2. National Income Accounting

EXERCISE

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

Ans: The four production factors are:

i. Land: The land is defined broadly as a factor of production and can take many forms, ranging from agricultural land to commercial real estate to the resources accessible from a specific piece of land. The land has natural resources that may be exploited and refined for human consumption, such as oil and gold. When man alters any of these resources from its original state, it becomes a capital good. For instance, although oil is a natural resource, gasoline is a capital good. A retail mall is a capital good, but farmland is a natural resource.

ii. Capital: Capital refers to man-made goods that are utilised to generate more riches. As a result, it is a manufactured material source of production. Alternatively, capital refers to any man-made production aids that are not consumed for their own sake. To put it another way, items that can be used or consumed in the manufacture of other things. Machines, tools, houses, roads, bridges, and industries are all examples.

iii. Labour: It is defined as human work that is done mentally or physically with the goal of generating money. As a result, it is a physical or mental effort made by a human being during the production process. Wages are the remuneration given to workers in exchange for their productive work.

iv. Entrepreneur: An entrepreneur is an individual being who arranges the other variables in a production and takes on the risks and uncertainties that come with it. He hires the other three factors, gets them together, organises, and coordinates them so that they can make the most money possible. An entrepreneur, for example, is someone who takes the risk of producing television sets.

Factor payments or factor incomes refer to the remunerations given to the factors of production. Rent, wage, interest, and profit are added together to form these figures.

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

Ans: In an economy made up of homes and businesses, the only way for households to spend their money is on the goods and services supplied by the businesses. The factors of production spend their earnings on goods and services. As a result, the profit will be returned to the producers in the form of sales revenue. As a result, there is no difference between the amount that firms transfer in the form of factor payments and the amount that households spend on consumption. Year after year, the same thing happens. There is a disparity between aggregate consumer spending and aggregate factor payments if there has been any fault or fissure in the form of savings, imports, or taxes. Households will spend less than their actual earnings if there is some leakage. As a result, enterprises will receive less money in the form of revenue, lowering production and employment. Every subsequent round will repeat the process, resulting in lower levels of production and employment. As a result, for the economy to run smoothly, there must be equality between aggregate consumption expenditure and aggregate factor payments.

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

Ans: Difference between Stock and Flow:

	Stock	Flow
1.	The term "stock" refers to a variable that may be measured at a specific point in time. For instance, consider the bank balance on March 31, 2020.	The variables that are measured throughout time are referred to as the flow. For example, interest earned on bank savings for a period of one year, from April 1, 2019 to September 30, 2020.
2.	There are no time dimensions to it.	It has time dimensions such as 1 year, 6 months, and so on.
3.	Equity shareholdings, inventories, bank deposits, water in a tank, and so on are examples.	Sale of shares of an organisation, purchase of shares by individuals or institutions, interest deposit in various financial institutions, withdrawal of funds, etc are the examples.

Difference between Net investment and Capital:

	Net Investment	Capital
1.	The amount spent by a corporation or an economy on capital assets, or gross investment less depreciation on assets, is known as net investment.	The amount spent by a corporation or an economy on capital assets, or gross investment less depreciation on assets, is known as net investment.
2.	The term net investment refers to flow variables.	The term "capital" refers to a stock variable.

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

Ans: Planned Inventory Accumulation: Inventory that has been planned In the event of a predicted drop in sales, the company will have unsold stock of goods that it had not budgeted for. As a result, inventories will be built up in advance.

Unplanned Inventory Accumulation: Inventory accumulation that was not intended. In the case where there is an unexpected decline in the sales, the company will have unsold goods that it had not budgeted for. As a result, unanticipated inventory accumulation will occur.

Relationship between Inventory Changes and Value Added:

Change in a firm's inventories over a year = value added + intermediate products utilised by the firm – the firm's sale over the year and value added. It is value added in the net contribution made by a firm in the production process = value of production – value of intermediary products consumed.

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

Ans:

The following three approaches can be used to compute GDP:

(a) Source of income: National income is calculated using this method in terms of factors of production.

GDP = Total payments made to the factors of production

$\mathrm{GDP}\equiv\sum_{\mathrm i=1}^{\mathrm M}{\mathrm W}_{\mathrm i}+\sum_{\mathrm i=1}^{\mathrm M}{\mathrm P}_{\mathrm i}+\sum_{\mathrm i=1}^{\mathrm M}{\mathrm I}_{\mathrm i}+\sum_{\mathrm i=1}^{\mathrm M}{\mathrm R}_{\mathrm i}$ --------- (i)

$\sum_{\mathrm i=1}^{\mathrm M}{\mathrm W}_{\mathrm i}$ represents total wages and salaries received by i-th households.

$\sum_{\mathrm i=1}^{\mathrm M}{\mathrm P}_{\mathrm i}$ represents total profit received by i-th households.

$\sum_{\mathrm i=1}^{\mathrm M}{\mathrm I}_{\mathrm i}$ represents total income received by i-th households.

$\sum_{\mathrm i=1}^{\mathrm M}{\mathrm R}_{\mathrm i}$ represents total rent received by i-th households.

Equation (i) can be simplified as

$\mathrm{GDP}\equiv\mathrm W+\mathrm P+\mathrm I+\mathrm R$

(b) Value Added Product: The way of measuring national income in terms of each generating firm in the economy is known as value added or product method.

$\mathrm{GDP}\equiv\mathrm{Sum}\;\mathrm{of}\;\mathrm{gross}\;\mathrm{value}\;\mathrm{added}\;\mathrm{by}\;\mathrm{all}\;\mathrm{firms}\;\mathrm{in}\;\mathrm{an}\;\mathrm{economy}$

$\mathrm{GDP}\equiv{\mathrm{GVA}}_1+{\mathrm{GVA}}_2+.......{\mathrm{GVA}}_{\mathrm n}$

Where,

${\mathrm{GVA}}_1$ represents the 1st firm's gross value added.

${\mathrm{GVA}}_2$ represents the 2nd firm’s gross value added

${\mathrm{GVA}}_{\mathrm n}$ represents the gross value added by the nth firm.

Therefore,

$\mathrm{GDP}\equiv\sum_{\mathrm i=1}^{\mathrm n}{\mathrm{GVA}}_{\mathrm i}$

$\mathrm{GDP}\equiv\mathrm{Total}\;\mathrm{consumption}\;+\;\mathrm{Investment}\;+\;\mathrm{Government}\;\mathrm{Consumption}\;\mathrm{expenditure}\;+\;\mathrm{Net}\;\mathrm{exports}$

$\equiv\sum_{\mathrm i=1}^{\mathrm N}{\mathrm C}_{\mathrm i}+\sum_{\mathrm i=1}^{\mathrm N}{\mathrm I}_{\mathrm i}+\sum_{\mathrm i=1}^{\mathrm N}{\mathrm G}_{\mathrm i}+\sum_{\mathrm i=1}^{\mathrm N}{\mathrm X}_{\mathrm i}$

Since households spend a portion of their income on imports, imports account for a portion of consumer expenditure, which is denoted by ${\mathrm C}_{\mathrm M}$ . Similarly, foreign investment products and imports account for a portion of both investment and government consumption spending. ${\mathrm I}_{\mathrm M}$ and ${\mathrm G}_{\mathrm M}$ represent the portions of investment and government consumption expenditures, respectively. Thus, the final consumption, investment, and government expenditures spent on domestic firms are denoted by $\mathrm C-{\mathrm C}_{\mathrm M},\mathrm I-{\mathrm I}_{\mathrm M},$ and $\mathrm G-{\mathrm G}_{\mathrm M}$ , respectively.

Substituting these values in the above equation

$\mathrm{GDP}=\mathrm C-{\mathrm C}_{\mathrm M}+\mathrm I-{\mathrm I}_{\mathrm M}+\mathrm G-{\mathrm G}_{\mathrm M}+\sum_{\mathrm i=1}^{\mathrm M}{\mathrm X}_{\mathrm i}$

$=\mathrm C+\mathrm I+\mathrm G+\sum_{\mathrm i=1}^{\mathrm M}{\mathrm X}_{\mathrm i}-\left({\mathrm C}_{\mathrm M}+{\mathrm I}_{\mathrm M}+{\mathrm G}_{\mathrm M}\right)\\=\mathrm C+\mathrm I+\mathrm G+\mathrm X-\mathrm M$

What is created in the economy is either consumed or invested, as a result all three techniques get the same outcome for calculating GDP. From three separate perspectives, the three techniques present the same picture of an economy. The product method shows the entire value added, the income method shows the revenue earned by all components, and the expenditure approach shows the expenditure incurred by all factors. The producer in the economy employs four factors of production to manufacture final items and receives money through sales, which is equal to the firm's total value addition. Firms give remuneration to factors, which operate as the factors' income. These remunerations are equal to the contributions of the factors to the value added. These factor incomes are then spent on goods and services, demonstrating that factor income and expenditure are equal. As a result, the three approaches will always yield the same GDP value.

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

Ans: A budget deficit occurs when government spending exceeds tax revenue, and a trade imbalance occurs when the economy's import spending exceeds its export revenue.

Budget deficit = G - T

Where,

G = the government expenditure

T = government income that is tax revenue

Trade Deficit = M - T or (I - S) + (G - T)

Where,

M = Import expenditure

T = export revenue

I = Investment multiplied by Inflow into the country

S = Savings

It is given that,

I - S = Rs. 2000 crores.

G -T = (-) Rs. 1500 crores.

Therefore,

Trade deficit = (I - S) + (G - T)

= 2000 + (-1500)

= Rs. 500 crores.

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

Ans: It is mentioned that,

National Income $\left({\mathrm{NNP}}_{\mathrm{FC}}\right)= Rs. 850 crores$

$\left({\mathrm{GDP}}_{\mathrm{MP}}\right)= Rs. 1100 crores$

Net factor income from abroad = Rs. 100 crores

Net indirect taxes = Rs. 150 crores

${\mathrm{NNP}}_{\mathrm{FC}}= {\mathrm{GDP}}_{\mathrm{FC}}+ \text{Net factor income from abroad - Depreciation - net indirect taxes}$

Putting these values in the formula,

850 = 1100 + 100 - Depreciation - 150

850 = 1100 - 50 - Depreciation

850 = 1050 - Depreciation

Depreciation = 1050 - 850 = Rs. 200 crores

So, depreciation is Rs. 200 crores.

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

Ans:

${\mathrm{NNP}}_{\mathrm{FC}}$ = Rs. 1900 crores

PDI = Rs. 1200 crores

Personal income tax = Rs. 600 crores

Value of retained earnings = Rs. 200 crores

$PDI = {\mathrm{NNP}}_{\mathrm{FC}}- \text{Value of retained earnings of firms and government + Value of transfer payments - Personal Tax}$

1200 = 1900 -200 + Value of Transfer payments - 600

1200 = 1100 + Value of transfer payments

Value of transfer payment = 1200 - 1100 = Rs. 100 crores.

9. From the following data, calculate Personal Income and Personal Disposable Income.

		Rs (Crore)
(a)	Net Domestic Product at factor cost	8,000
(b)	Net Factor Income from abroad	200
(c)	Undisbursed Profit	1,000
(d)	Corporate Tax	500
(e)	Interest Received by Households	1,500
(f)	Interest Paid by Households	1,200
(g)	Transfer Income	300
(h)	Personal Tax	500

Ans:

$\text{Personal Income} = {\mathrm{NDP}}_{\mathrm{FC}}+ \text{Net factor income from abroad (NFIA) + Transfer Income - Undistributed Profit - Corporate Tax - Net Interest Paid by Households}$ .

${\mathrm{NDP}}_{\mathrm{FC}}= Rs. 8000\;crores$

NFIA = Rs. 200 crores

Transfer Income = Rs. 300 crores

Undistributed profit = Rs. 1,000 crores

Corporate tax = Rs. 500 crores

Net interest paid by households = Interest paid - Interest received

= 1200 - 1500

= (-) Rs. 300 crores

So, putting the values in the above formula

PI = 8000 + 200 + 300 - 1000 - 5000 -(- 300)

= 8000 + 200 + 300 - 1000 - 500 + 300

PI = 7300

So, Personal Income = Rs. 7300 crores

Personal Disposable Income = Personal Income - Personal Payments

= 7300 -500

= Rs. 6800 crores.

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

Ans:

Its given that,

Indirect tax = 30

Personal tax = 20

Depreciation = 50

Retained earnings = 220

(i) ${\mathrm{GDP}}_{\mathrm{MP}}= Rs. 500$

(ii) ${\mathrm{NNP}}_{\mathrm{MP}}$ = GDP - Depreciation

= 500 - 50

= Rs. 450

(iii) ${\mathrm{NNP}}_{\mathrm{FC}}$ = NNP - Sales tax

= 450 - 30

= Rs. 420

(iv) $PI = {\mathrm{NNP}}_{\mathrm{FC}}- \text{Retained earnings}$

= 420 - 220

= Rs. 220

(v) PDI = PI - Income Tax

= 200 - 20

= Rs. 180

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

Ans: It is given that,

Nominal GNP = Rs. 2500

Real GNP = Rs. 3000

GNP deflator $=\dfrac{\mathrm{Nominal}\;\mathrm{GNP}}{\mathrm{Real}\;\mathrm{GNP}}\times100$

= 83.33 %

So, (100-83.33)% = 16.67%

No, the price level has fallen down by 16.67%.

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

Ans:

The following are some of the drawbacks of using GDP as a metric:

1. GDP distribution: It is possible that when GDP rises, disparities in income distribution may rise as well, widening the gap between rich and poor. GDP does not take into account changes in income distribution inequities. As a result, people's well-being may not increase at the same rate as GDP.

2. Non-monetary transactions: Many economic activities are not measured in monetary terms. Non-market transactions, such as housewife services, kitchen gardening, leisure time activities, and so on, are not included in GDP due to a lack of data. However, such actions have an impact on the economy.

3. Change in pricing: If an increase in GDP is due to an increase in prices rather than an increase in physical output, it is not a valid indicator of economic well-being.

4. Rate of population growth: GDP does not take into account changes in a country's population. If the pace of population increase exceeds the rate of GDP growth, the availability of goods and services per capita will decline, negatively impacting economic welfare.

5. Externalities: Externalities are the conditions referring to the benefits or harms of an activity that are caused by a firm or an individual and for which they are neither paid nor penalized. Activities which result in benefits to others are termed as positive externalities and activities which result in harm to others are termed as negative externalities.