ECONOMICS ASSIGNMENT

DIVYA R REDDY
I BA HEP
20HEP066

MODULE-I
INTRODUCTION TO MACROECONOMICS

1) Define macroeconomics. (3 marks)

Ans) Macroeconomics is that branch of Economics which deals with the study of aggregate
behavior of the whole economy. It is also known as Aggregative Economics.

According to Ackley, “Macroeconomics deals with economic affairs ‘in the large’. It looks at the
total size and shape of the functioning of the ‘elephant’ of economic experiences, rather than
working of the individual part. It studies the character of the forest, independently of the trees
which compose it.”

2) What are the branches of macroeconomics? (5 marks)

Ans) Macroeconomics is that branch of Economics which deals with the study of aggregate
behavior of the whole economy.
The four major branches of economics are as follows:
a) Theory of Income and Employment
b) The General theory of Price
c) Theory of Economic growth
d) Theory of Economic Distribution
a) Theory of Income and Employment: Income and employment theory, a body of economics
analysis is concerned with the relative levels of output, employment, and prices in an
economy. By defining the interrelation of these macroeconomic factors, government tries to
create policies that contribute to economic stability. The classical economists believed that
there was always full employment in the economy. In case of unemployment, a general cut in
money wages would take the economy to the full employment level. This argument is based
on the assumption that there is a direct and proportional relation between money wages and
real wages.
b) The General Theory of Price: The general theory of price is an economic theory that states
that the price for any specific good or service is based on the relationship between its supply
and demand. The theory of price also referred to as ‘price theory’ is a microeconomic
principle that uses the concept of supply and demand to determine the appropriate price point
for a given good or service. The optimal market price, or equilibrium, is the point at which
the total number of items available can be reasonably consumed by potential consumers.

c) Theory of Economic Growth: Economic growth is am increase in the production of

economic goods and services, compared from one period of time to another. Traditionally,
aggregate economic growth is measured in terms of gross national product (GNP) or gross
domestic product (GDP), although alternative metrics are sometimes used. The new
economic growth theory is an economic concept, positing that humans’ desires and unlimited
wants foster ever-increasing productivity and economic growth. The new growth theory
argues that real GDP per person will perpetually increase because of people’s pursuit of
profits.

d) Theory of Economic Distribution: Distribution theory, in economics, is the systematic

attempt to account for the sharing of the national income among the owners of the factors of
production – land, labour, and capital. Traditionally, economists have studied how the costs
of these factors and the size of their return- rent, wages, and profits are fixed. The modern
theory of factor pricing provides a satisfactory explanation of the problem of distribution. It
is known as the demand and supply theory of distribution. Prices paid for productive services
are like any other price and they are basically determined by demand and supply conditions.

3) Distinguish between stock and flow with examples. (5 marks)

Ans) The following table distinguishes between stock and flow variables.
STOCK FLOW
1) Stock variable refers to that variable, which 1) Flow variable refers to that variable, which
is measured as a particular point of time. is measured over a period of time.
2) In economics, the term ‘stock’ means the 2) In economics, the term ‘flock’ indicates the
total quantity of goods, assets, liabilities or movement of any asset, goods or funds, from
 funds which is stored or is ready for one place to another and its measurement is
distribution or sale or simply held by a firm performed over an interval of time. Here, the
on a given date. term ‘interval of time’ determines the
duration or length of time, in which the flow
of the asset or commodity is measured.
3) It is a static concept, which means that 3) It is a dynamic concept as it takes into
whenever we measure stock, it gives a account such variables which show a constant
snapshot of the goods available or left at that activity, progress or change.
particular moment.
4) It is not time dimensional as we measure 4) It is time dimensional as we always
the stock without referring to the duration of measure the flow of variable in relation to the
the time. duration of time.
5)Money supply, inventory, wealth, debt, 5) National income, output, consumption and
savings, capital are the examples of stock investment are examples of flow variables.
variables.

4) Define the terms Macro Statics, Comparative Statics and Macro Dynamics. (3 marks
each)
Ans)
MACRO STATICS:
 Macro Statics is a methodology of studying economic phenomena independently of the time
element. It is the study of the variable at a given point of time.
 Static analysis does not include or involve any adjustment process.
For example, Y= C+I does not explain how the total income reaches equilibrium level. The
ceteris paribus condition is used in static analysis and it represents a stationary equilibrium.
 It explains the static equilibrium position of the economy.
Example: Y= C+I, it is a timeless quantity identity equilibrium without any adjusting
mechanism. It is a timeless economy, a still picture.

MACRO DYNAMICS:
 According to Kurihara, “It treats discrete movements or rates of change of macro variables. It
enables one to see a motion picture of the functioning of the economy as a progressive
whole.”
Example: The investment multiplier.
 It deals with the study of economic phenomena which vary with time. It analyses the
transition of equilibrium over time. It specifically shows the time path of adjustment.
 Static is the study of a variable as an event whereas dynamics study the variable as a process.

COMPARATIVE STATICS:
 Comparative Statics is a method in which different equilibrium situations are compared.
 Static state is functioning at a point of time. Comparative statics is related to change from
point A to point B. It compares the equilibrium position A with equilibrium position B. Thus,
comparative statics is concerned with the transitional period but “involves the study of
variations in equilibrium positions corresponding to specified changes in underlying data.”
Example: The Keynesian Employment, Income and Output analysis is based on the theory of
shifting equilibrium wherein he compares different equilibrium levels of income.

5) Distinguish between micro and macroeconomics. (5 marks)

Ans) The following table draws the distinction between microeconomics and macroeconomics:
MICROECONOMICS MACROECONOMICS
1) Microeconomics is that branch of 1) Macroeconomics is that branch of
economics which is mainly concerned with economics which is mainly concerned with
the study of the behavior of individual the study of the behavior of an economy as a
economic agents such as a firm, an industry, a whole, such as aggregate demand and supply,
consumer, a household unit etc. general price level, national income,
aggregate employment etc.
2) The microeconomic approach is called as 2) The macroeconomic approach is called as
the slicing method, as it divides the entire lumping method, as it brings together the
economy into smaller parts for the purpose of various individual variables and makes a
intensive study. collective study.
3)Microeconomics studies the partial 3)Macroeconomics studies the general
equilibrium in the economy, such as equilibrium in the economy, such as
consumer equilibrium, producer equilibrium equilibrium in the general price level, market
and equilibrium of a particular firm of an equilibrium and equilibrium in the aggregate
industry, etc. output level, etc.
4)Microeconomics is comparatively less 4) Macroeconomics is more dynamic as it
dynamic. studies the economy in terms of change in
time, and its impact on the goods and
services,
5)Microeconomics gives a worm’s eye view 5)Macroeconomics gives a bird’s eye view of
of the economy, which is in particular about the economy, a humongous one which is
the individual parts of the economy. more general in nature.
6)Microeconomics has a very narrow scope. 6)Macroeconomics has a very wider scope.
7)Microeconomics is an unrealistic study as it 6)Macroeconomics, on the other hand, is
is not very practical. comparatively more realistic and used to
solve several economic problems of the
economy and, hence is more practical and
applied more.
 6) Define micro economic paradox. Give an example. (3 marks)
Ans) A paradox is a statement which seems to be absurd, but appears to be true. Although it
sounds strange or senseless it contains the truth.
 Micro economic paradoxes are those which are true when applied to the entire economic
system or the aggregate, but are untrue when applied to a single individual unit. They explain
how an economic principle when applied to the aggregate, give the expected result but if the
same principle is applied to an individual unit, it may prove wrong.
 Example: If an economy has achieved a growth rate of 9%, it does not mean that the same
growth rate is achieved in all the sectors of the economy. If the national income of a country
has increased by 6% it does not imply that per capita income has also increased by the same
percentage.

7) Define macroeconomic paradox. Give an example. (3 marks)

Ans) A paradox is a statement which seems to be absurd, but appears to be true. Although it
sounds strange or senseless it contains the truth.
 Macroeconomic paradoxes are those which are true when applied to a single individual but
are untrue when applied to the economic system as a whole. They explain how an economic
principle when applied to an individual or person gives the expected result, but if the same
principle is applied to the entire system it may not be true.
 Example: Individuals savings is a virtue, but collective savings is a vice. This is because
individual savings may lead to higher investment, production, income and employment
whereas higher social savings would certainly reduce the level of demand, consumption,
income and employment in a country.

8) Briefly explain the uses and limitations of macroeconomics. (15 marks)

Ans) Macroeconomics is that branch of Economics which deals with the study of aggregate
behavior of the whole economy. It is also known as Aggregative Economics. According to
Ackley, “Macroeconomics deals with economic affairs ‘in the large’. It looks at the total size and
shape of the functioning of the ‘elephant’ of economic experiences, rather than working of the
individual part. It studies the character of the forest, independently of the trees which compose
it.”

USES / IMPORTANCE OF MACROECONOMICS:

a) To understand the working of an economy: In order to understand the working of an

economy, it is necessary to know and understand the working of various macroeconomic
variables. These variables are statistically measurable, thereby facilitating the possibilities of
analyzing the effects on the functioning of the economy. As Tinberg observes,
 macroeconomic concepts help in “making the elimination process understandable and
transparent”.

b) It helps in the formulation of economic policies: Macroeconomics is extremely useful from

the point of view of economic policy. Modern governments, especially of the
underdeveloped economies, are confronted with innumerable national problems. They are the
problems of overpopulation, inflation, balance of payments, general underproduction, etc. the
main responsibility of the government rests in the regulation and control of overpopulation,
general prices, general volume of trade, general outputs, etc. no government can solve these
problems in terms of individual behavior. Hence, they have to make use to macroeconomic
principles to resolve such issues.
 In general unemployment: The Keynesian theory of unemployment is an exercise in
macroeconomics. The general level of unemployment in an economy depends upon
effective demand which in turn depends on aggregate demand and aggregate supply
functions. Unemployment is thus caused by the deficiency of effective demand. In
order to eliminate it, effective demand should be raised by increasing total investment,
total output, total income and total consumption. Thus, macroeconomics has special
significance in studying the causes, effects and remedies of general unemployment.
 In national income: The study of macroeconomics is very important for evaluating
the overall performance of the economy in terms of national income. With the advent
of the Great Depression of the 1930s, it became necessary to analyze the causes of
general overproduction and general unemployment. This led to the construction of the
data on national income. National income data helps in the forecasting the level of
economic activity and to understand the distribution of income among different groups
of people in the economy.
 In economic growth: The economics of growth is also a study in macroeconomics. It
is on the basis of macroeconomics that the resources and capabilities of an economy
are evaluated. Plan for the overall increase in the national income, output and
employment are framed and implemented so as to raise the level of the economy as a
whole.
 In Monetary problems: It is in terms of macroeconomics that monetary problems can
be analyzed and understood properly. Frequent changes in the value of money –
inflation or deflation – affect the economy adversely. They can be counteracted by
adopting monetary, fiscal and direct control measures for the economy as a whole.
 In Business cycles: Further, macroeconomics as an approach to economic problems
started after the Great Depression. Thus, its importance lies in analyzing the causes of
economic fluctuations and in providing remedies.

c) It helps in the formulation of macroeconomic theories: It addresses specific issues from

the aggregative perspective like that of an industrial sector, where it aids in addressing an
industry from a microeconomic perspective.
d) It measures volume of economic welfare: Economic welfare is a very important branch of
macroeconomics. When we look at the role of the government, it acts as a welfare state. For
instance, providing infrastructural facilities, creating social overhead capital, education,
health to the backward and the minority citizens of the country.

e) International comparisons: Comparison between two different countries in terms of trade is

essential. It includes, managing international trade, deciding on various policies related to
trade, which in turn studies the international relations between countries in detail. For
example, India exporting its vaccine, Covaxin to 14 other nations facilitates the good ties we
have with them and enhances the trade relationship. All these are possible only with the data
that is collected at the macrolevel.

f) It helps in forecasting: Forecasting is the requisite to understand what our future holds for
us and that is possible only by looking at the macroeconomic factors like growth rate, fiscal
deficit, etc. Today, we are aware of all these and are able to anticipate due to the study of
microeconomics.

LIMITATIONS OF MACROECONOMICS:
a) Fallacy of composition: In macroeconomic analysis, the “fallacy of composition” is
involved, that is, aggregate economic behavior is the sum total of individual activities. But
the reality is, what is true of individuals is not necessarily true of the economy as a whole.
For instance, savings are a private virtue but a public vice. If total savings in the economy
increase, they may initiate a depression unless they are invested. Again, if an individual
depositor withdraws his money from the bank there is no danger; but if all depositors do it
simultaneously, there will be a run on the banks and the banking system will be adversely
affected.

b) To regard aggregates as homogeneous: The main defect in macro analysis is that it regards
the aggregates as homogeneous without caring about their internal composition and structure.
The average wage in a country is the sum total of wages in all occupants, that is, wages of
clerks, typist, teachers, nurses, etc. But the volume of aggregate employment depends on the
relative structure of wages rather than on the average wage. If, for instance, wages of nurses
increase but of typists fall, the average may remain unchanged. But if the employment of
nurses falls a little and of typists rises much, aggregate employment would increase.

c) Aggregate variables may not be important necessarily: The aggregate variables which
form the economic system may not be of much significance. For instance, the national
income of a country is the total of all individual incomes. A rise in national income does not
mean that individual incomes have risen. The increase in national income might be the
reason of the increase in the incomes of a few rich people in the country. Thus, a rise in
national income of this type has little significance from the point of view of the community.
Boulding calls these three difficulties as “macroeconomic paradoxes” which are applied to a
single individual but are untrue when applied to the economic system as a whole.
d) Indiscriminate use of macroeconomics misleading: An indiscriminate and uncritical use of
macroeconomics in analyzing the problems of the real world can often be misleading. For
instance, if the policy measures needed to achieve and maintain full employment in the
economy are applied to structural unemployment in individual firms and industries, they
become irrelevant. Similarly, measures aimed at controlling general prices cannot be applied
with much advantage for controlling prices of individual products.

e) Statistical and conceptual difficulties: The measurement of macroeconomic concepts

involves a number of statistical and conceptual difficulties. These problems relate to the
aggregation of microeconomic variables. If individual units are almost similar, aggregation
does not present much difficulty. But if microeconomic variables relate to similar individual
units, their aggregation into one macroeconomic variable may be wrong and dangerous.

9) What is circular flow of income? Explain the two-sector, three-sector and four-sector
models. (5 marks each)
Ans) The circular flow of income is a macroeconomic model that explains how an economy
works. An economy is a system of inter-related economic activities where income continuously
circulates among the different sectors of the economy. Basic economic activities include
production, exchange and consumption.

TWO SECTOR MODEL - WITHOUT SAVINGS:

 The household sector owns the factors of production in the factor market. They sell land,
labour, capital and organization to the business sector. The factor incomes rent, wages,
interest and profit are used to buy different goods and services in the product market.
 Thus, income generated in the factor market is spent in the product market. The business
sector buys the factor inputs from the household sector and makes payments to them.
 Thus, it is clear that services flow from the household sector to the business sector in the
factor market and goods flow from the business sector to the household sector in the product
market.

TWO SECTOR MODEL (CLOSED ECONOMY) - WITH SAVINGS:

 The household sector owns the factors of production in the factor market. They sell land,
labour, capital and organization to the business sector. The factor incomes rent, wages,
interest and profit are used to buy different goods and services in the product market.
 Thus, income generated in the factor market is spent in the product market. The business
sector buys the factor inputs from the household sector and makes payments to them.
 Thus, it is clear that services flow from the household sector to the business sector in the
factor market and goods flow from the business sector to the household sector in the product
market.
 In order to understand the working of the real economy, we have to introduce savings and
investment in the analysis. Savings is a part of income which is not spent on goods and
services. Investment is the money spent on buying capital goods to expand production
capacity.
 The capital market operates in between savings and investment flows from the household to
the business firms.
 The household supplies savings to the capital market and the firm gets investment from the
capital market. Thus, the capital market coordinates the savings and investments of the two-
sectors.

THREE SECTOR MODEL:

 In the three-sector model, the government sector is incorporated. The income of the
households and the business sector is influenced by taxes and public expenditure of the
government. Taxes lead to a reduction in the income and public expenditure leads to addition
in the income flow.
 The households and the government sector can be linked to the factor markets. Income of the
household increases due to government expenditure on factor services and income flow to
the households in the form of wages, rent and interest payments by the government. Public
expenditure on education, health, infrastructure and social services, transfer payments such as
old age pensions etc., constitute the expenditure of the government, direct taxes such as
income tax and corporate tax and indirect taxes such as excise duty, sales tax, GST, custom
duties, etc., determine the income of the government.
 Similar flows take place between the government and business sector. Firms pay a part of its
income as taxes to the government. In return, the government purchases goods and services
from the business firms and gives a part of its income as subsidy to the business firms. The
business and the government sectors can be linked through the product market.
 FOUR SECTOR MODEL:

 Modern economies are open economies. An open economy is one that carries on trade with
other countries. In a four-sector model, we have the households, business, government, and
the foreign sector operating.
 Foreign trade plays a major role in the economic development and prosperity of a country. It
includes exports and imports. Exports help to earn money in the form of foreign exchange
and these act as an inflow into an economy. Imports on the other, require payments to be
made to the foreign countries and this constitutes the leakages from the circular flow of
income.
 The total inflows and outflows of income and expenditure are reflected on the accounts of
exports and imports. The household, business sector and the government would export and
import different goods and services in an economy during an accounting year. These
outflows and inflows passed through the foreign sector is also known as balance of payment
sector.
 If exports are greater than imports, there is a surplus in the balance of payments and if
imports exceed exports, there will be a deficit in the balance of payments.
CONCLUSION:
The study of circular flow of income is essential to the policy makers in any country. This is
because it gives information of working of the economy, the nature of disequilibrium,
information of savings and investment and also the importance of a monetary and fiscal policy in
the smooth functioning of an economy.

10) Define national income. Explain the various concepts of national income. (15 marks)
Ans) National income measures the aggregate economic performance of the whole economy.
According to Kuznets, “National income is the net output of commodities and services flowing
during the year from the country’s productive system, into the hands of the ultimate consumer.”
National income is the value of all the final goods and services produced in a country in a given
period of time which is usually a financial year. Since the modern economy is the money
economy, national income is measured in terms of money.
THE MEASURES OF NATIONAL INCOME:
1) National Product: IT consists of all goods and services produced by the community and
exchanged for money during a year. The national product of a country can be estimated
by multiplying the total output of final goods and services with their market prices.
2) National Dividend: It consists of all incomes in cash and kind accruing the factors of
production in the course of generating the national product.
3) National Expenditure: It is the total spending of the community on all goods and
services produced in a year.

CONCEPTS OF NATIONAL INCOME:

There are a number of concepts pertaining to national income. A few sacrosanct ones are as
follows:
1) GROSS DOMESTRIC PRODUCT (GDP):
 When we take the sum of the values of output of goods and services in the country without
2adding net factor income received from abroad, the value so obtained is known as Gross
Domestic Product (GDP). This is calculated at market prices and is known as GDP at market
prices.
 Denberg defines GDP at market price as “The market value of the output of final goods and
services produced in the domestic territory of a country during an accounting year.”
 The formula for Gross Domestic Product is, GDP = C+I+G+(X-M);
 where, C= consumption, I= Investment, G=Government Expenditure, (X-M) = Net exports

2) GROSS DOMESTIC PRODUCT (GDP) AT FACTOR COST:

 GDP at factor cost is the sum of net value added by all producers within the country. Since
the net value added gets distributed as incomes to the owners of factors of production, GDP
is the sum of domestic factor incomes and fixed capital consumption (depreciation).
 Thus, GDP at factor cost = Net Value Added = Depreciation.
 GDP at factor cost includes: Compensation of employees (wages, salaries, etc.,), Operating
surplus which is the business profit of both incorporated and unincorporated firms and Mixed
Income of Self-Employed.

3) GROSS NATIONAL PRODUCT (GNP):

 Gross National Product (GNP) is the aggregate market value of all the final goods and
services produced during a given year.
 GNP includes the following:
a) Value of all consumption goods which are currently produced.
b) Value of government services which are measured in terms of governmental expenditure
on various goods and services.
c) The value of net exports.
d) The net amount earned abroad.
 The formula of Gross National Product is, GNP = C+I+G+[(X-M) +(R-P)];
where, C= consumption, I= Investment, G=Government Expenditure, (X-M) = Net exports,
R= Receipts from abroad, P= Payments made abroad.

4) NET DOMESTIC PRODUCT (NDP):

 It is the difference between the Gross Domestic Product and the depreciation charges.
 Depreciation charges are also known as replacement allowance of capital assets.
 The formula used to calculate NDP is,
NDP = GDP – Deprecation charges

5) NET NATIONAL PRODUCT (NNP):

 NNP includes the value of the total output of consumption goods and investment goods. But
the process of production uses up a certain amount of fixed capital. Some fixed equipment
wears out, its other components are damaged or destroyed, and still others are rendered
obsolete through technological changes. All this process is termed depreciation or capital
consumption allowance. Hence in order to attain at NNP, we deduct depreciation from GNP.
 Net National Product is the difference between Gross National Product and Depreciation
charges.
 The formula used to calculate NNP is, NNP = GNP – Depreciation charges.

6) DISPOSABLE INCOME:
 Disposable income means the actual income which can be spent on consumption by
individuals and families. The whole of the personal income cannot be spent on consumption,
because it is the income that accrues before direct taxes have actually been paid. Therefore,
in order to obtain disposable income, direct taxes are deducted from personal income. Thus,
Disposable Income = Personal Income – Direct Taxes.
 But the whole of disposable income is not spent on consumption and a part of it is saved.
Therefore, disposable income is divided into consumption expenditure and savings. Thus,
Disposable income = Consumption Expenditure + Savings.

7) PER CAPITA INCOME (PCI):

 The average income of the people of the country in a particular year is called as per capita
income for that year.
 PCI also refers to the measurement of income at current prices and at constant prices. for
instance, in order to find out the per capita income for the year 2001, at current prices, the
national income of the country is divided by the population pf that country in that year.
Per Capita Income = National Income of a Country / Total Population of that Country.
 This concept enables us to know the average income and standard of living of the people. But
it is not very reliable, because in every country due to unequal distribution of national
income, a major portion of it goes to the richer sections of the society and thus income
received by the common man is lower than the per capita income.

11) Explain the various methods used in measuring national income – income, consumption,
expenditure and value added methods. (15 marks each)
Ans) National income measures the aggregate economic performance of the whole economy.
According to Kuznets, “National income is the net output of commodities and services flowing
during the year from the country’s productive system, into the hands of the ultimate consumer.”
METHODS TO MEASURE NATIONAL INCOME:
a) The Census of Products method / Output method / Consumption method
b) The Census of Income method
c) The Expenditure method
d) The Value added method

a) THE CENSUS OF PRODUCTS METHOD / OUTPUT METHOD/

CONSUMPTION METHOD:
 The Output method measures the output of the country. It is also called the inventory
method. Under this method, from the census of production, the gross value of output from
different sectors like agriculture, industry, trade and commerce is obtained for the entire
economy during a year. This is the GNP at market price. This method requires to avoid
double counting. Hence two methods are used.
 The formula used to measure national income using this method is,
 Y = (P-D) = (S-T) + [(X-M) + (R-P)]; where, P =Domestic output of all production sectors,
D = Depreciation, S =Subsidy, T = Indirect taxes, X = Exports, M = Imports, R = Receipts
from abroad, P = Payments made abroad.
 The following precautions are necessary to obtain a correct result of the National Income
estimate through the census of Product Method:
1. To avoid double counting, we must add only the final product. Raw materials
and intermediate goods should not be included as this leads to double counting.
2. Farm products kept for self-consumption by the farmers should be estimated as
the prevailing market rates.
3. While evaluating output, changes in the price level between various years must
be taken into account.
4. Indirect taxes that are included in the price had to be deducted to get the exact
market value of the products.
5. Add the value of exports or the income earned abroad and deduct the value of
imports.
 This method is widely used in the underdeveloped countries. In India, it is applied to
agriculture, mining and the manufacturing sector.
FINAL GOODS METHOD:
 In this method of estimating GNP, only the final values of goods and services are collected
ignoring all intermediate transactions. Thus, the value of final output includes the value of
intermediate product.

b) THE CENSUS OF INCOME METHOD:

 In the Income method of measuring national income, the total of all the money incomes such
as wages, rent, profit and interest earned by the different individuals and enterprises in the
country during the year are totalled up.
 In practice, income figures are obtained from income tax returns, books of accounts, reports,
published accounts as well as estimates for small income. This method is also called the
factor cost method.
 The formula used to measure national income using income method is, Y = Σ (w + i + r + π)
+ [(X-M) + (R-P)]; where, w = wages, r = rent, i = interest, π = profit.
 The following classification of income is considered as comprehensive:
1) Wages and salaries
2) Supplemental labour income in the form of social security.
3) Earnings of self-employed or professional incomes.
4) Dividends
5) Undistributed profits
6) Interest
7) Rent
8) Profit of state enterprises.
Anyway, transfer payments like gifts, subsidies, etc., are to be deducted from the total of the
factor income. Thus, national income is equal to factor incomes minus transfer payments.
National Income = Factor Incomes – Transfer payments
However, these are certain precautions that needs to be taken while following this method:
i. All transfer payments, that is, government and personal which do not represent earning
from productive services such as social security benefits like pension, charity, personal
gifts, etc., are not to be included. Similarly, earnings from gambling, lottery, etc., are
considered to be transfer incomes and hence are excluded as well. Likewise, scholarships
received by students are also considered to be transfer incomes and hence should not be
included.
ii. All unpaid services like the service of a housewife has to be excluded.
iii. Financial investment such as equity shares and the sales of old property including land
are to be excluded as they do not add anything to the real national income.
iv. Direct tax revenue to the government should be subtracted from the total income as it is
only a transfer of income.
v. Similarly, government subsidies should be deducted from the profits of the subsidized
industries.

c) THE EXPENDITURE METHOD:

 Incomes earned by factor inputs are spent on buying different goods and services. If we add
the total expenditure incurred by people in a year’s time, we can calculate the total income.
 In this method, we have to consider the following:
1. Estimate private and public expenditure on consumer goods and services.
2. We have to add the value of investment in fixed capital and stocks, with due
considerations for net positive or negative inventories.
3. Add the value of exports and deduct the value of imports.
 From the expenditure point of view, GNP is the sum total of expenditure incurred on goods
and services during one year in a country. It includes the following items:
i. Private consumption expenditure: It includes all types of expenditure on personal
consumption by the individuals of a country. It comprises expenses on durable goods
like watch, bicycle, radio, etc., expenditure on single-used consumers’ goods like milk,
bread, ghee, clothes, etc., as also the expenditure incurred on services pf all kinds like
fees for school, doctor, lawyer and transport. All these are taken as final goods.
ii. Gross domestic private investment: under this comes the expenditure incurred by private
enterprise on new investment and on replacement of old capital. It includes expenditure
on house construction, factory-buildings, all types of machinery, plants and capital
equipment. In particular, the increase or decrease in inventory is added or subtracted
from it. The inventory includes produced but unsold manufacture and semi-
manufactured goods during the year and the stocks of raw materials, which have to be
 accounted for in GNP. It does not take into account the financial exchange of shares and
stocks because their sale and purchase is not real investment. But depreciation is added.
iii. Net foreign investment: it means the difference between exports and imports or export
surplus. Every country exports to or imports from certain foreign countries. The
imported goods are not produced within the country and hence cannot be included in
national income, but the exported goods are manufactured within the country. Therefore,
the difference of value between exports and imports, whether positive or negative is
included in the GNP.
iv. Good expenditure on goods and services: the expenditure incurred by the government on
goods and services is a part of GNP. Central, state or local governments spend a lot on
their employees, police and army. To run the offices, the governments also have to
spend on contingencies which include paper, pen, pencil and various types of stationery,
cloth, furniture, car, etc. It also includes the expenditure on government enterprises. But
expenditure on transfer payments is not added, because these payments are not made in
exchange for goods and services produced during the current year.
 Thus, the formula used to measure national income using this method is,
Y = C+I+G+[(X-M) + (R-P]

d) VALUE ADDED METHOD:

 In this method, a summation of the increase in the value at each separate stage of production
leading to the output in the final form gives the value of GNP. To avoids double counting of
intermediate goods, one must carefully estimate the value added at each stage in the
production process.
 From the total value created a given stage, we should subtract all the costs of materials and
intermediate goods that are not produced in that stage.
 Example:

PRODUCTION VALUE
STAGES QUANTITY COST ADDED
Wheat 1 kg ₹ 20 ₹20

Flour 1 kg ₹30 ₹10

Bread 1 kg ₹40 ₹102

Total = ₹90 Total = ₹ 40

Hence the value of inputs at a given stage should be deducted from the value of output. Even the
value of inputs purchased from other firms or sectors should be subtracted. In short, GNP is
obtained as the sum total of values added by all the different stages of the production process till
the final output is reached in the hands of the consumers to meet the final demand.
 12) What are the various problems involved in the measurement of national income?
(15 marks)
Ans) National income measures the aggregate economic performance of the whole economy.
According to Kuznets, “National income is the net output of commodities and services flowing
during the year from the country’s productive system, into the hands of the ultimate consumer.”
National income is the value of all the final goods and services produced in a country in a given
period of time which is usually a financial year. Since the modern economy is the money
economy, national income is measured in terms of money.
PROBLEMS IN THE MEASUREMENT OF NATIONAL INCOME:
a) Choice of method of measuring National Income: Different sectors use different methods
to measure national income. For instance, the sectors which deal with agriculture, trade and
commerce, industry outcome would prefer to measure national income using product or
output method. Statisticians and economists use different methods as per the prevalent data
and circumstances. Hence, none of the methods can be declared as the best one to measure
national income.

b) The items to be included in the National Income estimates: There are many kinds of
expenditures like the consumption expenditure, government expenditure, income expenditure
and so on, when we take these into consideration many queries arise. Those queries include,
are these expenditures defines? Do they fall under national expenditure/income? The
government would have invested on a lot of things like the productive and the non-
productive activities. Do all these non-productive activities fall under national income? If
yes, then would it be included under government expenditure or consumption expenditure? Is
it planned expenditure and is it included in the budget? What if it comes out of blue? Say
there’s a natural calamity and the government has to release some fund to incur the losses.
All these queries leave us in dilemma, proving that the items to be included in the national
income aren’t precisely enlisted, rather they’re vague.

c) Non-availability of data: In many nations, a large percentage of data of the incomes of the
population (working class) wouldn’t be available. Especially in India, we observe that only
around 5% of the businesses are under the organized sector whereas the rest of the 95% fall
under unorganized sector. Owing to this fact, there is no precise data of income of
approximately 95% of the working class. Similarly, a lot of other required data wouldn’t be
handy.

d) Absence of trained personnel, records: We need information and data to calculate national
income. In order to collect required information, trained personnel (enumerators) are needed
and they need to be supervised timely. Unfortunately, we lack this kind of trained personnel
and the records of the information stored, thereby, this is a drawback which arises during the
measurement of national income.
e) Problem of double counting: Double counting is certainly a serious problem which is seen
during the calculation of national income. It is that another important issue which the
government continuously addresses. When double counting is considered there would be a
deceptive increase or exaggeration in the value of goods and services, and this, in economics
is known as ‘cascading effect’. Hence, double counting has to be done with and a suitable
method must be used to calculate national income.

f) Existence of a non-monetized sector: The non-monetized sector would include the services
of the housewives, goods that are produced for self-consumption by farmers or even people
stitching their own clothes at home. When these items are manufactured for commercial
purposes, they fall under national products, which would be included whilst calculating the
national income. But the above mentioned non-monetized sectors would be neglected.

g) Existence of a parallel economy: A parallel economy functions alongside with the normal
economy and it includes the study of undisclosed income (black money). Due to the
existence of such an economy, we are not sure about the exact amount of money that had
been generated in the parallel economy.

h) Different methods to calculate depreciation charges: There is no one single method that
has been followed to calculate depreciation charges, every sector use different methods to
calculate them and this causes nonuniformity. A uniformity in the method to calculate
depreciation charges is the need of the hour.

i) Coverage of commodities and services: This particular topic arises a number of queries
such what type of commodities and services come under the per view of national income?
What method should be used to calculate the commodities and services’ value? Are the
necessities of life also a part of payment of taxes? Are they also going to be a part of the
national income? All such questions pose a contradiction while calculating the national
income.

j) Goods kept for self-consumption: Certain goods kept for self-consumption like that of the
crops cultivated by the farmers for their own consumption, garments (clothes) stitched by
people for their own use are excluded while calculating the national income. Hence, this is
again another drawback.

k) Capital gains or losses: They happen mainly in investments that people make in financial
institutions. For instance, a consumer who bought a share or a debenture in the market makes
a lot of profit one day and suffer huge losses, the other day. So, the question is, how these
would be accounted in the national income. Another example is, wherein, the lotteries won
by certain people would not be added in the national income. But in reality, it should be
added in the national income as it falls under an individual’s profit or loss, yet this would not
give a clear picture of the national income.
l) Existence of non-market transactions: Sometimes, transactions do not happen legally,
rather would happen in a parallel economy. So, it just goes unnoticed, without getting
registered and would not be accounted the way it ought to be. For example, if one purchases
a particular good and then resell to one of his friends, then it would not fall under national
income; whereas the former will be included. Since there is no intervention of market in it, it
would not be included while calculating the national income.
Therefore, these are the major problems faced while calculating the national income of a country.