Class 12 Economics Chapter 1 National Income And Related Aggregates

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Class 12 Economics Chapter 1 National Income And Related Aggregates

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National Income And Related Aggregates

Chapter: 1

PART – (A) INTRODUCTORY MACROECONOMICS

(A) Very Short Types Question & Answers:

1. Fill in the blank:

(a) Macroeconomics deals with the __________ variables of an economy.

Ans: Aggregate.

(b) In an year the total production of final goods of an economy can be either in the farm of consumption or __________.

Ans: Investment.

(c) GNP = GDP + _________.

Ans: NFIFA.

(d) NNP = GNP __________.

Ans: Depreciation.

(e) Depreciation is _________ of fixed capital.

Ans: Consumption.

2. Why do we need to calculate value added in measuring the national income.

Ans: To measure the National Income.

3. Write true or false: Value added of a firm is a flow variable.

Ans: True.

4. Who are the macroeconomic decision makers?

Ans: Society or Govt.

5. Why are the expenditures on intermediate not included in the estimation of GDP?

Ans: Because, it is non factor input.

6. Which of the following is not included in the subject matter of macroeconomics—

(a) Balance of Payment.

(b) National Income.

(d) Consumer’s surplus.

Ans: (c) Demand for money.

7. Write true or false:

Macroeconomics deals with the aggregate economic variables of an economy.

Ans: True.

8. What is macroeconomics?

Ans: The term macro has been derived from a Greek word makros meaning large. Thus macroeconomics is concerned with the economical as a whole.

9. What do you mean by Economic agents?

Ans: Economic agents are individuals or institutions which take economic decisions.

10. Name any one of the four sectors of an economy?

Ans: Household sector.

11. Who wrote the book “An Enquiry into the Nature and cause of the wealth of Nations?

Ans: Adam Smith.

12. Define final goods.

Ans: Final goods refer to those goods which have crossed all phases of production and readily available for the final users.

13. Define Gross Investment of an economy.

Ans: The total addition made to the capital stock of economy in a given period is termed as gross investment. Capital stock consists of fixed assets and unsold stock. So, gross investment is the expenditure on purchase of fixed assets and unsold stock during the accounting year.

14. Define depreciation.

Ans: Depreciation refers to a fall in the value of fixed assets due to normal wear and tear, passage of time and expected obsolescence or change in technology.

15. What are the economic functions of a state?

Ans: The functions are:

(a) Distribution of national income.

(b) Allo-cations of resources.

16. What is macro economic model?

Ans: Economic model reflects some basic features of economic activities in a society.

17. Name the four factors of production and their features.

Ans: (i) Land.

(ii) Labour.

(iii) capital.

(iv) organisation.

18. What is national disposable income?

Ans: It refers to the income which is available to the entire country for disposal.

19. What is net national product at factor cost.

Ans: It is the net money value of all the final goods and services produced by the normal residents of a country during a period of one year.

20. Explain the concept of intermediate goods.

Ans: Intermediate goods refer to those goods, which are used either for resale or for further production in the same year.

21. Define and distinguish personal from private income.

Ans: Private income refers to the income, which occurs to the private sector from all the sources within and outside the country.

Personal income is the sum total of all the incomes that are actually received by households from all the sources.

22. Explain how to calculate gross national product from gross domestic product.

Ans: GNP is calculate from GDP by adding the net factor income from abroad (NFIFA), i.e.,

GNP = GDP + NFIFA.

23. Among whom is the value added of a firm distributed?

Ans: Among the four factors of production.

24. What is gross value added?

Ans: It is the money value of all the output produced in all the sectors of an economy.

25. What is net value added?

Ans: When depreciation cost and net indirect tax is deducted from gross value added, it is called net value added.

26. Suppose the GDP at market price of a country is ₹ 950 crores. If the amount of depreciation is ₹ 100 crores, find out the NDP at market price.

Ans: We know, NDP _MP= GD_MP – Depreciation = 950-100 = Rs. 850 crs.

27. Who is the founder father of modern economics?

Ans: Adam Smith.

28. What is National Income?

Ans: National income means income earned by the normal residents of a country in an accounting year.

29. What is base year?

Ans: Base year is the reference period with which the analysis is made.

30. What do you understand by depreciation of capital?

Ans: In economics, depreciation of capital refers to the gradual decrease in the economic value of the capital stock of a firm, nation or other entity, either through physical depreciation, obsolescence or changes in the demand for the services of the capital in question.

31. Give any two examples of macroeconomic variable.

Ans: National income (measured in Gross Domestic Product), employment, inflation and investment are some examples of macroeconomic variables.

32. What is Personal Disposable Income (PDI)?

Ans: Personal disposable income is the total amount of money that house holds have available for spending and saving after income taxes have been paid.

33. Name some macroeconomic decision agent.

Ans: Some macroeconomic decision agents are –

(i) Firms.

(ii) Households.

(iii) The Government.

(iv) External Sector.

34. What is GDP?

Ans: GDP stands for Gross Domestic Product and is a measure of the total value of all final goods and services produced within a country’s borders during a specific time period, usually a year. It is commonly used as an indicator of economic activity and the size of an economy.

35. What is Gross Domestic Product (GDP)?

Ans: GDP is an aggregate that measures the total value of all final goods and services produced within a country’s borders during a specific time period, typically a year. It includes consumption, investment, government spending, and net exports.

36. What is Gross National Product (GNP)?

Ans: GNP is an aggregate that measures the total value of all final goods and services produced by the residents of a country, whether within the country or abroad, during a specific time period. It includes GDP plus net income from abroad.

37. What is Net National Product (NNP)?

Ans: NNP is an aggregate that represents the value of all final goods and services produced by the residents of a country after accounting for depreciation (wear and tear) of capital goods. It is calculated by subtracting depreciation from GNP.

38. What is National Income (NI)?

Ans: National Income is an aggregate that represents the total income earned by individuals and businesses within a country’s borders during a specific time period. It includes wages, rents, interest, profits, and other forms of income.

39. What is Personal Income (PI)?

Ans: Personal Income is an aggregate that represents the income received by individuals from all sources, including wages, salaries, property income, transfer payments, and other forms of income. It is a broader measure than National Income as it includes income received by individuals from both domestic and foreign sources.

40. What is Disposable Income (DI)?

Ans: Disposable Income is an aggregate that represents the income available to individuals for consumption or saving after paying taxes and receiving transfer payments. It is calculated by subtracting taxes from Personal Income and adding transfer payments.

41. What is Gross Domestic Product (GDP)?

42. What is Gross National Product (GNP)?

43. What is Net National Product (NNP)?

44. What is National Income (NI)?

45. What is Personal Income (PI)?

46. What is Disposable Income (DI)?

(B) Short Type Questions & Answers:

1. How is national income calculated using the expenditure method?

Ans: National income is calculated by adding up the components of expenditure (C + I + G + NX) and subtracting any taxes on production and imports (such as sales taxes or tariffs) and subsidies given to producers. The resulting figure represents the total income generated in the economy during a particular period.

2. What is meant by factor cost in national income accounting?

Ans: In national income accounting, factor cost refers to the total income earned by the factors of production (land, labour, capital, and entrepreneurship) for their contribution to the production of goods and services. It represents the cost incurred by the producer in terms of factor payments.

3. What are the components of factor cost?

Ans: The components of factor cost include wages and salaries paid to labour, rent paid for the use of land, interest paid on capital, and profits earned by entrepreneurs. These payments represent the income earned by individuals or entities for their respective factor inputs.

4. What is meant by basic prices in national income accounting?

Ans: Basic prices refer to the prices received by the producers of goods and services for their output. It represents the actual revenue received by the producer, excluding any taxes on production or subsidies received.

5. What are the factors that affect basic prices?

Ans: Basic prices are influenced by factors such as production costs, market demand and supply dynamics, competition, inflation, and government policies related to pricing and subsidies.

6. What is meant by market prices in national income accounting?

Ans: Market prices refer to the prices at which goods and services are bought and sold in the market. They represent the prices paid by the final consumers of goods and services and include any taxes on products and subsidies.

7. How are market prices different from basic prices?

Ans: Market prices include taxes on products, which are added to the basic prices, and subsidies, which are subtracted from the basic prices. Market prices reflect the total expenditure made by consumers, whereas basic prices reflect the revenue received by producers.

8. How are factor cost and market prices related in national income accounting?

Ans: Factor cost serves as the basis for calculating national income, as it represents the income earned by the factors of production. Market prices, on the other hand, are used to determine the value of goods and services consumed by individuals or entities. The difference between factor cost and market prices is primarily due to taxes on production and subsidies provided by the government.

9. What are aggregates in the context of national income?

Ans: Aggregates in national income refer to the total values or sums of various economic variables used to measure the overall performance and size of an economy. These aggregates provide a comprehensive view of the economy’s income, output, expenditure, and employment levels.

10. What are the main aggregates used in national income accounting?

Ans: The main aggregates used in national income accounting include Gross Domestic Product (GDP), Gross National Product (GNP), Net National Product (NNP), National Income (NI), Personal Income (PI), and Disposable Income (DI).

11. Is GDP a comprehensive measure of welfare or well-being?

Ans: No, GDP is not a comprehensive measure of welfare or well-being. While GDP provides information about the economic output and income generation of a country, it does not directly capture various aspects of welfare, such as quality of life, income distribution, environmental sustainability, social indicators, and non-market activities like household work or volunteerism.

12. Why is GDP often criticised as a measure of welfare?

Ans: GDP is often criticised as a measure of welfare because it does not account for several factors that are important for people’s well-being. It does not consider income inequality, distribution of wealth, access to healthcare, education, social services, environmental degradation, and subjective factors like happiness or life satisfaction. Therefore, relying solely on GDP can lead to an incomplete assessment of overall welfare.

13. Why is it important to consider measures beyond GDP to assess welfare?

Ans: It is important to consider measures beyond GDP to assess welfare because economic output alone does not necessarily reflect the overall well-being of individuals or society. Factors such as income distribution, access to healthcare and education, social cohesion, environmental sustainability, and subjective well-being are crucial for a comprehensive understanding of welfare. Using multiple indicators provides a more accurate and nuanced assessment of the quality of life and progress within a society.

14. How can policymakers use measures beyond GDP to improve welfare?

Ans: Policymakers can use measures beyond GDP to gain a more comprehensive understanding of welfare and guide policy decisions accordingly. By considering a broader range of indicators, they can prioritise policies that address income inequality, social inclusion, healthcare, education, environmental protection, and overall well-being. This can lead to more balanced and sustainable development strategies that prioritise the welfare of citizens.

15. What is value added of a firm?

Ans: Inventory is a stock variable. In economics, the stock of unsold finished goods, or semi-finished goods or raw-materials which a firm carries from one year to the next is called inventory.

Value added of a firm = value of production of the firm-value of intermediate goods used by the firm. The value added of a firm is distributed among its four factors of production, mainly labour, capital, entrepreneurship and bond. Therefore, wage, interest, profits and rent, paid out by the firm must add up to the value added of the firm. Value added is a flow variable.

16. Explain the role of the state in a development economy.

Ans: (i) Provides internal and external security.

(ii) Engaged in the activities of welfare state. Such as creating infrastructures, expansion of education and culture etc.

(iii) Maintain law and order situation and provides social justice and equity.

17. Explain how macroeconomics is related to microeconomics.

Ans: The foundations of macroeconomics theory are in microeconomics, as the aggregate economy is made of small economic units such as individuals, firms and markets. The aggregate demand of the economy depends upon the individual demand of different household and national income is the sum total of factors income at micro level. Likewise micro variables depends on the behaviour of macro variables. For example wage rate is a particular industry will be influenced by overall wage rate in an economy.

18. What is the circular flow of income?

Ans: The circular flow of income is a model that illustrates the flow of money and goods and services between different sectors of an economy. It shows how households, businesses, and the government interact in the process of producing and consuming goods and services.

19. What are the main components of the circular flow of income?

Ans: The main components of the circular flow of income are households, businesses, and the government. Households supply factors of production (such as labour) to businesses, which in turn produce goods and services. Businesses pay wages and salaries to households for their services, and households use this income to purchase goods and services from businesses. The government collects taxes from both households and businesses and provides public goods and services.

20. What is the role of financial institutions in the circular flow of income?

Ans: Financial institutions play a crucial role in the circular flow of income by facilitating the flow of funds between households and businesses. They provide banking services, such as savings accounts, loans, and credit, which enable households to save their income and invest in businesses.

Businesses, in turn, can borrow funds from financial institutions to finance their operations and investments. This interaction helps channel savings into productive investments and supports economic growth.

21. What is national income?

Ans: National income refers to the total value of goods and services produced within a country’s borders over a specific period, typically a year. It is a measure of the economic activity and output generated by the factors of production within an economy.

22. What is the expenditure method of calculating national income?

Ans: The expenditure method calculates national income by summing up all the expenditures made on final goods and services within an economy. It includes four major components: consumption expenditure by households, investment expenditure by businesses, government expenditure on goods and services, and net exports (exports minus imports).

23. What is the income method of calculating national income?

Ans: The income method calculates national income by summing up all the income earned by individuals and businesses in an economy. It includes various components such as wages and salaries, profits, rents, interest, and other forms of income.

24. What is the production method of calculating national income?

Ans: The production method, also known as the value-added method, calculates national income by summing up the value added at each stage of production in an economy. It measures the contribution of different industries or sectors to the overall output of goods and services.

25. How is consumption expenditure calculated in the expenditure method?

Ans: Consumption expenditure is calculated by summing up all the expenditures made by households on final goods and services. This includes spending on items such as food, clothing, housing, healthcare, transportation, and entertainment.

26. How is investment expenditure calculated in the expenditure method?

Ans: Investment expenditure is calculated by summing up the investments made by businesses in capital goods, such as machinery, equipment, buildings, and infrastructure. It also includes changes in inventories, which represent the value of goods produced but not yet sold.

27. How is government expenditure calculated in the expenditure method?

Ans: Government expenditure is calculated by summing up all the spending by the government on goods, services, and public investments. This includes expenditures on areas such as defence, education, healthcare, infrastructure, and social welfare programs.

28. What is the formula for calculating national income using the expenditure method?

Ans: The formula for calculating national income using the expenditure method is:

National Income = Consumption Expenditure + Investment Expenditure + Government Expenditure + Net Exports

By summing up the expenditures in these categories, we can estimate the total value of goods and services produced within an economy, which represents the national income.

29. What is the national income expenditure method?

Ans: The national income expenditure method is a technique used to calculate the national income of a country by measuring the total expenditure on goods and services produced within its borders during a specific time period.

30. What are the components of expenditure considered in the national income expenditure method?

Ans: The components of expenditure considered in the national income expenditure method include:

Consumption (C): The total spending by households on goods and services.

Investment (I): The spending by businesses on capital goods, such as machinery, equipment, and construction.

Government spending (G): The expenditures by the government on public goods and services.

Net exports (NX): The difference between a country’s exports (goods and services sold to other countries) and imports (goods and services purchased from other countries).

31. How is national income calculated using the production method?

Ans: National income using the production method is calculated by adding up the value added at each stage of production in an economy. Value added is the difference between the value of output and the value of intermediate inputs (materials, components, etc.) used in the production process. By summing up the value added across all industries or sectors, the total national income can be determined.

Alternatively, national income can also be calculated by adding up the total factor income earned by the factors of production (land, labour, capital, entrepreneurship) throughout the economy. This approach focuses on the income generated by the factors of production rather than the value added at each stage of production.

32. Briefly explain the birth history of macroeconomics.

Ans: Macroeconomics gets its new height with J. M. Keynes publishing the book “The general theory of employment, Interest and Money”. Before keynes it were the classical economist like Marshall, Ricarde etc. Which has also contributed a lot in the development of macroeconomics. The classicalist was of the view that in an economy there always prevails full employment and if any problems occurs then it will automatically adjusted. But this view fails during the ‘Great Depression’ of 29 and keynes came with his view to overcome this difficulty and then the birth of more economics took place.

33. Distinguish between intermediate goods and final goods.

Ans: Goods which are used for further production or for resale in the same year are known as intermediate goods. Intermediate goods are purchased by one production unit from other production units. eg. are — wheat purchased by the flour mill, cotton for the spinning mill.

Final goods are meant for final consumption and final investment. The strength of a macro economy is seen in its capability of producing final goods and services.

34. Mention any two types of leakages found in the Circular Flow of Income.

Ans: In a closed circular income stream, money flowes continuously from firms to households. Households spend all of their money on goods and business spend all of their money on labour and expansion. The basic model of the circular flow of income ignores common consumer action that take money out of the circular of income, or leakage. For instance, most households save money and some companies retain earning.

35. Define Gross Domestic Product.

Ans: (a) Gross domestic product at market price (GDP_MP): It is the gross market value of all final goods and service produced within the domestic territory of a country during a period of one year.

(b) Gross domestic product at factor cost (GDP_FC): GDP_FC is the gross money value of all the final goods and services produced within the domestic territory of a country during a period of one year.

GDP_FC = GDP_MP – Net indirect taxes.

36. From the data given below calculate:

(i) GDP at factor cost.

Ans: GDP at factor cost = C + I + G + X – M

Where C = Consumption expenditure.

I = Investment expenditure.

G = Government expenditure.

X = Export, M = Import.

∴ GDP at factor cost = Rs. 2000 crores + Rs. 1200 crores + Rs. 450 crores + Rs. 80 crores – Rs. 95 crores. = Rs. (3730-95) = Rs. 3635 crores.

(ii) GNP at market price.

Ans: GNP _MP = GDP + Net factor income from abroad

= Rs. (3635+60) crores Rs. = 3690 crores.

37. What are the components included in the expenditure method of calculating national income?

Ans: The expenditure method includes four major components:

(a) Consumption Expenditure: The total amount spent by households on goods and services.

(b) Investment Expenditure: The sum of investments made by businesses in capital goods and inventories.

(c) Government Expenditure: The total spending by the government on goods, services, and public investments.

(d) Net Exports: The difference between the value of exports and imports.

38. What is GDP deflator?

Ans: It is seen that, nominal GDP is affected by both changes in price and physical output. On the other hand, Real GDP is affected by change in physical output only. From these two concepts, a third concept is computed and it is termed as ‘GDP Deflator’. GDP deflator measures the average level of prices of all the goods and services that make up GDP. It is used to eliminate the effects of price changes and to determine the real change in physical output.

GDP Deflator: = Nominal GDP/Real GDP x 100

39. Discuss the reasons why it will not be correct to say that GDP is the index for measuring welfare of the people of a country.

Ans: It is not always correct to say that GDP is the index for measuring welfare of the people of a country, because of distribution of GDP may not always be favourable. Sometimes there may be increased production of war equipments rather capital equipments and it may not lead to wel-fare. Again, non-monetary or non economic services are not included in GDP. But such activities to influence the economic welfare. Besides, GDP increases due to rise in prices and not due to increase in physical output, then also we can not say it is a good measure of welfare.

40. Mention two subject matters of Macroeconomics.

Ans: There is no clear cut division between micro and macro economics. The scope of macro-economics can be stated by giving a list of most important problems with which it is concerned. Macroeconomics is income and employment, inflation balance of payment problems etc.

The purpose of macroeconomics is to present a logical framework for the analysis of these phenomena. What does determine income and employment? What does determine the price level? How are these related?

(C) Long Type Questions & Answers:

1. Suppose the GDP at market price of a country is ₹ 1100 crores. Again, net factor income from abroad is ₹ 150 crores and depreciation is ₹ 80 crores. Now, if the value of indirect taxed — subsidies is ₹ 120 crores, find out the value of national income.

Ans: Given,

GDP _MP = 1100 cr.

NFIFA = 150cr.

Depreciation = 80cr.

Subsidies = 120cr.

∴ NNP _FC = GDP _MP dep + NFIFA – NIT

= 1100 – 80+ 150- [0-120] = Rs 1290 cr.

2. Suppose the net national product at market price (NNP at market price) of a country is ₹ 1600 crores. If the total indirect tax is ₹ 100 crores and the total amount of subsidy paid by the government is ₹ 80 crores, find out the level of national income of the country.

Ans: Given,

NNP _MP = 1600 cr.

Indirect Tax (IT) = 100cr

Subsidies = 80cr.

∴ NNP _FC = NNP_MP -NIT = 1600 – [100-80] = Rs. 1580 cr.

3. The value of the nominal GNP of an economy in a particular year is ₹ 2,800. The value of GNP of that country during the same year evaluated at the prices of the year in percentage terms has the price level risen between the base year and the year under consideration?

Ans: Given,

National GNP = Rs 2800 cr.

Real GNP = Rs 3200 cr.

We know that,

GNP deflator = Nominal GNP/Real GNP × 100 = 2800/3200 × 100 =80

4. The value of nominal GNP of an economy in a particular year is ₹ 4,000 crores. While calculating GNP for the same year at constant price becomes ₹ 3500 crores. Calculate the value of GNP deflator of the year at percentage terms.

Ans: Given,

Nominal GNP = Rs. 4000cr.

Gnp (Constant prices) = Rs. 3500cr.

∴ GNP Deflator = 4000/3500 × 100 =114.2

5. How is national income calculated using the income method?

Ans: National income using the income method is calculated by adding up the following components:

(a) Wages and Salaries: The total income earned by individuals through employment.

(b) Profits: The income earned by businesses after deducting all expenses, including wages, taxes, and costs.

(c) Rents: The income received by individuals or businesses for the use of their property or assets.

(d) Interest: The income earned from loans, bonds, or other forms of lending.

(e) Other Forms of Income: Any other miscellaneous income sources, such as dividends or transfer payments.

The formula for calculating national income using the income method is:

National Income = Wages and Salaries + Profits + Rents + Interest + Other Forms of Income

6. State and describe the four major sectors in an economy from macroeconomic point of view.

Ans: According to the macroeconomic point of view, in an economy, there are four major sectors. They are described below-The one major sector is the capitalist economy. The capitalist countries have came into being only during the last three to four hundred years. At present, a handful of countries in North America, Europe and Asia will qualify as capitalist countries. A capitalist economy have some characteristics, (a) there is private ownership of means of production, (b) production takes place for selling the output in the market, (c) there is sale and purchase of labour services at a prickle, which is called the wage rate. In may underdeveloped countries, production is carried out by peasant families. Wage labour is seldom used and most of the labour is performed by the family member themselves. Production is not solely for the market, a great part of it is consumed by the family. But many developing countries have a significant presence of production units which are organised according to capitalists principles. The production units are called the firms. In a firm the entrepreneur is at the helm of affairs. She hires wage labour from the market, she employs the services of capital and land as well. After hiring these inputs she undertakes the task of production. Her motive for producing goods and services is to sell them in the market and earn profits. In the process she undertakes risks and uncertainties. In a capitalist country the factors of production earn their incomes through the process of production and sale of the resultant output in the market.

In both the developed and developing countries, apart from the private capitalist sector, there is the institution of state. The role of the state includes framing laws, enforcing them and delivering justice. The state, in many instances, undertakes production-apart from imposing taxes and spending money on building public infrastructure running school, colleges, providing health service etc. These economic functions of the state have to be taken into accountant when we want to describe the economy of the country.

Apart from the capitalist and the government (socialist), there is another major sector in an economy which is called the household sector. By a household, we mean a single individual, who takes decisions relating to her own consumption, or a group of individual for whom decisions relating to consumption are jointly determined. Household also save and pay taxes. The household individuals are the ones, who work in the government department and earn salaries, or they are the owners of firms and earn profits. Indeed the market in which the firms sell their products could not have been functioning without the demand coming from the household.

Above mentioned three sectors are the major players in the domestic economy. But all the countries of the world are also engaged in external trade. The external sector is the fourth important sector. Trade with the external sector can be of two kinds.

(a) The domestic country may sell goods to the rest of the world. These are called exports.

(b) The economy may also buy goods from the rest of the world. These are called imports. The rest of the world affects the domestic economy in other ways as well.

Capital from foreign countries may flow into the domestic country, or the domestic country may be exporting capital to foreign countries.

7. Explain briefly the areas that macroeconomics deals with.

Ans: Scope of macroeconomics means the areas of study under macroeconomics.

Macroeconomics largely deals with the following areas of study:

(a) Theory of national income: Macroeconomics studies the concept of national income, its different elements, methods of measurement and social accounting.

(b) Theory of employment: Macroeconomics is concerned with determination of level of employment in the whole economy. It studies aggregate demand, aggregate supply, consumption, savings and investment etc.

(c) Theory of money: Macroeconomics deals with the various components of money supply, functions of money and their effects in the economy. Banks and other financial institutions are also part of its study.

(d) Theory of general price level: Determination of and change in general price-level are also studied under macroeconomics problems concerning inflation or general rise in prices and deflation or general fall in price are also studied under macroeconomics.

(e) Theory of economic growth: Study of problems relating to economic growth or increase in per capita real income forms part of macroeconomics. It studies the economic growth of underdeveloped economics. Monetary and fiscal policies of the government are also studied therein.

(f) Theory of international trade: Macroeconomics also studies trade among different countries. Theory of international trade tariff, protection etc. are subject of great significance to macroeconomics.

8. Distinguish between micro economics and macroeconomics.

Ans: The main differences between Microeconomics and Macro economics are as follows:

(a) Focus of the study: Microeconomics studies problems of scarcity and choice at the level of an individual a household, a firm or an industry.

Macroeconomics studies problems of scarcity and choice at the level of an economy as a whole.

(b) Degree of aggregation: In microeconomics, there is a limited degree of aggregation of economic variables, compared to macro economics.

(c) Different set of assumption: Micro and macroeconomics are based on a different set of assumptions. Certain variables are assumed to be constant in microeconomics, whereas they are assumed to be in macro. Similarly, certain variables that are assumed to be constant in macro are assumed to be changing in microeconomics.

(d) Central issue: Determination of price is the central issue in microeconomics, while determination of output/employment is the central issue in macroeconomics.

(e) Micro-Macro paradox: What is logical at the micró level may not be logical at the macro level.

9. “Macroeconomics deals with the aggregate economic variable of an economy.” Explain.

Ans: “Macroeconomics deals with the aggregate economic variable of an economy.” Macroeconomic simplify the analysis of how the country’s total output and the level of employment are related to variable like prices, rate of interest, wage rates, profits and so on. It focus on macroeconomic variables. Macroeconomic variable refers to those economic issues or problems which are studied at the level of an economy as a whole. These include national income, aggregate demand, aggregate supply, total consumption, expenditure problem of unemployment, general price level etc. macroeconomics has also been called ‘aggregate economics.”

10. Distinguish between gross investment and net investment.

Ans: Investment or capital formation refers to the capital stock of economy. For example construction of building, purchase of machinery etc. Investment can be looked up in two forms.

(a) Gross investment. and

(b) Net investment.

The total addition made to the capital stock of economy in a given period is termed as gross investment. Capital stock consists of fixed assets and unsold stock. So, gross investment is the expenditure on purchase of fixed assets and unsold stock during the accounting year.

The actual addition made to the capital stock of economy in a given period is termed as Net investment.

Net investment = Gross investment – Depreciation.

Depreciation refers to a fall in the value of fixed assets due to normal wear and tear, passage of time and expected obsolescence or change in technology.

11. Describe the circular causation between the act if consumption and production in a simple economy.

Ans: In a two sector simple economy, it was assumed that there are no savings, i.e. households spend their entire income on purchase of goods and services and firms spend all the receipts from sale of goods and services in making factor payments.

But in actual practice, households do not spend their entire income on consumption, i.e. a part of their income is saved. Similarly, firms also save some part of their receipts for expansion or other reasons. Firms also borrow money to finance their expansion programmer. All savings and borrowings are channelized through a financial market. Financial market refers to institutions such as banks, insurance companies etc. which transact in loanable funds. Savings of households accumulated in the financial market are utilised by firms for investment purpose. So, the circular flow of income continues as shown in the following diagram.

12. Explain the concept of gross domestic product on the basis of the following:

GDP ≥ Eⁿ _i=1GV Ai

Ans: The Product or Value Added Method:

the sum total of gross value added of all the ‘n’ firms.

The Expenditure Method:

GDP = C + I + G + X – M

where, C = consumption expenditure

I = investment expenditure

G = govt. expenditure

X-M = Export-Import

The Income Method:

GDP = W_i+P_i+In_i+R_i

where, W_i = wages and salaries received by the household in a particular year.

P_i = gross Profit.

In_i = Interest Payments.

R_i = Rents received.

The aggregate of incomes received by the households is equal to the expenditure received by the firms, because the income method and expenditure method would give us the same figure of GDP.

13. Distinguish between real GDP and nominal GDP.

Ans: Nominal GDP or GDP at current price refers to the production of goods and services solved at current prices and Real GDP or GDP at constant price refers to the production of goods and services valued at constant prices.

Real GDP is better as compared to Nominal GDP, the because of following reasons:

Real GDP helps in determining the effect of increased production of goods and services as it is affected by change in physical output only. On the other hand, nominal GDP can increase even without any increase in physical output as it is affected by changes in prices also.

(ii) Real GDP is a better measure to make periodic comparison in the physical output of goods and services over different years.

(iii) Real GDP facilitates international comparison of economic performance across the countries.

Therefore, real GDP is better than nominal GDP as it truly reflects the growth of an economy.

14. Distinguish between consumer goods and capital goods.

Ans: Consumption goods refer to those goods which satisfy the wants of the consumers directly. Examples bread, butter, shirts, pens etc. Consumption goods are of four kinds.

They are:

(i) Durable goods such as Television, refrigerator etc.

(ii) Semi-durable goods, like clothes, shoes.

(iii) Nondurable goods. For example. Milk bread, paper.

(iv) Services like services of teachers, doctors, banks etc.

Again, capital goods are those final goods, which help in production of other goods and services. Examples machinery, equipments, plants etc.

Differences between consumption goods and capital goods are given as follows:

(a) Consumption goods satisfy human wants directly. So, such goods have direct demand. But capital goods satisfy human wants indirectly. So, such goods have derived demand.

(b) Consumption goods not promote production capacity. On the other hand, capital goods help in raising producing capacity.

(c) Most of the consumption goods have limited expected life. Capital goods generally have an expected life of more than one year.

15. Distinguish between stocks and flows in regards to National Income.

Ans: The main difference between stock and flow are as follows:

(a) Stock variable refers to that variable, which is measured at a particular point of time.

Flow variable refers to that variable, which is measured over a period of time.

(b) Stock does not have a time dimension and flow has a time dimension as its magnitude can be measured over a period of time.

16. Distinguish between gross national product and gross domestic product.

Ans: (a) Gross domestic product at market price (GDP_Mp): It is the gross market value of all final goods and service produced within the domestic territory of a country during a period of one year.

(b) Gross domestic product at factor cost (GDP_Fc): GDP_Fc is the gross money value of all the final goods and services produced within the domestic territory of a country during a period of one year.

GDP_Fc = GDP_MP – Net in direct taxes.

(c) Gross National product at market price (GNP_MP): GNP_MP is the gross market value of all the final goods and services produced by the normal residents of a country during a period of one year.

GNP_MP = GDP_MP + Net factor income form abroad.

(d) Gross National product at factor cost (GNP_FC): Gross national product at factor cost is the money value of all the final goods and services produced by the normal residents of a country during a period of one year.

GNP_FC = GNP_MP – Net indirect taxes.

17. A country’s national product at factor cost in a particular year is ₹ 2100 crores. The personal disposable income of the household is ₹ 1500 crores. The personal income taxes paid by them is ₹ 500 crores and the value of retained earnings of the firm and government is valued at ₹ 300 crores. There is no interest payments made by the households to the firms/government or by the firms/government to the households. – calculate the value of transfer payments made by the government to the government and firms to the household.

Ans: Personal income = personal disposable income (PDI) + personal income tax

= 1200 + 600 = 1800 = Rs. 1800 crores.

PDI = NNpat FC – Net retained earning to the firm’s government + transfer payments – personal income tax.

1200 = 1900 – 200 + transfer payments – 600

Transfer payments = 1900-200-1200-600

(-) Transfer payment = (-) 100 = Rs. 100 crores.

18. It is planned to increase national income by Rs. 1,000 crore in an economy. How much increase in investment is required to achieve this goal if MPC = 0.6?

Ans: Given that Δy = 1,000 crore MPC = 0.6

We know that multiplier k = 1/1-MPC = 1/1-6 = 1/4 = 10/4 = 2.5

We also know that k = Δy/ΔI

ΔI = change in investment

or,. 2.5 = 1000/ΔI or,. 2.5 ΔΙ = 1000

∴ ΔI = 1000/2.5 = 10000/25 = Rs. 400 crore

Thus, Rs. 400 crore will be needed as additional investment to achieve the planned goal.

19. From the following data, calculate personal income and personal disposable income.

	₹ Crores
(a) GDP at market price	9,000
(b) Depreciation	500
(c) Net factor income from abroad	200
(d) (indirect tax-Subsidy) net indirect tax	100
(e) Undistributed profit	1,500
(f) Corporate tax	1,000
(g) Interest received by households	1,200
(h) Interest paid by households	1,000
(i) Transfer income	800
(J) Direct tax	600

Ans: We know that,

NDP_FC = GDP_MP – Depreciation – NIT = 9000-500-100 = 8400cr.

Again, Private income = NDP_FC + NFIFA + Transfer income + Interest Received (household) = 8400 + 200 + 1200 + 800 = 10,600cr.

Therefore,

(i) Personal Income = Private Income – corporate Tax – Undistb profit = 10,600 – 1000 – 1,500 = Rs. 8100 cr.

(ii) Personal Disposable Income = Personal Income – Interest paid (household) – Direct tax = 8100-1000-600 = Rs. 6500cr.

20. In a particular year a businessman gets ₹ 8000 by selling his products. The depreciation value of his equipment is ₹ 500. Out of the remaining ₹ 7,500 he pays a sales tax of ₹ 800 and buying of new equipment. And finally, he pays 10% of his income as income tax — On the basis of the above information calculate his contribution to the following measures of income.

(i) GDP at market price.

(ii) NNP at market price.

(iii) NNP at factor cost.

(iv) Personal disposable income.

	₹ Crores
(i) NDP at factor cost	9,000
(ii) Net factor income from abroad	150
(iii) Undistributed tax	500
(iv) Corporate tax	600
(v) Interest received by household	1,200
(vi) Interest paid by household	1,000
(vii) Transfer income	400
(viii) Personal tax	600

Ans: Value added by firm A:

= Sales by firm A + change in stock of firm A – purchase by firm A from firm C = 500+20-320 = Rs. 200 crores.

Value added by firm B:

= Sales by firm B to general government + Sales by firm B to households + (Closing stock of firm B- Opening stock of firm B)- purchases by firm B from firm A = 100+350+(40-30)-200=260 = Rs. 260 crores.

Gross Domestic product at market price.

= Value added by firm A+value added by firm B

= 200 +260 = Rs. 460 crores.

Net value added at factor cost.

= Gross Domestic product at market price-consumption of fixed capital-indirect taxes paid by both the firms.

= 460-120-75 = Rs. 265 crores.

21. Explain the circular flow of income simplified economy with two sectors — households and firms.

Ans: A simple economy assumes the existence of only two sectors. i.e. household sector and firm sector. Households are the owners of factors of production and consumers of goods and services. Firms produce goods and services and sell them to the households.

A two-sector circular flow model is drawn on the following assumptions.

(i) There are only 2 sectors in the economy households and firms. It means, there is no government and foreign sector.

(ii) Household sector supplies factor services only to firms and the firms hire factor services only from households.

(iii) Firm produce goods and services and sell their entire output to the households.

(iv) Households receive factor income for their services and spend the entire amount on consumption of goods and services.

(v) There are no savings in the economy i.e. neither the households save from their incomes, nor the firms save from their profits.

The circular flow in two-sector economy can be better understood with the help of a figure.

The outer loop of diagram shows the real flow, i.e. flow of factor services from households to firms and corresponding flow of goods and services flow from firms to households. The inner lop shows the money flow, i.e. flow of factor payments from firms to households and the corresponding flow of consumption expenditure from households to firms. It must be noted that entire amount of money, which is paid by firms as factor payments is paid back by the factor owners to the firms, so, here is a circular and continuous flow of money income.

In the circular flow of income, production generates factor income, which is converted into expenditure. This flow of income continues as production is a continuous activity due to never-ending human wants. It makes the flow of income circular.

Conclusions of circular flow in a simple economy:

Total production = Total consumption

Factor payments = Factors income

Consumption expenditure = Factor income

Real Flow = Money flow.

22. Explain the value added method of calculating GDP.

Ans: The various precautions to be taken in value added method are given below:

(a) Intermediate goods are not to be included: The value of intermediate goods is not included in the national income, since it is already included in the value of final goods and if it is included again, it will lead to double counting.

(b) Sale and purchase of second hand goods is not included: Sale and purchase of used goods do not add to current flow of goods and services and can not be treated as fresh production. They were included in the year in which they were produced. So, they do not qualify for inclusion in national income.

(c) Domestic services are not included: Domestic services like services of a housewife, kitchen, gardening etc. are not included in the national income, since it is difficult to measure their market value. These services are produced and consumed at home and never enter the market place and are termed as non-market transactions.

(d) Production for self-consumption will be included: Value of goods, that are retained for consumption by the producer himself, will be included in the national income as they contribute to the current output. Their value is to be estimated or imputed as they are not sold in the market.

(e) Imputed value of owner occupied house-hold be included: People, who like in their won houses do not pay any rent. But they enjoy housing services similar to those people who stay in rented houses.

Therefore, value of such housing services is estimated according to market rent of similar accommodation. Such an estimated rent is known as imputed rent.

(f) Change in stock of goods (inventory will be included): Net increase in the stock of inventories will be included in the national income as it is a part of capital formation.

23. Explain the following equation:

GDP = Eⁿ _i=1 RV_i = C + I + G+ X – M

Ans:

implies that the gross domestic product (GDP) of a country is equal to the expenditure incurred by all the sectors of the economy, they are:

Consumption expenditure (C) by the household sector.

Investment expenditure (I) by the firm sector.

Government expenditure (G) by the Government sector and Export and Import (X-M) by the foreign or external sector.

24. Explain the income method of calculating GDP.

Ans: The various steps involved in estimating national income by income method are—

Step 1: Identify and classify the production units. All the producing enterprises employing various factors of production are identified and classified into primary, secondary and tertiary sector.

Step 2: Estimate the factor income paid by each sector. The factor incomes paid by each sector are classified under the following heads.

(a) Compensation of employees.

(b) Interest.

(d) Mixed income.

Step 3: Calculate domestic income (NDP_FC): When factor incomes of all the sectors are summed up, we get domestic income. In short NDP_FC = Compensation of employees + Rent and Realty + Interest + Profit + Mixed income.

Step 4: 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.

NNP_FC = NDP _FC = Net factor income from aborad.

While calculating national income by income method following precautions are required.

(i) Transfer income will not be included: Transfer earnings like scholarships, donations, charity, old age pensions etc. are not included in the national income, because such receipts are not connected with any productive activity and there is no value addition.

(ii) Income from sale of second hand goods will not be included: Any income from sale of second hand goods is not to be included in national income as their original sale has already been counted. If they are included again. It would lead to double counting.

(iii) Income from sale of shares and bonds is not included: Such income will not be included as such transactions are not related to flow of goods and services. Such financial assets are mere paper claims and do not contribute to the production of goods and services.

(iv) Windfall gains will not be included: Windfall gains, like income from lotteries, horse race etc. are not included as there is no productive activity connected with them.

(v) Imputed value of services provided by owners of production units will be included: Imputed value of owner occupied houses, interest on own capital, production of self consumption etc. will be included as there are productive activities and add to the flow of goods and services.

(vi) Payments out of past savings are not included: Payments like death duties, gift tax, wealth tax etc. are paid out of the wealth or past savings of the tax-payers. Hence, they should not be included in the national income as they do not and to the current flow of goods and services.

(vii) Indirect taxes are not included: Taxes like sale tax, excise duty, custom duty etc, raise the market price of go services. So, such taxes are to be included in national income at market price but not in national income at factor cost.

25. Explain the Precautions needed to be taken while calculating National Income by expenditure method.

Ans: The various precautions to be taken while using the Expenditure Method are:

(a) Expenditure on Intermediate Goods will not be included in the national income as it is already included in the value of final expenditure. If it is included again, it will lead to double counting of expenditures.

(b) Transfer Payments are not included as such payments are not connected with any productive activity and there is no value addition.

(c) Purchase of second-hand goods will not be included as such expenditure has already been included when they were originally purchased. Such goods do not affect the current flow of goods and services. However, any commission or brokerage on such goods is included as it is a payment made for productive service.

(d) Purchase of financial assets (shares, debentures, bonds etc.) will not be included as such transactions do not contribute to current flow of goods and services. These financial assets are mere paper claims and involve a change of title only. However, any commission or brokerage on such financial assets is included as it is a productive service.

(e) Expenditure on own account production (like production for self-consumption, imputed value of owner occupied houses, free services from general government and private non-profit making institutions serving households) will be included in the national income since these are productive services.

Class 12 Economics Chapter 1 National Income And Related Aggregates

National Income And Related Aggregates

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