii) producers.
purchased by firm X from firm Y for resale
are intermediate goods because value is added Examples of final consumer goods - Consumers are
to the shirts through resale the final users of clothes, shoes, bread, butter etc.
They are final consumer goods. Some other examples
If the retailer purchased the shirt from the are milk, if it is directly bought for consumption,
wholesaler for Rs 400 and sells to the consumer shampoo bought by us, wheat purchased by us
for Rs 500 then the value addition is of Rs 100 etc.Expenditure on these items by the households is
(Rs500 – Rs400). This is the final stage of value known as consumption expenditure
addition to the shirt and it has crossed the
boundary line of production. The shirt worth Examples of final producer goods - Producers are
Rs500 will only be counted as the final good. the final consumers of plant and machineries. For
example tractors and harvesters are final producer
Likewise wood purchased by the carpenter goods as they are used by the farmers. Expenditure
from the timber merchant for making chairs on these items by the producers is known as
is an intermediate good because wood is used investment expenditure
as the raw material. Value is to be added to
wood by converting it into chairs.

Some other examples of intermediate goods

are-milk, if it is bought by a factory for making
ice cream, shampoo bought by a beauty salon,
wheat purchased by a miller etc.

Expenditure on intermediate goods by the

producers is known as intermediate
consumption

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Intermediate goods have derived demand 7)Final goods have direct demand

Important Note:The same good can be final or intermediate. It depends on the end use of the
goods. For example , sugar used as a raw material in the production of biscuits, milk used in the
production of ice creams , paper purchased by a publisher for making books are all examples of
intermediate consumption.

But sugar used by the households in tea or coffee, milk used by the households for drinking
purpose, paper purchased by a student for writing are all examples of final goods.

Question: Classify the following as intermediate or final goods

1) Sewing machine used in households

It is a final good because it is a capital good which is going to help in producing more
goods in future. It is not a raw material. It will not be resold to make profits. It is outside
the boundary line of production and ready to be used by the final consumer. No value will
be added to it. Thus it is a final good.

2) Raw cotton purchased by a spinning mill

It is an intermediate good as it is non durable and is used to produce a final good, namely,
yarn. It is raw material which is use to produce other goods. It remains within the
boundary line of the production function and is not ready for use by their final
consumers. Value is yet to be added to it.

3) Sugar purchased by a hotel

It is an intermediate good. It can be used to produce other goods like sweets etc. It
remains within the boundary line of the production function and is not ready for use by
their final consumers. Value is yet to be added to it.

4) Machine purchased by a factory

It is a final good because it is a capital good which is going to help in producing more
goods in future. It is not a raw material. It will not be resold to make profits. It is outside
the boundary line of production and ready to be used by the final consumer. No value will
be added to it. Thus it is a final good.

5) Sewing machine used by a tailor

It is a final good because it is a capital good which is going to help in producing more
goods in future. It is not a raw material. It will not be resold to make profits. It is outside
the boundary line of production and ready to be used by the final consumer. No value will
be added to it. Thus it is a final good.

6) Exhaust fans used for manufacturing desert coolers

It is an intermediate good. It is used to produce the final good which is desert cooler. It
remains within the boundary line of the production function and is not ready for use by
their final consumers. Value is yet to be added to it.

16
 7) Furniture purchased by a household
It is a final good as it is directly used for the satisfaction of the wants of the household.It is
not a raw material. It will not be resold to make profits. It is outside the boundary line of
production and ready to be used by the final consumer i.e. the household. No value will be
added to it. Thus it is a final good.

8) Food cooked at home

It is a final good as it is directly used for the satisfaction of the wants of the household.It is
not a raw material. It will not be resold to make profits. It is outside the boundary line of
production and ready to be used by the final consumer i.e. the household. No value will be
added to it. Thus it is a final good.

9) Coal used in a factory

It is an intermediate good as it is non durable and is used to produce a final good. It is raw
material which is use to produce other goods. It remains within the boundary line of the
production function and is not ready for use by their final consumers.

Question Bank
1) Give one example each for the use of coal as an intermediate good and as a final
good(Coal used by industries/railways is an intermediate good. Coal used by households
is final good)
2) Give one example each for the use of electricity as an intermediate good and as a final
good
3) Give 2 examples of goods which are intermediate in one case and final in another.
4) Name two items of intermediate consumption by a transport company. (Petrol and tyre)
5) Name two items of intermediate consumption by a textile mill.(Raw cotton and dye)
6) Name two items of intermediate consumption by the railways
Note: Expenses on services of a lawyer to the business enterprise is an intermediate expense

1) Explain the basis of classifying goods into intermediate and final goods. Give suitable examples
(Delhi 2010)
2) Giving reasons classify the following into intermediate and final goods: (AI 2010)
a) Machines purchased by a dealer of machines
b) Car purchased by a household
3) Giving reasons classify the following into intermediate and final goods: (Delhi 2011)
a) Furniture purchased by a school
b) Chalks, dusters, etc. purchased by a school
c) Computers installed in an office
d) Mobile sets purchased by a mobile dealer
4) Giving reasons identify whether the following are intermediate and final expenditures: (Delhi
2011)
a) Expenditure on maintenance of an office building
b) Expenditure on improvement
3.13.2 Consumer of aCapital
goods and machinegoods
in a factory
5) Giving reasons identify whether the following are intermediate and final expenditures: (AI 2012)
a) Purchase of a furniture by a firm
b) Expenditure on maintenance by a firm 17
 CONSUMER GOODS CAPITAL GOODS
These are directly used by the consumers to These goods are used in future productive
satisfy their wants. process but they themselves do not get
transformed in the production process. They
are used in the process of production for
several years and are high in value(For
example nails and screws are used for several
years but they are low in value so they are not
capital goods)
Example: ice cream, milk, car with a Example: plants and machineries used by a
consumer household, sewing machine with a firm, car with a tourist company, sewing
household etc. machine in a tailoring shop etc.
Consumer goods can broadly be classified into All capital goods are producer goods but all
four categories: producer goods are not capital goods.
(i) Durable consumer goods – which can Producer goods are used in the production of
be used for several years and are of other goods. These goods include-
relatively high value like TV, car (i) Raw materials like wood to make
washing machine etc. furniture. These are single use producer
(ii) Semi-durable consumer goods- which goods (ii) goods used as fixed assets like
can be used for a period of one year or plants and machineries.
slightly more like
clothes,crockery,furniture etc. Capital goods will include only fixed
(iii) Non-durable or single use consumer assets of the producers i.e. (ii). These are
goods- which are used in a single act of durable use producer goods.
consumption for example bread, fruits
etc that we eat to satisfy our hunger is
used in a single act of consumption.
The same bread or the same fruits
cannot be used again. Ink, petrol, gas ,
milk are some other examples of non
durable goods
(iv) Services – they are non material goods
which directly satisfy human wants.
For example doctor,lawyer,domestic
servant etc.

Question Bank
A. Indicate whether the following are single use consumer goods, single use producer
goods, durable use consumer goods or durable use producer goods
1) Wheat used by a flour mill – single use producer good
2) Coal used by a household – single use consumer good
3) Electricity used in a factory – single use producer good
4) Sewing machine purchased by a household – durable use consumer good
5) Typewriters used in an office – durable use producer good
6) Sewing machines used in a tailoring shop – durable use producer good
B. Indicate whether the following are consumer goods, capital goods or intermediate goods

18
 1) Car purchased by a consumer household – consumer good
2) Truck purchased by a farmer – producer good
3) Seeds, fertilizers purchased by a farmer – intermediate goods
4) Airplane purchased by an air line company – producer good
5) Refrigerator used by a shopkeeper selling cold drinks – capital good
6) Refrigerator purchased by a household – consumer good
7) Paper purchased by a student – consumer good
8) Paper purchased by a publishing house – intermediary good
9) Coal used by the household in the kitchen – consumer good
10) Coal used by a factory as fuel – intermediary good

1) Distinguish between consumer goods and capital goods. Which of these are final goods? (Delhi
2010
2) Define capital goods. (Foreign 2011, Foreign 2012, Delhi 2012)
3) Define consumption goods. (AI 2012)
4) State whether the following statement is true or false giving reasons: Bread is always a consumer
good. (Sample Paper 2012)

3.14 MEASUREMENT OF NATIONAL INCOME

There are three aspects of National Income –

1) Production aspect : Production aspect shows the flow of goods and services in the economy
or the process of value addition. Production of goods and services is done in the economy by
using factor services. This implies national income in the form of goods and services or
National Product produced during the year
2) Income or Distribution aspect : Value of national product is distributed among those who
produce it. Thus, national product is distributed among the factors of production in the form
of rent, interest, profit and wages. Accordingly, we get national income in the form of factor
incomes.
3) Expenditure or Disposition aspect : Income is spent on the purchase of goods and services.
Expenditure or disposition aspect indicates disposal of income in terms of consumption
expenditure or investment expenditure. Thus income is converted into expenditure, and we
get national income in the form of national expenditure.

Economists have tried to measure national income in terms of all its three aspects, i.e.
production, income and expenditure aspects.

Accordingly, we have three methods of measuring national income-

1) Product method or Value added method

2) Income method
3) Expenditure method

3.14.1 PRODUCT METHOD OR VALUE ADDED METHOD

19
Product method or value added method is that method, which measures the national
income by estimating the contribution of each producing enterprise to production in the
domestic territory of the country in an accounting year.

Value of output: It refers to the market value of goods or services produced by a firm during an
accounting year.
Value of output is equal to the quantity of output produced during a year multiplied by the price
per unit.

Value of output = p x q
Or
Value of output = Sales + Change in stock + Self Consumption

(Sales = Domestic sales + Exports)

(Change in stock = Closing stock – Opening stock)

If the entire output of the year is sold during the year, value of output = sales

Value of output = Sales, if entire output of the year is sold during the year

If some output remains unsold, it is added to the firm’s inventory stock. It is expressed as change
in stock (∆ stock) In such a situation value of output is expressed as –

Value of output = Sales + Change in stock, if some output remains unsold during the year +
Self Consumption

Value added: Value added is defined as the difference between the total value of output of a
firm and value of intermediate consumption

Value added = value of Output – Intermediate Consumption

Intermediate consumption refers to the value of non-factor inputs (all inputs other than factor
inputs of land, labor, capital and entrepreneurship). Primarily; it includes value of raw material
used in the process of production.

For example, in order to make a chair a carpenter buys wood worth Rs 500, adhesive worth Rs
100, nails worth Rs 50.All these are non factor inputs( otherthan land, labor, capital and
entrepreneurship).Sum total of these purchases are –

500 +100+50=Rs 650

If the market value of output i.e. chair is Rs 1500 then value added is –

Rs 1500 – Rs 650 = Rs 850

20
Production is any activity that results in value addition. Therefore production means value added
and not the value of output.

To convert value added to value of output, add intermediate consumption

To convert value of output to value added, deduct intermediate consumption
Domestic product is the sum total of value added by all the firms within the domestic territory of
a country during an accounting year. Thus –

Value added by all the firms within the domestic territory = Domestic Product

∑ VA = GDP MP
- Depreciation
= NVA MP
- NIT
= NVA FC
+ NFIA
= NNPFC = National Income

Steps involved in value added or product method :

1) Identifying and classifying the various producing enterprises into 3 sectors –

a) Primary Sector – It produces goods by exploiting the natural resources e.g. fishing,
mining agriculture etc.
b) Secondary Sector –It is the manufacturing sector. It transforms one good into another
c) Tertiary Sector – It is the service sector e.g. banking, hospital etc.

2) Estimating the Gross Domestic Product at market price –

It requires calculating –

a) Value of Output – It is equal to the quantity of output produced during a year multiplied
by the price per unit(Sales) + Change in stock+ Self Consumption

Value of Output = p x q + Change in Stock + Self Consumption

Or
Value of Output = Sales + Change in Stock + Self Consumption
Or
Value of Output = (Domestic sale + Export )+ Change in Stock+ Self Consumption

b) Value of intermediate consumption – It refers to the value of non-factor inputs (all

inputs other than factor inputs of land, labor, capital and entrepreneurship). Primarily; it
includes value of raw material used in the process of production. It is calculated on the
basis of price paid for the inputs.
VOI = Purchase of raw materials + Semi finished goods + Imports + Consumption of
electricity, fuel etc.

21
 c) Value added – It is the difference between the value of output and intermediate
consumption.
Therefore –
GVA (MP) = GVO (MP) – IC

d) Aggregation – By aggregating the gross value added at market price of all the producers in
all the three sectors we get the Gross Domestic Product at market price.
∑VA=GVA (MP) = GDP (MP)
3) Estimation of National Income –National Income can be found as follows –
GDP (MP) – Depreciation = NDP (MP)
NDP (MP) +NFIA = NNP (MP)
NNP(MP)-NIT= NNP(FC)/NI

4) Avoid problem of double counting: Estimating the value of goods and services more
than once is called as the problem of double counting.It leads to over estimation of the
value of goods and services produced and thereby over estimating the value of GDP.It can be
explained with the help of the following table-
Production Items Value of Intermediate Value added
produced Output Consumption
Farmer Wheat 400 0 400
Flour Mill Flour 500 400 100
Baker Bread 600 500 100
Shop keeper Sale of bread 650 600 50
2150 650

A farmer produces wheat and sells it for Rs 400 to a flour mill. As far as the farmer is concerned
the sale of wheat is the final sale and he gets Rs 400 for it.

The purchase of wheat by the flour mill is an intermediate consumption. It converts wheat into
flour and sells it for Rs 500 to a baker

The flour mill treats the flour as final product, but the bakeruses it as an intermediate good and
manufactures bread. The baker sells the bread to the shop keeper for Rs 600.

The shopkeeper sells the bread to the final customer for Rs 650.

Thus the Value of Output = 400+ 500+ 600+ 650 = Rs 2150

If the Value of Output at different stages of production is added, it will be equal to Rs 2150.
Each producer treats his sale as final. If the final output is calculated this way, it involves the
counting of the value of wheat 4 times, flour 3 times and bread 2 times. Thus it will lead to
double counting. The counting of the value of commodity more than once is called double
counting.

22
 In order to avoid this problem, the value of intermediate good is deducted from the value of
output. Thus, the total value added by each producer in the different stages involved is equal to
Rs 650. It is the same as the amount at which the consumers buy the bread. It is the final good
from the grocery.

This leads to 2 alternative ways of avoiding double counting in order to correctly estimate the
value of the final output
a) Taking the value added at each stage of production
b) Taking the value of final products only.

Explain the problem of double counting in estimating national income, with the help of an example.
Also explain two alternative ways of avoiding the problem. (AI 2010)

Precautions of Value Added Method:

1) Sale of second hand goods are not to be included because these goods are already included
in the national income estimates during the year when they were produced.
2) Value of intermediate goods are not to be included because it leads to double counting
3) Commission or brokerage paid to commission agents / brokers should be included
because it is payment made for productive service of transferring goods from one person to
another
4) Production of goods / fixed assets for self consumption should be included because these
goods are like those produced for the market. They are simply not sold due to their need by
the producers themselves. For example farmer’s family using their own farm output, landlord
constructing a compound wall, farmer digging a well or making cattle shed etc.
(IMPORTANT NOTE: Services for self consumption are not considered because it is
difficult to estimate their market value. For example services of housewife, teacher teaching
own child etc.)
5) Imputed rent of owner occupied houses should be included because imputed rent is taken
as a part of factor income and factor income has got to be identical with value added.

Question Bank
1) From the following data calculate the Value added by firm A and firm B
a) Closing stock of firm A – 20
b) Closing stock of firm B – 15
c) Opening stock of firm A -5
d) Opening stock of firm B- 10
e) Domestic sales by firm A – 300
f) Purchases by firm A from firm B – 100
g) Purchases by firm B from firm A – 80
h) Domestic sales by firm B – 250
i) Import of raw materials by firm A – 50
j) Exports by firm B – 30

23
2) Calculate value added by firm X and firm Y from the following data
a) Sales by firm X – 100
b) Sales by firm Y -500
c) Purchases by households from firm Y=300
d) Exports by firm Y – 50
e) Change in stock of X -20
f) Change in stock of Y -10
g) Imports by firm X -70
h) Sales by firm Z to firm Y – 250
i) Purchases by firm Y from firm X – 20

3) In an imaginary economy the transactions described below takes place. Estimate the value
added by firms A,B,C and D
a) A imports goods worth Rs 50, exports goods worth Rs 20 and sells goods worth Rs 40 to
B.
b) B sells goods worth Rs 60 to households
c) C sells goods worth Rs 40 to D and for private consumption worth Rs 10
d) D exports goods worth Rs 50 and sells goods worth Rs 20 to government

4) Suppose that firm A sold raw materials worth Rs 800 to firm B and worth Rs 500 to firm C.
Firm B sold goods worth Rs 900 to private consumers and exported the remaining goods worth
Rs 600. Firm C sold a part of its production worth Rs 1250 to government for public
consumption and the rest worth Rs 1250 was unsold stock. Compute the value added by firms A,
B, C

5) Estimate National Income from the following:-

a) 500 tonnes of sugar produced and price per tonne is Rs 10,000
b) 100 tonnes of steel produced and price per tonne is Rs 5,000
c) Raw materials purchased from different firms Rs 70,000
d) Government collects indirect taxes Rs 15,000
e) Subsidies given to the firms Rs 8,000
f) Consumption of fixed capital Rs 5,000
g) Factor income received from the Rest of the World- Rs 35,000
h) Factor income paid to the Rest of the World- Rs 50,000
i) Consumption of electricity- Rs 5,000
j) Import of raw materials- Rs 20,000

6) Estimate national income from the following-

a) Domestic Sales- Rs 28000
b) Consumption of fixed capital – 700
c) Consumption of electricity-1100
d) Export of goods-2200
e) Closing balance of stock-1700
f) Opening balance of stock-2000
g) Purchase of raw materials from firm A- 5500

24
 h) Import of raw materials-1500
i) Value of goods for self consumption- 750
j) Indirect taxes-400
k) Subsidies-150
l) NFIA- (-) 600

7) Estimate national income from the following

a) Export of goods-500
b) Import- 800
c) Value of goods for self consumption-750
d) Factor Income received from the Rest Of the World- 900
e) Factor Income paid to the Rest Of the World - 1100
f) Domestic sales-7800
g) Closing stock- 200
h) Indirect taxes-500
i) Subsidies- 250
j) Opening stock-250
k) Unsold goods with producer- 200
l) Purchase of raw materials from firm A-1200
m) Purchase of raw materials from firm B- 800
n) Consumption of electricity- 150
o) Depreciation- 450

8) Estimate NI from the following-

a) Value of output
Primary sector- 1800
Secondary sector-1500
Tertiary sector-2200
b) Value of input
Primary sector-500
Secondary sector-700
Tertiary sector-800
c) Consumption of fixed capital- 100
d) NIT- 25
e) NFIA- 70

9) From the following data calculate GDP (mp) and NI

a) Value of output of primary sector- 2000
b) Intermediate consumption of secondary sector-800
c) Intermediate consumption of primary sector-1000
d) NFIA- (-)30
e) NIT- 300
f) Value of output of tertiary sector- 1400
g) Value of output of secondary sector-1800
h) Intermediate consumption of tertiary sector- 600
i) Consumption of Fixed Capital- 100

25
Revision
1) Calculate value added by firm X from the following data
• Sales- 600
• Domestic purchase of raw material- 200
• Import of raw materials-100
• Import of machines-200
• Closing stock-40
• Opening stock-10

2) CalculateGross value added at market price and National income from the following data:
a) Value of output
Primary sector-800
Secondary sector- 200
Tertiary Sector- 300
b) Value of intermediate inputs purchased by:
Primary sector- 400
Secondary sector- 100
Tertiary sector- 50
c) Indirect taxes paid by all sectors- 50
d) Consumption of fixed capital of all sectors- 80
e) Factor income received by the residents from the ROW- 10
f) Factor income paid to non residents -20
g) Subsidies received by all sectors – 20

3) (a)Calculate NDP(FC)
Items Primary Sector Secondary Sector Tertiary Sector
Sales 100 150 130
Closing stock 15 20 25
Intermediate 15 25 15
consumption
Opening stock 10 10 15
Indirect tax 12 13 17
Subsidies 7 8 7
Consumption of 10 12 15
fixed capital
Expenses of 3 4 3
electricity and fuel

(b) An economy has only two firms A and B. On the basis of the following information about
these firms find out-
Value added by the firms A and B
Gross domestic Product at market prices
a) Exports by firm A- 40
b) Imports by firm A-100
c) Sales to households by from A-180

26
 d) Sales to firm B by firm A-80
e) Sales to firm A by firm B-60
f) Sales to households by firm B-120

4) Calculate the value added by firm A and firm B from the following data:
a) Purchase by firm A from the ROW-30
b) Sales by firm B- 90
c) Purchases by firm A from firm B-50
d) Sales by firm A- 100
e) Exports by firm A-30
f) Opening stock of firm A-35
g) Closing stock of firm A- 20
h) Opening stock of firm B-30
i) Closing stock from firm B- 20
j) Purchases by firm B from A- 50
3.14.2 INCOME METHOD – Income method measures National Income from the side of
payments in the form of wages, rent, interest and profit to the factors of production for their
productive services in an accounting year.

According to this method, National Income is estimated as the sum total of factor incomes
of normal residents of a country during an accountingyear.

Each rupee worth of goods and services produced equals the income generatedi.e. NVA (FC) =
Sum of factor incomes. National Income thus calculated will be the same as that by the Output
method.

Steps involved in Income method –The steps involved in this method are as follows –

1) Identifying and classifying the production units – Production units located in the domestic
territory are classified into distinct industrial sectors on the basis of activity. They are
classified as –
a) Primary sector
b) Secondary sector
c) Tertiary sector

27
2) Classification of factor incomes – Factor incomes are broadly classified as under

A. Compensation of Employees – (Factor Income received by labour)

It includes the following components –
1. Wages and Salaries in cash
2. Wages and Salaries in kind
3. Employer’s contribution towards Social Security Schemes e.g. provident fund, social
insurance, life insurance, retirement pensions etc.
(Note: Retirement pensions are to be included in National Income but Old Age pensions are not
to be included as they are transfer payments)

B. Operating Surplus –
It is the sum of income from property and entrepreneurship. It is the sum of rent, interest
and profit

(Royalty- Payment for the use of trademark, copyright patents, sub soil resources is also a part of
Operating surplus)

1. Rent – It is the payment made by the firms to the households for the temporary use of
some capital asset. Example payment made for the use of land, buildings etc.It has two
components –
1. Paid out rent 2. Imputed rent

28
2. Interest- It refers to the net interest income received by the households because households
both receive and pay interest.
Net Interest = Interest received – Interest paid

3. Profits- It is the reward that the owners of the firms receive for organizing production
and taking inherent risk. It has three components –
• Dividends – It is the part of the profit that is distributed to the households/ shareholders
by the firms. It is also called as ‘Distributed Profit’
• Corporate Tax – It is the part of the profit that is paid by the firms to the government. It
is also called as the ‘Profit Tax’
• Undistributed Profit/ Corporate Savings/ Retained Profits– It is the part of the profit
retained by the firms for further investments. It is kept for future use, particularly to meet
some contingent expenses.

C. Mixed Income of Self Employed – In India there exists a vast unorganized sector. It is a
sector where –
• People are self-employed. Self-owned factors are used there. Separate estimates of
rent, interest, profit and wages are not available because factors are not hired from the
factor market. So their income is put under a new concept called Mixed Income of Self
Employed. Example- farmers, carpenters, doctors etc.
• Mixed Income of Self Employed also includes profits and dividends ofunincorporated
enterprises (small enterprises)
3) Estimation of Factor Income of each producing enterprise –

• The income paid out by each enterprise is estimated. By adding the incomes paid out by
all the enterprises in a particular sector, income generated by the sector can be determined.
• By summing up the factor incomes paid out by all the three sectors in the domestic
territory, NDP (FC) can be determined.
• Thus sum total of factor incomes generated within the domestic territory of a country
is called NDP (FC)

4) Estimation of National Income – National Income or NNP (FC)can be found out by adding
NFIA toNDP (FC)
NNP (FC)= NDP (FC)+ NFIA

Precautions of Income Method –

Items not to be included –

1) Income from sale of second hand goods e.g. second hand car, second hand TV, second hand
house etc. should not be included because it is not a part of currentproduction. Value of
second hand goods are already estimated while these were initially produced.

2)Income from transfer payments e.g. old age pensions, unemployment allowance, scholarships
etc. are not to be included because they do not contribute anything to the flow of income.
There is no value addition in the economy.

29
(Note: Retirement Pension is included in National Income as it is a part of Compensation of
Employees)

3) Income from sale of bonds, shares, debentures (new/old) is not to be included because these
are part of financial capital only. They are just paper titles. They show only a claim or change
in ownership. It does not affect the productive activity.

4) Income from illegal activities e.g. gambling, black marketing, smuggling etc. is not to be
included because they are not accounted. They are a part of unaccounted money.

5) Income from windfall gains or unexpected gains e.g. lottery should not be included because
it is an unearned income. There is no value addition corresponding towindfall gains. It is just
due to luck. Similarly capital gains which are on account of increase in prices of land, buildings,
shares, bonds etc. also should not be taken into account. All these gains do not add to the flow
of goods and services in the economy.

6) Income from leisure time activities is not to be included because it is difficult to estimate
the value of that product.

7) Indirect Taxes like sales tax, excise duty etc.are not to be included. They tend to
justincrease the market price of goods and services. These are included only in the estimation
of national income at market price but are not included while estimating National Income at
factor cost.

8) Income Tax should not be separately added in the estimation of National Income because
income tax is paid out of Compensation of Employees so it should not be separately taken.

9) Death duties, wealth tax and taxes on windfall profits should not be included as they are
paid not out of current income but out of past savings of the tax payer. These are therefore
not to be added in the National Income as National Income includes only the income generated
during the year of estimation, called the current income.

Items to be included:
1) Brokerage, commission etc. to be paid for transaction of second hand goods should be
included because it is payment for productive service of transferring goods from one person
to another.

2) Imputed rent of owner occupied houses is included because houses whether these are
rented out or are self occupied have rental value. Houses generate factor income in the form
of rent. By letting out his house the owner would have earned rental income. For the owner
occupied houses we thus take the rental value. If they are not the owner of the house they may
have to spend a part of their income for the payment of rent.

3) Value of goods for self consumption is to be included because goods produced for self
consumption are saleable in the market. Value is being added through the production of these
goods.

30
(Note: Value of self consumed services should not be included because it is difficult to find
market value of self consumed services e.g. services of housewives)

Question Bank
1) Calculate the compensation of employees from the following-
a) Wages and salaries paid in cash – Rs 20,000
b) Free accommodation by employers to employees – Rs 4,000
c) LIC premium paid by employees – Rs 600
d) Employers contribution to provident fund – Rs 2,000
e) Subsidized food provided by employers – Rs 5,000

2) From the following estimate the Compensation of Employees –

a) Wages and salaries – Rs 45,000
b) Value of free medical service – Rs 5,000
c) Subsidized food provided by employers – Rs 10,000
d) Employees contribution to provident fund – Rs 5,000
e) Travel allowance (towards actual expense) – Rs 25,000

3) Calculate Operating Surplus from the following data –

a) Rent – Rs 50
b) Profit – Rs 30
c) NDP (FC) – Rs 260
d) Interest – Rs 20
e) Royalty – Rs 5
(Ans- Rs 105)

4) Calculate (i) National Income (ii) Operating Surplus (iii) Compensation of Employees
a) Rent – Rs 30
b) Indirect Tax – Rs 60
c) Interest – Rs 10
d) Royalty – Rs 5
e) Subsidy – Rs 10
f) Depreciation – Rs 50
g) GDP (MP) – Rs 450
h) Profit – Rs 45
i) NFIA –Rs (-) 10
(Ans- (i) Rs 340 (ii) Rs 90 (iii) Rs 260)

5) Calculate Operating Surplus from the following –

a) Gross value added at MP – Rs 8,000
b) Consumption of fixed capital – Rs 700
c) Wages and salaries – Rs 4,000
d) Indirect taxes – Rs 500
e) Subsidies – Rs 200
(Ans – Rs 3000)

31
6) Calculate National Income from the following -
a) Wages and salaries in cash – Rs 70,000
b) Provident fund contribution by Employers – Rs 1,200
c) Subsidized food – Rs 200
d) Rent – Rs 1,500
e) Interest – Rs 2,000
f) Profits – Rs 1,800
g) Transfer Payments – Rs 2,000
h) Provident fund contributions by Employees – Rs 800
i) NFIA – Rs (-) 750
j) Consumption of fixed capital – Rs 900
k) Mixed Income of Self Employed – Rs 5,500
(Ans – Rs 81,450)

7) Calculate National Income and GNP (MP) from the following data-
a) Consumption of fixed capital (Depreciation) – Rs 1,100
b) Mixed Income of Self Employed – Rs 26,000
c) Royalty – Rs 900
d) Undistributed profits – Rs 750
e) Dividends – Rs 2,250
f) Corporate Tax – Rs 500
g) Wages and salaries in cash – Rs 15,000
h) Social security Contributions by Employees – Rs 1,800
i) LIC premium paid by employees – Rs 800
j) Subsidized food – Rs 700
k) Interest – Rs 2,200
(Ans – Rs 51,200 and Rs 53,550)

8) Calculate GDP (MP) and GNP (MP) by Income method -

a) Compensation of Employees – Rs 13,363
b) Government Final Consumption Expenditure – Rs 3,801
c) Indirect Taxes – Rs 3,864
d) Gross Fixed Capital Formation – Rs 6,305
e) Mixed Income of Self Employed – Rs 16,112
f) Interest, Rent, Profit – Rs 5,044
g) Subsidies – Rs 337
h) NFIA –Rs (-) 284
i) Consumption of fixed capital – Rs 2,217
(Ans – GNP (MP) Rs 39,979 GDP (MP) Rs 40,263)

3.14.3 EXPENDITURE METHOD -

Expenditure method measures the final expenditure on gross domestic product at market
price during an accounting year. Final expenditure is equal to Gross Domestic Product at
market price.

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It involves measuring of all expenditure incurred on final goods and services produced by
the production units located within the domestic territory during a year.

It is the other side of the coin of value added method. It estimates the domestic product from the
purchase side. The final expenditure is incurred by households, firms and government. It is the
expenditure on consumption and investment.

Steps involved in expenditure method :

1) Identification and classification of economic units incurring final expenditure -Economic

units are classified as follows -
a) Household sector
b) Producer sector
c) Government sector
d) Rest of the World sector

2) Classification of Final Expenditure –Final expenditure is classified as follows -

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 CLASSIFICATION OF FINAL EXPENDITURE

Private final Government Investment Net Exports

Consumption Final Expenditure (X – M)
Expenditure Consumption
Expenditure

Fixed
Inventory
Investment Investment or
Change in Stock
Durable Non Services (Closing – Opening
goods durable Stock)
goods

Business Fixed Public fixed

Fixed Investment investment
Investment by e.g. roads,
e.g. plants & Households dams, bridges
machineries e.g. etc.
(Investment residential (Investment
by firms on construction by
fixed assets) investment government
on fixed
assets)

A. Private Final Consumption Expenditure (C) – It refers to the expenditure by the

households on final goods and services. It has three components -
1. Private Consumption Expenditure on durable goods – These are those goods which
are repeatedly used over a long period of time. Example – TV, refrigerator, furniture etc.
2. Private Consumption Expenditure on non durable goods -These are those goods
which are not repeatedly used or are largely used only once. Example milk, butter etc.
3. Private Consumption Expenditure on Services – such as banking, insurance, and
transport services etc.

B. Government Final Consumption Expenditure (G) – It refers to the expenditure on final

goods and services by the Government. Example Compensation of Employees by the
government, direct purchases abroad by the government, expenditure on purchase of goods for
the consumption by the defence personnel etc.

Government purchases goods and services for producing; hence government purchases would be
intermediate. However, we assume that the government is the final consumer of goods that it
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purchases. Therefore, government purchases are treated as final purchases. However it does not
include government expenditure on transfer payments to the firms and households in the
form of subsidies, scholarships, old age pensions etc.

C. Investment Expenditure (I) – Investment is defined as the addition to the stock of capital
goods during a period of time. This addition to the stock of capital is also called as capital
formation. Thus the term investment and capital formation are one and the same and can be used
interchangeably

It can be expressed as Gross Investment i.e. inclusive of depreciation or it can be expressed as

Net Investment i.e. exclusive of depreciation.
Investment expenditure is classified as follows –

1. Fixed Investment – It is classified as follows -

• Business Fixed Investment – It refers to the amount spent by the firms on the purchase
of new fixed assets. Example purchase of plants and machineries by the firms
• Fixed investment by the households – Example expenditure on construction of
residential units by the households (Residential Construction Investment)
• Public Fixed Investment – It includes the expenditure by the government on
construction of fixed assets like roads, dams, bridges etc.

2. Inventory Investment/ Change in Stocks – It is difference between the closing stock and the
opening stock. It includes –
a) Addition to the stock of finished goods (Unsold Stocks)
b) Addition to the stock of unfinished goods
c)Addition to the stock of raw materials

Note: Expenditure on purchase of fixed assets or on inventory stock during the year is
called as Gross Investment
Gross investment also includes the expenditure on the replacement of worn out fixed assets i.e.
the depreciation amount (or the depreciation reserve fund to take care of the replacement of fixed
assets when these are worn out or when they become obsolete)
Replacement of fixed assets, due to their depreciation is a part of Gross Investment. But it
does not cause any net increase in the existing stock of capital.
If this depreciation amount is excluded from Gross investment we get Net Investment
Gross Investment – Depreciation = Net Investment
Net Investment + Depreciation = Gross Investment

Net Investment implies net addition to the stock of capital. It helps in –

1. Increasing the production capacity and the level of output
2. Generating employment opportunities
3. Accelerating the pace of economic growth
D. Net Exports (X-M) – Net Export refers to the difference between the exports and imports
during an accounting year. It is the difference between the expenditure on exports by the non-
residents less the expenditure on imports by the resident households.
(Imports are to be deducted from Exports)

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 Net Exports = Exports – Imports
Or
Net Exports = X – M

3) Estimating the GDP (MP) – By adding all the components of Final Expenditure mentioned
above we arrive at GDP (MP)
GDP (MP) = C + I+ G + (X –M)

4) Estimating National Income – To estimate National Income fromGDP (MP) we have to

follow the following steps -
GDP (MP) – Depreciation = NDP (MP)
NDP (MP) – NIT = NDP (FC)
NDP (FC) + NFIA = NNP (FC) / National Income

Precautions of Expenditure Method –

Items not to be included:

1) Expenditure incurred for purchase of second hand goods/ used goods are not to be
included because they are not a part of current production
2) Expenditure incurred for transfer payments are not to be included because they do not
contribute to the flow of income
3) Expenditure incurred on financial capital items like purchase of shares, bonds etc. are
not to be included because they show only a claim or change in ownership. These are
mere paper claims and are not related to the flow of final goods and services. Such
expenditures do not cause any value addition.
4) Expenditure incurred on intermediate consumption (inputs) is not to be included
because it leads to double counting. Value of intermediate expenditure is already
reflected in the value of final expenditure.

Items to be included:
5) Expenditure incurred on payment of commission or brokerage should be included
because it is payment made for productive services of transferring goods from one person
to another

Question Bank
1) Estimate GDP (MP) from the following
a) Private Final Consumption Expenditure – Rs 15,000
b) Government Final Consumption Expenditure – Rs 7,500
c) Export of goods and services – Rs 2,500
d) Import of goods and services – Rs 3,000
e) Gross Business Fixed Investment – Rs 800
f) Gross public Investment – Rs 700
g) Gross Residential Construction – Rs 500
h) Closing balance of stock – Rs 400
i) Opening balance of stock – Rs 150
j) Transfer payments – Rs 300

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 k) NFIA – Rs (-) 300

2) Calculate GNP (MP) by Income method and Expenditure method

a) Private Final Consumption Expenditure – Rs 200
b) Government Final Consumption Expenditure – Rs 20
c) Gross Domestic Fixed Capital formation – Rs 30
d) Export of goods and services – Rs 35
e) Wages and salaries – Rs 165
f) Import of goods and services – Rs 40
g) Employer’s contribution to social security – Rs 10
h) Profit – Rs 15
i) Interest – Rs 20
j) Indirect Tax – Rs 30
k) Subsidies – Rs 5
l) Rent – Rs 15
m) NFIA – Rs 5
n) Consumption of fixed capital – Rs 5
o) Change in stock – Rs 10

3) Calculate National Income / NNP (FC) by expenditure method and Income method from the
following
a) Private final consumption expenditure – Rs 100
b) Factor Income received from the Rest of the World – Rs 100
c) Factor Income paid to the Rest of the World- Rs 110
d) Indirect Taxes – Rs 25
e) Rent – Rs 5
f) Government Final Consumption Expenditure – Rs 20
g) Net Domestic Fixed Capital Formation – Rs 30
h) Operating Surplus – Rs 20
i) Wages and salaries – Rs 50
j) Export of goods and services – Rs 55
k) Import of goods and services – Rs 60
l) Employer’s contribution to social security – Rs 10
m) Closing balance of stock – Rs 35
n) Opening balance of stock – Rs 40
o) Employee’s contribution to social security – Rs 15
p) Mixed Income of Self Employed – Rs 40
q) Consumption of fixed capital / Depreciation – Rs 20

4) From the following data calculate National Income / NNP (FC) by Income method and
expenditure method
a) Government Final Consumption Expenditure – Rs 1,000
b) Profit-Rs 700
c) Net Indirect Tax – Rs 110
d) Private Final Consumption Expenditure – Rs 1,500
e) Net Exports – Rs (-) 20

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 f) Compensation of Employees – Rs 1,200
g) Rent – Rs 200
h) Interest – Rs 270
i) NFIA –Rs 30
j) Mixed Income of Self Employed – Rs 600
k) Gross Domestic Capital Formation – Rs 700
l) Net Domestic Capital Formation – Rs 600

5) Estimate National Income by Income method and Expenditure method

a) Government Final Consumption Expenditure – Rs 50
b) Operating Surplus – Rs 300
c) Opening stock – Rs 20
d) Private Final Consumption Expenditure – Rs 480
e) Gross Fixed Capital Formation – Rs 90
f) Closing stock – Rs 35
g) Net Exports – Rs (-) 5
h) NIT –Rs 60
i) Compensation of Employees – Rs 200
j) Consumption of fixed capital – Rs 20
k) Mixed Income of Self Employed – Rs 50
l) NFIA –Rs 20
m) Employers contribution to social security – Rs 20

6) Calculate GNP (FC) from the following data by using Income method and expenditure
method
a) Wages and Salaries – Rs 800
b) Employers contribution to social security – Rs 200
c) Net Imports – Rs 30
d) Rent – Rs 100
e) Net Indirect Tax – Rs 40
f) Mixed Income of Self Employed – Rs 600
g) Interest – Rs 150
h) Dividend – Rs 100
i) Undistributed Profit – Rs 125
j) Corporate tax – Rs 25
k) NFIA – Rs 20
l) Consumption of fixed capital – Rs 40
m) Government Final Consumption Expenditure – Rs 490
n) Private Final Consumption Expenditure – Rs 1,400
o) Net fixed capital formation – Rs 250
p) Change in stock – Rs 30
q) Interest on National Debt – Rs 25

7) Calculate GNP (MP) by expenditure method

a) Rent – Rs 40
b) Private Final Consumption Expenditure – Rs 800

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 c) Net Exports – Rs 20
d) Interest – Rs 60
e) Profits – Rs 120
f) Government Final Consumption Expenditure – Rs 200
g) Net domestic capital formation – Rs 100
h) Compensation of Employees – Rs 800
i) Consumption of Fixed Capital – Rs 20
j) NIT – Rs 100
k) NFIA – Rs (-) 20

8) Calculate – (a) GNP (MP) (b) NNP (FC) from the following –
a) NFIA – Rs (-) 5
b) Net Exports – Rs (-) 7
c) NIT – Rs 47
d) Net Change in Stock – Rs 13
e) Private Final Consumption Expenditure – Rs 265
f) Government Final Consumption Expenditure – Rs 50
g) Consumption of fixed capital – Rs 45
h) Gross Domestic Capital Formation – Rs 100

3.15 Distinguish between Factor Income and Transfer Income–

Factor Income/ Payment Transfer Income / Payment

1) They are bilateral 1) They are unilateral
2) It is earned income (earning concept) 2) It is a receipt concept
3) They are rewards for rendering factor 3) No service is rendered in return for
services. An equivalent amount of goods transfer payments. No additional goods and
and services are produced in the market services are produced corresponding to
transfer payment
4) They are included in National Income 4) They are not included in National
Income but are included in individual’s
personal income
5) Examples – Rent, interest, wages and 5) Examples – Old age pensions,
profit unemployment allowance, taxes, subsidies,
scholarships, donations etc.

3.16 Distinguish between Domestic Income and National Income–

Domestic Income National Income

1) It includes income earned within the 1) It includes income earned both within
domestic territory and outside the country of residence
2) It includes income earned by residents 2) It includes income earned by residents
and non residents only
3) It is a geographic concept 3) ) It is an economic concept
4) It does not include NFIA. 4) It includes NFIA.
NDP (FC) = COE + OS + MISE NNP (FC) = NDP (FC) + NFIA

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 3.17 IMPORTANT RULES

DO NOT INCLUDE THE FOLLOWING INCLUDE THE FOLLOWING ITEMS OR

ITEMS OR TRANSACTIONS TRANSACTIONS –
1) Sale and purchase of second hand goods - 1) Broker’s commission-because it is payment
because they are not a part of current made for productive services of transferring
production goods from one person to another
2) Financial sale and purchase of shares, 2)Production of goods for self-consumption-
bonds and debentures - becausethey show because these goods are like those produced for
only a claim or change in ownership. These are the market. They are simply not sold due to
mere paper claims and are not related to the their need by the producers themselves
flow of final goods and services. Such
expenditures do not cause any value addition
3) Income generated through illegal activities 3) Free services by the government like free
-because they are not accounted. They are a part education, free medical services or street
of unaccounted money. Such activities are not lighting- it involves expenditure by the
accorded any social sanction government which is a part of government final
consumption expenditure. Hence these are
included in national income while using
expenditure method.
4) Capital gains and windfall gains -because 4) Defence and security services – For law and
it is an unearned income. There is no value order and defence of the country, the
addition corresponding to windfall gains. It is government has to employ defence personnel,
just due to luck. Similarly capital gains which policemen, judges etc. The services of these
are on account of increase in prices of land, persons are taken as final services as they
buildings, shares, bonds etc. also should not be provide security and peaceful existence to the
taken into account. All these gains do not add to households.It involves expenditure by the
the flow of goods and services in the economy. government which is a part of government final
(Examples of capital gains: Increase in the price consumption expenditure. Hence these are
of land, buildings, shares etc. Examples of included in national income while using
windfall gain: lottery) expenditure method
5) Indirect taxes like sales tax, excise duty etc 5) Government expenditure on street lighting
-They tend to just increase the market price of - as it is service provided by the government. It
goods and services. These are included only in involves expenditure by the government which
the estimation of national income at market is a part of government final consumption
price but are not included while estimating expenditure. Hence these are included in
National Income at factor cost. national income while using expenditure
method
6) Transfer payments like scholarship, gifts 6) Income of persons engaged in their own
from abroad, old age pensions, business -as they render productive activities. It
unemployment allowance and pocket money is a part of National Income even when such
to a child etc -because they do not contribute to income is not separately identified as wage,
the flow of income rent, interest and profit.
7) Value of intermediate goods like 7) Imputed value of owner occupied houses -
commodities used in basic scientific research, because houses whether these are rented out or

40
purchase of vegetables by a restaurant, are self occupied have rental value. Houses
expenses on electricity by a factory, generate factor income in the form of rent. By
transport expenses by a firm purchaseof cold letting out his house the owner would have
drinks by a school canteen from a earned rental income. For the owner occupied
manufacturer etc -because it leads to double houses we thus take the rental value. If they are
counting. Value of intermediate expenditure is not the owner of the house they may have to
already reflected in the value of final spend a part of their income for the payment of
expenditure rent.
8) Leisure time activities - because it is 8) Income of professional actors, singers,
difficult to estimate the value of that product. dancers etc - as they render productive
activities.
9) Services for self consumption like services 9) Change in the Stock of Raw Materials – it
rendered by the housewives, teacher teaching is a part of change in stock with the producers.
own child, doctor treating own family It is a part of inventory investment and
member etc - as it is difficult to find their therefore a part of National Income.
market value and these are not rendered for the
purpose of earning income.
10) Taxes on capital gains- as they are paid 10) (i) Dividends, Corporate tax,
not out of current income but out of past Undistributed profit - as they are a part of
savings of the tax payer. These are therefore not corporate profits.
to be added in the National Income as National (Note: Once profit is included in the estimation
Income includes only the income generated of National Income, any of these components
during the year of estimation, called the current should not be separately taken)
income. (ii) Employer’s contribution to provident
Payment of excise duty/GST by a firm- Such fund -as this is a part of compensation of
excise duty/ GST increase the market price of employees
goods and services. (iii) Pension on retirement- as this is a part of
compensation of employees
11) Increase in the price of shares of a 11) Expenditure on construction of a house-
company- as it is capital gain and no additional as it is a part of Gross Fixed Capital
goods and services are produced corresponding Formation
to this.
12 )Income Tax –should not be separately 12) Purchase of a machine by a factory- as it
added in the estimation of National Income is capital good and a final good. It is a part of
because income tax is paid out of fixed capital formation and therefore a part of
Compensation of Employees so it should not be National Income
separately taken.
13) Capital Loss –it may occur due to floods, 13) Interest received by an individual from a
earthquakes or any other sudden unknown bank- as it is a factor income
disaster. These cannot be accounted for in
advance.
14) Interest on loan taken by a consumer 14)Interest received on loan given to a
household-Interest payment on loan taken for foreign company in India-It will be included
consumption purpose are not factor payments. in the National income because it is a part of
factor income from abroad.

41
15)Interest received on loans given to a 15)Payment of interest by a bank to an
friend for purchasing a car/motor cycle- individual.-
Because it is non-factor receipt as the loan is It will be included in the National income
not used for production but for consumption because it is a part of factor income
16) Payment of interest on borrowings by 16)Payment of interest by a firm to a bank- It
general government-Because it is a non-factor is assumed that firm has taken loan for
payment as general government borrows only production purpose.
for consumption purpose
17) Interest on public debt or Interest on 17)Royalty- Royalty is a return for productive
national debt-Conventionally, interest on use of sub-soil resources.
consumption borrowing which does not add to
flow of goods and services
18) Value of bonus shares received by 18)Interest received on debentures- Interest
shareholders of a company. –Bonus shares are received is a factor income. Debenture is a sort
paper claims only and do not contribute to the of loan taken by production unit.
production of goods and services

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