PREVIEW PART I: MEANING OF NATIONAL INCOME PART II: PHASES OF CIRCULAR FLOW OF INCOME PART III: METHODS OF CALCULATING NATIONAL INCOME

PART-I

National income is the sum total of factor incomes earned by normal residents of a country during the period of an accounting year.

PART-II

PRODUCTION INCOME EXPENDITURE CIRCULAR FLOW CHART TRIPLE IDENTITY

PART-III

METHODS OF CALCULATING NATIONAL INCOME PRODUCT METHOD/ VALUE ADDED METHOD INCOME METHOD EXPENDITURE METHOD

PRODUCT METHOD/ VALUE ADDED METHOD

This method is also known as Net output Method or Industrial origin method. Under value added method national income is estimated by taking the contribution [ or value added ] made by each producing enterprise to production in the domestic territory of a country in an accounting year.

CLASSIFICATION OF PRODUCTIVE ENTERPRISES First of all, productive enterprises are identified and classified into : Secondary sector Tertiary sector Primary sector

ESTIMATION OF VALUE ADDED Value Added = Value of Output – Intermediate Consumption Value of Output = Sales + ∆ Stock ∆ Stock = C/S – O/S This value added is known as GDPmp VALUE ADDED = Valued Added by Primary sector + Value added by Secondary sector + Value added by Tertiary sector.

CALCULATION OF NATIONAL INCOME (NNP FC ) NNP FC = GDP mp - Depreciation + Net Factor Income from Abroad – Net Indirect Taxes. Net Indirect Taxes = Indirect taxes – Subsidies.

PRECAUTIONS The sale and purchase of secondhand goods should not be included in national income. But commission, if any, earned by brokers of such goods should be included. The value of retained goods foRself – consumption should be included. Imputed value of owner – occupied houses should be included. Own account production of fixed capital by households, firms and the government should be included. Domestic services are not included in national income. However, production of services by paid employees will be included. Although leisure is one of the important determinants of economic welfare but it is not included in national income. Because its valuation is not possible.

EXAMPLE Calculated value added by firm X from the following data : Rs [in lakh] [a] Sales 600 [b] Purchase of raw material 200 [c] Import of raw material 100 [d] Import of machines 200 [e] Closing stock 40 [f] Opening stock 10

INTERMEDIATE CONSUMPTIONVALUE OF OUTPUT Rs. Purchase of raw material 200 Import of raw material 100 Rs. Sales 600 {+} Change in 30 Stock [40 – 10] Total Value Added = Value of output – Intermediate Consumption = Rs.630 – Rs. 330 = Rs. 330 Lakh. Solution :-

ITEM TREATMENT REMARKS Production for self - consumption Included in National income. Part of National income. Hence, its imputed value to be included. Services of House -wivesNot included. These services are rendered free of cost. Free meals to workersIncluded in National Income. A wage in kind. Profits earned by foreign banks in India. Not included in National Income. Part of factor income accruing to the rest of the world. Free services by the government. Included in National Income. These are productive services.Value estimated on basis of cost. VALUE ADDED METHOD

INCOME METHOD

ACCORDING TO THE INCOME METHOD, NATIONAL INCOME IS MEASURED IN TERMS OF PAYMENTS MADE TO THE PRIMARY FACTORS OF PRODUCTION VIZ, LAND, LABOUR, CAPITAL AND ENTREPRENEURSHIP FOR THEIR PRODUCTIVE SERVICES.

NATIONAL INCOME = SUM TOTAL OF FACTOR INCOME EARNED BY THE NORMAL RESIDENTS OF A COUNTRY (NDP FC ) + NET FACTOR INCOME FROM ABROAD. NDP FC is also known as Domestic Income.

CLASSIFICATION OF FACTOR INCOME Factor income is grouped into following heads : Compensation of employees Rent Interest Profits Mixed Income ESTIMATION OF FACTOR INCOMES OR PAYMENTS Domestic Factor Income [or NDP FC ] = Compensation of employees + Rent + Interest + Profits +Mixed Income National income [ or NNP FC ] = NDP FC + Net Factor Income from abroad

COMPONENTS OF DOMESTIC FACTOR INCOME COMPENSATION OF EMPLOYEES OPERATING SURPLUS MIXED INCOME OF THE SELF – EMPLOYED COMPENSATION OF EMPLOYEES - 1.WAGES AND SALARIES IN CASH [ i ] Basic pay [ vi ] Bonus and commissions [ ii ] Dearness allowance [ vii] Leave travel concessions [ iii ] House rent allowance [ viii] Sick leave allowance [ iv ] Overtime allowance [ ix ] C.C.A. [ v ] Cost of travel

2. COMPENSATION IN KIND [i] Free housing and Education [ii] Medical facilities [iii] Free food and Uniforms [iv] Conveyance facilities [v] Creches for children of employees [vi] Value of interest foregone on loans to employees 3. EMPLOYER’S CONTRIBUTION TO SOCIAL SECURITY SCHEMES [i] Provident fund [ii] Life insurance [iii] Casualty insurance 4. PENSION ON RETIREMENT

OPERATING SURPLUS 1. INCOME FROM PROPERTY [ i ] Rent [ ii ] Interest [ iii ] Royalty 2. INCOME FROM ENTREPRENEURSHIP [ i ] Profit COMPONENTS OF PROFIT 1. Dividends 2. Corporate Profit Tax 3. Undistributed Profits

MIXED INCOME Refers to the income of self- employed persons using their own labour, land, capital and entrepreneurship to produce goods and services.

PRECAUTIONS TRANSFER PAYMENTS OR INCOMES - TRANSFER PAYMENTS SHOULD NOT BE INCLUDED IN THE NATIONAL INCOME. ILLEGAL INCOME – INCOME THROUGH ILLEGAL ACTIVITIES, LIKE SMUGGLING, BLACK MARKETING, THEFT, DACOITY, ETC., IS NOT INCLUDED IN THE NATIONAL INCOME. INCOME FROM THE SALE OF SECOND HAND GOODS – INCOME OR MONEY RECEIVED BY WAY OF SELLING SECONDHAND GOODS [ E.G., OLD HOUSE, OLD TV SETS, ETC.] IS NOT INCLUDED IN THE NATIONAL INCOME.

MONEY RECEIVED BY SELLING SHARES AND BONDS [ BOTH OLD AND NEW ] IN THE MARKET IS NOT TREATED AS INCOME. WINDFALL GAINS LIKE INCOME FROM LOTTERIES ARE NOT INCLUDED. INDIRECT TAXES TEND TO RAISE THE MARKET PRICE OF GOODS AND SERVICES. THESE ARE INCLUDED IN THE NATIONAL INCOME AT MARKET PRICE. CORPORATION TAX AND INCOME TAX - CORPORATION TAX IS A PROFIT, IT SHOULD NOT BE SEPARATELY INCLUDED IN THE NATIONAL INCOME. PROFITS BEFORE DEDUCTION OF CORPORATION TAX IS TO BE INCLUDED. COMPENSATION OF EMPLOYEES INCLUDES INCOME TAX PAID BY THE EMPLOYEES AND SHOULD NOT BE INCLUDED SEPARATELY.

PRODUCTION FOR SELF – CONSUMPTION - IT SHOULD BE INCLUDED. DOMESTIC SERVICES FOR SELF – CONSUMPTION ARE NOT INCLUDED. BUT IF THE SAME ARE PRODUCED BY THE PAID EMPLOYED STAFF SUCH AS COOKS, GARDENERS, GUARDS, WILL DE INCLUDED IN THE NATIONAL INCOME. IMPUTED RENT OF OWNER OCCUPIED HOUSES, SHOULD BE IMPUTED ON THE BASIS OF PREVAILING MARKET PRICE AND INCLUDED IN THE NATIONAL INCOME. DEATH DUTIES,GIFT TAX, WEALTH TAX, DEATH DUTIES, ARE PAID OUT OF THE WEALTH OR PAST SAVINGS OF THE TAX – PAYERS.

EXAMPLE Calculate [ i ] Gross domestic product at market prices,and [ ii ] Net national product at factor cost from the following data : - Rs. [in Crore] [ i] Consumption of fixed capital 34 [ii ] Employer’s contribution to social 30 Security schemes [ iii ] Rent 10 [ iv] Interest 20 [ v] Profits 25 [ vi] Royalty 5 [ vii] Wages and Salaries 170 [ viii] Net indirect taxes 38 [ix] Net factor income from abroad (-) 3

Solution : - [ i] GDP MP = Rent + Interest + Profits + Royalty + Wages and salaries +Consumption of fixed capital + Employer’s contribution to social Security schemes + Net indirect taxes = = Rs. 332 crore. [ ii] NNP FC = GDP MP - Consumption of fixed capital + Net factor income from Abroad – Net indirect taxes = 332 – 34 + (-3) – 38 = Rs. 257 crore.

ITEM TREATMENT REMARKS Rent received by Indian residents on building rented out to foreign embassies in India. Included in National Income It is a factor income. Windfall gains Not included in National Income No corresponding increase in production Money received from a relative working in a foreign country. Not included in National Income. It is a transfer payment. Profit earned by Indian companies abroad. Included in National Income Part of NFIA. INCOME METHOD

EXPENDITURE METHOD

UNDER EXPENDITURE METHOD, NATIONAL INCOME IS ESTIMATED BY AGGREGATING ALL THE FINAL EXPENDITURES IN AN ECONOMY DURING A YEAR.

Classification of Final Expenditure The final Expenditure is classified in the following five main categories : Private final consumption Expenditure Government final consumption Expenditure Gross fixed capital formation [ or gross domestic fixed investment Expenditure ] Change in stocks [ or inventories ] Net Exports

COMPONENTS OF FINAL EXPENDITURE FINAL CONSUMPTION EXPENDITURE PRIVATE FINAL CONSUMPTION EXPENDITURE + GOVT. FINAL CONSUMPTION EXPENDITURE GROSS DOMESTIC CAPITAL FORMATION GROSS DOMESTIC FIXED CAPITAL FORMATION + CHANGE IN STOCK NET EXPORTS EXPORTS - IMPORTS CLOSING STOCK OPENING STOCK ----

SUM TOTAL OF EXPENDITURE ON THE DOMESTICALLY PRODUCED GOODS AND SERVICES DURING AN ACCOUNTING YEAR IS CALLED GDP MP GDP MP = C+ I + G + ( X- M) NNP FC = GDP MP – Dep + Net factor income from abroad –indirect taxes + Subsidies

PRECAUTIONS ALL EXPENDITURES ON SECONDHAND GOODS SHOULD NOT BE TAKEN INTO ACCOUNT. EXPENDITURE ON SHARES AND BONDS [ BOTH OLD AND NEW ] SHOULD BE EXCLUDED BECAUSE THEY ARE SIMPLY PAPER CLAIMS. EXPENDITURE ON TRANSFER PAYMENTS BY THE GOVERNMENT SHOULD BE EXCLUDED. EXPENDITURE INCURRED BY THE PRODUCERS ON INTERMEDIATE GOODS HAS TO BE EXCLUDED.

EXAMPLE On the basis of information given below, calculate net national product at factor cost [ NNP FC ] Rs. [ in crore ] 1.Consumption of fixed capital 2, Indirect taxes less subsidies 3, Imports 2, Exports 1, Change in stocks 1, Gross fixed capital formation 5, Govt. final consumption expenditure 3, Private final consumption expenditure 25,000

SOLUTION NNP FC = PRIVATE FINAL CONSUMPTION EXPENDITURE + GOVT FINAL CONSUMPTION EXPENDITURE +GROSS FIXED CAPITAL ` FORMATION + CHANGE IN STOCKS+ EXPORTS – IMPORTS – CONSUMPTION OF FIXED CAPITAL – INDIRECT TAXES + SUBSIDIES = 25, , ,000+ 1, ,000 – 2,000 – 2,200 – 3,500 = 35,500 – 7,700 = Rs. 27, 800 crore.

ITEM TREATMENT REMARKS Govt. Expenditure on street - lighting Included in National Income. It is a part of govt. final consumption. Purchase of vegetables by a hotel. Not Included in National Income. It is an Intermediate consumption. Expenses of foreign visitors in India. Included in National Income. It is a part of Net Exports. Payment of pocket money by a father to his son. Not Included in National Income. It is not a reward for any productive services. EXPENDITURE METHOD

SHIVALI SHARMA ( PGT-ECONOMICS) KENDRIYA VIDYALAYA NO.1 GANDHINAGAR, JAMMU