Class 12 Macroeconomics

National Income :
 National Income is the total value of a country‟s final output of
all new goods and services produced in one year.
 National income is considered the most comprehensive measure
of the performance of an economy.

National Income of a Country can be measured by 3 different Methods

Value-added Income Expenditure

Method Method Method
Value-added Method :
 This method is used to measure national income in different
phases of production in the circular flow.
 It shows the contribution (value added) of each producing
unit in the production process.
a) Every individual enterprise adds a certain value to the products,
which it purchases from some other firm as intermediate goods.
b) When the value added by each and every individual firm is
summed up, we get the value of national income.

The Value-added Method is also known as :

i. Product Method;
ii. Inventory Method;
iii. Net Output Method;
iv. Industrial Origin Method; and
v. Commodity Service Method.
 Concept of Value-added Method
Value added refers to the addition of value to the raw material
(Intermediate Goods) by a firm, by virtue of its productive activities.

Value Added = Value of Output – Intermediate Consumption

Example of Concept of Value Added
Suppose a baker needs only flour to produce bread. He purchases flour as inputs worth Rs. 500 from the miller
and then by virtue of its productive activities, converts the flour into bread and sells the bread for Rs. 700.
In the given example :
 Flour is an input and its value of Rs. 500 is termed as the value of "Intermediate Consumption".
 Bread is the output and its value of Rs. 700 is termed as “Value of Output”.
 The difference between the value of output and intermediate consumption is termed as "Value Added". Here, the
baker has added a value of Rs. 200 to the total flow of final goods and services in the economy.
 Value added by each producing enterprise is also known as the GVAMP. Here, value added by baker Rs. 200 can be
termed either as Value Added or GVAMP.
∑ GVAMP = GDPMP
Intermediate Consumption : Final Consumption :
It refers to the It refers to the
expenditure incurred by expenditure on goods
a production unit on and services meant for
purchasing those goods final consumption and
and services from other investment.
production units, which
are meant for resale or
for use up completely
during the same year.
 Imports are not
separately included
because of the  If the value of intermediate
following reasons :
consumption is given, then
imports are not included
separately as imports are
already included in the value
of intermediate consumption.
 However, if domestic purchases
are specifically mentioned,
then imports will also be
included.
 Value of It refers to the market value of all
Output : goods and services produced during a
period of one year.
Measure the Value of Output
When the entire output is sold in an accounting year, then :
Value of Output = Sales + Production for self-consumption.
When the entire output is not sold in an accounting year, then a Change in Stock is added to the value of sales :

Value of Output = Sales + Change in Stock + Production for self-consumption

(Where, Change in Stock = Closing Stock – Opening Stock).

ALTERNATIVE METHOD
• Value of output = (Quantity × Price) + Change in Stock
 Exports are not
separately included in
the value of output
because of the  Exports are not separately
following reasons : included in the value of
output if “Sales” are given
(and domestic sales are not
specifically mentioned).
 In the case of an open
economy, sales include both
domestic sales and exports.
Steps of Value Added Method : The main steps for estimating
National Income by Value Added Method are :
Step Identify and Classify the production units :
 The first step is to identify and classify all the producing enterprises of an
1 economy into primary, secondary and tertiary sectors.

Estimate Gross Domestic Product at Market Price :

Step  In the second step, Gross Value Added at Market Price (GVAMP) of each sector is
calculated and the sum total of GVAMP of all sector give GDPMP, i.e.
2 ∑ GVAMP = GDPMP

Calculate domestic income (NDPFC) :

Step  By subtracting the amount of depreciation and net indirect taxes from GDPMP,
we get domestic income.
3  NDPFC= GDPMP - Depreciation - Net Indirect Taxes

Step Estimate net factor income from abroad (NFIA) to arrive at National Income :
 In the final step, NFIA is added to domestic income to arrive at National income.
4  National income (NNPFC) =NDPFC + NFIA.
 Value Added Method
GVAMP of Primary Sector
(+) GVAMP of Secondary Sector
(+) GVAMP of Tertiary Sector

Gross Domestic Product at Market Price (GDPMP)

(-) Depreciation
(-) Net Indirect Taxes

Domestic Income (NDPFC)

(+) NFIA

National Income (NNPFC)

Precautions of Value Added Method
Intermediate Goods are not to
 Since such goods are already included in the value of final goods.
be included in the national
 If they are included again, it will lead to double counting.
income

 As they were included in the year in which they were produced and do not add to the current flow of goods
Sale and Purchase of second- and services.
hand goods are not included  However, any commission or brokerage on the sale or purchase of such goods will be included in the
national income as it is a productive service.

 Domestic services like the services of a housewife, kitchen gardening, etc. are not included in the national
income since it is difficult to measure their market value.
Production of services for self-
 These services are produced and consumed at home and never enter the marketplace
consumption (domestic
and are termed as non-market transactions.
services) is not included
 It must be noted that paid services, like the services of maids, drivers, private tutors,
etc. should be included in the national income.

Production of goods for self-  It will be included in the national income as they contribute to the current output.
consumption will be included  Their value is to be estimated or imputed as they are not sold in the market.

 People, who live in their own houses, do not pay any rent. But they enjoy housing
The imputed value of owner- services similar to those people who stay in rented houses.
occupied houses should be  Therefore, the value of such housing services is estimated according to the
included market rent of similar accommodations.
 Such estimated rent is known as imputed rent.

Change in stocks of goods  Net increase in the stock of inventories will be included in the national income
(inventory) will be included as it is a part of capital formation.
The Problem of
Double  Double counting refers to counting
Counting : an output more than once while
passing through various stages of
production.
 In measuring the national income,
the value of only final goods and
services is to be included.
 However, the problem of double
counting arises when the value of
intermediate goods is also included
along with the value of final goods.
 Two ways of avoiding Double counting

Final Output Value-added

Method Method

 According to this method, the sum

 According to this method, the total of the value added by each
value of only final goods should be producing unit should be taken into
added to determine the national the national income.
income.  It is also known as the product
method.
  According to this method, all the income that accrues to the factor
Income of production by way of wages, profits, rent, interest, etc. is
Method : summed up to obtain the national income.
 The income method is also known as the 'Distributive Share
Method' or 'Factor Payment Method'.

Components of Factor Income

1) Compensation of Employees (COE) :
 COE refers to the amount paid to employees by the employer for rendering productive services.
 It includes all the payments and benefits, which employees receive, directly or indirectly, from the employer.
 Compensation of employees consists of 3 elements :

 It includes all the monetary benefits, like wages, salaries, bonus, dearness allowances,
A. Wages and salaries in cash : commission, etc.

 It includes all non-monetary benefits, like a rent-free home, free car, free medical and
B. Wages and salaries in kind : educational facilities, etc.
 An imputed value of these benefits should be included in national income.

C. Employer's contribution to  It includes contributions made by employers for the social security of employees.
 The aim of such contributions is to ensure the safety and security of life of the employees.
social security schemes :  For example : Labour welfare funds, gratuity, and contributions to the provident fund.
2) Rent and Royalty :
 Rent is a factor of income earned by the owners for lending their services such as land and building etc.
 Royalty is the income earned by a person/institution for lending intellectual property rights and rights of subsoil
assets.

3) Interest :
 Interest refers to the amount received for lending funds to a production unit.
 It includes both actual interests as well as the imputed interest of funds provided by the entrepreneur.
 'Interest income' includes interest on loans taken for productive services only.

4) Profit :
 Profit is the reward to the entrepreneur for his contribution to the production of goods and services.
 The profit earned by enterprises is used for three purpose :

 It is the direct tax paid by an enterprise to the government on the total profit earned by it.
A. Corporate Tax :  It is also known as profit tax or business tax.

 It refers to that part of the profit, which is paid to the shareholders in the ratio of their shareholding.
B. Dividend :  It is also known as distributed profits.

 It refers to that part of the profit, which is kept as a reserve to meet unexpected contingencies or for
business expansion.
C. Retained Earnings :  It is also known as Undistributed Profits or Savings of the Private Sector or Reserves and Surplus.
 Profit = Corporate tax + Dividend + Retained Earnings.
5) Mixed Income :
 It is the income generated by own-account workers (like farmers, barbers, etc.) and unincorporated enterprises
(like retail traders, small shopkeepers, etc.)
 It is a term used for any income that has elements of more than one type of factor income.
 For example : The income of a doctor running a clinic at his residence.

The various steps involved in estimating national income by Income Method are :
Identify and classify the production unit :
Step 1  All the producing enterprises employing various factors of production are identified
and classified into primary, secondary and tertiary sectors.
Estimate the Factor Income paid by each sector :
 The factor income paid by each sector are classified under the following heads :
Step a) Compensation of employees
b) Rent and Royalty
2 c) Interest
d) Profit
e) Mixed-Income

Step Calculate Domestic Income (NDPFC) :

 When factor income of all the sectors are summed up, we get domestic income (NDPFC).
3  In short, NDPFC = Compensation of Employees + Rent and Royalty + Interest + profit + Mixed income.

Step Estimate net factor income from abroad (NFIA) to arrive at National Income :
 In the final step, NFIA is added to domestic income to arrive at National Income.
4  NNPFC = NDPFC + Net Factor Income from Abroad.
 Income Method
Compensation of Employees =
+ Rent & Royalty
+ Interest
+ Profit
+ Mixed Income

Domestic Income (NDPFC)

(+) NFIA

National Income (NNPFC)

Precautions to be considered while estimating the national income of the Income Method are :

1 Transfer Income (Like scholarships, donations, charity, old age pensions, etc.) are not included in the National Income :
 As such receipts are not connected with any productive activity and there is no value addition.

Income from the sale of second-hand goods will not be included in National Income :
 Their original sale has already been counted therefore will not be included in national income. If they are included
2 again, it would lead to double counting.
 However, any brokerage or commission received by broker or commission agents on the sale of such goods, will be
included as it is an income received for rendering productive service.

Income from the sale of shares, bonds and debentures will not be included :

3  It is just a change of ownership therefore; such a transaction does not contribute to the current flow of goods and
services.
 However, any commission or brokerage on such financial assets is included as it is a productive service

4 Windfall gains (like income from lotteries, horse races, etc.) are not included :
 There is no productive activity connected with them.

Imputed value of services provided by owners of production unit will be included :

5  Imputed value of owner-occupied houses, interest on own capital, etc. will be included.
 These are productive activities and add to the flow of goods and services.

6 Payments out of past savings (like death duties, gift tax, interest tax, etc.) are not included in the national income :
 They are paid out of wealth or past savings do not add to the current flow of goods and services.
 Expenditure  Factor income earned by the factor of
Method of production is spent in the form of
Estimating expenditure on the purchase of goods and
National Income : services produced by firms.
 This method measures national income as
the sum total of final expenditures incurred
by households, business firms, government
and foreigners.
 This total final expenditure is equal to a
gross domestic product at market price.
∑ Final expenditure = GDPMP.
 This method is also known as the 'Income
Disposable Method‟ or „Consumption and
Investment Method‟.
 Components of Final Expenditure
Components of Final Expenditure

Government
Private Final Gross Domestic
Final
Consumption Capital Net Exports
Consumption
Expenditure Formation
Expenditure

Gross Fixed
Inventory Exports Imports
Capital (+) (-)
Investment (X) (M)
Formation
  It refers to expenditure incurred by households and private non-
profit institutions serving households on all types of consumer
A. Private Final goods.
 PFCE = households final consumption expenditure + private
Consumption non-profit institutions serving households' final consumption
expenditure
Expenditure  PFCE includes expenditures incurred by normal residents,
(PFCE) : whether in the domestic territory or abroad. So, any
expenditure incurred by residents during their foreign tour will
be added to PFCE.

 It refers to the expenditure incurred by the general

B. Government Final government on various administrative services like
Consumption defence, law and order, education, etc.
Expenditure  Government produces goods and services with the
(GFCE) : aim of social welfare without any intention of
earning profits.
 C. Gross Domestic Capital Formation  It refers to the addition to the capital stock of the economy.
(GDCF) or Gross Investment :  There are two components of GDCF :

1) Gross Fixed Capital Formation : It refers to the expenditure incurred on the purchase of fixed assets. This expenditure is generally
divided into three sub-categories :
 Gross Business Fixed Investment : It includes expenditure on the purchase of new plants, equipment, etc.
 Gross Residential Construction Investment : It includes expenditure on the purchase or construction of
new houses by households.
 Gross Public Investment : It includes expenditure on the construction of flyovers, roads, etc. by the government.

2) Inventory Investment (change in stock) :

 It refers to the physical change in the stock of raw materials, semi-finished goods and finished goods lying with producers.
 It is included as an investment item because it represents the goods produced but not used for current consumption.
 It is calculated as the difference between the closing stock and the opening stock of the year.
GDCF = Gross Fixed Capital Formation + Inventory Investment
Or
GDCF = Gross Business Fixed Investment + Gross Residential Construction Investment + Gross Public Investment +
Inventory Investment.

 It refers to the difference between exports and imports of a country during a period of
D. Net Export one year.
 Exports (X) refers to expenditure by foreigners on the purchase of domestic products.
(X – M) :  Imports (M) is the expenditure by residents on foreign products.
The various steps involved in estimating national income by expenditure method are :
Identify the economic units incurring final expenditure :
 All the economic units, which incur final expenditure within the domestic territory are classified under 4 groups :
Step a) Household sector
b) Producing sector
1 c) Government sector
d) Rest of the world sector.

Classification of final expenditure :

 Final expenditures incurred by the mentioned economic units are estimated under the following heads :
a) Private final consumption expenditure (PFCE)
Step b) Government final consumption expenditure (GFCE)
c) Gross domestic capital formation (GDCF)
2 d) Net exports (X - M).
 The sum total of the 4 components of the final expenditure gives
GDPMP = PFCE + GFCE + GDCF + (X - M).

Step Calculate domestic income (NDPFC) :

 By subtracting the amount of depreciation and net indirect taxes from GDP MP, we get domestic income.
3  NDPFC = GDPMP – depreciation – net indirect taxes.

Step Estimate net factor income from abroad (NFIA) to arrive at national income :
 In the final step, NFIA is added to domestic income to arrive at national income.
4  Nation income (NNPFC) = NDPFC + NFIA.
 Expenditure Method
Private Final Consumption Expenditure
+ Government Final Consumption Expenditure
+ Gross Domestic Capital Formation
+ Net Exports

Gross Domestic Product at Market Price (GDPMP)

(-) Depreciation
(-) Net Indirect Taxes

Domestic Income (NDPFC)

(+) NFIA

National Income (NNPFC)

Precautions of Expenditure Method
Expenditure on intermediate goods will not be included in national income
 As it is already included in the value of the final expenditure therefore
1 will not be included again.
 If it is included again, it will lead to double counting of expenditures.

Transfer payments are not included

2  As such payments are not connected with any productive activity and there is no value
addition.

Purchase of second-hand goods will not be included

 As such expenditure has already been included when they were originally purchased.
3  However, any commission or brokerage on such goods is included as it is a payment made for
productive service.

Purchase of financial assets (shares, debentures, bonds etc.)will not be included

4  As such transactions do not contribute to the current flow of goods and services.
 These financial assets are more paper claims and involve a change of title only.

Expenditure on own account production (mixed income) will be include in national income
5  As production for self-consumption, the imputed value of owner-occupied houses and private
non-profit institutions serving households are productive services.
The Differences between Net Exports and Net Factor Income from Abroad are :
National Factor Income from
Basis Net Exports
Abroad
It refers to the It refers to the difference between
difference between factor income received from
Meaning
exports and imports of abroad and factor income paid
goods and services. abroad.

Concept It is a Domestic concept. It is a National concept.

Factors /
It includes non-factor
Non-factor It includes factor services.
services.
Services
 National  It is the monetary value of final goods and
services produced by normal residents of a
Income at country in a year, measured at the prices of
Current Price : the current year.
 It is also known as „Nominal National
Income‟.
 It does not show the true picture of the
economic growth of a country as any
increase in nominal national income may
be due to a rise in price level without a
change in physical output.
 For example : The measurement of India's
National Income of 2022-23 at the prices of
2022-2023.
 National  It is the money value of final goods and
services produced by normal residents of a
Income at
country in a year, measured at base year
Constant Price : price. Base Year is a normal year that is
free from price fluctuations.
 It is also known as „Real National Income‟.
 It shows the true picture of the economic
growth of a country as any increase in real
national income is due to an increase in
output only.

National Income at Constant Price =

National Income at Current Price
× 100
Current Price Index
The Differences between National Income at Current Price and National Income at Constant Price :

Basis Nation income at current price National income at constant price

It refers to the money value of final
It refers to the money value of final goods
goods and services produced by
and services produced by normal residents
Meaning normal residents of a country in a
of a country in a year, measured at base
year, measured at the prices of the
year prices.
current year.
Index of
It is not a good tool for measuring the It is a better tool for measuring the
economic
economic growth of a county. economic growth of a country
growth
Causes of It is affected by a change in both price
It is affected by a change in quantity only.
change and quantity.

Current Price (P1) x Current Quantity Base Year Price(P0) x Current Quantity
Calculation
(Q1). (Q1).
Alternative It is also known as „Nominal National
It is also known as „Real National Income‟.
name Income‟.
 Nominal GDP or GDP
at Current Price :  When the GDP of a given year is estimated
on the basis of the price of the same year, it
is called nominal GDP.
Real GDP or GDP at
Constant Price :  When the GDP of a given year is estimated
on the basis of the price of the Base Year, it is
called Real GDP.

Determination of Nominal GDP and Real GDP :

Nominal GDP
Real GDP = × 100
Price Index
𝑅eal GDP × Price Index
Nominal GDP =
100
Real GDP is better
 Real GDP helps in determining the effect
as compared to of increased production of goods and
Nominal GDP services as it is affected by a change in
because of the physical output only. On the other hand,
following reasons : Nominal GDP can increase in physical
output as it is affected by a change in
prices also.
 Real GDP is a better measure to make a
periodic comparison in the physical
output of goods and services over
different services.
 Real GDP facilitates international
comparison of economic performance
across countries.
 GDP
Deflator : GDP deflator measures the
average level of prices of all
goods and services that
make up GDP.
GDP Deflator (Price Index) =
Nominal GDP
× 100
Real GDP
 GDP and  GDP is considered as an index of the welfare of the people.
Welfare :  Welfare means a sense of material well-being among the people
 Higher GDP is generally taken as greater welfare of people.

However, this generalization may not be correct due to the following limitations :
1) Distribution of GDP :
 It is possible that with rising GDP, inequalities in the distribution of income
may also increase, which increases the gap between rich and poor.
 GDP does not take into account changes in inequalities in the distribution
of income. So, the welfare of the people may not rise as much as the rise in GDP.

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

3) Non-monetary Exchanges :
 Many activities in an economy are not evaluated in monetary terms.
 For example : Non-market transactions like services of housewives, kitchen gardening, etc. are not
included in GDP due to the non-availability of data.
 However, such activities influence economic welfare.
4) Externalities :
 Externalities refer to benefits or harms of an activity caused by a firm or an individual, for
which they are not paid or penalised.
 Activities that result in benefits to others are termed as positive externalities.
 Activities that result in harm to others are termed as negative externalities.
a) Example and impact of negative externality :
i. Environmental population caused by industrial plants.
ii. Such pollution reduces welfare through negative effects on health.
b) Example and impact of positive externality :
i. Use of public parks by the people for pleasure for which no
payments are made by the public.
ii. It increases welfare through a positive effect on health.

5) Rate of Population Growth :

 GDP does not consider the changes in the population of a country.
 If the rate of population growth is higher than the rate of growth of GDP, then it will
decrease the per capita availability of goods and services, which will adversely affect
economic welfare.
 Treatment of Different Items in National Income :
Items included in National Income Reasons
Commission, brokerage on sale/ purchase Services rendered by the brokers
of second-hand goods, financial assets. are productive.
They contribute to the current
output. Their values are to be
Production of goods for self-consumption
estimated or imputed as they are
not sold in the market.
Imputed value of services enjoyed in Houses have rental value, no matter
owner-occupied houses if they are self-occupied or rented.
Change in stock. As it is a part of capital formation
Imputed value of services provided by It is a productive activity and adds
owners of production units. to the flow of goods and services.
It is considered to be a corporate
Interest on loans paid by commercial
income to RBI and thus, it is
banks.
included.
 Items not included in
Reasons
National Income
Intermediate goods To avoid double counting
The value of these goods was included
Sale and purchase of Second- in the national income in the
hand goods. accounting year in which they are
produced.
It is difficult to ascertain their market
Production of services for self-
value and they are not rendered for
consumption.
earning income.
Income from the sale of shares, As it is a transfer income and does not
bonds, and debentures. connect with the production unit.
No corresponding addition in the
Windfalls gain.
following goods and services.
They are paid out of wealth or passed
Payments out of past savings,
savings and do not add to the current
capital loss, capital gains etc.
follow of goods and services.
 Some Important Notes
1) It must be noted that all three methods give the same value of National Income because they are used to measure the same
physical output at three different phases. In India, the task of estimating National Income is entrusted with the Central
Statistical Organization (CSO).

2) Production for self-consumption :

 Goods produced for self-consumption are included in national income.
 Services produced for self-consumption are not included in national income.

3) Any reimbursement of business expenses incurred by the employees will be excluded from COE as
such expenses are part of the intermediate consumption of business enterprises.

4) Any contribution by a third party (say, an insurance company) to an employee is not part of COE as the insurance company
is not the employer of the injured worker. Any contribution by employees is also not included as such payments are made by
the employees from COE only.

5) “Interest Income” does not include :

 Interest paid by the government on public debt and interest paid by consumers as such interest is paid on loans taken
for consumption purposes.
 Interest paid by one firm to another firm.

6) Operating Surplus :
 It refers to the sum total of income from property (rent + royalty + interest) and income from entrepreneurship (profit).
 It doesn‟t arise in the general government sector as it works with the motive of social welfare.
 Operating surplus = rent + royalty + interest + profit.
7) Avoid Capital Gain while Estimating National Income :
 Capital gain refers to income from the sale of second-hand goods and financial assets.

8) Estimation of Government Final Consumption Expenditure (GFCE) :

 GFCE = Intermediate consumption of government + COE paid by government + Direct purchases from abroad for
embassies and consulates located abroad – sale of goods and services produced by the general government.

9) Reconciliation of 3 Methods :

Reconciliation of 3 Methods

Value Added Method Income Method Expenditure Method

GVAMP OF Primary Sector Compensation of Employees = Private Final Consumption Expenditure + Government
(+) GVAMP of Secondary Sector + Rent and Royalty Final Consumption Expenditure + Gross Domestic Capital
(+) GVAMP of Tertiary Sector + Interest Formation + Net Exports
+ Profit
+ Mixed Income
Gross Domestic Product at Market Price (GDPMP)
Gross Domestic Product at Market Price (GDPMP)

(-) Depreciation
Domestic Income (NDPFC) (-) Depreciation
(-) Net Indirect Taxes
(-) Net Indirect Taxes

(+) NFIA
Domestic Income (NDPFC)
Domestic Income (NDPFC)
(+) NFIA
(+) NFIA
National Income (NNPFC)

National Income (NNPFC)

National Income (NNPFC)
10) Included in National Income, but not in Domestic Income :
 Salary received by an Indian employee working in the Japanese embassy in India.
 Profits of a branch of the State Bank of India (SBI) in England.

11) Included in Domestic Income, but not in National Income :

 Rent is received by a company in India, which is owned by a non-resident.
 Profits earned by a branch of a foreign bank in India.

12) Price Index :

 It is an index number that shows the change in price level between two different time periods.

13) Variations in Real GDP and Nominal GDP :

 Real GDP is more than Nominal GDP : The price level in the base year is more than the price
level in the current year.
 Real GDP is equal to nominal GDP : The price level in both years is the same.
 Real GDP is less than Nominal GDP : The price level in the base year is less than the
price level in the current year.

14) Green GNP :

 It measures national income or output adjusted for the depletion of natural resources and
degradation of the environment.
 It will help to attain sustainable use of the natural environment and equitable
distribution of benefits of developments.
 A larger number signifies greater sustainability.