National Income Accounting

This page contains the NCERT Economics class 12 chapter 2 National Income Accounting from Book II Introductory Macroeconomics. You can find the solutions for the chapter 2 of NCERT class 12 Economics, for the Short Answer Questions, Long Answer Questions and Projects/Assignments Questions in this page. So is the case if you are looking for NCERT class 12 Economics related topic National Income Accounting question and answers.
1. What are the four factors of production and what are the remunerations to each of these called?
The four factors of production and their remuneration to each of these are as follows:
Factor of Production
1. Human Labour
Contribution made by human effort in production
2. Capital
Financial and physical assets used in production
3. Entrepreneurship
Organization and risk-taking in business ventures
4. Land
Natural resources and geographical space used
2. Why should the aggregate final expenditure of an economy be equal to the aggregate factor payments? Explain.
The aggregate final expenditure of an economy should be equal to the aggregate factor payments due to the following reasons.
Circular Flow of Income: In an economy, there’s a circular flow of income and expenditure. Firms make factor payments (wages, interest, rent, and profits) to households for using the factors of production. These payments constitute the income of households.
Income, Consumption, and Savings: The income ({Y}) received by households is either used for consumption ({C}) or saved ({S}). This relationship is expressed as {Y = C + S}. In a simplified model of an economy, where there are no taxes or imports and exports, the total income must be either consumed or saved.
Expenditure on Goods and Services: The consumption part of the income ({C}) is used by households to purchase goods and services, which flows back to the firms. Thus, the consumption expenditure by households is a part of the aggregate final expenditure in the economy.
Equilibrium in Income and Expenditure: In a closed economy without government intervention, if we assume no savings for simplicity, the entire income ({Y}) becomes equivalent to consumption ({C}). Therefore, the total income in the economy (aggregate factor payments) equals the total expenditure on goods and services (aggregate final expenditure).
Aggregate Final Expenditure Equals Aggregate Factor Payments: Consequently, in such a simplified economic model, the aggregate final expenditure (total spending on final goods and services) must equal the aggregate factor payments (total income generated through wages, interest, rent, and profits). This is because the factor payments made by firms to households (which constitute the households’ income) are ultimately spent on the goods and services produced by the firms, maintaining a balance where total expenditure equals total income.
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.
Distinguishing Between Stock and Flow
A stock is a quantity measured at a particular point in time. It represents an accumulation of resources or value.
A flow is a quantity measured over a period of time. It represents a rate of change or movement of resources or value.
Time Dimension
Snapshot at a specific time (e.g., the amount of water in a tank at 8 AM).
Measured over a period (e.g., liters of water flowing into a tank per hour).
Wealth, population, quantity of goods in inventory.
Income, production rate, expenditure.
Net Investment and Capital: Stock or Flow?
Capital: Capital is a stock. It represents the total accumulated assets and resources available at a specific point in time.
Net Investment: Net investment is a flow. It refers to the rate at which new capital is added (investment) minus the rate at which existing capital depreciates over a period of time.
Analogy with Flow of Water into a Tank
Capital as Water in the Tank: Capital can be compared to the amount of water present in a tank at a given moment. Just as the water level in a tank represents a stock (a cumulative quantity at a specific time), capital represents the accumulated assets at a particular point in time.
Net Investment as Water Flow: Net investment is analogous to the flow of water into the tank. It represents the rate at which water (capital) is being added to the tank (economy) minus the rate at which it is lost due to leakage (depreciation). It’s a continuous process over time, much like a flow.
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.
Planned vs Unplanned Inventory Accumulation
Planned Inventory Accumulation
Unplanned Inventory Accumulation
Planned inventory accumulation occurs when a firm intentionally increases its inventory based on expected future sales, production plans, or market demands.
Unplanned inventory accumulation happens when actual sales are lower than expected, leading to an unintended increase in inventory.
It is a deliberate strategy based on forecasts and business goals.
It is not intentional and often results from miscalculations or unforeseen changes in market conditions.
Impact on Production
May lead to increased production if the accumulation is due to anticipated higher demand.
May lead to reduced production as the firm adjusts to align inventory with actual demand.
A retailer stocking up additional goods for an upcoming festive season.
Goods remaining unsold due to a sudden drop in market demand.
Relation Between Change in Inventories and Value Added of a Firm
Change in Inventories: This refers to the difference between the inventories at the beginning and the end of a period. It can be either an increase or a decrease.
Value Added: Value added is the difference between the firm’s output (in terms of goods and services) and the intermediate goods used in the production process.
Relationship: The change in inventories is a component of the firm’s output. When inventories increase (more goods are produced than sold), the value added by the firm is considered to have increased, as these unsold goods are part of the firm’s output. Conversely, a decrease in inventories (more goods sold than produced) would mean a reduction in the value added for that period.
Change in Inventories
Impact on Value Added
Increase in Inventories
Increases Value Added
Decrease in Inventories
Decreases Value Added
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.
GDP Calculation Methods and Their Identities
Production (or Output) Method:
Identity: {\text{GDP} ≡ \displaystyle∑\limits_{i=1}^N \text{GVA}_i}
Explanation: This method calculates GDP by summing the gross value added (GVA) of all firms in the economy. GVA for each firm is calculated as the value of sales plus value of change in inventories minus the value of intermediate goods used.
Income Method:
{≡ \displaystyle∑\limits_{i=1}^M W_i + \displaystyle∑\limits_{i=1}^M P_i + \displaystyle∑\limits_{i=1}^M \text{In}_i + \displaystyle∑\limits_{i=1}^M R_i}
{≡ W + P + \text{In} + R}
Explanation: This method sums up all the incomes received by households in the economy. It includes wages (W), profits (P), interest (In), and rents (R) received by all households.
Expenditure Method:
Identity: {\text{GDP} ≡ \displaystyle∑\limits_{i=1}^N (C_i + I_i + G_i + X_i - M_i)}
Explanation: This method calculates GDP by adding up total consumption (C), investment (I), government spending (G), and net exports (exports (X) minus imports (M)).
Why Each Method Yields the Same GDP Value
Interconnectedness of Production, Income, and Expenditure: The value of total production in an economy (output method) is equal to the total income generated from that production (income method), which in turn is equal to the total expenditure on the final goods and services produced (expenditure method). This is because in an economy, every transaction involves a payment that becomes income for someone else, and this income is generated by the production of goods and services.
Circular Flow of Economic Activity: The circular flow of economic activity ensures that the total value of production, which becomes income for producers, is eventually spent on the goods and services produced. Thus, regardless of the approach used, the total value measured remains the same, reflecting the overall economic activity.
Accounting Consistency: All three methods are based on the same set of economic transactions, just viewed from different perspectives (production, income, and expenditure). The accounting principles applied ensure that each method, despite its unique approach, arrives at the same total value for GDP.
This comprehensive explanation provides a detailed understanding of the three methods of calculating GDP and the rationale behind their consistency in measuring the same economic variable.
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?
Budget Deficit: A budget deficit occurs when a government spends more money than it receives in revenue. It’s the amount by which government expenditures exceed government revenues in a given period, typically a fiscal year.
Trade Deficit: A trade deficit happens when a country’s imports of goods and services exceed its exports. It indicates that a country is buying more from foreign countries than it is selling to them.
Calculating the Trade Deficit
Excess of private investment (I) over saving (S) = ₹ 2,000 crores.
Budget deficit (G – T, where G is government spending and T is taxes) = (-) ₹ 1,500 crores.
The macroeconomic identity for an open economy, considering the components of GDP, can be rearranged as:
{\text{Trade Deficit} = (I - S) + (G - T)}
Substituting the given values:
Trade Deficit
= 2000 + (-1500)
= 2000 – 1500
= 500
Therefore, the volume of the trade deficit of that country was ₹ 500 crores. Thank you for pointing out the discrepancy, and I appreciate the opportunity to correct it.
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.
To calculate the aggregate value of depreciation, also known as Capital Consumption Allowance (CCA) or depreciation of fixed capital assets, we can use the following formula:
GDP at Market Price (GDPMP)
National Income (NI) + Net Indirect Taxes + Depreciation – Net Factor Income from Abroad (NFIA)
GDP at Market Price
= ₹ 1,100 crores
Net Factor Income from Abroad (NFIA)
= ₹ 100 crores
Net Indirect Taxes
(Indirect Taxes – Subsidies)
= ₹ 150 crores
National Income (NI)
= ₹ 850 crores
We need to find the Depreciation. Rearranging the formula:
GDP at Market Price – National Income – Net Indirect Taxes + Net Factor Income from Abroad
Substituting the given values:
1100 – 850 – 150 + 100
1200 – 1000
₹ 200 crores
Therefore, the aggregate value of depreciation for that country in the particular year was ₹ 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?
To find the value of transfer payments made by the government and firms to the households, we can use the relationship between Net National Product at Factor Cost (NNPFC), Personal Disposable Income (PDI), Personal Income Taxes, Retained Earnings, and Transfer Payments.
– Net National Product at Factor Cost (NNPFC)
= ₹ 1,900 crores
– Personal Disposable Income (PDI)
= ₹ Rs 1,200 crores
– Personal Income Taxes
= ₹ 600 crores
– Retained Earnings of Firms and Government
= ₹ 200 crores
– No interest payments made by households to firms/government or vice versa
The relationship can be expressed as:
NNPFC – Personal Income Taxes – Retained Earnings + Transfer Payments
We need to find the Transfer Payments. Rearranging the formula:
Transfer Payments =
PDI + Personal Income Taxes + Retained Earnings – NNPFC
Substituting the given values:
Transfer Payments
1200 + 600 + 200 – 1900
2000 – 1900
₹ 100 crores
Therefore, the value of transfer payments made by the government and firms to the households in that particular year was ₹ 100 crores.
9. From the following data, calculate Personal Income and Personal Disposable Income.
₹ (crore)
Net Domestic Product at factor cost
Net Factor Income from abroad
Undisbursed Profit
Corporate Tax
Interest Received by Households
Interest Paid by Households
Transfer Income
Personal Tax
Personal Income (PI)
Given that
Net Domestic Product at Factor Cost (NDPFC)
= ₹ 8,000 crores
Net Factor Income from Abroad (NFIA)
= ₹ 200 crores
Transfer Income
= ₹ 300 crores
Undisbursed Profit
= ₹ 1,000 crores
Corporate Tax
= ₹ 500 crores
Now, Net Interest Paid by Households can be calculated as
Net Interest
Interest Paid – Interest Received
₹ 1,200 crores – ₹ 1,500 crores
(-) ₹ 300 crores
Now, the Personal Income (PI) can be calculated as
NDPFC + NFIA + Transfer Income – Undisbursed Profit – Corporate Tax – Net Interest Paid
8000 + 200 + 300 – 1000 – 500 – (-300)
8000 + 200 + 300 – 1000 – 500 + 300
₹ 7,300 crores
Personal Disposable Income (PDI)
Given that
Personal Tax = ₹ 500 crores
The personal disposable income (PDI) can be calculated as
PI – Personal Tax
7300 – 500
₹ 6,800 crores
Therefore, based on this calculation, the Personal Income is ₹ 7,300 crores, and the Personal Disposable Income is ₹ 6,800 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, complete Raju’s contribution to the following measures of income (a) Gross Domestic Product (b) NNP at market price (c) NNP at factor cost (d) Personal income (e) Personal disposable income.
(a) Gross Domestic Product (GDP)
GDP measures the total value of all final goods and services produced within a country’s borders in a specific time period. In Raju’s case, it’s the total value of his services.
Raju’s total collection from haircuts
= ₹ 500
Raju’s contribution to GDPMP
= ₹ 500
(b) Net National Product at Market Price (NNPMP)
NNPMP at Market Price is GDP minus depreciation.
= ₹ 50
= GDPMP – Depreciation
= ₹ 500 – ₹ 50
= ₹ 450
(c) NNP at Factor Cost
NNP at Factor Cost (NNPFC)is NNP at Market Price (NNPMP) minus indirect taxes (like sales tax).
Sales Tax
= ₹ 30
= NNPMP – Sales Tax
= ₹ 450 – ₹ 30
= ₹ 420
(d) Personal Income
Personal Income is calculated by subtracting retained earnings (amount retained for improvement and buying new equipment) from NNP at Factor Cost i.e., NNPFC.
= ₹ 420
Retained Earnings
= ₹ 220
Personal Income
= NNPFC – Retained Earnings
= ₹ 420 – ₹ 220
= ₹ 200
(e) Personal Disposable Income
Personal Disposable Income (PDI) is the income available to an individual after personal taxes have been paid.
Personal Income
= ₹ 200
Direct tax
= ₹ 20
= Personal Income – Direct Tax
= ₹ 200 – ₹ 20
= ₹ 180
In summary, Raju’s contributions are:
= ₹ 500
= ₹ 450
= ₹ 420
= ₹ 200
= ₹ 180
11. The value of the nominal GNP of an economy was Rs 2,500 crores in a particular year. The value of GNP of that country during the same year, evaluated at the prices of same base year, was Rs 3,000 crores. Calculate the value of the GNP deflator of the year in percentage terms. Has the price level risen between the base year and the year under consideration?
To calculate the GNP deflator and assess the change in price level, we use the formula for the GNP deflator, which is a measure of the level of prices of all new, domestically produced, final goods and services in an economy. The formula is:
{\text{GNP Deflator} = \left( \dfrac{\text{Nominal GNP}}{\text{Real GNP}} \right) × 100}
Nominal GNP
Value of GNP measured at current year prices
₹ 2,500 crores
Real GNP
Value of GNP measured at base year prices
₹ 3,000 crores
Substituting these values into the formula:
GNP Deflator
{= \dfrac{2500}{3000} × 100}
{= \dfrac{5}{6} \times 100}
{≈ 83.33\%}
The GNP deflator is approximately 83.33%.
Analysis of Price Level Change
If the GNP deflator is greater than 100, it indicates that the price level has risen since the base year.
If the GNP deflator is equal to 100, it indicates that the price level is the same as in the base year.
If the GNP deflator is less than 100, as in this case, it indicates that the price level has decreased since the base year.
Therefore, the price level has actually decreased (not risen) between the base year and the year under consideration, as indicated by the GNP deflator being less than 100%.
12. Write down some of the limitations of using GDP as an index of welfare of a country.
Gross Domestic Product (GDP) is widely used as an indicator of the economic health of a country, as well as a gauge of a country’s standard of living. However, it has several limitations when used as an index of the welfare of a country:
Distribution of GDP – How Uniform Is It: A rise in GDP may not correlate with an increase in welfare if the wealth is concentrated among a few. If a large portion of the population sees a decrease in real income, overall welfare cannot be said to have increased.
Non-monetary Exchanges: GDP overlooks non-monetary transactions such as barter exchanges and unpaid domestic work, leading to an underestimation of the productive activity and well-being in a country.
Externalities: GDP does not account for externalities. Negative externalities like pollution can decrease welfare, while positive externalities can increase it, leading to a misrepresentation of actual welfare.
Income Distribution: GDP does not reflect how income is distributed within a country. High GDP with significant income inequality may not indicate an overall increase in welfare.
Environmental Degradation: Activities that harm the environment can increase GDP in the short term but reduce welfare in the long term, which GDP does not account for.
Quality of Goods and Services: GDP measures quantity but not the quality of goods and services, failing to capture improvements in quality that enhance welfare.
Non-Economic Factors: Factors like leisure time, job security, political freedom, and social justice, which contribute to human welfare, are not measured by GDP.
Health and Education: While expenditure on health and education is included in GDP, it does not necessarily reflect the effectiveness of such spending in improving welfare.
Sustainability: GDP does not consider whether the current rate of economic growth is sustainable in the long term.
Shadow Economy: Economic activities in the informal sector are not included in GDP, which can be significant in some countries.
Happiness and Life Satisfaction: GDP does not measure the happiness or life satisfaction of the population.
In summary, while GDP is a useful economic tool, it has significant limitations as a comprehensive measure of a country’s welfare. It is important to consider these limitations and, where possible, supplement GDP with other indicators that provide a more complete picture of societal well-being.