Economics Chapter 1 National Income Class 12 Notes for kpk, exercises, short question and long question. (ics) notes.
Economics Chapter 1 National Income Class 12 Notes
Table of Contents
Exercises
Q.1) Review your understanding of Key Terms and Concepts. Public saving, corporate saving, transfer payments, depreciation, value added, flow variable, aggregate and aggregate supply, equilibrium income, GDP, GNP, NNP, national income at factor cost. Subsidy.
Answer:
1) Public saving
Public saving can be denied as a difference between government revenue and government expenditure.
2) Corporate saving
“Corporate Saving” is the difference between income and consumption.
3) Transfer payments
A payment made or income received in which no goods or services are being paid for, such as a benefit payment or subsidy is called transfer payment
4) Depreciation
Gradual decrease in the value of an asset is called depreciation.
5) Value added
The amount by which the value of an article is increased at each stage of its production, exclusive of initial costs is called value added.
6) Flow variable
A flow variable is measured over an interval of time. Therefore a flow would be measured per unit of time (say a year). Flow is roughly analogous to rate or speed in this sense. For example, Pakistan’s nominal gross domestic product refers to a total number of dollars spent over a time period, such as a year.
7) Aggregate demand and aggregate supply
Aggregate demand (AD) or domestic final demand (DFD) is the total demand for final goods and services in an economy at a given time. It specifies the amounts of goods and services that will be purchased at all possible price levels.
Aggregate supply (AS) is defined as the total amount of goods and services (real output) produced and supplied by an economy’s firms over a period of time.
8) Equilibrium income
This is established where aggregate quantity supplied is equal to aggregate quantity demanded. It is the central tendency of real income that equates the plans of consumers with those of producers. It is a stable level of income.
9) GDP
Gross Domestic Product (GDP) of a country means total value of goods and services produced within the country during one year.
10) GNP
GNP of a country is the annual sum of market values of all final goods and services produced by its nationals in or outside their country.
11) NNP
NNP is the measure of national production of a country obtained by deducting the amount of depreciation from GNP.
12) National income at factor cost
National income is the total of all incomes earned by the factors of production in the form of wages, rent, interest and profit.
13) Subsidy
A sum of money granted by the state or a public body to help an industry or business keep the price of a commodity or service low.
Q.2) Explain different concepts of national income.
Answer:
CONCEPTS OF NATIONAL INCOME
It is not enough to know the total income of a country for a particular year. We want to make this study more meaningful and a useful guide for economic policies. So we look at national income from different angles. Different concepts of national income have been developed to describe how and where national income is produced; what part of it is taken by the government through taxes. What part is distributed and, after deducting all taxes, how much is left with the people to spend (dispose of). The important concepts used about national income are:
1. GDP (Gross Domestic Product)
2. GNP (Gross National Product)
3. NNP (Net National Product)
4. NI (National Income)
5. PI (Personal Income)
6. DI (Disposable Income)
Gross Domestic Product (GDP)
It is the first measure for national income. Gross Domestic Product (GDP) of a country means total value of goods and services produced within the country during one year. The concept of GDP ignores the incomes received by its nationals from their property abroad or their services in other countries. Usually two kinds of firms work in a country. The local firms have their origin (or head office) in the same country. Foreign firms, which belong to other countries, have their origin and head office somewhere abroad. For example SERVIS (shoes) is a Pakistani firm while BATA is a foreign firm working in Pakistan. Similarly the individuals working in a country will be either locals or foreigners. Total value of output by all kinds of firms, which they produce inside Pakistan, is included in GDP of Pakistan. Thus production of both SERVIS and BATA is included in GDP of Pakistan. The salary of a Japanese engineer working in HONDA factory Lahore is also included in our GDP, since he performs his services in Pakistan. On the other hand, income of a Pakistani working in DUBAI is not counted in our GDP since the services have been rendered outside Pakistan.
The following points about GDP should be remembered.
i. GDP is a money measure of total domestic production.
ii. Only the value of goods produced in the current year is included.
iii. Growth rate of GDP is used to judge the success of government economic policies.
iv. The relative importance of various sectors of the economy is determined on the basis of each sector’s share in GDP.
v. Increase in GDP is an indicator that the economy is growing and expanding.
Gross National Product (GNP)
GNP is the most important and commonly used concept in national accounting. It is a basic but rough estimate of economic performance of a nation. GNP measures the total value of output of goods and services produced by the people in or outside their country. GNP is a wider and more comprehensive term than GDP. In addition to domestic production it considers net income received from abroad. It is the yardstick used to estimate and compare the economic position of various countries.“
It may be defined as:
“GNP of a country is the annual sum of market values of all final goods and services produced by its nationals in or outside their country.”
Every country produces various kinds of goods — consumer goods, such as grains, milk, sugar, textiles, shoes, and capital goods such as machinery, equipment, buildings etc. At the same time a large number of persons perform different services as engineers, doctors, teachers, artists, clerks and laborers. If the money values of all these goods and services are calculated at market prices and added, we arrive at a figure called gross national product.
The meaning of GNP is broader than GDP, which refers to only total domestic production inside a country. GNP includes all production by the residents of a country whether it is done in the country or somewhere abroad. The GNP of a country, say Pakistan, includes the profits sent home by all Pakistani firms and incomes of individuals even if they are working outside Pakistan. Similarly the part of profits and incomes transferred abroad by foreign firms and individuals are excluded.
GNP, = GDP plus income received by Pakistanis from abroad minus income of foreigners taken away from Pakistan.
OR
GNP = GDP plus Net Factor Income from abroad.
Suppose
GDP = Rs.140 billion
Plus Income of Pakistanis from abroad (+) = Rs. 30 billion.
Minus Income of foreigners taken away (-) = Rs. 20 billion.
GNP = Rs 150 billion.
The following points should be remembered about GNP.
1. It is a money measure. Because different units of measurement are employed for different goods, it is not possible to add unlike items such as apples and shoes directly. So their money value is taken and added.
2. To avoid double counting, the values of only final goods are included in the estimate.
3. Only the value of goods produced in the current year is included.
4. GNP is calculated either by summing total expenditure on all final output or by summing the incomes derived from production of that output.
- It provides a basis for economic comparison of countries.
- Increase in GNP is an indicator of improved economic performance and welfare of people of the country.
If GNP is measured in current prices, it is called nominal GNP. By using the index of the general price level, nominal GNP is deflated and converted into prices of some base year. The GNP adjusted for price changes is called real GNP or GNP at constant prices.
Real GNP = Nominal GNP/ deflator.
net National Product (NNP) (National Income at market prices).
NNP is the measure of national production of a country obtained by deducting the amount of depreciation from GNP. As a rough estimate, GNP is a very useful indicator of total production of a country. But if we are interested to have an accurate and true measure of what a country is producing and what is available for use, then GNP has a serious defect. It ignores the fact that some capital is used up during the process of production in the form of decrease in the value of machinery, buildings, etc. For example if a new bus runs for a year, its value will definitely decrease and at the end of the year the value will be less than that of a new bus.
NNP is a better measure to know how much total production an economy can make available for use without decreasing its capital stock.
NNP = GNP – Depreciation
Suppose the GNP of a country in a particular year is Rs.150 billion. While producing the goods and services included in GNP, machinery has worn out. Similarly the value of the buildings has decreased and a part of equipment and tools have been replaced.
Suppose the cost of all this wear and tear is Rs.20 billion. Then,
GNP = Rs. 150 billion
Depreciation allowance (-) = Rs. 20 billion
NNP (Net National Product) = Rs. 130 billion
NNP is the true measure of national income of a country
National Income (at Factor Cost)
National income is the total of all incomes earned by the factors of production in die form of wages, rent, interest and profit.
NNP gives us a measure of national income by adding the money values of all goods and services produced by a country in a given period at market prices. But the total value of national products is not distributed among the people as factor incomes (wages, rent interest and profit). So we find national income at factor cost. There are two causes of difference between NNP and income received by the people.
Firstly, a part of NNP is taken away by the government as indirect taxes on commodities such as sales tax and excise duty. These taxes out of a firm’s sales revenue reduce the amount to be distributed as wages etc. For example if a tax of Rs.5/- per meter is charged on cloth which sells at market price of Rs.50/-, then the factors will receive only Rs.45/- as income. The value of cloth at market price is Rs.50/- but at factor cost it is only Rs.45/-.
Secondly, sometimes, the government helps industries by paying subsidies. Subsidies raise the amount paid to the factors above market price. In order to arrive at national income, which factors actually receive, the amount of indirect taxes is deducted from and subsidies are added to NNP.
National income = NNP – indirect taxes + subsidies
Example: Suppose
NNP = Rs. 130 billion
Indirect taxes (-) = Rs. 15 billion
Subsidies (+) = Rs. 5 billion
Then National Income (at factor cost) = (130 – 15 + 5) = 120 billion
We must remember that if the government increases indirect taxes, then the market value of output will increase but the income received by factors will remain the same.
Personal Income (PI)
Personal income is the total income received by the people from all sources.
Personal income differs from national income for two reasons.
Firstly, there are some deductions from the earnings of persons in the form of social security contributions before they receive their salaries. Then the limited companies do not distribute the whole of the earned profit among the shareholders. They keep a part of it as reserves. Some part of the profits of firms is also taken away by the government as corporate taxes.
Secondly, there are some payments received by the people which they have not earned as incomes in exchange for production of goods e.g. pensions, gifts, Zakat, alms, unemployment allowance, scholarship, etc. These payments are called transfer payments and have to be added to national income to arrive at personal income.
Personal income (PI) = NI – Social security contributions
– Corporate taxes
– Undistributed profits (reserve fund )
+ Transfer payments.
Example: Suppose
National Income (NI) = Rs. 120 billion
Minus Social security contributions,
Corporate Taxes etc. (-) = Rs. 12 billion
Plus Transfer payments (+) = Rs. 27 billion.
Then Personal Income (PI) = Rs. (120-12 + 27) billion
= Rs. 135 billion.
Disposable Income (DI) (or Disposable Personal Income — DPI)
Disposable income (or disposable personal income) is the total net amount left with the individuals and households when they have paid direct taxes
Example:
Disposable income (Dl) = PI – Personal taxes.
Personal income = Rs. 135 billion
Personal taxes (-) = Rs. 10 billion
Disposable income (DI) = Rs. (135 – 10) = Rs.125 billion
PER CAPITA INCOME (Average income)
In order to know the average income of people in a country, per capita income is calculated i.e. income per head of population. It is obtained when national income is divided by the population of the country.
Per capita income = national income/ population
Let the national income of a country be Rs.600, 000 million and the population (estimate) as 120 million. Then per capita income = 600,000/120 = 5000 rupees. Per capita income is annual income per person.
The concept of per capita income is used to have an idea of the average standard of living of the people of a country.
A higher per capita income shows that people have more to consume in terms of goods and services. Lower per capita income implies widespread poverty. If per capita income of a country is compared over some years, we can know whether the country is making any economic progress and whether people’s living standard is rising or not.
If we consider the case of Pakistan we are worried that our per capita income is one of the lowest in the world. In dollars it is only 1254 while for the USA or Japan it is more than forty thousand and thirty five thousand. There are many economic, social and political causes for such a low income level. An important factor, which keeps our per capita income low, is the fast rising population.
Q.3) Explain circular flow of National Income with the help of a diagram
Answer:
CIRCULAR FLOW OF INCOME
Circular flow of income means that income and expenditure in an economy are related to each other in a circular way.
Circular-flow diagram presents a visual model of the economy which highlights the relationship between income generating and income spending activities. We know that receiving income and production of goods are two sides of one activity. There will be income only if goods and services are produced.
Again, income is earned only to be spent. When we study the process of how income is received and how it is spent, we find that there is a direct link between production of goods or services and spending of incomes. To explain it we take a simple model of economy, which consists of two types of decision makers, firms and households.
Firms represent the production side and perform two kinds of activities. By employing various factors of production, they produce all kinds of goods and services demanded by the people. They sell their output in the product market and receive money payments. Next, the money so received by firms is distributed among the factors employed, in the form of wages, rent, interest and profits. The receipts from the sale of output are always equal to the payments to factors of production.
Households represent the consumption side and also perform dual functions. Firstly, in the capacity of owners of factors, they provide factor services to firms through the factor market and in turn receive incomes. Secondly, the households become buyers in the product market and spend their incomes on the purchase of goods and services.
(i) Real flow Services of labour, land, and capital going from households to firms, and products of firms as physical goods or services flowing to households.
(ii) Money flow Firms making payments to households for factor services and households spending money to buy goods from firms.
The important fact about these flows is that they are never isolated. They are interrelated. If shown together in a diagram we get an interesting picture of national income in which production and consumption activities go on in a circular flow.
The two square boxes are drawn for firms and households while the two dotted circles represent product and factor markets. In the upper half of the diagram, an arrow is directed from households to firms. It indicates the supply of the factor services to the firms by the households as landlords, capitalists, laborers and entrepreneurs. The arrow in the opposite direction in the same portion shows the flow of money incomes from firms to households. This sale and purchase of factor services take place through the factor market, i.e. labour market, capital market, etc.
In the lower half of the diagram, one arrow represents that households spend money in the product market. This money goes to the firms. The opposite arrow indicates supply of goods by the firms to the households. The value of goods and services is equal to the total expenditure made by the households.
The anti-clockwise inner circle is a real flow in the sense that it shows the flow of goods from producing units to consuming units and the flow of factor services. The outer clockwise circle is a monetary flow. Money flows from households to firms against purchase of goods and then from firms to households as payments for factor services.
The following points need to be remembered:
1. Flow of money in the economy is in the reverse direction to the flow of ‘real’ goods and services.
2. We have shown only two sets of circular flows. This is a great simplification of reality. The actual economy is much different. For example we have ignored two important economic activities. Firstly there is the government which takes away a part of production of firms as taxes and then spends huge amounts in the goods market to purchase commodities and make payments to households as salaries or pensions. Secondly, families do not immediately spend all of their income on consumer items. They save a part of it. These savings are a type of leakage in the income stream. At the same time firms make investments (spend on machinery etc.) This investment spending is a kind of injection in the income stream. If we take all these things into consideration, it will make a complicated figure.
3. If we fully understand the way goods and money are flowing in the economy, we can easily see that there can be three methods for measurement of national income of a country i.e. as total annual value of goods and services going from production side to households; as total amount of payments made by firms to factors of production or as total annual expenditure made by households to buy goods and services.
Q.4) Explain different methods for measuring national income. What precautions are taken in each case to avoid double counting?
Answer:
MEASUREMENT OF NATIONAL INCOME
Measurement of national income is a very difficult task. Income is produced at millions of places and by millions of people working at farms, factories, shops, offices or construction sites etc. And there are thousands of ways or activities through which people can receive income. Therefore exact measurement is not possible. Only a good estimate can be made.
For every rupee of output produced, a rupee of income is created and this rupee either goes to consumer spending or saving or tax payments. This fact leads us to three alternative ways of measurement of national income.
- 1) Product method
- 2) Income method
- 3) Expenditure method
PRODUCT METHOD (or National Income at Market Prices)
This method is based on the concept of national income as “total market value of all final goods and services produced in a country during one year.”
According to this method, the economy is divided into different sectors such as agriculture, manufacturing, transport and communication, construction and services, etc. The net money value of total production of these sectors in a given year is then added. The income from abroad is also included. This gives us gross national product. When the amount of depreciation is subtracted, we get the net national product or national income. Depreciation represents a fall in the value of a nation’s stock of capital during the course of production of goods. For example an old car will certainly have less value than the value of a similar new car.
The net value of production of a sector means the gross value of its production minus the value of all purchases made by this sector from other sectors.
Example This method is explained by the following example. A country’s economy has been divided into seven sectors.
| PRODUCTION SECTOR | NET VALUEADDEDIn billion Rs. |
| AgricultureManufacturingTradeTransport and communicationConstructionElectricity, gasservices | 120805040302060400 |
Product method is useful to know the relative importance of various sectors of the economy. The above table shows that agriculture makes the greatest contribution to national income in this country.
Precautions The following precautions are observed in this method.
(i) Double counting is avoided because it causes overestimation of national income. From the example, it becomes clear that either we should count the value of the product (shirt) only or we should take the value-added at each stage of production. If along with the final product, the value of intermediate goods (yarn, cloth, etc.) is included, it would mean double (or multiple counting).
(ii) Non-marketed production and unpaid services are not included in the estimation of national income. This is because of difficulty in finding their correct value, e.g. services of a housewife, self-gardening or self-shaving are difficult to estimate in quantity and in money value.
(iii) In order to measure all current output, we must include the market value of any addition to inventories, i.e. the value of unsold goods or the goods which are in the process of production.
INCOME METHOD (or National Income at Factor Cost)
This method is derived from the concept of national income as “the sum total of the incomes of all the persons of a country during one year.”
Income method of measurement can be used because for every rupee of output produced, a rupee of income is created. The income approach to measurement highlights the distribution aspect of national income. People receive incomes in various forms and from various sources. They provide their personal services and receive wages and profits. They also provide the services of their property such as land, buildings and capital and receive rent and interest. All such incomes are added to arrive at national income.
| Sources of income | AmountIn billion rupees |
| Wages and salariesRentInterestProfits of the corporate sectorProprietors incomeIndirect business taxes | 2003020506040 |
| National income | 400 |
The advantage of measuring national income through this method is that we come to know the distribution of national income among various groups of society such as landlords, capitalists, workers and businessmen.
Precautions: The following precautions are necessary to apply this method.
1. Transfer payments such as pensions, gifts, Zakat, and scholarships are not included. Transfer payments, no doubt, are a source of personal incomes for some people but they do not make any addition to national income in true sense. These are payments received without performing any productive work.
2. Incomes from illegal sources like smuggling, theft and bribery are ignored.
EXPENDITURE METHOD
National income can also be computed by adding the total expenditure done by the people and government during a year. Every rupee spent on a good or service is income to somebody, that is. To every rupee of income, there is a rupee of expenditure. There are four main categories of expenditure:
Private consumption expenditure. This includes all consumer expenditure on good and services except for purchases for new houses which is included in Gross Fixed investment
Gross domestic investment: this is the expenditure on a fixed asset and changes in the value stock of goods.
Government current expenditure: This includes although no expenditure is done in
Expenditure on defence, police, education and other services
Exports minus imports. Because imports do not represent our domestic production, expenditure on imports is excluded. Instead, the value of exports is included.
Example: It is generally assumed that total expenditure in a country can be grouped under four items.
| Items of expenditure | Amount in billion Rs. |
| Private consumption expenditure gross domestic investment government purchasesExports minus imports | 250509010 |
| National income | 400 |
If we use symbols, we can write Y = C + I + G + (X – M)
Y = N. Income.
C = Consumption.
I = Investment
G = Govt. expenditure.
X = Exports
M = Imports
Precautions: The precautions to be taken in this method are:
1. Care is taken that every expenditure is counted only once.
2. Expenditure on second-hand goods is to be excluded. Such sales either do not reflect current production or involve double counting. Thus the purchase of an old house or old car is not included.
Conclusion
It should be noted that if proper precautions are observed, the sum of values of all final production, the sum of all incomes and the sum of all expenditure will be the same. Thus the following identity holds.
National output = National income = National expenditure
O = Y = E
Q.5) What are the difficulties in the measurement of national income?
Answer:
Difficulties in measuring national income
There are many difficulties in measuring the national income of a country accurately. The difficulties involved in national income accounting are both conceptual and statically in nature. Some of these difficulties involved in the measurement of national income are discussed below:
1. Non-Monetary Transactions
The first problem in National Income accounting relates to the treatment of non-monetary transactions such as the services of housewives to the members of the families. For example, if a man employs a maidservant for household work, payment to her will appear as a positive item in the national income. But, if the man were to marry the maidservant, she would be performing the same job as before but without any extra payments. In this case, the national income will decrease as her services performed remain the same as before.
2. Problem of Double Counting
Only final goods and services should be included in national income accounting. But, it is very difficult to distinguish between final goods and intermediate goods and services. Intermediate goods and services are used for final consumption. The difference between final goods and services and intermediate goods and services depends on the use, so there are possibilities of double counting.
3. The Underground Economy
The underground economy consists of illegal and nucleated transactions where the goods and services are themselves illegal such as drugs, gambling, smuggling, and prostitution. Since these incomes are not included in the national income, the national income seems to be less than the actual amount as they are not included in the accounting.
4. Petty Production
There are large numbers of petty producers and it is difficult to include their products in national income because they do not maintain any account.
5. Public Services
Another problem is whether the public services like general administration, police, army services, should be included in national income or not. It is very difficult to evaluate such services.
6.Transfer Payments
Individuals get pension, unemployment allowance and interest on public loans, but these payments create difficulty in the measurement of national income. These earnings are a part of individual income and they are also a part of government expenditures.
7. Capital Gains or Loss
when the market prices of capital assets change the owners make capital gains or loss such gains or losses are not included in national income.
8. Price Changes
National income is the money value of goods and services. Money value depends on market price, which often changes. The problem of changing prices is one of the major problems of national income accounting. Due to price rises the value of national income for a particular year appends to increase even when the production is decreasing.
9. Wages and Salaries paid in Kind
Additional payments made in kind may not be included in national income. But, the facilities given in kind are calculated as the supplements of wages and salaries on the income side.
10. Illiteracy and Ignorance
The main problem is whether to include the income generated within the country or even generated abroad in national income and which method should be used in the measurement of national income.
