NCERT Solutions for Class 12 Economics Part A Chapter 2 National Income Accounting

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    1. What are the four factors of production and what are the remunerations to each of these called?

    Ans. The four factors of production are:

    (i) Land: It refers to the natural resources like air, water, soil, etc. The payment that is paid by firms for acquiring their services is called rent.

    (ii) Labour: It denotes the physical and mental efforts required to do a work. For example, engineer, manager, worker, etc. The remuneration made to the labour against his/her services rendered is termed as wage. 

    (iii) Capital: It refers to the investments made in terms of money and physical and tangible investments like machinery, buildings, technology, tools, etc, which assists in production process. The remuneration received in exchange of the services rendered by them is called interest.

    (iv) Entrepreneur: It refers to the individual who undertakes the risk of organising the production process. Entrepreneurs are the ones who take risks and often are the innovators of new techniques. They get profit as reward in exchange of their entrepreneurship.

    The remunerations paid to the factors of productions are known as factor payments or factor incomes. These are the aggregation of rent, wage, interest and profit.

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

    Ans. In a two sector economy, consisting of households and firms, goods and services produced by the firms, is the only way in which the households can dispose their income.
    The factors of production utilise their remuneration in order to purchase goods and services. Thus, the income will circulate back to the producers in the form of sales' revenue. So, there remains no difference between the amount that is distributed by the firms in the form of factor payments and consumption expenditure incurred by the households. The same process is repeated year after year. However, if there is any leakage in the form of savings, imports or taxes, then a difference between the aggregate consumption expenditure and aggregate factor payments is observed. In the case of some leakage, the households are spending less than their factor incomes. Consequently, the firms will receive lesser amount in the form of revenue, which will further reduce the production level and employment level. This process is repeated in every successive round and production resulted to which, the employment levels will continue to drop. Thus, the equality between the aggregate consumption expenditure and the aggregate factor payment is extremely important for the smooth functioning of the economy. 

    3. Distinguish between stock and flow. Between net investment and capital, which is a stock and which is a flow? Compare net investment and capital with flow of water into a tank.

    Stock Flow
    (i) Stock variables are the ones that are being measured at a particular point of time. For example, bank balance as on 1st Oct., 2010 is `5000. Flow variables are the ones that are being measured over an interval of time. For example, interest earned on bank deposits for 1 year, i.e., from 1 Oct., 2009 to 30 Sep., 2010.
    (ii) It does not have any time dimensions. It has time dimensions, like 1 year, 6 months, 10 days, etc.
    (iii) Examples: Capital, bank deposits. Examples: Capital formation, interest on capital, water flowing in a stream.

    A classic example of stock can be the amount or level of water in a tank. At any given point of time, the amount or the level of water in a tank is measurable. Similarly, the capital is also an example of stock variable, as the capital can also be measured at any point of time.
    Now , if water is flowing out of a tank through a tap, then the level of water tends to change over time. The difference in the level of water over an interval of time is an example of a flow variable. Similarly, net investment gives the difference in the investment level over a period of time.
    Hence, capital is a stock as it is measured over a point of time. On the hand, net investment is a flow as it is measured over a period of time.

    4. What is the difference between planned and unplanned inventory accumulation? Write down the relation between change in inventories and value added of a firm.

    Ans. The stock of unsold goods (finished and semi-finished), which a firm carries forward from one year to another year is termed as an inventory.
    Inventory accumulation could be planned or unplanned. The planned inventory accumulation is the type of inventory that a firm can anticipate or plan. For example, a firm wants to raise its inventory from 2,000 to 3,000 units of shirts and expects sales to be 10000 units. Thereby, it produces 10000 + 1000 units, i.e., 11000 units (in order to raise the inventory by 1000 units). If in case, at the end of the year it is found that the actual sales that got realised were also 10000, then the firm witnesses a rise in its inventory from 1000 to 2000 units.
    The closing balance of inventory is then calculated in the following manner:

    Final Inventory = Opening inventory + Production – Sale
    = 1000 + 11000 - 10000
    = 2000 units of shirts

    In this case, the actual inventory accumulation is equal to the expected accumulation. Hence, this is an example of a planned inventory accumulation.
    Unplanned inventory accumulation is usually an unexpected change in inventory level. There is an unplanned accumulation in an inventory when the actual sales are observed to be unexpectedly low or high. For example, let us assume, a firm wants to raise inventory from 1000 to 2000 units and expects sales to be 10000 units and therefore, it produces 11000 units of shirts. If, at the end of the year, the actual sales found were 9000 units only, which were not anticipated by the firm and therefore, the inventory rose by 3000 units. The unexpected inventory accumulation is calculated as:

    Final Inventory = Opening inventory + Production – Sale
    = 1000 + 11000 - 9000
    = 3000 units of shirts
    Hence, this is an example of unexpected inventory accumulation.
    The relationship between value added and the change in inventory is shown by the given equation:
    Gross value added by a firm = Sales + Change in inventory – Value of intermediate goods
    It implies that, as inventory is increased, the value added by a firm is also increased, thus it confirms the positive relationship between the two.

    5. Write down the three identities of calculating the GDP of a country by the three methods. Also briefly explain why each of these should give us the same value of GDP.

    Ans. GDP can be calculated through the following three methods:
    (a) Income method: Under this method, National Income is measured in terms of factor payments to the owner of factor of production.
    GDP = Total payments made to the factors of production

    $$GDP ≡\sum_{i=1}^MW_i+\sum_{i=1}^MP_i+\sum_{i=1}^MI_i+\sum_{i=1}^MR_i...(i)$$

    SWi = total wages and salaries received by ith households.
    ΣPi = total profit received by ith households.
    ΣIi = total Income received by ithhouseholds.
    ΣRi = total Rent received by ith households.
    Equation (1) can be simplified as
    GDP = W + R + I + P
    Where, W = Wages
    R = Rent
    I = Interest (Net)
    P = Profit (Private & Government)

    (b) Value added or product method: National Income is measure in terms of value addition in this method.
    GDP ≡ Sum of gross value added by all firms in an economy
    or GDP ≡ GVA1 + GVA2 + … GVAn
    Where, GVA1 represents gross value added by the 1st firm
    GVA2 represents gross value added by the 2nd firm and so on
    GVAn represents gross value added by the nth firm

    $$\text{Therefore,}\space GDP ≡\sum_{i=1}^nGVA_i$$

    Or

    It is calculate as:
    Gross value added in the primary sector at market price + Gross value added in the secondary sector at market price + Gross value added in the tertiory sector at market price = GDPMP
    GDPMP (–) Depreciation = Net Domestic Product at market price (NDPMP) Net domestic product at factor cost (NDPFC)
    = NDPMP – Net Indirect Tax National income = NDPFC + NFIA

    (c) Expenditure method or final consumption method:

    GDP ≡ Sum total of revenues that firms earn

    Or

    GDP ≡ Total consumption + Investment + Government Consumption expenditure + Net exports

    $$≡\sum_{i=1}^NC_i+\sum_{i=1}^NI_i+\sum_{i=1}^NG_i+\sum_{i=1}^NX_i$$

    As households spend some part of their income on imports, a part of consumption expenditure also comprises of imports, which are denoted by CM. Similarly, a part of the investment expenditure and government consumption expenditure is spent on the foreign investment goods and imports. These portions of investment and government consumption expenditure are denoted by IM and GM respectively. Thus, the ultimate households' consumption expenditure, investment expenditure and final government expenditure that are spent on the domestic firms are denoted by C – CM, I – IM and G – GM respectively.
    Substituting these values in the above equation

    $$GDP ≡ C – CM + I – IM + G – GM +\sum_{i=1}^MX_i\\≡ C + I + G +\sum_{i=1}^MX_i -(CM + IM + GM)$$

    Hence, GDP = C + I + G + X – M

    The three methods will always give the same result for measuring GDP because whatever is produced in the economy is either consumed or invested. The three methods depict the same picture of an economy from three different dimensions. The product method is the one that represents the value added or total production, the income method is representing the income earned by all the factors and finally, the expenditure method is depicting the expenditure incurred by all the factors. In the economy, the producer employs four factors of production to produce final goods and earns revenue by selling those final goods, which is equivalent to the total value addition by the firm. The firms pay remunerations to the factors, which is the income of all the factors. These remunerations are equivalent to the factors' contributions to the value addition. These factor incomes are then spend on the goods and services, which confirms the equality between the factor income and expenditure. Hence, the three methods will always give the same value of GDP.

    6. Define budget deficit and trade deficit. The excess of private investment over saving of a country in a particular year was ₹2,000 crores. The amount of budget deficit was (–) ₹1,500 crores. What was the volume of trade deficit of that country?

    Ans. Budget Deficit: The excess of government expenditure over government income is known as budget deficit.
    Budget Deficit = G – T
    Where, 
    G represents the government expenditure T represents the government income Trade Deficit: Trade deficit measures the excess of import expenditure over the revenue from exports of a country. 
    Trade Deficit = M – X

    Where,

    M represents the expenditure on imports X represents the revenue earned by exports It is given that, 
    I – S = ₹2000 crores.
    G – T = (–) ₹1500 crores.

    Therefore,

    Trade deficit = [I – S] + [G – T]
    = 2000 + [– 1500]
    = ₹500 crores.

    7. Suppose the GDP at market price of a country in a particular year was ₹1,100 crores. Net Factor Income from Abroad was ₹100 crores. The value of Indirect taxes – Subsidies was ₹150 crores and National Income was ₹850 crores. Calculate the aggregate value of depreciation.

    Ans. Given,
    National Income (NNPFC) = ₹850 crores
    GDPMP = ₹1100 crores
    Net factor income from abroad =₹100 crores
    Net indirect taxes = ₹150 crores
    NNPFC = GDPMP + Net factor income from abroad – Depreciation – Net indirect taxes Putting these values in the formula:
    850 = 1100 + 100 – Depreciation – 150
    ⇒ 850 = 1100 – 50 – Depreciation
    ⇒ 850 = 1050 – Depreciation
    ⇒ Depreciation = 1050 – 850 = ₹200 crores
    So, depreciation is ₹200 crores.

    8. Net National Product at Factor Cost of a particular country in a year is ₹1,900 crores. There are no interest payments made by the households to the firms/government, or by the firms/government to the households. The Personal Disposable Income of the households is ₹1,200 crores. The personal income taxes paid by them is ₹600 crores and the value of retained earnings of the firms and government is valued at ₹200 crores. What is the value of transfer payments made by the government and firms to the households?

    Ans. Given,
    NNPFC = ₹1900 crores
    Personal Disposable Income = ₹1200 crores
    Personal income tax = ₹600 crores
    Value of retained earnings = ₹200 crores
    Personal Disposable Income = NNPFC – Value of retained earnings of firms and government + value of transfer payments – personal tax
    ⇒ 1200 = 1900 - 200 + Value of transfer payments – 600
    ⇒ 1200 = 1100 + Value of transfer payments
    ⇒ Value of transfer payment = 1200 – 1100
    = ₹100 crores.

    9. From the following data, calculate Personal Income and Personal Disposable Income. ₹(crore)
    (a) Net Domestic Product at factor cost 8,000
    (b) Net Factor Income from abroad 200
    (c) Undisbursed Profit 1,000
    (d) Corporate Tax 500
    (e) Interest Received by Households 1,500
    (f) Interest Paid by Households 1,200
    (g) Transfer Income 300
    (h) Personal Tax 500

    Ans. Given,
    NDPFC = ₹8000 crores
    NFIA = ₹200 crores
    Transfer Income = ₹300 crores
    Undistributed profit = ₹1,000 crores
    Corporate tax = ₹500 crores
    Net interest paid by households
    = Interest paid – Interest received
    = 1200 - 1500
    = (–) ₹300 crores
    Personal Income = NDPFC + Net factor income from abroad (NFIA) + Transfer Income – Undistributed profit - corporate tax - Net interest paid by households
    So, putting the values in the above formula Personal Income = 8000 + 200 + 300 – 1000 – 500 – (– 300)
    = 8000 + 200 + 300 – 1000 – 500 + 300
    ⇒ Personal Income = 7300
    So, Personal Income = ₹7300 crores
    Personal Disposable income
    = Personal Income – Personal Payments
    = 7300 – 500
    = ₹6800 crores. 

    10. In a single day Raju, the barber, collects ₹500 from haircuts; over this day, his equipment depreciates in value by ₹50. Of the remaining ₹450, Raju pays sales tax worth ₹30, takes home ₹200 and retains ₹220 for improvement and buying of new equipment. He further pays ₹20 as income tax from his income. Based on this information, compute Raju’s contribution through the following measures of income
    (a) Gross Domestic Product,
    (b) NNP at market price,
    (c) NNP at factor cost,
    (d) Personal income,
    (e) Personal disposable income.

    Ans. (i) GDPMP = ₹500
    [Barber collects from haircut]
    (ii) NNPMP = GDP – Depreciation
    = 500 – 50
    = ₹450
    (iii) NNPFC = NNP – Sales tax
    = 450 – 30
    = ₹420
    (iv) Personal Income = NNPFC – Retained earnings
    = 420 – 220
    = ₹200
    (v) Pesonal Disposable Income = PI – Income tax
    = 200 – 20
    = ₹180.

    11. The value of the nominal GNP of an economy was ₹2,500 crores in a particular year. The value of GNP of that country during the same year, evaluated at the prices of same base year, was ₹3,000 crores. Calculate the value of the GNP deflator of the year in percentage terms. Has the price level risen between the base year and the year under consideration?

    Ans. Nominal GNP = ₹2500
    Real GNP = ₹3000
    $$\text{GNP deflator} =\frac{\text{Nominal GNP}}{\text{Real NGP}}×100$$$$\text{So,}\text{GNP deflator} =\frac{2500}{\text{3000}}×100\\= 83.33%$$

    No, the price level has fallen down by 16.67 % [(100 – 83.33)%].

    12. Write down some of the limitations of using GDP as an index of welfare of a country.

    Ans. Limitations of using GDP as an indicator are mentioned as follows:

    (i) Non-monetary exchanges: GDP measures the goods and services that are produced in an economy during a particular period of time only. However, it does not take into account any of those transactions that do not come under monetary terms. In less developed countries there are exchanges, which are in monetary terms non-monetary, particularly in rural areas. Hence, such transactions are left outside the domain of GDP. The household sector and volunteer sectors get ignored in GDP.

    (ii) Inflation: The level of prices in a country is never taken into account by GDP. Due to inflation, the cost of living often increases leading to a significant decrease in the standard of living. The loss of welfare due to this decrease is not taken into account by GDP as an index of welfare.

    (iii) Externalities: Increase in the national income is often related with increased levels of unwanted situations like pollution, accidents, disasters, shortage and depletion of natural resources, etc. These factors not only affect human health but also lead to ecological degradation. GDP fails at considering the costs or valuations of such factors.

    (iv) Income pattern: GDP totally disregards the income distribution pattern in the country. The increase in aggregate national income may be because of the increase in income of a few individuals. Thus, this may lead to a faulty interpretation of social welfare.

    (v) Welfare: GDP also ignores the welfare component of the society as the goods and services produced may or may not add to the welfare to a society. For example, the products like guns, narcotic drugs, high-end luxurious goods increase the monetary value of production, but their production do not add to the welfare of the majority of population.

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