12th class ECONOMICSchanakyagroupofeconomics.com/wp-content/uploads/2020/04/...2012/05/09 · 12th class ECONOMICS CHANAKYA GROUP OF ECONOMICS SESSION 2020-21 2.Real GDP 1.Nominal

Market price & Factor costAggregates related to national

Income.

Macro Economics: Part-5

12th class ECONOMICS

CHANAKYA GROUP OF ECONOMICS

SESSION 2020-21

1.Gross domestic product at Market Price

GDP at Market price is the market value of final goods and

services produced within the domestic territory of a country

during an accounting year inclusive of depreciation.

(GDPmp include Indirect taxes and deduct subsidies)

Domestic product at Market price and factor cost

2.Gross domestic product at factor cost.

GDP at factor cost is the sum total of factor cost incurred on

the production of final goods and services within the

domestic territory of a country during an accounting year

inclusive of depreciation.

(GDPfc=Compensation of employee+ Rent+ Interest+profit.)

(GDPfc include subsidies and deduct Indirect taxes )

Formulas of GDPmp and GDPfc

1. GDP at Market price = GDPfc + indirect taxes-

subsidy.

1. GDP at Factor cost = GDPmp - indirect taxes+

subsidy.

Net indirect taxes= indirect taxes - subsidies

1.Gross National Product:Gross National Product (GNP) is defined as the total market value of all final goods and services produced in a country during a specific period of time, usually one year. It measures the output generated by a country’s organizations located domestically or abroad.

2.Gross Domestic Product:Gross Domestic Product (GDP) refers to the market value of final goods and services produced in a country in a given time period. It includes income earned by foreign players locally minus income earned by national players in abroad.

The GNP can be calculated with the help of the following formula:GNP = GDP +Net Factor Income from Abroad (NFIA)

From the above mentioned formula, we can calculate GDP as follows:GDP = GNP- NFIA

3.NDPmp refers to the market value of final goods and services produced by all the production units in the domestic territory of a country during a given time period. It excludes depreciation and includes indirect taxes. It is equal to the net value added at market price.

NDPmp can be calculated as follows:NDPmp = GDPmp – depreciation

4.NDPfc refers to the market value of final goods and services produced by all the production units in the domestic territory of a country during a given time period excluding depreciation and net indirect taxes. NDPfc is also known as Net Domestic Income (NDI).

It can be calculated as follows:NDPfc = GDPmp – depreciation – Net Indirect taxesOrNDPfc = NDPmp – Net Indirect Taxes = NDPmp – Indirect Taxes + Subsidies

5.Net National Product:Net National Product (NNP) is equal to GNP minus depreciation. It indicates the net output available for the consumption by society where society includes consumers, producers and government. NNP is the actual measure of the national income.

It can be calculated as follows:NNPmp = NDPmp + NFIANNPfc is defined as the measure of the factor earnings of the residents of a country, both from economic territory and abroad. Therefore, NNPfc is equal to national income of country.

It can be calculated as follows:NNPfc = NDPfc + NFIA

Aggregates related to national income

1.Domestic product

GDPmp NDPmp GDPfc NDPfc

NDPMP+Dep+indirect taxes –Subsidy. OR (+ net indirect taxes) GDPMP-

Dep+indirect taxes – Subsidy.

GDPMP-

indirect taxes + Subsidy.(- net indirect taxes)

GDPMP- Dep.

GDPFC- Dep

OR

OR

GDPMP-

indirect taxes + Subsidy.(- net indirect taxes)-dep

2.National Product

GNPmp NNPmp GNPfc NNPfc

GDPmp + NFIFA

NDPmp+ NFIFA

GDPfc+NFIFA

NDPfc+NFIFA

DOMESTIC PRODUCT

NATIONAL PRODUCT

NFIFA = Income earned by normal residents –

income earn by non- residents.

or

NFIFA = factor income from abroad – factor income

to abroad.

All the types of transfer incomes are kept out of the national income estimates. For recipients of transfer payment, it is called transfer income, while for payers; it is termed as transfer expenditures. There are two types of transfers namely current and capital transfers.

The following are some of the examples of current transfers:a. Tax payments to the governmentb. Donations to non-profit institutionsc. Scholarship to studentsd. Old age pensionse. Unemployment allowancesf. Gifts and lottery prizes

g. Aid provided by one country to another country in case of emergenciesh. Transfer of money by resident of one country to relatives residing in other countryOn the other hand, capital transfers are the transfers made out of the wealth or capital of the payer and added to the wealth or capital of the recipient.The example of capital transfers are as follows:a. Capital grants from government to organizationsb. Lump-sum payments to households in case of natural disastersc. Payment of taxes on capital and wealth

Real GDP & Nominal GDPMethods of calculating National

income.




SESSION 2020-21

2.Real GDP1.Nominal

GDP3.GDP

deflator

Concept of GDP

Nominal values of GDP from different time periods can differ due to changes in quantities of goods and services and/or changes in general price levels

1. Nominal GDP

Nominal GDP is measured on the basis of current price .

nominal GDP would also change even though output remained constant.

The Nominal GDP is the total value of all of the final goods and services that an economy produces during a given year, measured on the basis of current prices.

Nominal GDP = 100

Price indexReal GDP ×

If there is no inflation or deflation, nominal GDP will be the same as real GDP.

Q- quantity of final goods and services produced during an accounting year.

P- prices prevailing during the accounting s year.

Price index- it is difference between the price of two different periods.

Nominal GDP = Q × P

2.Real GDP

To find out the real GDP a base year is chosen when the general prices level is normal, ie it is neither to high nor too low.

The real GDP is the total value of all of the final goods and services that an economy produces during a given year, measured on the base year prices.

It is calculated using the prices of a selected base year.

GDP is calculated on the basis of fixed prices in some year.

If prices change from one period to the next but actual output does not, real GDP would be remain the same.

Real GDP = × 100GDP at current prices

Price index

Q- quantity of final goods and services produced during an accounting year.

P- prices prevailing during the base year.

Price index- it is difference between the price of two different periods.

Real GDP reflects changes in real production.

Real GDP = Q*P

Real GDP increases only when Q increases .

Because prices remain constant.

So when real GDP increases there is an increases in the flow of goods and services,

Other things remaining constant.

Real GDP increases- output or goods and services increases-quality of life improve.

Real GDP = Q*P

In an economy total production of notebooks is 100 and current price of each notebook is 12 rupees in 2019-20, and base year price is 10rs

Real GDP = Q*P

Real GDP = 100 × 10 = 1000

Real GDP example

In an economy total production of notebooks is 100 and current price of each notebook is 12 rupees in 2019-20 and base year price is 10rs

Nominal GDP = Q*P

Nominal GDP = 100 × 12 = 1200

Nominal GDP example

3.GDP deflator

GDP deflator is an index of price changes of goods and services included in GDP.

It is a price index which is calculated by diving the nominal GDP in a given year by the real GDP for the same year and multiplying by 100.

GDP Deflator = × 100Nominal (current price) GDP

Real( constant price) GDP

1.If real GDP is 50 , and Price index is 400 , then Nominal GDP?

2.If Nominal GDP is and Price index is 400 , then Real GDP?

3.If Nominal GDP is and Real GDP is then Price index ?

GDP and Welfare

There is positive relation between GDP of a country and Welfare of people.

Real GDP is considered as an index of welfare of the people.

Because it increase in real GDP means increase in level of output in the economy.

Welfare of the people measured in terms of the availability of goods and services per person.

1.Higher GDP Growth

6.Increase in investment.

5.Rise in inducement to invest.

4.Rise in aggregaredemand.

3.Rise in income of people

2.Rise in level of Employment.

GDP and Welfare

Limitation of GDP and Welfare

Increase in GDP always not lead to welfare of people, some time

high GDP lead to reduction in welfare of the people.

these are-

1. Unequal distribution of income – benefit of growth goes to

richer section of the society.

2. Composition of GDP -more production of capital

goods.(luxury goods)

3. Non-monetary transactions- (barter system) these goods are

not recorded in GDP.

4. Externalities- good and bad impact of economic activities.

If GDP increases by pollution related production activities then

welfare will be reduced.

home-workQ1. if real GDP is 520 and Price index.(base = 100) is 125 , calculatNominal GDP.

Q2. If the real GDP is 300 and nominal GDP is 330 , calculate price index.(base = 100)

Q3. if nominal GDP is 1200 and price index.(base = 100) is 120, calculate real GDP.

1.product method- I




Methods of calculating National income

calculating GDP OR GVA at Market prices and factor cost.

Methods of calculating national income

1.Product method/value

added method

2.Income method

3.Expenditure method.

1.Product method/value

added method

Value Added Method

This method is used to measure national income in different

phases of production in the circular flow. It shows the

contribution (value added) of each producing unit in the

production process.

i. Every individual enterprise adds certain value to the

products, which it purchases from some other firm as

intermediate goods.

ii. When value added by each and every individual firm is

summed up, we get the value of national income.

Value added Method is also known as:

(I) Product Method;(ii) Inventory Method;(iii) Net Output Method;(iv) Industrial Origin Method; and

Concept of value added

Value added is the difference between value of output of an enterprise and the value of its intermediate consumption.

Value added= value of output – intermediate consumption.

Domestic sale + exprot

Domestic consumption + import

Value of Output:Value of output refers to market value of all goods and services produced during a period of one year.

How to Measure the Value of Output?(i) When the entire output is sold in an accounting year, then:

(ii) When the entire output is not sold in an accounting year, then the unsold stock is added to the value of sales. Unsold stock is the excess of closing stock over opening stock and is termed as ‘Change in Stock’.

It means, Value of Output = Sales + Change in Stock,

Value of Output = SalesValue of Output = Sales

Change in stock = Closing stock – Opening stock

Exports are not separately Included:Like imports, exports are also not separately included in value of output if ‘Sales’ are given (and domestic sales are not specifically mentioned).

In case of an open economy, sales include both domestic sales and exports.

One More way to Calculate Value of Output:

Value of Output can also be calculated as:Value of Output = Quantity x Price For example,if a firm manufactures 1,000 pairs of shoes annually and sells them @ Rs 500 per pair, then: Value of Output = 1,000 x 500 =Rs 5, 00,000

Calculate Value of Output:

Case 1:(i) Sales = Rs 2,000;(ii) Exports = Rs 400Value of Output = Rs 2,000 As exports are already included in the value of sales.

Case 2:(i) Domestic Sales = Rs 700;(ii) Exports= Rs 200Value of Output = Rs 700 + Rs 200 = Rs 900 Exports are included as domestic sales are specifically mentioned.

Estimating value added or value addition.

Output Value of output

Intermediate cost

Value added

1.Farmer(wheat)

2. Flour mill

3.Bakery

4.Shopkeeper

500

700

900

1000

200

500

700

900

300

200

200

100

Total 3100 2300 800

the gross value added by all the producing enterprises is

300+200+200+100=800

example:

1. Farmer sells wheat to flour mill in RS 500 it include the cost of

inputs like seeds, fertilsers etc. so value adde by farmer is 500-

200=300

2. Flour mill buys wheat for 500 and sell it at 700 . Then value added

by flour mill is 700-500= 200.

3. Beker buy flour for rs 700 and sell the bread for 900 . Then value

added by baker is 900-700=200.

4. The shopkeeper buys the bread for 900, and sell them for 1000 to

the consumer , then value added by shopkeeper is 1000-900=100

Thus, the gross value added by all the producing enterprises is

300+200+200+100=800

1.Value added by primary sector.

2.Value added by secondary sector.

3.Value added by tertiary sector.

= GDPmp

Value added by each producing enterprise is also known as Gross value added at market price( GVAmp) . GDPmp = GVAmp

Calculation of national income by using Value added method.

Step 1: Identify and classify the production units:The first step is to identify and classify all the producing enterprises of an economy into primary, secondary and tertiary sectors.

Steps of Value Added Method:

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

Step 3: Calculate Domestic Income (NDPFC):By subtracting the amount of depreciation and net indirect taxes from GDPMP, we get domestic income, i.e. NDPFC = GDPMP –Depreciation – Net Indirect Taxes.

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.National Income (NNPFC) = NDPFC + NFIA

(viii) Subsidies 20(ix) Net factor income from abroad (-100)

HOME WORKCalculate the value of 1. Gross value added at Market price.2. National Income ( NNPfc)

1.product method- II





Problems of double counting and

precautions related with product method





In measuring the National Income, the value of only final goods and services is to be included.

However, the problem of double counting arises when value of intermediate goods is also included along with value of final goods.

Double counting refers to counting of an output more than once while passing through various stages of production. A commodity passes through various stages of production before reaching the final stage.

When value of the commodity is taken at each stage, it is likely to include the cost of inputs more than once. This leads to double counting.

Problem of Double Counting:

1. Farmer:

Suppose, farmer produces 50 kg of wheat and sells it for Rs 500 to miller

(flour mill). For farmer, wheat of Rs 500 is a final product. (If he does

not have to incur any expenditure on the cultivation of wheat then his

value added will be Rs 500).

2. Miller:

For miller, wheat is an intermediate good. Miller converts wheat into

flour and sells it for Rs 700 to a baker. Now, flour of Rs 700 is a final

product for the Miller. (Value added by miller = 700 – 500 = Rs 200)

3. Baker:

For baker, flour is an intermediate good. Baker manufactures bread from

flour and sells the entire bread to shopkeeper for Rs 900. Bread of Rs

900 is a final product for the baker. (Value added by baker = 900 – 700 =

Rs 200)

4. shopkeeper

For shopkeeper, bread is an intermediate good. He sells the entire bread

to final consumer for Rs 1000. Bread of Rs 1000. is a final product for

the shopkeeper. (Value added by shopkeeper = 1000 – 900 = Rs 100)

In the given example, wheat is a final product for farmer, flour for miller and bread for baker and shopkeeper.

As a general practice, every producer treats his commodity as the final output.It means: Total value of output = 500 + 700 +900+ 1,000 = Rs 3100.

However, a careful examination reveals that each transaction contains the value of intermediate goods.1. The value of wheat is included in the value of flour.2. The value of flour is included in the value of bread.As a result, the values of wheat and flour are counted more than once. This causes the problem of double counting. It leads to over estimation of value of goods and services produced.

There are two alternative ways of avoiding double counting:(i) Final Output Method:According to this method, value of only final goods should be added to determine the national income.

In the given example, value of bread of Rs1, 000 sold to final consumers should be taken in the national income.

How to Avoid Double Counting?

(ii) Value Added Method:According to this method, sum total of the value added by each producing unit should be taken in the national income.

In the given example, value added by farmer (Rs 500), miller (Rs 200) and baker (Rs 200), and shopkeeper (100) i.e. total of Rs 1000 should be included in the National Income.

Estimating value added or value addition.

Output Value of output

Intermediate cost

Value added

1.Farmer(wheat)

2. Flour mill

3.Bakery

4.Shopkeeper

500

700

900

1000

-

500

700

900

500

200

200

100

Total 3100 2300 1000

The various precautions to be taken in Value Added Method are:1. Intermediate Goods are not to be included in the national

income since such goods are already included in the value of final goods. If they are included again, it will lead to double counting.

2. Sale and Purchase of second-hand goods is not included as they were included in the year in which they were produced and do not add to current flow of goods and services.

However, any commission or brokerage on sale or purchase of such goods will be included in the national income as it is a productive service.

Precautions of Value Added Method:

3. Production of Services for self-consumption (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.

It must be noted that paid services, like services of maids, drivers, private tutors, etc. should be included in the national income.

4. Production of Goods for self-consumption 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.

5. Imputed value of owner-occupied houses should be included. People, who live in their own houses, do not pay any rent. But, they enjoy housing services similar to those people who stay in rented houses. Such an estimated rent is known as imputed rent.

6. 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.

HOME WORK

2.Income method-I





Classification of Income method&

Precautions regarding income method

Under this method, national income is measured as a flow of factor incomes.

There are generally four factors of production labour, capital, land and entrepreneurship.

Labour gets wages and salaries, capital gets interest, land gets rent and entrepreneurship gets profit as their remuneration.

Besides, there are some self-employed persons who employ their own labour and capital such as doctors, advocates, CAs, etc.

Their income is called mixed income.

The sum-total of all these factor incomes is called NDP at factor costs.

2. Income Method:

Measurement of national income through income method involves the following main steps:

1. The first step in income method is also to identify the productive enterprises and then classify them into various industrial sectors such as agriculture, fishing, forestry, manufacturing, transport, trade and commerce, banking, etc.

2. The second step is to classify the factor payments. The factor payments are classified into the following groups:

Classification of FACTOR INCOME

2.Operating surplus

3. Mixed Income

1.Compensation of Employee

which includes i. Wages, ii.salaries, both in cash and kind, iii. employers’ contribution to social security schemes.iv.Pension on retirement.

ii. Rent and also royalty, if any.iii. Interest.iv. Profits:

Profits are divided into three sub-groups:(i) Dividends(ii) Undistributed profits(iii) Corporate income tax

v. Mixed income of the self-employed:


1. Compensation of employees which includes

I. Wages, II. salaries, both in cash and kind, III. as well as employers’ contribution to social security

schemes.IV. Pension on retirement.

ii. Rent and also royalty, if any.

iii. Interest.

iv. Profits:

2.Operating surplus

Profits are divided into three sub-groups:

(i) Dividends- it is part of profit which is distributed among the

shareholders. It is also known as distributed profit.

(ii) Undistributed profits- it is part of profit which is kept by the firm

for future use, to meet some contingent expenses. It is also known as

corporate saving or undistributed profit.

(iii) Corporate income tax- it is part of profit which is paid to the govt

as profit tax.

3. Mixed Income

Mixed income refers to the Mixed income of the self-employed persons using their own labour, land , capital, and entrepreneurs in their household enterprises. These incomes are mixture of wages, rent, interest and profit.

2.Operating surplus

3. Mixed Income


+

+

=Net domestic product at factor

cost ( NDPFC)+

NFIA=NNPFC ( NATIONAL INCOME)

3. The third step is to measure factor payments. Income paid out by each enterprise can be estimated by gathering information about the number of units of each factor employed and the income paid out to each unit of every factor.

4. The adding up of factor payments by all enterprises belonging to an industrial sector would give us the incomes paid out to various factors by a particular industrial sector.

5. By summing up the incomes paid out by all industrial sectors we will obtain domestic factor income which is also called net domestic product at factor cost (NDPFC).

6. Finally, by adding net factor income earned from abroad to domestic factor income or NDPFC we get net national product at factor cost (NNPFC) which is also called national income.

Precautions:

While estimating national income through income method the following precautions should be taken:

1. Transfer payments are not included in estimating national income through this method.

2. Imputed rent of self-occupied houses are included in national income as these houses provide services to those who occupy them and its value can be easily estimated from the market value data.

3. Illegal money such as hawala money, money earned through smuggling etc. are not included as they cannot be easily estimated.

4. Windfall gains such as prizes won, lotteries are also not included.

5 The receipts from the sale of second-hand goods should not be treated as a part of national income. This is because the sale of second-hand goods does not create new flows goods and services in the current year.

6. Income equal to the value of production used for self-consumption should be estimated and included in the measure of national income.

2.Income method-II





Calculation of N.I by using Income method

Documents

12th class ECONOMICSchanakyagroupofeconomics.com/wp-content/uploads/2020/04/...2012/05/09 · 12th class ECONOMICS CHANAKYA GROUP OF ECONOMICS SESSION 2020-21 2.Real GDP 1.Nominal