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SAMPLE PDF Macroeconomics XII 2021-22 Edition by Subhash Dey
SAMPLE PDF Macroeconomics XII 2021-22 Edition by Subhash Dey
Introductory
Introductory MACRO ECONOMICS
MACROECONOMICS
A Textbook for Economics Class XII
Edition 2021-22
XII
SUBHASH DEY
Subhash Dey
Introductory
MACROECONOMICS
A Textbook for Economics Class XII
Subhash Dey
B.Com. (Hons.), M.Com. (Delhi School of Economics), M.A. (Economics),
PGDBA (Finance), B.Ed., PGD (Labour and Administrative Laws)
10 Marks
Unit
National Income and Related
Aggregates
CBSE Syllabus Content
What is Macroeconomics? 1.1 Some Basic Concepts of National Income Accounting
Some basic concepts: consumption goods, capital
1.2 Domestic Territory and Resident: Implications
goods, final goods, intermediate goods; stocks and
flows; gross investment and depreciation 1.3 Circular Flow of Income (Two-Sector Model)
Circular flow of income (two sector model)
1.4 Production Method (or Value Added Method) of
Methods of calculating national income–Value Added Calculating National Income
or Product method, Expenditure method and Income
method 1.5 Income Method of Calculating National Income
Aggregates related to national income: Gross National 1.6 Expenditure Method of Calculating National Income
Product (GNP), Net National Product (NNP), Gross
and Net Domestic Product (GDP and NDP)–at market 1.7 Real and Nominal GDP
price, at factor cost 1.8 GDP and Welfare
Real and Nominal GDP; GDP and welfare
"There is one rule for the industrialist and that is: make the best quality goods possible at the lowest cost possible, paying the
highest wages possible." —Henry Ford
“The subjects of every state ought to contribute towards the support of the government, as nearly as possible, in proportion to
their respective abilities.” —Adam Smith
8 Macroeconomics XII – by Subhash Dey
What is Macroeconomics?
In macroeconomics, we study the economic behaviour of the economy as a whole by focusing our attention on
aggregate measures such as total output, employment and aggregate price level.
Here, we are interested in finding out how the levels of these aggregate measures are determined and how the
levels of these aggregate measures change over time.
Some of the important questions that are studied in macroeconomics are as follows:
• What is the level of total output in the economy?
• How is the total output determined?
• How does the total output grow over time?
• Are the resources of the economy (e.g. labour) fully employed?
• What are the reasons behind the unemployment of resources?
• Why do prices rise?
Thus, instead of studying the different markets as is done in microeconomics, in macroeconomics, we try to
study the behaviour of aggregate or macro measures of the performance of the economy.
Top Tips
• Raw materials or non-factor inputs purchased for producing goods are intermediate goods.
• Intermediate goods are also called ‘single use producer goods’.
• The expenditure on the intermediate goods is called intermediate cost or intermediate consumption.
Examples:
(i) Steel sheets used for making automobiles and copper used for making utensils are intermediate goods
since they are purchased with the purpose of using them completely during the same year for production
of steel gates/utensils.
(ii) Mobile sets purchased by a mobile dealer are intermediate products because these are purchased for resale.
10 Macroeconomics XII – by Subhash Dey
(iii) Chalks, dusters, etc. purchased by a school are intermediate products because these are used up completely
during the same year in the production of educational services.
(iv) Paper purchased by a publisher is an intermediate product because it is used as raw material for production
of books in the same year.
(v) Purchase of rice by a grocery shop is an intermediate product because it is purchased for resale.
(vi) Coal used by a manufacturing firm is an intermediate product because it is used as a non-factor input for
production of other commodities during the same year.
(vii) Fertilisers used by the farmers are intermediate products because these are used up completely for
producing grains during the same year.
(viii) Cotton used by a spinning mill is an intermediate product because it is used for further production of
clothes during the same year.
Top Tip
National income includes the value of final goods only. The value of intermediate goods is not included in the national
income estimates because it is already included in the value of the final goods. Including intermediate goods separately
will inflate or overestimate the national income.
Top Tip
Basis of classification of final goods into consumption goods and capital goods
The same good can be consumption good and also capital good. It depends on the economic nature of its use. For
example, a machine purchased by a household is a consumption good whereas, if it is purchased by a firm for use in
the business, then it is a capital good. Similarly, a car purchased by a household is a consumption good whereas if it is
purchased by a firm for use in business, then it is a capital good.
Flows
Flows are economic variables measured over a period of time.
National income or Gross domestic product (GDP) or Production or Output, Sales, Savings, Expenditure, Profits,
Losses, Exports, Imports, Net capital formation or net investment, Depreciation, Interest, Change in inventories,
Change in money supply, Value added, etc. are flow variables since they are measured over a period of time.
Top Tip
An example to understand the difference between stock variables and flow variables
Suppose a tank is being filled with water coming from a tap. The amount of water which is flowing into the tank from the
tap per minute is a flow. But how much water there is in the tank at a particular point of time is a stock concept.
Example: Suppose a new machine is purchased for `20 lakh having useful life of service 10 years, after which it
falls into disrepair and needs to be replaced.
Suppose, the scrap value of the machine will be nil after 10 years.
` 20 lakhs − 0
Therefore, Depreciation on the machine = = `2 lakh per year.
10 years
Thus, the machine is gradually used up in each year’s production process and each year 1/10th of its original
value, i.e. `2 lakh gets depreciated. So, instead of considering a bulk investment for replacement after 10 years,
we consider an annual depreciation cost every year.
Note that depreciation does not take into account unexpected/unforeseen obsolescence or sudden destruction or
disuse of capital as can happen with accidents, natural calamities or other such extraneous circumstances. This is
called ‘capital loss’.
* The term ‘investment’ must not be confused with the commonplace notion of investment which implies using money to buy physical or financial
assets. Thus, use of the term investment to denote purchase of shares or property or even having an insurance policy has nothing to do with how
economists define investment.
12 Macroeconomics XII – by Subhash Dey
Top Tip
Depreciation is also defined as:
1. Consumption of fixed capital
2. Value of capital consumption
3. Current annual replacement cost of fixed capital assets
4. Annual replacement investment to keep the value of fixed capital assets constant
5. Annual allowance for normal wear and tear and foreseen obsolescence
6. Annual maintenance and replacement cost of existing capital goods
7. Regular wear and tear of capital
8. Part of capital stock used up in each year’s production process
* In India, Goods and Services Tax (GST) has replaced various indirect taxes, levied by the Central and State/UT Governments. Some of the major
taxes that were levied by Centre were Central Excise Duty, Service Tax, Central Sales Tax, etc. The major State taxes were VAT/Sales Tax, Entry
Tax, Luxury Tax, Octroi, Entertainment Tax, etc. These have been subsumed in GST.
UNIT 1: National Income and Related Aggregates 13
Top Tip
National income includes only factor payments which are received in return for the factor services provided in production
of goods and services.
On the other hand, transfer payment is not included in national income. This is because national income is a measure of
the value of production activity of a country, whereas transfer payment does not involve any production activity.
Change in inventories (or stock) takes place over a period of time. Therefore, it is a flow variable.
Top Tip
Inventory is treated as capital. So, it is a stock variable. On the other hand, change in the inventory of a firm is treated as
investment, i.e., addition to the stock of capital of a firm. So, it is a flow variable.
14 Macroeconomics XII – by Subhash Dey
Top Tip
• Market prices include both Net Product taxes and Net Production taxes.
• Basic prices include net production taxes but not net product taxes.
• Factor cost includes only the payment to factors of production, it does not include any tax.
Key Terms
Final goods—Goods purchased for final consumption, i.e., for satisfaction of wants, or final investment.
Intermediate goods—Goods purchased by a production unit from other production units with the purpose of reselling
or with the purpose of using them completely during the same year.
Consumption goods—The final goods which are consumed (or used) for satisfaction of wants by the consumers.
Capital goods—The final goods of durable character which are used in the production of other goods and services.
Stocks—Economic variables measured at a given point of time, e.g. capital, wealth, etc.
Flows—Economic variables measured over a period of time, e.g. income, output, etc.
Gross investment—That part of final output which comprises of capital goods such as machines.
Depreciation—An annual allowance for normal wear and tear and foreseen obsolescence of a fixed capital asset.
Net investment—New addition to capital stock in an economy is called net investment or net capital formation.
UNIT 1: National Income and Related Aggregates 15
RECAP
Macroeconomics
In macroeconomics, we study the economic behaviour of the economy as a whole, e.g. aggregate demand, aggregate supply,
levels of income, employment and price in the economy.
Final Goods and Intermediate Goods
Goods are classified as final goods and intermediate goods on the basis of the end use.
Final goods are the goods which are used for final consumption (i.e., for satisfaction of wants) or for investment.
Examples: (i) Machine purchased by a firm for installation in factory, (ii) Milk or bread purchased by households, (iii) Printer
purchased by a lawyer for office use, etc.
Intermediate goods (or single use producer goods) are the goods which are purchased during the year by a firm from another
for the purpose of further production or resale.
Examples: (i) Raw materials such as steel sheets used for making automobiles and copper used for making utensils, (ii) Mobile
sets purchased by a mobile dealer, (iii) Chalks, dusters, etc. purchased by a school, (iv) Paper purchased by a publisher, (v)
Purchase of rice by a grocery shop, (vi) Fertilisers used by the farmers, etc.
Consumption Goods and Capital Goods
Consumption goods (or consumer goods) are that part of the final goods which are consumed (or used) for satisfaction of
wants by the consumers, e.g., food, clothing, TV sets, refrigerators, etc.
Capital goods (or investment goods or durable use producer goods) are that part of the final goods which are bought not for
meeting immediate needs of the consumers but are for producing other goods, e.g., machines and equipments. They are of
durable character.
Stocks and Flows
Stocks are economic variables which can be measured at a given point of time, e.g. Capital, Wealth, Money supply, Inventories,
Buildings and machines in a factory, Balance in a bank account, etc.
Flows are economic variables which can be measured over a period of time, e.g, National income or GDP or Production or
Output, Sales, Savings, Expenditure, Profits, Losses, Exports, Imports, Gross/Net capital formation or Gross/Net Investment,
Depreciation, Interest, Change in inventories, Change in money supply or money creation, Value addition, etc.
Gross Investment and Depreciation
Gross investment (or gross capital formation) refers to the addition to capital stock of an economy during an accounting year.
Depreciation is an annual allowance for normal wear and tear and foreseen obsolescence of a fixed capital asset. Depreciation
is also defined as value of consumption of fixed capital or annual maintenance and replacement cost of fixed capital assets.
Cost of fixed capital asset - Scrap value after its useful life
Depreciation on fixed capital asset =
Estimated useful life of the fixed capital asset (in years)
Note: Unexpected/unforeseen obsolescence or sudden destruction of capital assets is not depreciation. It is called capital loss.
Net investment (or net capital formation) is the new addition to capital stock in an economy. A part of the capital goods produced
goes for maintenance or replacement of existing capital goods. Thus, Net Investment = Gross investment – Depreciation.
Indirect Tax and Subsidy
Indirect tax is a tax imposed by government on production and sale of goods and services. Examples: Goods and services tax
(GST), excise tax, etc. Indirect taxes increase market prices of goods and services.
Subsidy is a form of financial/economic assistance given by the government to the firms and households, with a motive of
general welfare. Examples: Cash grants, interest-free loan to the firms, subsidy on price of cooking gas to the households, etc.
Subsidies reduce the market prices of goods and services.
Net indirect tax = Indirect taxes – Subsidies
Market Price and Factor Cost
Market price is what the buyers pay. It includes indirect taxes but excludes subsidies.
Factor cost is what is actually available to production units. Factor cost = Market price – Indirect taxes + Subsidies
Factor Income and Transfer Income
The payment for the services rendered to the production units by the owners of factors of production is called factor payment
or factor income, e.g. wages and salary, rent, interest profit, etc.
Any payment for which no service is rendered is called a transfer payment or transfer income. It does not involve any production
of goods and services. Examples: Gifts, donations, charity, etc.
Inventory and Change in Inventories
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.
Net change (or increase) in inventories = Closing inventory – Opening inventory
16 Macroeconomics XII – by Subhash Dey
Numerical 1
Do it yourself 1
If a machine costing `2,00,000 has a useful life of 5 years with no scrap value, calculate the value of the machine which
is being gradually used up in each year’s production process. (3 marks)
[Ans. `40,000]
1. The good or service purchased by an individual or an enterprise is for : (Choose the correct alternative)
(a) Final use (b) Use in further production
(c) Both (a) and (b) (d) Consumption
2. A good that is meant for final use and will not pass through any more stages of production or transformations at the hands
of any producer is called __________ . (Fill in the blank)
3. A final good may also undergo transformations. True/False? Give reason.
4. It is not in the nature of the good but in the _______ that a good becomes a final good. (Fill in the blank)
5. If tea leaves are used in a restaurant for tea brewing , and the drinkable tea is sold to the customers, then the tea leaves
will be________________. (Choose the correct alternative)
(a) Final goods (b) Intermediate good
(c) Consumption goods (d) Capital goods
6. Final goods are: (Choose the correct alternative)
(a) Consumption goods (b) Capital goods
(c) Both (a) and (b) (d) Intermediate goods
7. Goods like food and clothing and services like recreation that are consumed when purchased by their ultimate consumers
are called ________________. (Fill in the blank)
8. Goods of durable character which make production of other commodities feasible but they themselves don’t get
transformed in the production process, are called ________________. (Fill in the blank)
9. The durable goods which undergo wear and tear with gradual use, and thus are repaired or gradually replaced over time
are : (Choose the correct alternative)
(a) Intermediate goods (b) Capital goods
(c) Consumer durables (d) Both (b) and (c)
10. All the final goods and services produced in an economy in a given period of time are either in the form of ________________
or __________ . (Fill in the blanks)
11. Of the total production taking place in the economy, a large number of products don’t end up in final consumption and are
not capital goods either. These are ________________. (Fill in the blank)
12. Raw materials or non-factor inputs used for production of other commodities are: (Choose the correct alternative)
(a) Capital goods (b) Final goods
(c) Intermediate goods (d) Consumer durables
13. Income, or output, or profits are concepts that make sense only when a time period is specified. These are called
___________. (Fill in the blank)
14. (i) ______________ (Stock / Flows) are defined over a period of time, whereas (ii) ______________ (Stock / Flows) are
defined at a particular point of time. (Choose the correct option)
15. Capital goods (e.g. buildings or machines in a factory) or consumer durables (e.g. television sets, home computers, etc)
once produced do not wear out or get consumed in a delineated time period. In fact, capital goods continue to serve us
through different cycles of production. There can be addition to, or deduction from, these if a new machine is added or a
machine falls in disuse and is not replaced. These are called ____________ . (Stock / Flows) (Choose the correct option)
16. Change in stocks are _____________. (Stocks / Flows). (Choose the correct option)
17. Suppose a tank is being filled with water coming from a tap. The amount of water which is flowing into the tank from
the tap per minute is a (i) _________________ (Stock concept / Flow concept). But how much water is in the tank is a
(ii) _________________ (Stock concept / Flow concept). (Choose the correct option)
18. The part of final goods that comprises of capital goods constitutes ______________ of an economy. (Fill in the blank)
19. All the capital goods produced in a year do not constitute net addition to the capital stock already existing.
True / False? Give reason.
20. A part of the capital goods produced this year goes for replacement of existing capital goods and is not an addition to
the stock of capital goods already existing and its value needs to be subtracted from gross investment for arriving at the
measure of net investment. This deletion, which is made from the value of gross investment in order to accommodate
regular wear and tear of capital is called __________ . (Fill in the blank)
18 Macroeconomics XII – by Subhash Dey
(ii) Indians going abroad for medical treatment are residents of India. Normally, visit for medical treatment
is a short period visit.
(iii) Foreign tourists who visit India for recreation, holidays, medical treatment, study, sports, conferences,
etc. are not residents of India, e.g. foreign tourists visiting India to see the Taj Mahal. Normally, visit to
see historical monuments like Taj Mahal is a short period visit.
(iv) Indian officials working in the Indian Embassy in USA are not residents of India because although they
are living within the domestic territory of India but they do not carry out the basic economic activities of
earnings, spending and accumulation in India.
(v) Americans working in Indian embassy in America are not residents of India, but residents of America
because they live in America.
Top Tip
Resident versus Citizen
Note that citizen and resident are two different terms. This does not mean that a citizen is not a resident, and a resident
not a citizen. A person can be a citizen as well as a resident, but it is not necessary that a citizen of a country is necessarily
the resident of that country. A person can be a citizen of one country and at the same time a resident of another country.
For example a NRI, Non-resident Indian. A NRI is citizen of India but a resident of the country in which he lives.
Citizenship is basically a legal concept based on the place of birth of the person or some legal provisions allowing a person
to become a citizen. On the other hand, residentship is basically an economic concept based on the basic economic
activities performed by a person.
(v) Yes, it will be included as it is part of Factor Income earned in domestic territory of India, though earned
by non-resident.
(vi) No, as profits are not earned within the domestic territory of India. It is factor income from abroad.
National product
National product includes production activities of residents irrespective of whether performed within the
economic territory or outside it.
Gross National Product (GNP), Net National Product (NNP) are some examples.
Illustrative example:
Will the following be included in Gross National Product (GNP)? Give reasons.
(i) Profits earned by a foreign company or a foreign bank in India
(ii) Salary paid to Americans working in Indian Embassy in America
(iii) Salaries received by Indian residents working in Russian Embassy in India
(iv) Dividend received by an Indian from his investment in shares of a foreign company
Answers:
(i) No, because it is a factor income earned by a non-resident (a foreign company or a foreign bank) from its
contribution to production inside the domestic territory of India, i.e., factor income paid to abroad.
(ii) No, because this factor income is paid to non-residents, i.e., factor income to abroad.
(iii) Yes, because it is a factor income earned by Indian residents outside the domestic territory of India i.e.,
factor income from abroad.
(iv) Yes, because it is a factor income earned by a resident from outside the domestic territory of India, i.e.,
factor income from abroad.
Top Tip
It can be realised that a factor income which is included in domestic factor income of India may not be included in
national income. For example, profits earned by a branch of a foreign bank in India will be included in the domestic factor
income of India because these profits are earned within the domestic territory of India. However, it will not be included
in national income of India as it is a factor income paid to abroad. (Foreign Bank is not a resident of India.)
Similarly, an income which is included in national income may not be included in the domestic factor income. For example,
salaries received by Indian residents working in Russian Embassy in India will be included in the national income as it is
residents’ contribution to production, though outside the domestic territory of India. However, it will not be included in
domestic income since this income is earned outside the domestic territory of the country i.e. factor income from abroad.
'Factor income received from abroad' is added to domestic product because this contribution of residents
is in addition to their contribution to domestic product.
'Factor income paid to abroad' is subtracted because this part of domestic product, does not belong to
the residents.
By subtracting "factor income paid to abroad" from "factor income received from abroad", we get a net figure
"Net factor income from abroad" popularly abbreviated as NFIA.
National product = Domestic product + Net factor income from abroad (NFIA)
Top Tip
Calculation of NFIA in different cases:
1. If factor income from abroad = `1000 crore and factor income to abroad = `800 crore, then
NFIA = 1000 – 800 = `200 crore
2. If factor income from abroad = `700 crore and factor income to abroad = `1100 crore, then
NFIA = 700 – 1100 = (–) `400 crore
3. If factor income to abroad = `200 crore and factor income from abroad is not given, then we assume that factor
income from abroad is zero. Therefore, NFIA = 0 – 200 = (–) `200 crore
4. If factor income to abroad = (–) `300 crore and factor income from abroad is not given, then we assume that factor
income from abroad is zero. Therefore, NFIA = 0 – (–)300 = `300 crore
5. If factor income from abroad = (–) `50 crore and factor income to abroad is not given, then we assume that factor
income to abroad is zero. Therefore, NFIA = –50 – 0 = (–) `50 crore
Key Terms
Domestic territory (or economic territory)—The geographical territory administered by a government within which
persons, goods and capital circulate freely.
Resident—A person or an institution whose centre of economic interest lies in the domestic territory of the country in
which he lives.
Domestic product—It includes production activity of the production units located in the economic territory irrespective
of whether carried out by the residents or non-residents.
National product—It includes production activities of residents irrespective of whether performed within the economic
territory or outside it.
Factor income received from abroad—Resident’s contribution to production outside the economic territory of the
country.
Factor income paid to abroad—Non-resident’s contribution to production inside the economic territory.
Net factor income from abroad (NFIA)—Difference between factor income from abroad and factor income to abroad.
UNIT 1: National Income and Related Aggregates 25
RECAP
1. Which of the following is within the domestic territory of India? (Choose the correct alternative)
(a) State Bank of India in UK (b) Google office in India
(c) Office of Tata Motors in USA (d) Russian Embassy in India
2. Foreign embassies in India are a part of India’s : (Choose the correct alternative)
(a) Economic territory (b) Geographical territory
(c) Both (a) and (b) (d) None of the above
3. Out of the following, who are residents of India? (Choose the correct alternative)
(a) Indians working permanently in the office of the United Nations Organisation in New York
(b) Indians working in Indian Embassy in America
(c) Indians working in a branch of an American Bank in India
(d) Americans working in India embassy in America
4. Which of the following will be included in gross national product of India? (Choose the correct alternative)
(a) Profits earned by a foreign company in India
(b) Salary paid to Americans working in Indian Embassy in America
(c) Salaries received by Indians working in Russian Embassy in India
(d) Salaries received by Indians working in Indian Embassy in Korea
5. National income is the sum of factor incomes accruing to: (Choose the correct alternative)
(a) Nationals (b) Economic territory
(c) Residents (d) Both residents and non-residents
26 Macroeconomics XII – by Subhash Dey
6. Which of the following will be included in Gross Domestic Product (GDP) of India? (Choose the correct alternative)
(a) Rent received by an Indian resident from his property in Singapore
(b) Salaries received by Indian residents working in Russian embassy in India
(c) Profits earned by a branch of State Bank of India in Japan
(d) Profits earned by standard Chartered Bank in India
7. Factor income earned by the domestic factors of production employed in the rest of the world – Factor income earned by the
factors of production of the rest of the world employed in the domestic economy = ? (Choose the correct alternative)
(a) Net exports (b) Net factor income from abroad
(c) Net compensation of employers (d) Net retained earnings
8. National income is always more than the domestic income. True/False? Give reason.
9. Wages earned by a citizen of India working in Saudi Arabia will be included in GDP of India. True/False? Give reason.
10. Profits earned by the Korean-owned Hyundai car factory in India will be included in National income of India. True/False?
11. GDP can be greater than GNP. True/False? Give reason.
Aggregate value of final goods and services produced = Aggregate factor payments
In this simplified economy, there is only one way in which the households may dispose off their earnings – by
spending their entire income to buy the goods and services produced by the firms. Households do not save,
they do not pay taxes to the government – since there is no government, and neither do they buy imported
goods since there is no external trade in this simple economy. So, households buy goods and services from
firms for which they make payment to the firms. Thus, consumption expenditure (i.e., spending on goods and
services) flows from households to the firms, making the circular flow of income complete. Hence, circular flow
of income in a two sector economy is based on the axiom that one’s expenditure is other’s income.
The entire income of the economy, therefore, comes back to the producers in the form of sales revenue. There is
no leakage** from the circular flow of income.
Aggregate factor payments = Aggregate final expenditure on purchase of goods and services
Note that the same amount of money is moving in a circular way. Thus, national income can be calculated by
three methods, which give us the same value.
1. Production method: Product method measures aggregate value of final goods and services produced by
all the firms in the economy during a year (Annual flow at A).
2. Income method: Income distribution method measures aggregate factor payments made in the economy
during a year (Annual flow at B).
3. Expenditure method: Expenditure method measures the aggregate final expenditure on goods and
services in the economy during a year (Annual flow at C).
Top Tip
Nominal Flow and Real Flow
• Nominal Flow/Money Flow is the flow of factor payments and payments for goods and services between households
and firms.
• Real Flow is the flow of factor services and the flow of goods and services between households and firms.
* Closed economy is one that does not trade with other nations in goods and services, and in financial assets.
** Leakages refer to withdrawal of money from the circular flow of income. It is that part of income, which does not pass through the circular flow.
For example, savings, taxes and imports are leakages from the circular flow of income.
28 Macroeconomics XII – by Subhash Dey
RECAP
Value added of a firm = Value of output produced by the firm – Cost of intermediate goods used
The value added of a firm is distributed among its four factors of production, namely, labour, capital,
entrepreneurship and land. Therefore wages, interest, profits and rents paid out by the firm must add up to the
value added of the firm. Value added is a flow variable.
We can represent the example given above in terms of the following Table.
Farmer Baker
Value of output 100 200
Intermediate consumption 0 50
Value added 100 200 – 50 =150
(a) If a firm had no initial unsold stock in the beginning of the year:
Value of output produced = Sales + Value of unsold stock
Top Tip
Intermediate consumption = Purchase of raw materials etc. + Imports of raw materials etc.
In our example of farmers and bakers, the Value Added by farmers and bakers are their Gross Value Added at
market price (GVAmp).
GVAmp of a firm = Value of output – Intermediate consumption
Now, if we sum the GVAmp of all the firms in all the sectors of the economy, we get Gross Domestic Product
at market price (GDPmp).
GDPmp = Value of output of all the firms in the economy – Intermediate costs
GDPmp is the money value of all final goods and services produced within the domestic territory of a country
during an accounting year. All production done by the national residents or the non-residents in the domestic
territory of the country gets included, regardless of whether that production is owned by a local company or a
foreign entity. Everything is valued at market prices.
UNIT 1: National Income and Related Aggregates 31
Top Tip
32 Macroeconomics XII – by Subhash Dey
Key Terms
Value of output — It is the market value of goods and services produced by a firm during an accounting year.
Double counting — The problem of double counting arises when the value of same goods and services are counted
more than once while estimating national income.
Value added/value addition — It is the difference between value of output and intermediate consumption.
Gross Domestic Product (GDP) — It is the money value of all final goods and services produced within the domestic
territory of a country during an accounting year.
NDP at factor cost — It is the income earned by the factors in the form of wages, profits, rent, interest, etc., within the
domestic territory of a country. It is also called net domestic factor income or domestic income.
National Income (NI)/NNP at factor cost — It is the sum of factor incomes earned by the normal residents in the form
of wages, profits, rent and interest, etc., during an accounting year within the domestic territory or abroad.
RECAP
1. Though intermediate goods are crucial inputs to any production process, yet we measure final goods only. This is because
_________________. (Complete the sentence)
2. Match the following:
(a) Inventories (i) Investment
(b) Change in inventories (ii) Capital
3. __________ is what production units actually receive for distribution of income among the owners of factors of
production. (Choose the correct alternative)
(a) GDPmp (b) NDPfc
(c) NNPfc (d) NNPmp
4. The problem of ‘Double counting’ can be avoided by __________. (Choose the correct alternative)
(a) counting only value added (b) counting only value of final products
(c) not counting value of intermediate products (d) All of these
34 Macroeconomics XII – by Subhash Dey
5. Market price and factor cost will be equal when there is: (Choose the correct alternative)
(a) No direct tax (b) No indirect tax
(c) No subsidy (d) No indirect tax and no subsidy
6. Market price is always more than factor cost. True/False? Give reason.
7. Goods produced for self-consumption will be included in national income. True/False? Give reason.
8. Counting intermediate goods separately will lead to the error of ____________ , which will highly exaggerate the
____________ . (Fill in the blanks)
9. In a simple economy, suppose there are only two producers/firms — the farmers who produce wheat and the bakers, i.e.
the bread makers. The total value of wheat produced by the farmers is `100, for which they do not need any input other
than human labour. Out of this, the farmers have sold `50 worth of wheat to the bakers, who have used it completely
during the year and have produced `200 worth of bread. The aggregate value of final goods produced by this simple
economy will be : (Choose the correct alternative)
(a) `300 (b) `250
(c) `350 (d) `200
10. Match the following:
(a) Net contribution made by a firm (i) Value of output
(b) Raw materials that a firm buys from (ii) Intermediate goods
another which are completely used up (iii) Value added
in the process of production.
11. Value of production of a firm – value of intermediate goods used by the firm = ____________. (Fill in the blank)
12. Value added is a flow variable. True/False? Give reason.
13. To calculate the net contribution made by a firm, we need to deduct (i) ___________ from the value of production. If we
do not do this, we shall commit the mistake or error of (ii) __________. (Fill in the blanks)
14. A firm produces `100 worth of goods per year, `20 is the value of intermediate goods used by it during the year and `10
is the value of capital consumption. The net value added will be: (Choose the correct alternative)
(a) `100 (b) `80
(c) `70 (d) `130
15. Match the following:
A firm buys raw materials from other firms.
(a) The part of raw materials which gets (i) Intermediate good.
used up in the same year. (ii) Final good
(b) The part of raw material which (iii) Inventory
does not get used up. (iv) Value added
16. In economics, ‘inventory’ includes the stock of unsold finished goods only. True/False? Give reason.
17. Match the following:
(i) If the value of inventories at the end of the (a) Inventories have increased
year is higher than that at the beginning of the year. (or accumulated)
(ii) If the value of inventories is less at the end (b) Inventories have decreased
of the year compared to the beginning of the year (or decumulated)
18. Production of a firm during a year – Sales of the firm during the year = ___________ ? (Fill in the blank)
19. In case of an unexpected fall in sales, there will be _________________ of inventories.
(unplanned accumulation / unplanned decumulation) (Fill in the blank with correct option)
20. In case, there is unexpected rise in sales, there will be ___________________ of inventories.
(unplanned accumulation / unplanned decumulation) (Fill in the blank with correct option)
21. Suppose a firm produces shirts. It starts the year with an inventory of 100 shirts. During the coming year it expects to sell
1,000 shirts. Hence, it produces 1,000 shirts, expecting to keep an inventory of 100 shirts at the end of the year. However,
during the year, the firm could sell only 600 shirts. The unexpected rise of inventories by ________ units is an example of
_________ inventories. (Fill in the blank)
22. A firm produces computers. It has opening inventory of 100 computers. During the coming year it expects to sell 1,000
computers. Hence, it produces 1,000 computers expecting to keep an inventory of 100 at the end of the year. But the sales
during the year is 1,050 computers. The reduction in inventory by ____________ computers is called ______________ of
inventories. (Fill in the blanks)
UNIT 1: National Income and Related Aggregates 35
23. A firm wants to raise the inventories from 100 to 200 shoes during the year. Expecting sales of 1,000 shoes during the
year, the firm produces 1,100 shoes. The sales are actually 1,000 shoes and the firm ends up with an inventory of 200
shoes. This rise in inventories is called _____________ (Planned accumulation of inventories/ unplanned accumulation of
inventories). (Fill in the blank with correct option)
24. A firm wants to reduce the inventories from 100 to 25 mobile phones. Expecting sales of 1,000 mobile phones during the
year, the firm produces 925 mobile phones. The sales turn out to be 1,000 as expected by the firm and the firm ends up
with an inventory of 25 mobile phones. This reduction in inventories is called ____________________.
(Planned decumulation of inventories / Unplanned decumulation of inventories). (Fill in the blank with correct option)
25. The sum total of gross value added of all the firms in the economy is called ______________. (Fill in the blank)
26. Sales by a firm includes sales to domestic buyers only. True/False? Give reason.
27. To calculate GVA at factor cost from GVA at market prices, which of the following is deducted : (Choose the correct alternative)
(a) Net product taxes (product taxes – product subsidies)
(b) Net production taxes (production taxes – production subsides)
(c) Both (a) and (b)
(d) Net factor income from abroad.
28. Production taxes are paid per unit of production. True/False? Give reason.
29. Excise tax, service tax, export and import duties, etc are product taxes. True/False? Give reason.
30. Basic prices include both product taxes (less product subsidies) and production taxes (less production subsidies).
True/False? Give reason.
31. __________ measures the aggregate production of final goods and services taking place within the domestic territory of
the country during a year. (Fill in the blank)
32. A part of the capital which gets consumed during the year due to wear and tear is called _________. If we deduct it from
GNP the measure of aggregate income we obtain is called __________. (Fill in the blanks)
33. Depreciation is deducted from GDP while calculating national income because ______________. (Fill in the blank)
34. Market prices include: (Choose the correct alternative)
(a) Subsidies (b) Indirect taxes
(c) Intermediate consumption (d) Depreciation
35. _____________ are deducted and ______________ are added from NNP at market prices in order to calculate that part
of NNP which actually accrues to the factors of production. (Fill in the blanks)
36. Indirect taxes are deducted from NNP at market prices to calculate national income because _________.
(Complete the sentence)
37. That part of NNP which actually accrues to the owners of factors of production is called ___________ . (Fill in the blank)
38. GDPmp includes market value of all final goods and services produced by the normal residents or the non-residents in a
country. True/False? Give reason.
39. The prices of products as received by the owners of factors of production is called _____________ . (Fill in the blank)
40. ______________ is the value of all the final goods and services that are produced by the normal residents of India and
is measured at the market prices, in a year, regardless of whatever they are located within the economic territory or
abroad. (Fill in the blank)
41. _______________ measures value of output received by the factors of production belonging to a country in a year of (in
domestic territory or abroad). (Choose the correct alternative)
(a) GNP at market price (b) GNP at factor cost
(c) GDP at market price (d) GDP at factor cost
42. This is a measure of how much a country can consume in a given period of time. It measures output regardless of where
that production has taken place (in domestic territory or abroad). (Choose the correct alternative)
(a) GNP at market price (b) GDP at market price
(c) NNP at market price (d) NDP at market price
43. It is the net domestic factor income added with the net factor income from abroad. (Choose the correct alternative)
(a) GNP at market price (b) GNP at factor cost
(c) NNP at market price (d) NNP at factor cost
44. ______________ is the sum of income earned by all factors of production in the form of wages, profits, rent and interest,
etc, belonging to a country during a year (in the domestic territory or abroad). (Fill in the blank)
36 Macroeconomics XII – by Subhash Dey
Numerical 2
Suppose in an imaginary economy GDP at market price in a particular fiscal year was `4000 crore, National Income
was `2500 crore, Net Factor Income paid by the economy to Rest of the World was `400 crore and the value of Net
Indirect Taxes is `450 crore. Estimate the value of consumption of fixed capital for the economy from the given data.
(NCERT) (3 marks)
Solution: National Income (NNPfc) = GDPmp – Consumption of fixed capital – Net indirect taxes + NFIA
2500 = 4000 – Consumption of fixed capital – 450 + (–)400
Consumption of fixed capital = 4000 – 450 – 400 – 2500 = `650 crore
Note: Net factor income paid by the economy to rest of the world = `400 crore. Therefore, NFIA = (–) `400 crore
Do it yourself 2
GNPmp of an imaginary economy is `120000 crore and its capital stock is worth `300000 crore. If capital stock
depreciates @ 20% per annum, indirect taxes amount to `30000 crore and subsidies are put at `15000 crore. What
is national income? (3 marks)
[Ans. `45000 crore]
UNIT 1: National Income and Related Aggregates 37
Numerical 3
Do it yourself 3
From the following data, calculate the value added by firm A and firm B. (3 marks)
S. No. Items (` in lakh)
(i) Closing stock of firm A 20
(ii) Closing stock of firm B 15
(iii) Opening stock of firm A 5
(iv) Opening stock of firm B 10
(v) Sales by firm A 300
(vi) Purchases by firm A from firm B 100
(vii) Purchases by firm B from firm A 80
(viii) Domestic sales by firm B 250
(ix) Import of raw material by firm A 50
(x) Exports by firm B 30
Numerical 4
In a single day, Raju, a barber, collects `500 from haircuts. Over this day, his equipment depreciates in value by `50.
Of the remaining `450, Raju pays sales tax `30, takes home `200 and retains `220 for improvement and buying of
new equipment. He further pays `20 as income tax.
Based on this information, calculate Raju's contribution to GDP, NDP and National Income. (3 marks)
Solution: Raju's contribution to:
(i) GDP = Value of haircuts service produced by him = `500
(ii) NDP = GDP – Depreciation of equipment
= 500 – 50 = `450
(iii) National Income (NNP at factor cost) = NDP – Sales Tax
= 450 – 30 = `420
38 Macroeconomics XII – by Subhash Dey
Do it yourself 4
From the following data about a firm, calculate the firm’s net value added at factor cost. 3 marks
Numerical 5
Note:
1. Sales = Output sold × Price per unit = 2,000 units × `10 = `20,000
2. Import of raw materials is already included in Purchase of raw materials. Import of machines is not included in
intermediate consumption.
3. Net product taxes = Product taxes – Product subsidies = 400 – 100 = `300
UNIT 1: National Income and Related Aggregates 39
Do it yourself 5
Numerical 6
Solution:
Particulars (` in lakh)
Sales 20
(+) Unsold output 2
Value of output 22
(–) Intermediate consumption (Single use producer goods) (–) 5
GVA at market prices 17
(–) Depreciation (note) (–) 1
(–) Net indirect taxes (–) 1
GVA at factor cost 15
Do it yourself 6
Numerical 7
Do it yourself 7
Numerical 8
Calculate (a) Gross Domestic Product at Market Price and (b) National Income. (6 marks)
S. No. Items (` in crore)
(i) Value of output
(a) Primary sector 800
(b) Secondary sector 200
(c) Tertiary sector 300
(ii) Cost of intermediate inputs
(a) Primary sector 400
(b) Secondary sector 100
(c) Tertiary sector 50
(iii) Indirect taxes paid by all sectors 50
(iv) Consumption of fixed capital of all sectors 80
(v) Factor income received by the residents from rest of the world 10
(vi) actor income paid to non-residents 20
(vii) Subsidies received by all sectors 20
UNIT 1: National Income and Related Aggregates 41
Solution:
Particulars (` in crore)
Value of output of all sectors (note 1) 1300
(–) Cost of intermediate inputs purchased by all sectors (note 2) (–)550
(a) Gross Domestic Product at Market Price (GDPmp) 750
Adjustments:
(–) Consumption of fixed capital of all sectors (–)80
(–) Indirect taxes paid by all sectors (–)50
(+) Subsidies received by all sectors 20
(+) Net factor income from abroad (NFIA) (note 3) (–)10
(b) National Income (NNPfc) 630
Note: 1. Value of output of all sectors = Value of output of primary, secondary and tertiary sectors
= 800 +200 + 300 = `1300 crore
2. Cost of intermediate inputs purchased by all sectors = 400 +100 + 50 = `550 crore
3. NFIA = Factor income received by the residents from rest of the world – Factor income paid to non-residents
= 10 – 20 = (–) `10 crore
Do it yourself 8
From the following data calculate the (a) Gross National Product at Market Price (b) National Income. 3 marks
Top Tip
ontribution to provident fund or insurance premium paid by employees is not included in national income because it is
C
paid out of compensation of employees, which is already included.
Similarly, compensation given by insurance company to an injured worker is not included as compensation is given by
insurance company to the employee, and not by employer.
Also, gifts received from employer, e.g. festival gift, gifts on independence day, etc. is not included in national income as
it is a transfer payment.
2. Operating surplus: Operating surplus is defined as the sum of rent, royalty, interest and profits.
Operating surplus can also be termed as 'Income from property and entrepreneurship', i.e.
incomes earned by property owners. It includes rent and royalty, profit and interest.
(a) Rent is defined as the amount receivable by a landlord from a tenant for the use of land.
(b) Royalty is defined as the amount receivable by the owner for granting the leasing rights of
sub-soil assets, e.g., royalty income received by an author of a book from the publisher.
(c) Interest is defined as the amount payable to the owners of financial assets in the production
unit. The production unit uses these assets for production and in turn makes interest
payment, imputed or actual.
Top Tip
Payment of interest by banks to its depositors or Payment of interest by a firm (government firm or a private firm) to
households or Payment of interest by a firm to a bank is included in national income because it is factor payment. The
borrowed money is used for carrying out production of goods and services.
However, payment of interest on a loan taken by an employee from the employer or payment of interest by an individual
to a bank on a loan to buy a car or interest received on loans given to a friend for purchasing a car will not be included in
national income because the individual is a consumer, and the loan is taken to meet consumption expenditure. There is
no contribution to production of goods and services. Therefore, it is not a factor payment.
(d)
Profit is a residual factor payment by the production unit to the owners of the production
unit. The production unit uses profit for (i) payment of corporation tax to the government,
(ii) dividend payments to the owners of the production unit, and (iii) undistributed profits/
retained earnings for investment in new projects and ventures.
Profits = Corporation tax
+ Dividend
+ Undistributed profits/Retained earnings/savings of private corporate sector
or, Profits = Corporate profit tax + After-tax profit
(Note: After-tax profit = Dividend + Retained earnings)
Top Tip
Payment of corporate tax by a firm is also not included in national income as it is a transfer payment. Corporate tax
is already included in profits. Corporate tax accrues to the government. It is not received by the owners of factors of
production. Hence, it is not a factor income.
UNIT 1: National Income and Related Aggregates 43
3. Mixed income of self-employed: The income of self employed people like doctors, chartered
accountants, consultants, etc. has two or more factor incomes. For example, a doctor’s income
may consist of salary from a hospital, fees earned by him from the patients in his own clinic, rental
income from his property, and profits of a business owned by him. In such cases, total income is
estimable, but not its different components. So, mixed income of self-employed is another factor
payment, which is added to the national income.
NDPfc = Compensation of employees + Operating surplus + Mixed income
Top Tip
The main source of factor payments are the accounts of production units. Since accounts of most production units are not
available to the estimators, and also since the accounting practices differ, it is not possible for the estimators to clearly identify
the components. Therefore, in cases where total factors payment is estimable but not its different components, an additional
factor payment item called 'mixed income' is added. Since this problem arises mainly in case of self employed people like
doctors, chartered accountants, consultants, etc, this factor payment is popularly called "mixed income of the self-employed".
Step 3: Once we estimate NDPfc, we can find NNPfc (national income) by adding NFIA to it.
National income (NNPfc) = NDPfc + NFIA
Top Tip
Components of National Income by Income Method are:
(i) Compensation of employees (ii) Operating surplus
(iii) Mixed income of self-employed (iv) Net factor income from abroad (NFIA)
National income (NNPfc) = Compensation of employees + Operating surplus + Mixed income + NFIA
11. Contribution to provident fund or No, it is not included in Because it is paid out of compensation of
insurance premium paid by employees national income. employees, which is already included.
12. Compensation given by insurance No, it is not included in As compensation is given to the employee
company to an injured worker. national income. by insurance company, not by employer.
13. Salaries paid to Russians working in It will be included in As it is a factor income paid to abroad.
Indian Embassy in Russia. domestic income of India It is subtracted from domestic income to
(since the factor income is get national income.
earned within the domestic
territory). But it will not be
included in national income
of India.
14. Imputed rent of self occupied houses. Yes, it will be included in the Because self-occupied houses provide
national income. housing services similar to those as
rented houses.
15. Earnings of shareholders from the sale No, it will not be included Because financial assets (shares, bonds,
of shares. in the national income. etc.) are neither goods nor services, and
do not contribute to any production of
goods and services.
16. Capital gains to Indian residents from No, capital gains from sale of As they do not add to the current flow of
sale of shares of a foreign company. shares will not be included in goods and services in the economy.
national income.
17. Money received from sale of second- No, it will not be included Because sale of second hand goods is
hand goods/ Money received from sale in national income. not a fresh production transaction. So
of old house or old car. any income arising to the owners of
such goods is not a factor income, but a
capital gain.
18. Commission received by a dealer from Yes, it will be included in As it is a factor income because any
the buyer and seller of a house. national income. commission paid to facilitate the sale of
house is a fresh production activity.
19. Prize won in a lottery No, it will not be included Because it is a windfall gain, not a factor
in national income. income.
20. Receipts from sale of land No, it will not be included As land is a free gift of nature and cannot
in national income. be produced.
21. Profit earned by foreign banks in India. It will be included in domestic As it is a factor income paid to abroad.
income of India (since the It is subtracted from domestic factor
factor income is earned within income to get national income.
the domestic territory). But
it will not be included in
national income of India.
22. Profits earned by an Indian bank from Yes, it will be included in As it is a factor income from abroad.
its branches abroad. national income.
23. Dividend received by a foreigner from No, it will not be included As it is a factor income paid to abroad.
investment in shares of an Indian company. in national income.
24. Dividend received by shareholders. Yes, it will be included in As it is a part of the profits of production
national income. units, which is distributed to the owners.
Hence, it is a factor income.
25. Rent received by Indian residents on Yes, it will be included in This factor income is earned by the
their buildings rented out to foreigners national income. residents.
in India.
26. Royalty Yes, it will be included in As royalty is a productive income.
national income.
46 Macroeconomics XII – by Subhash Dey
Key Terms
Compensation of employees — It is defined as the total remuneration in cash or in kind, payable by the employers
to employees in return for work done by them during an accounting year. It includes (a) Wages and salaries in cash
and in kind and (b) Employers’ contribution in social security schemes.
Operating surplus — Operating surplus is defined as the sum of rent, royalty, interest and profits.
Income from property and entrepreneurship — are incomes earned by property owners. It includes rent and royalty,
profit and interest. It can also be termed as operating surplus.
Mixed Income — Income of self-employed people like doctors, chartered accountants, consultants, etc. has two
or more factor incomes. Total income is estimable, but not its different components. So, mixed income is added to
national income.
RECAP
1. Which of the following will be included in national income? (Choose the correct alternative)
(a) Money receipt from sale of old car (b) Scholarships received by students
(c) Remittances from abroad (d) Free services of owner occupied building
2. Which of the following transactions is not included in national income? (Choose the correct alternative)
(a) Payment of interest by a private firm
(b) Payment of interest by banks on deposits
(c) Interest paid by an individual on a car loan taken from a bank
(d) Interest on finance provided by the owners of the production units
3. Which one of the following is not included in compensation of employees? (Choose the correct alternative)
(a) Payment of bonus by a firm to its employees (b) House rent allowance by the employer
(c) Free medical facilities by the employer (d) Festival gift from an employer
4. Which of the following is not included in compensation of employees? (Choose the correct alternative)
(a) Wages and salaries in cash (b) Wages and salaries in kind
(c) Employees’ contribution to social security schemes (d) Employers’ contribution to social security schemes
5. Broker’s commission on sale and purchase of second hand goods is included in national income because:
(Choose the correct alternative)
(a) It is a part of compensation of employees
(b) It is a part of gross domestic capital formation
(c) It is an income earned for rendering productive services
(d) None of these
6. Which of the following will be included in national income? (Choose the correct alternative)
(a) Financial transactions (b) Sale of old goods
(c) Illegal activities (d) Production of goods and services
7. Which of the following transactions is not included in national income? (Choose the correct alternative)
(a) Brokerage paid to broker for facilitating sale of second hand goods
(b) Payment of corporation tax by a firm
(c) Interest on finance provided by the owners of the production units
(d) Interest paid by banks on deposits by individuals
8. Wages, interest, profits and rents paid out by the firm must add up to _________ of the firm. (Fill in the blank)
9. Prizes received by the household from government and firms are included in National Income. True/ False? Give reason.
10. Payment of interests by households to the firm and the government as well, in case they hold borrowed money from
either, will be included in National Income. True/ False? Give reason.
11. A part of profit which is distributed among the factors of production is called _____________ . (Fill in the blank)
12. _____________ is the income earned by the factors of production in the form of wages, profits , rent interest, etc, within
the domestic territory of a country. (Fill in the blank)
2. How will you treat the following in the calculation of Net Domestic Product (NDP) of India? Give reasons
for your answer.
(a) Factor income from abroad.
(b) Remittances from non-resident Indians to their families in India. (3 marks)
Ans. (a) No, it is not included in NDP of India because the factor income is earned outside the domestic territory
of India.
(b) No, it is not included in NDP of India because it is a transfer income from abroad.
3. Are the following items part of compensation of employees? Give reasons for your answer.
(i) Entertainment allowance to an employee to entertain business guests.
(ii) Employers’ contribution to gratuity fund of the employees.
(iii) Employees’ contribution to provident fund.
(iv) Payment of insurance claim by LIC to the injured worker.
(v) Old age pension to an employee.
(vi) Medical expenses of a firm on treatment of an employee’s family. (6 marks)
Ans. (i) It is not a part of compensation of employees because it is paid for the benefit of business and not for the
employee. It is an intermediate expenditure.
(ii) It is a part of compensation of employees because such contribution is for the benefit of the employees and
is paid for their productive services.
(iii) It is not a part of compensation of employees because such contribution is made by an employee from his
wages/salary.
(iv) It is not a part of compensation of employees because it is not paid by the employer, but by LIC.
(v) It is not a part of compensation of employees because it is paid to the old employee without any productive
service by him in return. It is a transfer payment.
(vi) It is a part of compensation of employees because such expenses are incurred by the firm in return of
productive services of the employee.
4.
Giving reason state whether the following will be included in domestic product (or domestic factor income):
(i) Profits earned by branches of a country’s bank in other countries
(ii) Profits earned by foreign companies of India
(iii) Salaries of Indian working in the Russian Embassy in India (3 marks)
(i) No, it is not included in domestic product because this factor income is not generated in the domestic
Ans.
territory of the country. It is factor income from abroad.
(ii) Yes, it is included in domestic factor income of India because this factor income is earned within domestic
territory of India.
(iii) No, it is not included in domestic factor income of India because Russian Embassy in India is not a part of
the domestic territory of India. It is factor income from abroad.
5. Giving reason state how the following are treated in estimation of national income:
(i) Payment of interest by banks to its depositors.
(ii) Expenditure on old age pensions by government.
(iii) Profits earned by a company partly owned by residents and party owned by non-residents and located
in India. (CBSE 2017) (3 marks)
Ans. (i) Payment of interest by banks is included in national income because it is factor income paid by a
production unit.
(ii) Expenditure on old age pension is not included because it is a transfer payment.
(iii) Yes, it will be included in the domestic factor income of India as profits are earned within the domestic
territory of India.
UNIT 1: National Income and Related Aggregates 49
Numerical 9
Do it yourself 9
Numerical 10
Solution:
Particulars (` in crore)
Compensation of employees 2,000
(+) Interest paid by production units 500
(+) Rent 700
(+) Profits 800
(+) Mixed income of self employed 1,500
(–) Net factor income to abroad (–)150
National Income (NNPfc) 5,350
Do it yourself 10
Numerical 11
Do it yourself 11
Numerical 12
Solution:
Particulars (` in crore)
Compensation of employees (wages and salaries) 5,000
(+) Interest received by households 600
(+) Rent and royalty 700
(+) Profit 1,200
(+) Mixed income of self-employed 8,000
Domestic factor income (NDPfc) 15,500
(+) Net indirect tax 850
Net Domestic Product at market price (NDPmp) 16,350
Do it yourself 12
From the following data calculate the Gross National Product at Market Price. 4 marks
Numerical 13
Solution:
Particulars (` in crore)
Compensation of employees 2,500
(+) Profit 700
(+) Rent and royalty 400
(+) Interest 350
(+) Mixed income of self-employed 7,500
Domestic income (NDPfc) 11,450
Adjustments:
(+) Depreciation (note 1) 70
(+) Goods and Services Tax 200
(–) Subsidies (–)50
(+) Net factor income from abroad (NFIA) (note 2) 50
GNP at market price 11,720
Note: 1. Depreciation = Gross investment – Net investment (or Net addition to capital stock)
= 470 – 400
= `70 crore
2. Net factor income from abroad (NFIA) = Factor income from abroad – Factor income paid to abroad
= 150 – 100
= `50 crore
3. Profits = Profits after tax + Corporation Tax
= 500 + 200
= `700 crore
54 Macroeconomics XII – by Subhash Dey
Do it yourself 13
Calculate Gross National Product at Market Price from the following data. 4 marks
Numerical 14
Do it yourself 14
Numerical 15
Do it yourself 15
Calculate: (a) Net national product at factor cost and (b) Gross Domestic product at market prices. 6 marks
Numerical 16
Calculate the value of “Rent” from the following data: (CBSE 2019) (4 marks)
S. No. Particulars (` in crore)
(i) Gross Domestic Product at market Price 18,000
(ii) Mixed Income of Self-Employed 7,000
(iii) Subsidies 250
(iv) Interest 800
(v) Rent ?
(vi) Profit 975
(vii) Compensation of Employees 6,000
(viii) Consumption of Fixed Capital 1,000
(ix) Indirect Tax 2,000
Solution: GDPmp = NDPfc+ Depreciation + Net indirect tax
(i) = (vii) + (ii)+ [(iv) + (vi) + Rent] + (viii) + [(ix)-(iii)]
18,000 = (6,000 + 7,000 + (800 + 975 + Rent) + 1,000 + (2,000 – 250)
18000 = 17525 + Rent ⇒ Rent = `475 crore
Do it yourself 16
Numerical 17
Calculate compensation of employees from the following data: (CBSE Sample Question Paper 2020) (3 marks)
S. No. Particulars (` in crore)
(i) Profits after tax 20
(ii) Interest 45
(iii) Gross Domestic Product at Market Price 200
(iv) Goods and Services Tax 10
(v) Consumption of Fixed Capital 50
(vi) Rent 25
(vii) Corporate Tax 5
Solution: GDPmp = NDPfc + Consumption of Fixed Capital + Goods and Services Tax
GDPmp = Compensation of employees + Profits (Profits after tax + Corporate Tax) + Interest + Rent
+ Consumption of Fixed Capital + Goods and Services Tax
200 = Compensation of employees + (20 + 5) + 45 + 25 + 50 + 10
Compensation of employees = 200 – 25 – 45 –25 – 50 – 10 = `45 crore
UNIT 1: National Income and Related Aggregates 57
Do it yourself 17
Calculate the value of “Mixed Income of Self-Employed” from the following data: (CBSE 2019) (4 marks)
S. No. Particulars (` in crore)
(i) Compensation of Employees 17,300
(ii) Interest 1,200
(iii) Consumption of Fixed Capital 1,100
(iv) Mixed Income of Self-Employed ?
(v) Subsidies 750
(vi) Gross Domestic Product at Market price 27,500
(vii) Indirect Taxes 2,100
(viii) Profits 1,800
(ix) Rent 2,000
[Ans. `2,750crore]
Top Tip
Expenditure method includes only final expenditures, i.e. expenditure on consumption and investment. Intermediate
expenditure like that on raw materials, etc. is not included in national income.
Final Expenditure refers to the expenditure on final goods and services produced within the domestic territory of the
country, which are meant for final consumption and investment. Examples:
(i) Expenditure on purchase of car/furniture/sewing machine/refrigerator by a household is a final expenditure on
consumption, and thus included in national income.
(ii) Expenditure on purchase of a car/furniture/machine/refrigerator for use by a firm is a final investment expenditure,
and thus included in national income.
Intermediate Expenditure/Intermediate Consumption/Intermediate Cost refers to the expenditure incurred by a
production unit on purchasing those goods and services from other production units, which are meant for resale or for
using up completely during the same year. Examples:
(i) Expenditure on fertilisers by a farmer
(ii) Payment of electricity bill by a school
(iii) Purchase of uniforms for nurses by a hospital
(iv) Expenditure on engine oil by a car service station
(v) Expenditure by a firm on payment of fees to a chartered accountant or a lawyer (Note that a chartered accountant or a
lawyer is an outsider to the firm. So, payment of fees to them will not be a factor income, but an intermediate expenditure)
(vi) Expenditure on maintenance of factory building by a firm
(vii) Fees to a mechanic paid by a firm
(viii) Transport expenses by a firm
(ix) Expenditure on advertisement and scientific research by a firm
Top Tip
Net imports is negative of net exports. For example, if net imports = `30 crore, it means net exports = (–) `30 crore.
GDPmp = PFCE + GFCE + GDCF – Net Imports
By making the usual adjustments we can arrive at national income.
National Income (NNPfc) = GDPmp – Depreciation – Indirect taxes + Subsidies + NFIA
16. Expenditure by a firm on No, it is not included in national Because it is intermediate cost
payment of fees to a chartered income. or intermediate expenditure of
accountant or lawyer the firm. (Note that a chartered
accountant or a lawyer is an outsider
to the firm. So, payment of fees to
them will not be a factor income, but
an intermediate expenditure)
17. Fees to a mechanic paid by a No, it is not included in national Because it is intermediate cost or
firm. income. intermediate expenditure of the firm.
18. Expenditure on maintenance of No, it will not be included in the Because it is an intermediate
factory building by a firm national income. expenditure of the firm.
19. Transport expenses by a firm No, it will not be included in Because it is a part of intermediate
national income. consumption.
20. Expenditure on advertisement No, it will not be included in Because it is an intermediate
and scientific research by a firm national income. expenditure.
21. Purchase of bonds by a domestic No, it will not be included in the Because buying financial assets
firm national income. like bonds, shares, etc. does not
contribute to any production of
goods and services.
Key Terms
Final Expenditure — It refers to the expenditure on final goods and services produced within the domestic territory of
the country, which are meant for final consumption and investment.
Intermediate Expenditure (or Intermediate Consumption or Intermediate Cost) — It refers to the expenditure incurred
by a production unit on purchasing those goods and services from other production units, which are meant for resale
or for using up completely during the same year.
Net Exports — It refers to the excess of the value of exports over the value of imports of a country in an accounting year.
RECAP
1. Which one of the following is an intermediate expenditure? (Choose the correct alternative)
(a) Expenditure on purchase of furniture by a firm for its own use
(b) Expenditure on maintenance by a firm
(c) Expenditure on purchase of tractor by a firm for its own use
(d) Machine bought by a household
2. Which one of the following is not included in national income? (Choose the correct alternative)
(a) Payment of indirect tax by a firm (b) Bonus paid to employees
(c) Addition to stocks during a year (d) Purchase of taxi by a taxi driver
3. Purchase of car by a household is a part of gross domestic capital formation. True/False? Give reason.
4. Free services provided by the government will not be included in national income. True/False? Give reason.
5. Gross domestic capital formation is always greater than gross fixed capital formation. True/False? Give reason.
6. Match the following:
(i) Addition to the machinery (a) Change in inventories factory buildings and equipment
(ii) Addition of housing facilities employed by the firms.
(iii) Addition to the stock of capital of the firms (b) Residential investment
(c) Fixed business investment
7. It is only the households which undertake the final consumption expenditure on the goods and services produced by the
firms. True/False? Give reason.
8. The expenditure on intermediate goods is not included in the calculation of GDP, whereas the expenditure on investment
goods is included. True/False? Give reason.
9. The final expenditure incurred by the government includes the consumption expenditure only. True/False? Give reason.
62 Macroeconomics XII – by Subhash Dey
10. Aggregate imports expenditure incurred by the economy includes expenditure on the imports of consumption goods by
households, expenditure on imports of foreign investment goods by firms and _______________. (Fill in the blank)
11. ____________ (Exports / Imports), which denotes aggregate expenditure incurred by the foreigners on the final goods and
services produced in the domestic territory of the country is ____________ ( included / not included) in national income.
(Fill in the blanks with the correct options)
12. Final expenditure is the spending on (i) ______________; it does not include spending on (ii) _____________(Intermediate
goods / Final goods). (Fill in the blanks with the correct options)
13. Which one of the following is not a part of a country’s Net Domestic Product at market price’? (Choose the correct alternative)
(a) Depreciation (b) Indirect tax
(c) Net exports (d) Net change in stocks
4. Why are (a) net exports and (b) net change is stocks included in national income? Explain. (4 marks)
Ans. (a) National income by expenditure method includes net exports (= exports – imports) because it is an item of
final expenditure. Exports, though purchased by non-residents, are produced within our domestic territory,
and therefore, a part of domestic product and hence included in national income. Imports are deducted
because goods and services imported are not produced within the domestic territory of the country.
(b) Net change in stocks, i.e., net addition to stocks during a year is included in national income because it
is a component of final investment expenditure since Gross investment = Net change in stocks + Fixed
business investment + Residential investment.
5. Are the following a part of a country’s Net Domestic Product at market price? Explain giving reasons.
(i) Indirect tax (ii) Net exports
(iii) Net factor income from abroad (iv) Consumption of fixed capital (6 marks)
Ans. NDPmp (by production method) = Value of output – Intermediate consumption – Depreciation
NDPmp (by expenditure method) = Private final consumption expenditure + Government final consumption expenditure
+ Gross domestic capital formation + Net exports – Depreciation
(i) Yes, Indirect tax is a part of NDPmp because indirect taxes have not been paid yet to the government.
(ii) Yes, Net exports is a part of NDPmp because it is an item of final expenditure.
(iii) No, NFIA is not a part of NDPmp because this is the net income earned outside the domestic territory of the country.
(iv) No, consumption of fixed capital (or depreciation) is not a part of NDPmp because provision for
depreciation has been made while arriving at NDPmp.
Numerical 18
Do it yourself 18
Numerical 19
Find National Income from the following using expenditure method. (4 marks)
S. No. Particulars (` in crore)
(i) Current transfers from rest of the world 50
(ii) Net indirect taxes 100
(iii) Net exports (–)25
(iv) Rent 90
(v) Private final consumption expenditure 900
(vi) Net domestic capital formation 200
(vii) Compensation of employees 500
(viii) Net factor income from abroad (–)10
(ix) Government final consumption expenditure 400
(x) Profit 220
(xi) Mixed income of self-employed 400
(xii) Interest 230
Solution:
Particulars (` in crore)
Private final consumption expenditure 900
Government final consumption expenditure 400
Net domestic capital formation 200
Net exports (–)25
Net Domestic Product at market price (NDPmp) 1,475
(–) Net indirect taxes (–)100
(+) Net factor income from abroad (NFIA) (–)10
National Income (NNPfc) 1,365
UNIT 1: National Income and Related Aggregates 65
Do it yourself 19
Calculate Net National Product at factor cost by expenditure method from the data given below. (4 marks)
Numerical 20
Solution:
Particulars (` in crore)
Private final consumption expenditure 8,000
Government final consumption expenditure 3,000
Gross domestic capital formation (note) 400
Net exports (–)60
Gross Domestic Product at market price 11,340
(–) Depreciation (–)40
(+) Net factor income from abroad (NFIA) 80
Net National Product at market price 11,380
Note: Gross domestic capital formation = Gross domestic fixed capital formation (i) + Change in stock (iv – viii)
= 350 + (150 – 100) = 350 + 50 = `400 crore
66 Macroeconomics XII – by Subhash Dey
Do it yourself 20
Calculate Gross National Product at factor cost from the following data. (4 marks)
S. No. Particulars (` in crore)
(i) Net domestic fixed capital formation 310
(ii) Closing stock 100
(iii) Government final consumption expenditure 200
(iv) Net indirect taxes 50
(v) Opening stock 60
(vi) Consumption of fixed capital 50
(vii) Net exports (–)10
(viii) Private final consumption expenditure 1,500
(ix) Imports 20
(x) Net factor income from abroad (–)10
Numerical 21
Do it yourself 21
Find out Gross National Product at market price from the following data. (4 marks)
S. No. Particulars (` in crore)
(i) Consumption of fixed capital 60
(ii) Government final consumption expenditure 200
(iii) Net factor income received from abroad (–) 10
(iv) Private final consumption expenditure 800
(v) Exports 50
(vi) Opening stock 30
(vii) Imports 60
(viii) Closing stock 20
(ix) Gross domestic fixed capital formation 230
Numerical 22
Suppose there are only two firms, A and B in an imaginary economy. Firm A uses no raw material and produces cotton
worth `50 lakh. Firm A gives `20 lakh to the workers as wages and keeps the remaining `30 lakh as its profits. Firm A
sells its cotton to firm B, who uses it produce cloth. Firm B sells the cloth produced to consumers for `200 lakh and
gives `60 lakh as wages and keeps the remaining income generated as profits.
Assuming no depreciation and indirect taxes or subsidies, calculate GDP by three methods. (NCERT) (6 marks)
Solution: (i) GDP by Value Added Method (Production phase)
Value added (VA) = Value of output – Intermediate consumption
VA by Firm A = 50 – 0 = `50 lakh
VA by Firm B = 200 – 50 (purchases of cotton by Firm B from Firm A) = `150 lakh
Hence, GDP = VA by Firm A + VA by Firm B
= 50 + 150 = `200 lakh
(ii) GDP by Income Method (Distribution phase)
Firm A Firm B Total
Wages 20 60 80
Profits 30 90 120
Top Tip
In Numerical 22, we have left out factor payments in the form of rent and interest. But this will not make any difference
to the basic result, because after paying wages the remainder of value added by a firm will be distributed between
rent, interest and profits (together called operating surplus).
68 Macroeconomics XII – by Subhash Dey
Do it yourself 22
In an imaginary economy, suppose there are only two kinds of producers — farmers and bakers (bread makers). Farmers
produced wheat worth `100 crore with no intermediate costs. They sold `50 crore worth of wheat to the bakers,
who used this amount of wheat completely during the year and produced `200 crore worth of bread. Value of capital
consumption is `10 crore.
Calculate GDP and NDP by (i) Value Added method, and (ii) Expenditure method. (4 marks)
[Ans. `240 crore]
Numerical 23
Calculate Net domestic product at market price by (a) Income method and (b) expenditure method. (6 marks)
S. No. Particulars (` in crore)
(i) Net Indirect taxes 40
(ii) Net exports 10
(iii) Social security contribution by employers 50
(iv) Operating surplus 110
(v) Net purchases of goods and services by general government 30
(vi) Net domestic capital formation 60
(vii) Government final consumption expenditure 130
(viii) Change in stocks 10
(ix) Sales by general government 10
(x) Compensation of employees 500
(xi) Private final consumption expenditure 450
Solution: (a) Net domestic product at market price (Income method) = Compensation of employees + Operating
surplus + Net indirect taxes = 500 + 110 + 40 = `650 crore
(b) Net domestic product at market price (Expenditure method) = Private final consumption expenditure +
Government final consumption expenditure + Net domestic capital formation + Net exports
= 450 + 130 + 60 + 10 = `650 crore
Do it yourself 23
From the data given below, calculate: (a) Gross National Product at market price by expenditure method (b) Gross
Domestic Product at market price by income method (6 marks)
S. No. Particulars (` in crore)
(i) Private final consumption expenditure 200
(ii) Government final consumption expenditure 20
(iii) Gross domestic capital formation 40
(iv) Net exports (–) 5
(v) Wages and salaries 165
(vi) Employers’ contribution to social security schemes 10
(vii) Profits 15
(viii) Interest 20
(ix) Indirect taxes 30
(x) Subsidies 5
(xi) Rent 15
(xii) Net factor income from abroad 5
(xiii) Consumption of fixed capital 5
Numerical 24
Solution: (a) National income (Income method) = Wages and salaries + Contribution of employers towards social security
+ Operating surplus + Net factor income received from abroad
= 80 + 10 + 20 + (–) 5 = `105 crore
(b)
Gross Domestic Product at factor cost (Expenditure method) = Private final consumption expenditure
+ Government final consumption expenditure + Net domestic fixed capital formation + Consumption
of fixed capital + Change in stock (Closing stock – opening stock) + Net exports – Net indirect taxes
= 85 + 10 + 25 + 2 + (10 – 5) + (– 5) – 10 = `112 crore
Do it yourself 24
Calculate national income by (a) Income method and (b) Expenditure method. (6 marks)
S. No. Particulars (` in crore)
(i) Rent 50
(ii) Net factor income from abroad 5
(iii) Compensation of employees 500
(iv) Indirect taxes 100
(v) Government final consumption expenditure 120
(vi) Subsidies 30
(vii) Royalty 20
(viii) Net exports (–)20
(ix) Interest 40
(x) Corporate tax 20
(xi) Profit after tax 100
(xii) Private final consumption expenditure 630
(xiii) Change in stocks 10
(xiv) Net domestic fixed capital formation 60
Numerical 25
Calculate from the following data, net national product at market price by (a) income method and (b) expenditure
method. (6 marks)
Solution: (a) Net National Product at market price (Income method) = Compensation of employees + Operating surplus
+ Mixed income of the self-employed – Net factor income to abroad + Indirect taxes – Subsidies
= 1,200 + 1,000 + 800 – 20 + 140 – 20 = `3,100 crore
(b) Net National Product at market price (Expenditure method) = Private final consumption expenditure
+ Government final consumption expenditure + Net capital formation + Export – Imports – Net factor
income to abroad
= 2,100 + 600 + 450 + 10 – 40 – 20 = `3,100 crore
Do it yourself 25
Numerical 26
Calculate from the following data, Net National Product at market price by (a) income method and (b) expenditure
method. (6 marks)
Do it yourself 26
Calculate gross national product at market price from the following data by (a) income method and (b) expenditure
method. (6 marks)
S. No. Particulars (` in crore)
(i) Mixed income of self-employed 800
(ii) Corporation tax 50
(iii) Interest 100
(iv) Rent 80
(v) Undistributed profits 150
(vi) Dividends 70
(vii) Employers’ contribution to social security schemes 120
(viii) Compensation of employees 1,200
(ix) Government final consumption expenditure 730
(x) Private final consumption expenditure 1,580
(xi) Net factor income to abroad 20
(xii) Gross capital formation 300
(xiii) Change in stocks 40
(xiv) Net indirect taxes 100
(xv) Current replacement cost 50
(xvi) Net exports (–)10
Numerical 27
Calculate gross national product at market price by income method and expenditure method from the following data.
(6 marks)
Solution: GNPmp (Income method) = Compensation of employees + Rent + Interest + Profit + Consumption of fixed
capital + Net factor income from abroad + Net indirect taxes
= 800 + 40 + 60 + 120 + 20 + (–20) + 100 = `1,120 crore
GNPmp (Expenditure method) = Private final consumption expenditure + Government final consumption
expenditure + Net domestic capital formation + Consumption of fixed capital + Net exports + Net factor
income from abroad = 800 + 200 + 100 + 20 + 20 + (–20) = `1,120 crore
Do it yourself 27
Calculate gross national product at factor cost by income method and expenditure method from th following data.
(6 marks)
S. No. Particulars (` in crore)
(i) Factor income from abroad 10
(ii) Compensation of employees 150
(iii) Net domestic capital formation 50
(iv) Private final consumption expenditure 220
(v) Factor income to abroad 15
(vi) Change in stock 15
(vii) Employers’ contribution to social security schemes 10
(viii) Consumption of fixed capital 15
(ix) Interest 40
(x) Exports 20
(xi) Imports 25
(xii) Indirect taxes 30
(xiii) Subsidies 10
(xiv) Rent 40
(xv) Government final consumption expenditure 85
(xvi) Net current transfers from abroad (–)80
(xvii) Profit 100
(xviii) Dividend 40
Numerical 28
Given the following data, find the missing value of ‘Government Final Consumption Expenditure’ and ‘Mixed Income
of Self Employed’. (CBSE 2019) (6 marks)
Do it yourself 28
Given the following data, find the missing values of ‘Private Final Consumption Expenditure’ and ‘Operating
surplus’. (CBSE 2019) (6 marks)
[Ans. Private final Consumption expenditure `19,700 crore; Operating surplus `16,500 crore]
74 Macroeconomics XII – by Subhash Dey
Numerical 29
Given the following data, find the missing values of ‘Gross Domestic Capital Formation’ and ‘Wages and Salaries’.
(CBSE 2019) (6 marks)
Do it yourself 29
Given the following data, find the values of “Gross Domestic Capital Formation” and “Operating Surplus. (6 marks)
[Ans. Gross Domestic Capital Formation `6,750 crore; Operating surplus `5,450 crore]
UNIT 1: National Income and Related Aggregates 75
Numerical 30
Given the following data, find the missing values of ‘Gross Domestic Capital Formation’ and ‘Wages and Salaries’.
(CBSE 2019) (6 marks)
Solution: National Income (vi) = Wages and Salaries (viii) + Operating Surplus + Mixed Income (i) + NFIA (ii)
Operating Surplus = (vi) – (viii) – (i) – (ii) = 5,000 – 2200 – 700 – 150 = `1,950 crore
National Income (vi) = PFCE (iii) + GFCE (x) + GDCF (vii) + Net Exports (ix) – Consumption of Fixed
Capital (xi) – Net Indirect Taxes (v) + NFIA (ii)
Net exports = (vi) – (iii) – (x) – (vii) + (xi) + (v) – (ii)
= 5,000 – 2,200 – 1,300 – 1,100 + 200 + 150 – 150 = `600 crore
Do it yourself 30
Given the following data, find the values of “Gross Domestic Capital Formation” and “Operating Surplus. (6 marks)
Top Tip
Real GDP is a better indicator of economic growth and welfare of people of the country than Nominal GDP as it is not
affected by changes in general price level. Secondly, because increase in real GDP means more goods and services are
available to the society during the year. Thus, welfare increases.
Numerical Example:
Goods Price of Current Year Price of Base Year Quantity of Current Nominal GDP Real GDP
(P1) (in `) (P0) (in `) Year (Q1) (in units) (P1Q1) (P0Q1)
A 20 10 100 2,000 1,000
B 10 5 200 2,000 1,000
C 30 20 50 1,500 1,000
ΣP1Q1 = 5,500 ΣP0Q1 = 3,000
In the above example, Nominal GDP = ΣP1Q1 = `5,500 and Real GDP = ΣP0Q1 = `3,000
The difference between Nominal GDP and Real GDP is 5,500 – 3,000 = `2,500. This is only the monetary
difference as the quantity sold in the market remains unchanged and the variation in the value of nominal and
real GDP is merely due to the change in the prices in the economy between the base year and current year.
GDP Deflator
The ratio of Nominal GDP to Real GDP of current year is a well known price index, called GDP Deflator.
Nominal GDP
GDP Deflator =
Real GDP
Sometimes GDP deflator is also denoted in percentage terms. In such a case,
Nominal GDP × 100
GDP Deflator =
Real GDP
It gives the change in price level between the base year and current year. This is because in the calculation of real
and nominal GDP of the current year, the volume of production is fixed. Therefore, if these measures differ it is
only due to change in the price level between the base year and the current year.
* Base year is the year whose prices are used to calculate the real GDP.
UNIT 1: National Income and Related Aggregates 77
In our numerical example, Nominal GDP = ΣP1Q1 = `5,500 and Real GDP = ΣP0Q1 = `3,000
Nominal GDP 5, 500
Therefore, GDP Deflator = ¥100 = ¥ 100 = 183.33%
Real GDP 3, 000
This implies that the prices have risen by 83.33% between the base year and the current year.
Top Tip
Nominal GNP, Real GNP and GNP Deflator
• Nominal GNP is the value of GNP at the current year’s prices.
• Real GNP is the value of GNP at the base year’s prices.
• The ratio of nominal GNP to real GNP of the current year is called GNP Deflator.
Nominal GNP
GNP Deflator = × 100
Real GNP
Numerical Example:
Goods Price of Current Year Price of Base Year Quantity of Current Nominal NI Real NI
(P1) (in `) (P0) (in `) Year (Q1) (in units) (P1Q1) (P0Q1)
A 20 10 100 2,000 1,000
B 10 5 200 2,000 1,000
C 30 20 50 1,500 1,000
ΣP1Q1 = 5,500 ΣP0Q1 = 3,000
Nominal National Income = ΣP1Q1 = `5,500; Real National Income = ΣP0Q1 = `3,000
The difference between Nominal National Income and Real National Income is 5,500 – 3,000 = `2,500.
This is only the monetary difference as the quantity sold in the market remains unchanged and the variation in
the value of nominal and real national income is merely due to the change in the prices in the economy between
the base year and current year.
Given the Nominal National Income, how to find out Real National Income?
Given the Nominal national income, we can find out Real national income by eliminating the effect of change
in prices between the base year and the current year.
The effect of change in prices on the nominal national income can be eliminated in the following way:
Nominal national income
Real national income = × 100
Price Index
Example: Suppose Nominal national income = `288 and Price index = 120, then Real national income can be
calculated as:
Nominal national income 288
Real national income = ¥ 100 = ¥ 100 = ` 240
Price Index 120
RECAP
Nominal GDP
Nominal GDP is measured as the product of current year’s output (Q1) of final goods and services and their current year’s price
(P1). Nominal GDP may increase even if there is no increase in the output of goods and services produced in the economy, due
to rise in general price level during the current year.
Real GDP
Real GDP is measured as product of current year output (Q1) and their base year’s price (P0). Real GDP will increase only if the
output of goods and services produced in the economy is increasing. Thus, Real GDP is a better indicator of economic growth
and welfare of people of the country than Nominal GDP as it is not affected by changes in general price level.
Given Nominal GDP, we can find Real GDP by eliminating the effect of change in prices between the base year and the current
Nomin al GDP
year in the following way: Real GDP = ¥ 100
GDP Deflator Price Index
The ratio of Nominal GDP to Real GDP of current year is a well known price index, called GDP Deflator. It gives the change in
Nominal GDP
price level between the base year and current year. GDP Deflator/Price Index = ¥ 100
Real GDP
Nominal and Real National Income
• When national income (product) of the current year is estimated on the basis of prices prevailing in the current year, it is called
nominal national income (or national income at current prices) whereas when national product of the current year is estimated
on the basis of prices prevailing in the base year, it is called real national income (or national income at constant prices).
• Nominal national income may increase due to increase in prices of goods and services during the current year without
increase in the flow of goods and services in the economy. Real national income reflects the real growth of an economy
because it increases only when there is an increase in real national output over a period of time.
Given Nominal Income, we can find Real Income by eliminating the effect of change in prices between the base year and the
current year in the following way:
Nominal National Income
Real National Income = ¥ 100
Price Index
UNIT 1: National Income and Related Aggregates 79
Key Terms
Nominal GDP — It is the market value of the final goods and services produced within domestic territory of a country
during an accounting year, as estimated at the current year’s prices.
Real GDP — It is the market value of the final goods and services produced within the domestic territory of a country
during an accounting year, as estimated at the base year’s* prices/constant prices.
GDP Deflator — The ratio of Nominal GDP to Real GDP of current year is a well known price index, called GDP Deflator.
Nominal National Income — When national income (product) of the current year is estimated on the basis of prices
prevailing in the current year, it is called nominal national income.
Real National Income — When national income (product) of the current year is estimated on the basis of prices
prevailing in the base year, it is called real national income.
1. If the nominal GDP of the current year is double the nominal GDP of the base year, the volume of production of the country
must have doubled. True/False? Given reason.
2. In order to compare the GDP figures of different countries , we cannot rely on (i) ____________. For comparison we take
help of (ii) ____________. (Real GDP/ Nominal GDP) (Fill in the blanks with correct options)
3. Nominal GDP can never be less than Real GDP. True/False? Given reason.
4. Real gross domestic product can be equal to nominal gross domestic product. True/False? Given reason.
5. National income at current prices is higher than national income at constant prices during a period of:
(Choose the correct alternative)
(a) Rising prices (b) Falling prices
(c) Constant prices (d) Both (a) and (b)
6. Suppose a country produces bread only. In the year 2018 - 19 it had produced 1,000 units of bread, price was `10 per
bread . In 2019 - 20, it produced 1,100 units of bread at price of `12 per bread. In 2019 - 20, the nominal and real GDP are:
(a) `10,000 and `10,000 (b) `10,000 and `11,000
(c) `13, 200 and `10,000 (d) `13,200 and `11,000
7. The ratio of nominal GDP to real GDP is a well-known index of prices, called ______________. (Fill in the blank)
8. Which of the following formula is correct? (Choose the correct alternative)
price index
(a) Real GDP = × 100
nominal GDP
nominal GDP
(b) Real GDP = × 100
price index
real GDP
=
(c) Nominal GDP × 100
price index
price index
=
(d) Nominal GDP × 100
real GDP
9. In the calculation of real and nominal GDP of the current year, the difference between the two is due to ________________.
(Change in volume of production / Change in the price level between the base year and the current year)
(Fill in the blank with correct options)
10. Cost of purchase of a given basket of commodities by a representative consumer in the current year is expressed as a
percentage of the cost of purchase of the same basket in the base year, this gives us ___________ . (Fill in the blank)
11. If the GDP deflator is 150 % and real GDP is `1,100 the nominal GDP will be : (Choose the correct alternative)
(a) `733 (b) `1,650
(c) `1,100 (d) `2,750
12. A representative consumer had to spend `1,400 on purchase of a given basket of commodities in the year 2015-16. Due to
inflation, CPI of the year 2019-20 (taking 2015-16 as base year) was 120. How much amount the consumer had to spend
on purchase of the same basket of commodities in the year 2019-20? (Choose the correct alternative)
(a) `1,167 (b) `1,680
(c) `1,520 (d) `1,280
13. Like Consumer Price Index (CPI), the index for wholesale prices is called _____________. (Fill in the blank)
14. ___________ takes into account all the goods and services produced in a country. (Choose the correct alternative)
(a) GDP deflator (b) Consumer Price Index
(c) Producer Price Index (d) Wholesale Price Index
15. CPI includes prices of imported goods also but GDP deflator does not include price of imported goods.
True/False? Given reason.
16. The weights are constant in (i) _______________ but they differ according to production level of each good in
(ii) _______________. (GDP deflator/ CPI) (Fill in the blank with correct options)
UNIT 1: National Income and Related Aggregates 81
Numerical 31
Calculate real national income, nominal national income and price index. Also, interpret the result. (6 marks)
Goods Price of Current Year Price of Base Year Quantity of Current Quantity of Base
(in `) (in `) Year (in units) Year (in units)
A 20 10 10 5
B 30 20 20 10
C 50 40 5 2
Solution:
Goods Price of Current Price of Base Year Quantity of Current Quantity of Base Nominal NI Real NI
Year (P1) (in `) (P0) (in `) Year (Q1) (in units) Year (Q0) (in units) (P1Q1) (P0Q1)
A 20 10 10 5 200 100
B 30 20 20 10 600 400
C 50 40 5 2 250 200
ΣP1Q1 = 1,050 ΣP0Q1 = 700
Nominal National Income = `P1Q1 = `1,050; Real National Income = `P0Q1 = `700
No min al national income 1, 050
Price Index = ¥ 100 = ¥ 100 = 150%
Real national income 700
Interpretation: The difference between Nominal National Income and Real National Income is 1,050 – 700 = `350.
This is only the monetary difference as the quantity sold in the market remains unchanged and the variation in the
value of nominal and real national income is merely due to the change in the prices in the economy between the base
year and current year.
Price index of 150% signifies that price level has increased by 50% between the base year and the current year.
Do it yourself 31
Calculate real GNP, nominal GNP and GNP Deflator. Also, interpret the result. (6 marks)
Goods Price of Current Year (in `) Price of Base Year (in `) Quantity of Current Year (in units)
A 20 10 100
B 10 5 200
C 30 20 50
[Ans. Nominal GNP= `5,500; Real GNP = `3,000; Price index 183.33%]
82 Macroeconomics XII – by Subhash Dey
Numerical 32
If the Nominal Gross Domestic Product = `4400 crore and the Price Index (base = 100) = 110, calculate the Real
Gross Domestic Product. (3 marks)
No min al GDP 4, 400
Solution: Real GDP = ¥ 100 = ¥ 100 = ` 4, 000 crore
Price Index 110
Do it yourself 32
If the Real GNP is `500 crore and Price Index (base = 100) is 125, calculate the Nominal GNP. (3 marks)
[Ans. Nominal GNP= `625 crore]
Numerical 33
Suppose only one Product X is produced in the country. Its output during the year 2019 and 2020 was 100 units and
110 units respectively. The market price of X during the years 2019 and 2020 were `50 and `55 per unit respectively.
(i) Calculate the percentage change in real GDP and nominal GDP in year 2020 using 2019 as the base year.
(ii) Calculate GDP deflator for the years 2019 and 2020 (in percentage terms) and comment on the results. (6 marks)
Solution:
Year Output Market Price Real GDP using Nominal GDP using
(units) (`per unit) base year price current year price
2019 100 50 100 × `50 = `5,000 100 × `50 = `5,000
2020 110 55 110 × `50 = `5,500 110 × `55 = `6,050
∆ in real GDP 500
(i) Percentage Change in Real GDP = × 100 = × 100 = 10%
Base year real GDP 5000
∆ in nominal GDP 1050
Percentage Change in Nominal GDP = × 100 = × 100 = 21%
Base year nominal GDP 5000
Do it yourself 33
Use the following information of an imaginary country: (CBSE Sample Question Paper 2018) (4 marks)
Year 2017-2018 2018-2019 2019-2020
Nominal GDP 6.5 8.4 9
GDP deflator 100 140 125
(i) For which year is real GDP and nominal GDP same and why?
(ii) Calculate real GDP for the given years. Is there any year for which real GDP falls?
[Ans. (a) 2017-18 because it is the base year (b) GDP declined in the year 2018-2019]
UNIT 1: National Income and Related Aggregates 83
Key Terms
Non-monetary exchanges—Those activities in an economy which cannot be evaluated in terms of money due to non-
availability of data, e.g. domestic services of a housewife/family members.
Externalities—Harms (or benefits) a firm or an individual causes to another for which they are not penalised (or not
paid).
84 Macroeconomics XII – by Subhash Dey
RECAP
1. If the real GDP of a country is rising, the welfare of people always rise. True/False? Given reason.
2. The exchanges which take place in the informal sector without the help of money are called________. They are generally
not counted in the GDP of a country. This is a case of _________ of GDP. (Fill in the blanks)
3. GDP calculated in the standard manner may not give us a clear indication of the productive activity and well-being of a
country because of : (Choose the correct alternative)
(a) Unequal distribution of GDP (b) Non-monetary exchanges
(c) Externalities (d) All of the above
UNIT 1: National Income and Related Aggregates 85
Q.6 Which of the following items will be included/not included while estimating Gross Domestic Product? Give
valid reasons in support of your answer.
(a) Wages received by an Indian working in the British Embassy in India.
(b) Financial aids received from abroad after “Fani cyclone”.
(c) Purchase of second hand machinery from abroad. (3 marks)
Q.7 What is meant by the problem of double counting? Discuss briefly the two approaches to avoid this problem.
(3 marks)
Q.8 (a) Distinguish between Real Gross Domestic Product and Nominal Gross Domestic Product. (2 marks)
(b) "Real Gross Domestic Product is a better indicator of economic growth than Nominal Gross Domestic
Product."
Do you agree with the given statement? Support your answer with a suitable numerical example. (4 marks)
Q.9 (a) The value of the nominal GNP of an economy was `2500 crore in a particular year. The value of GNP of
that country during the same year, evaluated at the prices of base year, was `3000 crore. 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? (3 marks)
(b) Calculate compensation of employees from the following data: (3 marks)
S. No Particulars Amount (in ` crore)
i. Profits after tax 20
ii. Interest 45
iii. Gross Domestic Product at Market Price 200
iv. Goods and Services Tax 10
v. Consumption of Fixed Capital 50
vi. Rent 25
vii. Corporate Tax 5
UNIT 1: National Income and Related Aggregates 87
Q.6 If in a locality, a new park is developed by the municipal corporation, it will have externalities, both positive and
negative. State on example each of both types of externalities with reason. (3 marks)
Q.7 Define the problem of double counting in the computation of national income. State any two approaches to
correct the problem of double counting. (3 marks)
Q.8 Explain any three precautions while calculating national income by Income Distributed Method. (6 marks)
OR
Will the following be included in domestic factor income of India? Give reasons in support of your answer.
(6 marks)
(i) Compensation of employees paid by a foreign company located in India.
(ii) Compensation of employees paid by American embassy in India to resident Indians.
(iii) Expenditure on engine oil by car service station.
Q.9 Given the following data, find the values of ‘Operating Surplus’ and ‘Gross Domestic Capital Formation’:
(6 marks)
S. No. Items (` in crore)
i Government Final Consumption Expenditure 2,000
ii Mixed Income of Self-Employed 1,500
iii National Income 12,000
iv Net Factor Income from Abroad 200
v Operating Surplus ?
vi Profits 500
vii Private Final Consumption Expenditure 6,000
viii Net Indirect Taxes 700
xi Net Exports 1,800
x Consumption of Fixed Capital 600
xi Gross Domestic Capital Formation ?
xii Wages and Salaries 6,000
UNIT 1: National Income and Related Aggregates 89
Objective Type Questions 1.1 28. Capital goods 3. (c) Indians working in a branch of
1. (c) Both (a) and (b) 29. (i) - (a), (ii) - (a) an American Bank in India
2. a final good 30. (d) All of the above 4. (c) Salaries received by Indians
3. True: Final goods may be transformed 31. True: Inventory is measured at a working in Russian Embassy in
during their consumption, e.g. the tea particular point of time. It may have India
leaves purchased by the consumers a value at the beginning of the year 5. (c) Residents
are used to make drinkable tea. or it may have a value at the end of 6. (d) Profits earned by standard
4. economic nature of its use the year. Chartered Bank in India
5. (b) Intermediate good 32. False: Change in inventories is a flow 7. (b) Net factor income from abroad
6. (c) Both (a) and (b) variable. It takes place over a period 8. False: National income can be less
7. Consumption goods or consumer of time (say one year). than domestic income when net
goods 33. True: as exports are measured on an factor income from abroad (NFIA)
8. Capital goods annual basis, i.e. over a period of time is negative. National income can
9. (d) Both (b) and (c) 34. (d) Exports also be equal to domestic income if
10. Consumption goods (both durable 35. (a) Money supply NFIA is zero.
and non-durable); Capital goods 36. (b) Flow variable 9. False: It will be included in Saudi
11. Intermediate goods 37. (a) Capital Arabian GDP , not in GDP of
12. (c) Intermediate goods 38. (a) Wealth India as it is not earned within the
13. flows 39. (c) Depreciation domestic territory of India.
14. (i) Flows (ii) Stocks 40. (c) Wheat used by a flour mill 10. False: It is a factor income paid to
15. Stocks 41. (d) All of these abroad. It will be subtracted from
16. Flows 42. (c) Normal wear and tear and the GDP of India to arrive at the
17. (i) Flow concept (ii) Stock concept foreseen obsolescence National income.
18. Gross investment 43. (b) Capital loss 11. True: GDP can be greater than
19. True: Significant part of current 44. (d) Both (a) and (c) GNP if factor income paid to
output of capital goods goes in 45. (c) Both (a) and (b) abroad is greater than factor income
maintaining or replacing part of the 46. (a) Investment received from abroad, i.e., when net
existing stock of capital goods in an 47. (c) Both (a) and (b) factor income from abroad (NFIA)
economy. This is because the already 48. (i) – (b), (ii) – (b), (ii) – (a), (iv) – (b) is negative.
existing capital stock suffers wear 49. True: Capital formation is measured
over a period of time. Objective Type Questions 1.3
and tear and needs maintenance and
replacement. 50. False: It depends on the economic use 1. (i) – (b) , (ii) – (c) (iii) – (a) (iv) – (d)
20. Depreciation/Consumption of fixed of bread. When it is purchased by a 2. (a) Spending on the goods and
capital household, it is a consumer good. If services produced by the
21. Net investment/Net capital formation it is purchased by restaurant, it is a domestic firms.
22. (c) Unexpected or sudden producer (intermediate) good. 3. Aggregate factor payments (i.e.
destruction or disuse of capital 51. False: It is a flow variable as it is wages and salaries , rent , interest
as can happen with accidents, measured over a period of time. and profits).
natural calamities etc. 52. False: It will be an intermediate 4. product or value added
23. True: No real expenditure may have product if it is for resale or used by a 5. (a) – (ii), (b) – (i), (c) – (iii)
actually been incurred each year yet restaurant for preparing meals. 6. Nominal flow/Money flow
depreciation is annually provided for. 53. False: National income is flow 7. Expenditure method
24. (d) Capital formation ,i.e. a gross variable since it is measured over a
period of time. Objective Type Questions 1.4
or net addition to capital stock.
54. False: Capital goods like machines 1. the value of final goods already
25. False: In economics, ‘investment’
make production of other goods includes the value of the
implies capital formation, i.e. a gross
feasible, but they themselves don’t intermediate goods also.
or net addition to capital stock/
get transformed in the production 2. (a) – (ii) , (b) – (i)
goods, e.g. machines, tools and
process, i.e., they are not used up to 3. (b) NDPfc
implements, buildings, office spaces,
produce other goods. 4. (d) All of these
store houses, or infrastructure like
5. (d) No indirect tax and no subsidy
roads, bridges, airports or jetties.
Objective Type Questions 1.2 6. False: Market price can be less than
26. (d) All of the above
1. (b) Google office in India factor cost if net indirect tax (i.e.,
27. False
2. (b) Geographical territory indirect taxes – subsidy) is negative,
92 Macroeconomics XII – by Subhash Dey
subsidy is more than indirect taxes. 37. Net National Product at factor cost intermediate goods are consumed in
Market price can also be equal to or National Income. the process of production.
factor cost if net indirect tax is zero. 38. True: GDPmp includes the market 9. False: The expenditure that the
7. True: Such goods represent the current value of all final goods and services government makes on the final goods
output and their imputed value will be produced within the domestic territory and services, includes both final
included in national income. of a country in a year, regardless of consumption expenditure and final
8. Double counting ; National income whether production unit is owned by a investment expenditure.
9. (b) `250 local company or a foreign entity. 10. Government expenditure incurred on
10. (a) – (iii), (b) – (ii) 39. Factor cost imports
11. Value added of the firm 40. GNP at market prices 11. Exports , included
12. True: Since value added (= value of 41. (b) GNP at factor cost 12. (i) Final goods (ii) Intermediate goods
output – intermediate costs) is the 42. (c) NNP at market price 13. (a) Depreciation
net contribution of a firm during a 43. (d) NNP at factor cost.
period of time (say one year) 44. Net National Product at factor cost Objective Type Questions 1.7
13. (i) Intermediate costs / Intermediate (NNPfc) or National Income (NI). 1. False: It is possible that only prices
consumption (ii) Double counting of all goods and services (i.e. price
14. (c) `70 Objective Type Questions 1.5 level) have doubled between the base
15. (a) – (i) , (b) – (iii) 1. (d) Free services of owner occupied year and the current year whereas the
16. False: In economics, ‘inventory’ building production has remained constant.
includes the stock of unsold finished 2. (c) Interest paid by an individual on 2. (i) Nominal GDP (ii)Real GDP
goods, or semi finished goods, or raw a car loan taken from a bank 3. False: Nominal GDP can be less than
materials which a firm carries from 3. (d) Festival gift from an employer real GDP, if prices in the current year
one year to the next. 4. (c) Employees’ contribution to social are less than the prices in the base
17. (i) – (a) , (ii) – (b) security schemes year.
18. Change in inventories of the firm 5. (c) It is an income earned for 4. True: Real GDP can be equal to
during a year. rendering productive services nominal GDP if prices in the current
19. Unplanned accumulation 6. (d) Production of goods and services year are equal to the base year’s
20. Unplanned decumulation 7. (b) Payment of corporation tax by a firm prices.
21. 400, unplanned accumulation 8. Net value added at factor cost (NVAfc) 5. (a) Rising prices
22. 50 , unplanned decumulation 9. False : It is a transfer payment. 6. (d) `13,200 and `11,000
23. Planned accumulation of inventories 10. False: It is not a factor payment because 7. GDP deflator
24. planned decumulation of inventories the borrowings by households are assumed 8. (b)
25. Gross Domestic Product (GDP). to be on consumption expenditure. 9. Change in the price level between the
26. False: Sales by a firm includes sales 11. dividend base year and the current year.
not only to domestic buyers but also 12. Net Domestic Product at factor cost 10. the consumer price index (CPI) of
to buyers abroad (i.e. exports). the current year
27. (c) Both (a) and (b) Objective Type Questions 1.6 11. (b) `1,650
28. False: Production taxes are paid 1. (b) Expenditure on maintenance by a firm 12. (b) `1,680
in relation to production and are 2. (a) Payment of indirect tax by a firm 13. Wholesale Price Index (WPI)
independent of the volume of 3. False: It is a private final consumption 14. (a) GDP deflator
production, e.g. land revenues, expenditure. 15. True: CPI includes prices of goods
stamp and registration fee. 4. False: It will be included in national consumed by the representative
29. True: There are paid per unit of product. income as it is government final consumer, hence it includes prices of
30. False: Basic prices include the consumption expenditure. imported goods. But GDP Deflator
production taxes (less production 5. False: Gross domestic capital formation calculated on the basis of nominal
subsides) but not product taxes (less can be less than gross fixed capital and real GDP includes domestically
product subsidies). formation if change in stock is produced goods only.
31. Gross Domestic Product at market negative, i.e., when opening stock 16. (i) CPI (ii) GDP deflator
price (GDPmp) exceeds closing stock.
32. Depreciation; Net National Product 6. (i) – (c) , (ii) – (b) , (iii) – (a) Objective Type Questions 1.8
33. depreciation does not become part 7. False: Final consumption expenditure is 1. False: With rise in real GDP, welfare
of anybody’s income also incurred by the government. Firms may not rise if there is inequality
34. (b) Indirect taxes may also buy consumption goods to in the distribution of GDP, or due
35. Indirect taxes ; Subsidies treat their guests or for their employees. to externalities and non - monetary
36. Indirect taxes accrue to the government. 8. True: The reason is that investment exchanges.
It is a transfer payment, not a factor goods remain with the firm, whereas 2. barter exchanges , under-estimation
payment. 3. (b) Non-monetary exchanges
Preparing for Examinations and Sample Papers 253
Investment Multiplier
∆Y
Investment Multiplier, k =
∆I
∆Y ∆Y
Since DA = DI, therefore=
k =
∆I ∆A
1
Investment Multiplier, k =
1 − MPC
1
Since 1 – MPC = MPS, therefore, value of investment multiplier is: k =
MPS
20 Marks
CBSE Guidelines for Project Work
and Sample Project
Objectives
The objectives of the project work are to enable learners to:
probe deeper into theoretical concepts learnt in class XII
analyse and evaluate real world economic scenarios using theoretical constructs and arguments
demonstrate the learning of economic theory
follow up aspects of economics in which learners have interest
develop the communication skills to argue logically
Expections
The expectations of the project work are that:
learners will complete only ONE project during the academic session.
project should be of 3,500 - 4,000 words (excluding diagrams & graphs), preferably hand-written.
it will be an independent, self-directed piece of study.
320 Macroeconomics XII – by Subhash Dey
Organization of material/data
Present material/data
Expected Checklist:
Introduction of topic/title
Identifying the causes, consequences and/or remedies
Various stakeholders and effect on each of them
Advantages and disadvantages of situations or issues identified
Short-term and long-term implications of economic strategies suggested in the course of research
Validity, reliability, appropriateness and relevance of data used for research work and for presentation in the project
file
Presentation and writing that is succinct and coherent in project file
Citation of the materials referred to, in the file in footnotes, resources section, bibliography etc.
Marking Scheme:
Marks are suggested to be given as:
S. No. Heading Marks Allotted
1. Relevance of the topic 3
2. Knowledge Content/Research Work 6
3. Presentation Technique 3
4. Viva-voce 8
Total 20 Marks
Money
and
Banking From BARTER to CRYPTO
In stone age days we used to rely on barter system to trade where goods were exchanged for goods. Gradually, money came
into existence which carried certain values and got accepted as a medium of payment for transacting goods and services. It
was adopted as a legal tender within the country to be used in any market.
What is Money?
Money is a kind of legal tender acceptable by people of any country where it has been legalized and carries certain value. It
is used as an official payment mode for exchange of any goods and services or to clear any debts.
When agriculture became mainstream in 9000–6000 BC , both livestock and plant products were used as money. There is
a remarkable statement by Aristotle where he spoke why money got created he said:
"When the inhabitants of one country became more dependent on those of another, and they imported what they
needed, and exported what they had too much of, money necessarily came into use."
Project Work 323
Bronze Age
Bronze age was more a kind of Commodity Money, objects that have value in themselves as well as value in their use as
money. Shekel was used by Mesopotamian. Ancient China, Africa & India used Cowrie shells .
The shekel was the unit of weight and currency, first recorded circa 3000 BC, referring to a specific weight of barley, and
equivalent amounts of silver, bronze, copper etc.
Cowrie shells, found abundantly in the Indian Ocean, were among the earliest forms of currency used in the world. In
India, they were referred to as kaudi and were used in certain areas like Odisha even until the early 1800s.
Coin Age
Coins were an evolution of 'currency' systems of the Late Bronze Age , where standard-sized ingots, and tokens such as
knife money, were used to store and transfer value. Indian coins were a kind of punched metal and Chinese were a casted
bronze with holes in the centre.
The very first coins used in U.S were called cents which was first introduced in 1793.
According to Aristotle (fr. 611,37, ed. V. Rose) and Pollux (Onamastikon IX.83), Hermodike of Kyme was the first person
to issue coins.
Most coins ('currency' in modern term) currently are made of a base metal and their value is decided based on the country and
its marketplace demand and supply needs. The value of the coin is decreed by government law and thus, is determined by the
free market only as national currencies are used in domestic trade and also traded internationally on foreign exchange markets.
INDIAN CONTEXT
The first documented instance of coins being used as currency in India dates back to the seventh or sixth century BC. These
‘punch-marked’ coins were stamped bars of metal (usually silver and copper) that were first issued in the Mahajanapada
kingdoms of the Indian Iron Age, and they lasted until the end of the Imperial Mauryan period.
The Indo-Greek kings then introduced new types of coins that would influence Indian coinage for many centuries to
come. The Kushan empire, which existed from the first to third centuries CE, began minting gold coins which featured
mythological deities. The Gupta empire, from 320-470 CE, produced the largest number of gold coins in Indian history,
which is why it is often referred to as the ‘golden period’. Coins continued to take on various forms through the subsequent
dynasties in India — from the Rajput and Mughal empires in the North to the Maratha and Vijayanagara kingdoms in the
South.
It was Sher Shah Suri who, during his five-year rule from 1540-1545, introduced to the nation a new currency which is
the ancestor of the modern-day Rupee. After defeating Humayun and taking over the Mughal Empire in 1540, Suri set
up a new civic and military administration that issued a silver coin termed the Rupiya, which remained in circulation
even during the remainder of the Mughal Period as well as during the Maratha era. The Rupiya remained the dominant
standard currency even during the British Raj, despite the East India Company’s efforts to introduce the Sterling Pound in
India as early as the 1600s. But the coins issued in Western India (Bombay and Surat) and South India (Madras) provinces
differed from their northern counterparts in both design and metrology.
Cowrie shells Silver and Gold Coins
Cowrie shells were some of the first forms of currency used in India, before being replaced by silver and gold coins, such as
these ones from the Maurya dynasty (bottom).
324 Macroeconomics XII – by Subhash Dey
The issuance of a uniform coinage in India was brought about only in the early 19th century when the English, who were
now the dominant power in the country, enacted the Coinage Act of 1835 . The newly-designed coins saw the traditional
Indian images and symbols replaced with the effigy of King William IV, which was itself replaced by the portrait of Queen
Victoria from 1840 onwards. However, it was only after the Indian Rebellion of 1857, also known as the Sepoy Mutiny,
the British declared the Rupee as the official currency of colonial India.
The RBI was formally inaugurated on April 1, 1935, with its Central Office at Calcutta (now Kolkata) which was relocated
to Bombay (now Mumbai) in 1937. A year later, the apex bank issued its first series of notes which now bore a portrait of
the new British monarch — George VI. The Five Rupee note was the first one to be issued in this series and Rs. 1, 2, and
10,000 notes were subsequently added to the pre-existing denominations.
When the Republic of India was established on January 26, 1950, the portrait of George VI on the Rupee note was
replaced by an image of the Ashoka Pillar. This currency remained in circulation unchanged until The High Denomination
Bank Notes (Demonetisation) Act, 1978. Under this law, the Indian Parliament halted the use of high-denomination
banknotes of Rs. 1,000, 5,000, and 10,000 which were undermining the Indian economy due to their use in illegal
financial transactions.
It was in 1996 that the first notes bearing the picture of Mahatma Gandhi were printed. These notes, which featured
upgraded security measures and tangible aids for the visually impaired, remain in circulation even today, with the exception
of the Rs 500 and Rs 1,000 notes which were replaced after the 2016 Demonetisation.
INDIAN CURRENCY
THROUGH THE AGES
From shell money to cashless transactions
HUMBLE BEGINNINGS
Cowrie Shells are some of the earliest documented
forms of a currency system in India, pre-dating
many Indian dynasties and kingdoms.
EARLY COINAGE
The first coinage systems appeared around the
7th to 6th centuries BC. Pictured on the left is a
collection of silver Mauryan coins.
COLONIAL CURRENCY
Under British rule, Indian currency went through
several iterations with different series (Right) 1
Mohur from 1862, the Victoria series.
THE AGE OF PAPER MONEY
Post-independence cash– especially paper money
– established an unshakeable foothold in India.
Despite two denomination cycles, paper money
continues to hold sway over large chunks of the
Indian currency system.
DIGITAL PAYMENTS
1871: The start of e-money
Founded as the New York and Mississippi Valley Printing Telegraph Company in 1851, Western Union built a
transcontinental telephone line across America in 1861. But after a party of Sioux warriors cut a large part of the wire
to make bracelets, the pace of change slowed. When some of the bracelet-wearing warriors fell ill, a Sioux medicine man
declared that the great spirit of the “talking wire” had sought revenge for its destruction. Western Union was left to connect
the East and West Coast of America, with the first fund transfer via telegram taking place in 1871: the concept of e-money
was born.
1950: The first credit card
Created in 1950 by Frank McNamara when he found himself without enough cash to pay for dinner, the Diners Club
Card was the world’s first credit card. Realizing his shortfall as he reached into his pocket to pay for dinner, McNamara was
forced to call his wife and ask her to bring cash to the restaurant. He vowed this would be the last such supper.
Today, more than half of all transactions in the U.S. and U.K. are put on plastic, thanks to McNamara’s embarrassing
dinner.
1967: The invention of ATMs
Legend has it that John Shepherd-Barron devised the world’s first automatic teller machine while taking a bath, which has
historically proven to be the single best place to have an epiphany. Eureka! He pitched the idea to Barclays Bank, with the
first model installed in Enfield, North London, in 1967.
As plastic payment cards had not yet been invented, early ATMs used checks impregnated with carbon 14 – a radioactive
substance – and paid out a maximum of £10 at a time. The expanding ATM network then paved the way for the rise of
debit cards.
In 2016, ATMs are now simply a (sometimes frustrating) fact of our daily lives. Convenience is a drug with the most bitter
and exponential buildup of tolerance. As soon as you have even a smidgen, it becomes a standard requirement and you
suddenly lose any idea of how people survived without it.
1983: Telephone banking
The Bank of Scotland offered Nottingham Building Society customers the first Internet banking service, named Homelink.
Customers needed a television set and a telephone to send transfers and pay the bills, building the foundations for Internet
banking as we know it.
1990: Internet banking
The beginning of the 90s marked the bloom of click-and-brick euphoria, wherein businesses and banks alike sought to
gain the loyalty of their customers by expanding into the web. But this strategy proved trickier than previously thought, as
it took over 10 years for Bank of America to acquire 2 million Internet banking users.
1997: Contactless fuel payment
In 1997, Mobil Oil Corp introduced Speedpass, an electronic payment tag that let consumers pay for fuel at the pump.
Speedpass was the first example of contactless payment, a concept that has now spread across the globe.
2000: Y2K
As the new millennium began, it dealt a substantial psychological blow to internet culture worldwide. Seen as the mark of
an era, customers were now more eager than ever to go online. To go “modern.”
2005: Chip and pin
In 2005, retailers that had not yet signed up to chip and pin became liable for fraudulent transactions, as shoppers downed
their pens and tapped in four-digit personal codes at pay points instead. Retailers were up in arms; at the time of the shift,
around four in ten bank cards were yet to be upgraded to chip and pin technology.
2014: Apple Pay
Continuing the fintech revolution, Apple Pay is released to the public through an iOS update in 2014. The mobile service
lets consumers pay using the Apple device, removing the need for a wallet. And with nearly 40 percent of U.S. retailers
now accepting contactless payments. It will soon be time to leave the plastic at home.
328 Macroeconomics XII – by Subhash Dey
Digital payments themselves are evolving with the inception of cryptocurrency. Since they are a decentralised and highly
secure form of money, currencies like Bitcoin, Ethereum, and Monero are rapidly gaining popularity around the world.
While it may take a while for them to be accepted as a formal currency by the world’s governments, they are undoubtedly
the next step in this long evolution of payments.
330 Macroeconomics XII – by Subhash Dey
MACRO
Economics
XII
Accommodating transactions – These are the balance of payments transactions which are determined by the gap in the
balance of payments, i.e. whether there is a deficit or surplus in the balance of payments.
Aggregate Demand (AD) – It means the total demand for final goods in an economy during an accounting year.
Aggregate Supply (AS) – It is the value of total quantity of final goods and services produced in the economic teritory of a
country.
Appreciation of domestic currency – In a flexible exchange rate system, when the price of foreign currency (say, dollars) in
terms of domestic currency (rupees) falls, the value of domestic currency in terms of foreign currency increases, it is called
appreciation of domestic currency.
Autonomous consumption – Consumption at zero level of income i.e., consumption which is independent of income. It
is the subsistence level of consumption.
Autonomous expenditure (A) – It is the sum of autonomous consumption (C) and Autonomous investment (I)
Autonomous investment – It refers to the investment expenditure which is independent of income.
Autonomous transactions – These are international economic transactions made due to some reason other than to bridge
the gap in the balance of payments, i.e. these transactions are independent of the state of country’s BoP.
Average propensity to consume (APC) – APC is the consumption per unit of income, i.e. C/Y.
Average propensity to save (APS) – It is the savings per unit of income, i.e. S/Y.
Balanced Budget – When the government's budgetary expenditure is equal to the revenue it collects, this is known as a
balanced budget.
332 Macroeconomics XII – by Subhash Dey
Balance of Payments (BoP) – The statement of accounts of a country’s inflows and outflows of foreign exchange in a fiscal
year.
Balance of Payments Equilibrium – A country is said to be in balance of payments equilibrium if the current account
deficit is financed entirely by net capital inflows (i.e. capital account surplus) without any official reserve change/movements.
Balance of Trade (BoT) – The difference between the value of exports and imports of goods of a country in a given period
of time.
Balance on Capital Account – Sum total of net foreign investments, net external borrowings and net external assistance.
Balance on Current Account – Sum total of balance of trade and balance on invisibles.
Bank money – Demand deposits are created by the commercial banks and are called bank money.
Bank of issue – The Central Bank is the sole authority for the issue of currency in the country.
Bank rate – Bank rate is the rate of interest at which commercial banks can borrow from the Central Bank.
BoP Deficit – The balance of payments is in deficit if autonomous foreign exchange receipts are less than autonomous
foreign exchange payments.
BoP Surplus – The balance of payments is in surplus if autonomous foreign exchange receipts are greater than autonomous
foreign exchange payments.
Break-even point – The point at which the level of consumption is equal to the income.
Budget Deficit – When a government spends more than it collects by way of revenues, it incurs a budget deficit.
Capital Account – The record of all international transactions of assets, e.g. money, stocks, bonds, government debt,
etc.
Capital Budget – Those receipts and expenditure that concern the assets and liabilities of the government are included in
the capital budget. It includes both capital receipts and capital expenditure.
Capital expenditure – An expenditure of the Government which either leads to creation of assets (e.g. construction of
school buildings, hospitals, etc.) or reduces its liabilities (e.g. repayment of loans).
Capital goods – The final goods of durable character which are used in the production of other goods and services.
Capital receipts – Those receipts of the government which either create a liability (e.g. borrowings) or lead to reduction in
assets (e.g. recovery of loans, sale of shares in Public Sector Undertakings, etc.).
Cash reserve ratio (CRR) – It is the fraction of net total demand and time deposits that commercial banks must keep as
cash reserves with the Central Bank.
Central Bank – Central Bank is the apex institution of a country's monetary system. The design and the control of the
country's monetary policy is its main responsibility.
Compensation of employees – It is defined as the total remuneration in cash or in kind, payable by the employers to
employees in return for work done by them during an accounting year. It includes (a) Wages and salaries in cash and in kind
and (b) Employers’ contribution in social security schemes.
Consumption function – It describes the relation between consumption and income.
Consumption goods – The final goods which are consumed (or used) for satisfaction of wants by the consumers.
Credit Control – The central bank controls the money supply and credit in the best interests of the economy by taking
recourse to various quantitative and qualitative tools.
Credit – Any international transaction which results in inflow of foreign exchange is entered as a credit in BoP accounts.
Current Account Deficit (CAD) – A situation that arises when the receipts on current account are less than the payments
on current account.
Current Account Surplus (CAS) – A situation that arises when the receipts on current account are more than the payments
on current account.
Current Account – The record of trade in goods and services and transfer payments.
Debit – Any international transaction which results in outflow of foreign exchange is entered as a debit in BoP accounts.
Debt creating capital receipts – Borrowings made by the government.
Glossary of Key Terms 333
Deficient Demand – When aggregate demand is less than aggregate supply at full employment, it is a situation of deficient
demand.
Deficit Budget – When the government's budgetary expenditure is more than budgetary receipts, this is known as a deficit
budget.
Deflationary gap – It is the amount by which the aggregate demand falls short of aggregate supply at full employment.
Demand deposits – Demand deposits are the deposits which can be withdrawn on demand by the depositors from banks,
e.g. current account and savings account deposits.
Demand pull inflation – An aggregate demand induced rise in the general price level.
Depreciation of domestic currency – Depreciation is the fall in the value of domestic currency in relation to a foreign
currency caused by rise in foreign exchange rate in the foreign exchange market under the flexible exchange rate system.
Depreciation – An annual allowance for normal wear and tear and foreseen obsolescence of a fixed capital asset.
Devaluation of domestic currency – In a fixed exchange rate system, when some government action increases the exchange
rate (thereby, making domestic currency cheaper) is called Devaluation of domestic currency.
Direct taxes – Those taxes which cannot be shifted to the other person/entity, e.g. income tax, corporation tax, etc.
Domestic product – It includes production activity of the production units located in the economic territory irrespective
of whether carried out by the residents or non-residents.
Domestic territory (or economic territory) – The geographical territory administered by a government within which
persons, goods and capital circulate freely.
Double counting – The problem of double counting arises when the value of same goods and services are counted more
than once while estimating national income.
Economic growth – It implies a sustainable increase in real GDP of an economy, i.e., an increase in volume of goods and
services produced in an economy.
Economic stability (or price stability) – It means absence of large-scale fluctuations in general price level in the economy.
Effective Demand – It refers to that level of income/output where ex-ante aggregate demand is equal to the ex-ante
aggregate supply, i.e. AD = AS.
Equilibrium exchange rate – Equilibrium exchange rate is the rate at which market demand and supply of foreign exchange
are equal.
Equilibrium level of income or output – It is that level of income or output at which ex-ante aggregate demand becomes
equal to ex-ante aggregate supply or ex-ante savings and ex-ante investment are equal.
Ex-ante and ex-post – Ex-ante variable is the planned or expected value of the variable whereas, ex-post variable is the
actual or realised value of the variable.
Ex-ante consumption – It refers to planned consumption expenditure on final goods in the economy.
Ex-ante investment – It refers to planned investment expenditure on final goods in the economy.
Ex-ante savings – It refers to the planned savings at different levels of income in an economy.
Ex-post investment – Ex-post investments are the actual amount of investments made in the economy during a period.
Excess Demand – When aggregate demand is more than the aggregate supply at full employment, it is a situation of excess
demand.
External Assistance – Government Aid, Inter-governmental, Multilateral and Bilateral Loans.
External Borrowings – External Commercial Borrowings, Short-term Debt.
Externalities – Harms (or benefits) a firm or an individual causes to another for which they are not penalised (or not paid).
Factor income paid to abroad – Factor income paid to abroad means non-resident’s contribution to production inside
the economic territory.
Factor income received from abroad – Resident’s contribution to production outside the economic territory of the country.
Factor income – Net international earnings on factors of production (like labour, land and capital).
Final Expenditure – It refers to the expenditure on final goods and services produced within the domestic territory of the
country, which are meant for final consumption and investment.
334 Macroeconomics XII – by Subhash Dey
Final goods – Goods purchased for final consumption, i.e., for satisfaction of wants, or final investment.
Fiscal deficit – It is the difference between the Government’s budgetary expenditure and its budgetary receipts excluding
borrowings.
Fixed exchange rate – An exchange rate between the two currencies fixed at government level is called fixed exchange rate.
Flexible (or Floating) Exchange Rates – An exchange rate determined by the forces of demand and supply in the foreign
exchange market is flexible or floating exchange rate.
Flows – Economic variables measured over a period of time, e.g. income, output, etc.
Foreign exchange market – The market in which national currencies are traded for one another is known as the foreign
exchange market.
Foreign exchange rate – Foreign Exchange Rate (also called 'Forex Rate') is the rate at which one currency can be converted
into another currency.
Foreign exchange – Any currency other than the domestic currency.
Foreign Investments – Foreign Direct Investments (FDIs), Portfolio Investment, e.g. Foreign Institutional Investments
(FIIs).
Full employment level of income – It is that level of income where all the factors of production are fully employed in the
production process.
Full employment – It refers to a situation of no involuntary unemployment.
GDP Deflator – The ratio of Nominal GDP to Real GDP of current year is a well known price index, called GDP Deflator.
Government Budget – Government Budget is a financial statement of budgetary receipts and budgetary expenditure of
the government during a fiscal year.
Gross Domestic Product (GDP) – It is the money value of all final goods and services produced within the domestic
territory of a country during an accounting year.
Gross investment – That part of final output which comprises of capital goods such as machines.
High powered money – The currency issued by the central bank (Reserve Bank of India in India) can be held by the
public or by the commercial banks, and is called the high‑powered money.
Income from property and entrepreneurship – are incomes earned by property owners. It includes rent and royalty,
profit and interest. It can also be termed as operating surplus.
Indirect taxes – Those taxes which can be shifted to another person/entity, e.g. Goods and services tax (GST)
Induced consumption – The consumption expenditure which is dependent on the level of income.
Induced investment – It refers to the investment expenditure which is dependent on the level of income.
Inequalities of income and wealth – It reflects a section of society being deprived of even basic necessities.
Inflationary gap – It is the amount by which the aggregate demand exceeds aggregate supply at full employment.
Intermediate Expenditure (or Intermediate Consumption or Intermediate Cost) – It refers to the expenditure incurred
by a production unit on purchasing those goods and services from other production units, which are meant for resale or
for using up completely during the same year.
Intermediate goods – Goods purchased by a production unit from other production units with the purpose of reselling or
with the purpose of using them completely during the same year.
Investment expenditure – It refers to the addition to the stock of physical capital and change in inventories of a firm in an
economy.
Invisibles – Services, transfers and flows of income that take place between different countries.
Involuntary unemployment – It refers to a situation when a person who is willing and able to work at the prevailing wage
rate, does not get work.
Legal Reserve Ratio (LRR) – It is the minimum reserve that a commercial bank must maintain as per the instructions of
the central bank.
Glossary of Key Terms 335
Lender of Last Resort – It refers to the role of the Central Bank (RBI), of being ready to lend to banks, especially when a
bank is faced with unanticipated severe financial crises.
Managed floating exchange rate (also called 'dirty floating') – Managed floating exchange rate is the floating
(or flexible) exchange rate which can be influenced by the intervention of the Central Bank in the foreign exchange market.
Marginal propensity to consume (MPC) – Change in consumption per unit change in income, i.e. DC/DY.
Marginal propensity to save (MPS) – It refers to the change in savings due to a given change in income, i.e. MPS = DS/DY.
Margin requirement on loan – The difference between the current value of the security offered and amount of loan granted.
Mixed Income – Income of self-employed people like doctors, chartered accountants, consultants, etc. has two or more
factor incomes. Total income is estimable, but not its different components. So, mixed income is added to national income.
Monetary Policy – The policy adopted by the Central Bank of a country in the direction of credit control or money
supply is known as Monetary Policy.
Money creation (or deposits creation or credit creation) – It is a process by which a commercial bank creates total deposits
number of times the primary deposits.
Money Multiplier (or Credit Multiplier or Deposit Multiplier) – It is the number by which total deposits can increase
due to a given change in deposits.
Money supply – Money supply refers to the total quantity of money in circulation in the economy at a given point of time.
Money – Anything which is commonly accepted as a medium of exchange is called money.
National Income (NI)/NNP at factor cost – It is the sum of factor incomes earned by the normal residents in the form
of wages, profits, rent and interest, etc., during an accounting year within the domestic territory or abroad.
National product – It includes production activities of residents irrespective of whether performed within the economic
territory or outside it.
NDP at factor cost – It is the income earned by the factors in the form of wages, profits, rent, interest, etc., within the
domestic territory of a country. It is also called net domestic factor income or domestic income.
Net Exports – It refers to the excess of the value of exports over the value of imports of a country in an accounting year.
Net factor income from abroad (NFIA) – Difference between factor income from abroad and factor income to abroad.
Net investment – New addition to capital stock in an economy is called net investment or net capital formation.
Nominal GDP – It is the market value of the final goods and services produced within domestic territory of a country
during an accounting year, as estimated at the current year’s prices.
Nominal National Income – When national income (product) of the current year is estimated on the basis of prices
prevailing in the current year, it is called nominal national income.
Non-debt creating capital receipts – Those captial receipts which are not borrowings and therefore, do not give rise to
debt. For example, PSU disinvestment, recovery of loans.
Non-factor income – Net sale of service products like shipping, banking, tourism, software services, etc.
Non-monetary exchanges –Those activities in an economy which cannot be evaluated in terms of money due to non-
availability of data, e.g. domestic services of a housewife/family members.
Non-tax revenues/Non-tax receipts – Revenue earned by the government from sources other than taxes, e.g. interest
receipts, dividends and profits on investments, fees and fines, ccash grants in aid.
Official Reserve Sale – The country can use its reserves of foreign exchange in order to balance any deficit in its balance
of payments. The Reserve Bank of India (RBI) sells foreign exchange in the foreign exchange market when there is a deficit
in balance of payments. This is called 'official reserve sale'.
Official reserve transactions – The transactions carried on by monetary authorities of a country, which causes changes in
official reserves.
Open market operations – Sale and purchase of government securities in the open market by the Central Bank(RBI).
Operating surplus – Operating surplus is defined as the sum of rent, royalty, interest and profits.
336 Macroeconomics XII – by Subhash Dey
Primary deficit – It is the difference between fiscal deficit and the interest payments made by the government.
Primary deposits – It refers to the initial deposits with commercial banks.
Public goods – Non-profitable economic activities which are not undertaken by the private sector either due to lack of
enough profits or huge investment expenditure, e.g. water supply, sanitation, maintaining law and order, etc. are called
public goods.
Real GDP – It is the market value of the final goods and services produced within the domestic territory of a country
during an accounting year, as estimated at the base year’s* prices/constant prices.
Reallocation of resources – It refers to re-distribution of resources from one use to another.
Real National Income – When national income (product) of the current year is estimated on the basis of prices prevailing
in the base year, it is called real national income.
Repo rate – The rate at which commercial banks borrow money from the Central Bank for a short period by selling their
financial securities to the Central Bank.
Resident – A person or an institution whose centre of economic interest lies in the domestic territory of the country in
which he lives.
Revaluation of domestic currency – In a fixed exchange rate system, when some government action decreases the exchange
rate (thereby, making domestic currency costlier) is called Revaluation of domestic currency.
Revenue Budget – Those receipts and expenditure that relate to the current financial year only are included in the revenue
budget. It includes both revenue receipts and revenue expenditure.
Revenue deficit – It refers to excess of government’s revenue expenditure over its revenue receipts.
Revenue expenditure – That expenditure of the government that neither creates any asset nor reduces any liability, e.g.
interest payments, subsidies, etc.
Revenue receipts – Those receipts of the government that neither create a liability nor lead to reduction in assets, e.g.
income tax, profit of PSU, dividends, fees and fines etc.
Reverse repo rate – The rate at which Central Bank borrows money from commercial banks.
Savings Function – The relationship between savings and income is called the savings function.
Statutory liquidity ratio (SLR) – It is the fraction of net total demand and time deposits that commercial banks must keep
with themselves in the form of specified liquid assets.
Stocks – Economic variables measured at a given point of time, e.g. capital, wealth, etc.
Surplus Budget – When tax collection exceeds the required expenditure, it is called a surplus budget.
Surplus in capital account – Capital inflows (like receipt of loans from abroad, sale of assets or shares in foreign companies)
are greater than capital outflows (like repayment of loans, purchase of assets or shares in foreign countries).
Tax revenue/tax receipt – Revenue earned by the government from taxes levied on income, wealth and commodities, e.g.
corporation tax, personal income tax, GST, etc.
Tax – Legally compulsory transfer payment made by the people to the government.
Time deposits – Those deposits in banks which have a fixed period of maturity, e.g., Fixed Deposits (FD).
Under-employment equilibrium – When aggregate demand and aggregate supply are equal at below full employment
level, it is called under-employment equilibrium.
Value added/value addition – It is the difference between value of output and intermediate consumption.
Value of output – It is the market value of goods and services produced by a firm during an accounting year.
Accounting for Not-for-Profit Organisations 1.337
Case Study
Case Based Integrated Questions
(As per CBSE Sample Question Paper 2021)
01 Case Study Read the following News Report and answer Q. 1-4 on the basis of the same:
The Monetary Policy Committee of the Reserve Bank of India kept interest rates on hold Thursday even as it vowed to
keep policy sufficiently loose to help revive the coronavirus-battered economy. Accepting a key demand of lenders and
the corporate sector, the central bank cleared a one-time restructuring of loan accounts to bail out stressed borrowers,
including personal, small and medium loans.
The details of the loan restructuring scheme — expected to kick in after the moratorium on loan repayments ends August
31 — will be worked out by a committee headed by former ICICI Bank Chairman KV Kamath. The RBI also continued to
provide support on the liquidity front and opened a new targeted window for small lenders.
The central bank kept the repo rate unchanged at 4 per cent and reduced the reverse repo rate to 3.35 per cent.
1. Suppose you are a member of the Monetary Policy Committee of the RBI. You have suggested the ________
(restriction/release) of the money supply be ensured to help revive the coronavirus-battered economy.
2. “The Monetary Policy Committee of the RBI kept interest rates on hold...” Which of the following is highlighted
above by the term ‘interest rates’?
(a) Bank Rate and Repo Rate (b) Bank Rate and Lending Rate
(c) Repo Rate and Reverse Repo Rate (d) Bank Rate and Reverse Repo Rate
3. What does the ‘Repo Rate’ mean?
(a) Rate at which banks borrow from the RBI for short-term.
(b) Rate at which banks borrow from the RBI for long-term.
(c) Rate at which banks deposit excess funds with the RBI.
(d) Rate at which banks lend funds to the public.
4. ‘Reduction in Repo Rate by RBI’ is likely to _________ (increase/decrease) the demand for goods and services in
the economy.
02 Case Study Read the following News Report and answer Q. 5-8 on the basis of the same:
The six-member RBI panel expects the real GDP growth to be negative for the year 2020-21 as a whole. “An early
containment of the Covid-19 pandemic may impart an upside to the outlook. A more protracted spread of the pandemic,
deviations from the forecast of a normal monsoon and global financial market volatility are the key downside risks,” the
Monetary Policy Committee (MPC) said.
The RBI panel, which slashed the repo rate, the main policy instrument by 115 basis points to 4 per cent since February
this year, noted that like elsewhere, in India too, economic activity had started to recover from the lows of April-May, but
surges of fresh infections have forced re-clamping of lockdowns in several cities and states. “Consequently, several high
frequency indicators have levelled off,” it underlined.
The RBI Governer, Shaktikanta Das said the economy is experiencing unprecedented stress in an austere global
environment. “Extreme uncertainty characterises the outlook, which is heavily contingent upon the intensity, spread
and duration of the pandemic – particularly the heightened risks associated with a second wave of infections – and the
discovery of the vaccine,” he said.
338 Macroeconomics XII – by Subhash Dey
5. “...The real GDP growth to be negative for the year 2020-21 as a whole.” Which of the following is a fiscal measure
that may be taken by the Government of India to correct the Covid-19 pandemic?
(a) Cut in Repo Rate by the RBI. (b) Decrease the taxes.
(c) Increase in public expenditure. (d) Both (b) and (c)
6. What does negative real GDP growth for the year 2020-21 signify?
(a) Real GDP of the year 2020-21 has decreased as compared to 2019-20.
(b) Real GDP of the year 2020-21 has become negative.
(c) Real GDP of the year 2020-21 is less than Nominal GDP of the same period.
(d) None of the above
7. What will be the impact reduction in Repo Rate in the economy?
(a) Fall in aggregate demand (b) Rise in aggregate demand
(c) Rise in general price level (d) No change in aggregate demand
8. “The RBI panel, which slashed the repo rate, the main policy instrument by 115 basis points to 4 per cent since
February this year...” What was the Repo Rate before February?
(a) 5.15 per cent (b) 4 per cent
(c) 1.15 per cent (d) 2.85 per cent
03 Case Study Read the following News Report and answer Q. 9-12 on the basis of the same:
Read the following news report and answer Questions 7-10 on the basis of the same:
The Reserve Bank of India (RBI), cut Repo Rate to 4.4%, the lowest in at least 15 years. Also, it reduced the Cash Reserve Ratio
(CRR) maintained by the banks for the first time in over seven years. CRR for all banks was cut by 100 basis points to release `1.37
lakh crores across the banking system. RBI governor Dr. Shaktikanta Das predicted a big global recession and said India will not be
immune. It all depends how India responds to the situation. Aggregate demand may weaken and ease core inflation.
The Economic Times; March 27th, 2020
Q.7 Cut in Repo rate by RBI is likely to ___________ (increase/decrease) the demand for goods and services in the economy.
(Choose the correct alternative) (1)
Q.8 Decrease in Cash Reserve Ratio will lead to ___________ . (Choose the correct alternative) (1)
(a) fall in aggregate demand (b) no change in aggregate demand
(c) rise in aggregate demand (d) fall in general price level
Q.9 The difference by which actual Aggregate Demand exceeds the Aggregate Demand, required to establish full employment
equilibrium is known as ___________ (inflationary gap/deflationary gap). (Choose the correct alternative) (1)
Q.10 The impact of ‘Excess Demand’ under Keynesian theory of income and employment, in an economy are:
(Choose the correct alternative) (1)
(a) decrease in income, output, employment and general price level
(b) decrease in nominal income, but no change in real output
(c) increase in income, output, employment and general price level
(d) no change in output/employment but increase in general price level.
Q.11 State with valid reason, which of the following statement is true or false: (3)
(a) Gross Value Added at market price and Gross Domestic Product at market price are one and the same thing.
(b) Intermediate goods are always durable in nature.
Q.12 State, giving valid reasons, whether the following statements are true or false: (3)
(a) Current account in Balance of Payments records only the exports and imports of goods and services.
(b) Borrowings from abroad are recorded in the Capital Account of the Balance of Payments on the debit side.
OR
‘Trade Deficit must exist if a country is facing a situation of Current Account Deficit’. Defend or refute the statement, with
valid argument.
Q.13 (a) Define money multiplier. (1)
(b) ‘Credit creation is inversely related to the reserve deposit ratio’. Justify the given statement, using a hypothetical example. (3)
Q.14 In an economy C= 200 + 0.5 Y is the consumption function where C is the consumption expenditure and Y is the
national income. Investment expenditure is `400 crores. Is the economy in equilibrium at an income level `1500 crores?
Justify your answer. (4)
OR
Define: (i) Ex-Ante Savings (ii) Full Employment
Q.15 ‘India’s GDP contracted 23.9% in the April-June quarter of 2020-21 as compared to same period of 2019-20, suggesting
that the lockdown has hit the economy hard’. The Hindustan Times, 1st September 2020. State and discuss any two fiscal
measures that may be taken by the Government of India to correct the situation indicated in the above news report. (4)
Q.16 (a) ‘Domestic/household services performed by a woman may not be considered as an economic activity’. Defend or refute
the given statement with valid reason. (3)
(b) ‘Compensation to the victims of a cyclone is an example of a welfare measure taken by the government’. State with
valid reason, should it be included/not included in the estimation of national income of India. (3)
OR
Suppose the Gross Domestic Product (GDP) of Nation X was `2,000 crores in 2018-19, whereas the Gross Domestic
Product of Nation Y in the same year was `120,000 crores. If the Gross Domestic Product of Nation X rises to `4,000
crores in 2019-20 and the Gross Domestic Product of Nation Y rises to `200,000 crores in 2019-20. Domestic Product of
Nation Y rises to `200,000 crores in 2019-20. (6)
Q.17 (a) Elaborate the objective of ‘allocation of resources’ in the Government budget. (3)
(b) Discuss briefly how the Government budget can be used as an effective tool in the process of employment generation. (3)
CBSE New Sample Question Papers 2021 345
Answer Key
1. (a) stock, flow. OR (c) `240 crores prevailing wage rate. It is a situation where there is no
2. release 3. (c) 4. (b) involuntary unemployment.
5. (c) 6. (a) 7. increase 15. The situation suggests that Aggregate Demand is less than
8. (c) 9. inflationary gap 10. (d) Aggregate Supply. Two fiscal measures to control it:
11. (a) The given statement is false as Gross Domestic Product is (a) Decrease in Taxes: To curb the situation, the
the result of sum of Gross Value Added by all the producing government may decrease the taxes. This may increase
units/firms in an economy, during an accounting year. the purchasing power in the hands of the general
(b) The given statement is false as intermediate goods are public. This may increase the Aggregate Demand in
generally non-durable in nature. They are the goods the economy to bring it equal to the Aggregate Supply.
used as raw material and they lose their identity in (b) Increase in Government Expenditure: The government
the production process for the creation of a new may also increase its expenditure. This may increase the
commodity, during an accounting year. purchasing power in the hands of the general public
12. (a) The given statement is false as the Current Account which in turn may increase the Aggregate Demand in
of Balance of Payments records unilateral transfers the economy to bring it equal to the Aggregate Supply.
along with exports and imports of goods and services. 16. (a) The given statement is defended; as it is difficult to
(b) The given statement is false as the borrowings from measure the monetary value of the services performed
abroad are recorded in the Capital Account of by a woman (homemaker). Therefore, these activities
Balance of Payments on the credit side as it results in may not be considered as an economic activity.
an inflow of foreign currency in the economy. (b) Compensation given to the victims of a cyclone is
OR an example of a social welfare measure taken by the
The given statement is refuted as the Current Account Deficit government. However, it is not included in estimation
(CAD) is a broader concept. CAD occurs when the foreign of national income as it is a transfer payment which does
exchange payments on account of visible, invisibles and current not lead to corresponding flow of goods and services.
transfers are in excess over the receipts of visible, invisibles and OR
current transfers. A country may face a situation of CAD, even Compare the rate of change of GDP of Nations X and Y,
if the country has trade surplus, with greater negative balances taking 2018-19 as base year.
on account of services and unilateral transfers. Nations/ 2018-19 2019-20 Growth Rate of GDP
13. (a) Money multiplier is the process by which the
Years = Change in GDP/Base
commercial banks create credit, based upon the Year GDP × 100
reserve ratio and initial deposits. (Base year = 2018-19)
(b) Reserve deposit ratio is the minimum reserves which a X `2,000 `4,000 = 2000/ 2000
commercial bank must maintain as per the instructions crores crores × 100 = 100%
of the Central Bank. Credit Creation = 1/reserve ratio Y `1,20,000 `2,00,000 = 80,000/ 1,20,000
Thus, credit creation is inversely related to the reserve deposit ratio. crores crores × 100 = 66.67%
For Example: Suppose the Reserve Ratio is 0.2 and initial Nation X has registered a GDP growth rate of 100% and has
deposit is `1000 crores. Total Credit Created = 1/reserve performed better on the front of GDP rise as compared to
ratio × initial deposits = 1/0.2 × 1000 = `5,000 crores. Nation Y that has registered a GDP growth rate of 66.67%.
Now, suppose reserve ratio is increased to 0.5. Total Credit 17. (a) Allocation of resources: Government seeks to allocate
Created = 1/0.5 × 1000 = `2,000 crore. resources with a view to balance the goals of all sections
Thus, on the basis of the above illustration we can say that there of the society. Production of goods and services which
exists an inverse relation between reserve and credit creation. are injurious to health may be discouraged through
14. Given, Consumption function(C)=200+0.5Y, Investment taxation policy. Similarly, production of goods of socially
(I) = 400, Level of income (Y) = 1500 beneficial nature may be encouraged through subsidies.
At Equilibrium level, AD = AS or Y = C + I If the private sector does not take initiative in certain
Y = (200 + 0.5Y) + 400 Y – 0.5 Y = 600 Y = 600/0.5 = `1200 crores. activities (Public Goods), the government may directly
The equilibrium level of income = `1200 crores. control them like water supply and sanitation etc.
The given income (`1500 crores) is greater than (b) Employment Generation: Government budget can be
equilibrium level of income (`1200 crores). Therefore, the used as an effective tool in the process of employment
economy is not in equilibrium. generation in various ways. Investment in infrastructural
OR projects like construction of flyovers, bridges, expansion
(i) Ex-ante savings: Ex-ante savings refers to the planned of roads etc. creates jobs for different sections of the
savings of an economy at different levels of income. workforce. In rural/urban areas government can provide
(ii) Full employment: It refers to a situation, where all jobs through various employment generation schemes
the willing and capable resources get a gainful job at like MGNREGA, SJSRY, PMRY etc.
346 Macroeconomics XII – by Subhash Dey
Q.13 ‘‘A country deliberately keeps the value of its currency low under the managed floating system.’’ Discuss briefly how it will
affect the exports of the country. (4)
OR
On which side and in which sub-account of Balance of Payments, will ‘foreign investment in India’ be recorded? State valid
reason for your answer.
Q.14 (a) Describe the ‘Banker to the Government’ function of the Central Bank. (2)
(b) Describe the ‘Bank of currency issue’ function of the Central Bank. (2)
Q.15 Distinguish between fiscal deficit and revenue deficit in a Government Budget. (4)
Q.16 (a) Giving valid reasons, state how the services of a ‘School Teacher’ will be undertaken in estimation of National Income. (2)
(b) Distinguish between ‘Real Gross Domestic Product’ and ‘Nominal Gross Domestic Product’. (2)
(c) Discuss briefly how the money received from the sale of a second hand car will be undertaken in estimation of
national income. (2)
Q.17 (a) ‘‘To boost the falling demand in the economy, Reserve Bank of India recently reduced Repo Rate and Reverse
Repo Rate.’’ Elaborate the rationale behind the steps taken by the Central Bank. (4)
(b) Define involuntary unemployment. (2)
OR
What is meant by deflationary gap? State any two monetary measures to correct the situation of deflationary gap. (6)
364 Macroeconomics XII – by Subhash Dey
AD
AD2
1
Aggregate Demand
E1
AD2
AD1
E2
o
45
O Y2 Y1 X
Income/Output
Q.4 The value of MPC can exceed one. True/False? Give valid reason. (1)
Q.5 If inflation is higher in country A than in country B, and the exchange rate between the two countries is fixed what is likely
to happen to the trade balance between two countries? (1)
(a) Trade balance of country A will show a deficit whereas trade balance of country B will show a surplus.
(b) Trade balance of country A will show a surplus whereas trade balance of country B will show a deficit.
(c) Balance of trade of both the countries will be in balance
(d) None of the above.
Q.6 A rise in the interest rates at home leads to ________ of the foreign currency. (depreciation/appreciation) (1)
Read the following News Report and answer Q. 7-10 on the basis of the same:
10 major highlights of Budget 2020
• Empowering people to create wealth and boost purchasing power.
• Fundamentals of the economy are strong.
• GST brings 60 lakh new taxpayers.
• Three pillars of Union Budget 2020 – (i) Aspirational India. (ii) Economic Development (iii) Caring society.
• Promoting Education In India – Finance minister has allocated a total of `99,300 crore to the education sector of India.
• National Infrastructure policy to spend `100 lakh crore over the next 5 years.
• Building Data centre parks and National Quantum Tech Plan.
• Developing the structure of tourism.
• Governance is key.
• Empowering the scheduled class and scheduled tribes – Government has allocated `85k crore for the scheduled class and
other backward classes for the year 2020-21 and `53,700 crore for the scheduled tribes.
Q.7 Goods and Services Tax (GST) is a __________ (direct/indirect) tax. (1)
Q.8 “GST brings 60 lakh new taxpayers.” What will be its likely effect on revenue deficit in government budget? (1)
(a) Increase (b) Decrease
(c) Constant (d) None of these
CBSE New Sample Question Papers 2021 365
Q.9 “National Infrastructure policy to spend `100 lakh crore over the next 5 years.” Building Infrastructure facilities is a _______
(revenue/capital) expenditure in a government budget.
Q.10 “Government has allocated `85k crore for the scheduled class and other backward classes for the year 2020-21 and `53,700
crore for the scheduled tribes.” What objective of government budget has been highlighted in the above lines?
(a) Reallocation of resources (b) Reduction in income inequalities
(c) Price stability (d) Economic growth
Q.11 Saving function of an economy is: S = – 250 + 0.25Y. If the planned investment is `2,000 crores, calculate the following:
(a) Equilibrium level of income in the economy. (b) Aggregate demand of income of `5,000 crores. (3)
OR
Consumption function of an economy is : C = 40 + 0.8Y (amount in `crores). Determine that level of income where
average propensity to consume will be one. (3)
Q.12 Use the following information of an imaginary country: (3)
Year 2016 2017 2018
Nominal GDP 6.5 8.4 9
GDP deflator 100 140 125
(i) For which year is real GDP and nominal GDP same and why?
(ii) Calculate real GDP for the given years. Is there any year for which real GDP falls?
Q.13 Assuming that initial deposits with bank `5,000 and Legal Reserve Deposit Ratio 10%, explain the process of credit creation
by the bank. (4)
Q.14 Explain, giving examples, the two components of capital receipts in a government budget. (4)
Q.15 “Government of India is giving incentives for exports.” State and discuss the likely effects of the given statement on foreign
exchange rate with reference to the Indian Economy. (4)
OR
State on which side of capital account/current account will the following transactions be recorded and why:
(i) Interest on loan received from Nepal (ii) Import of mobile phones from China
Q.16 (a) Compute National Income. (`in crore) (3)
(i) Private final consumption expenditure 900
(ii) Government final consumption expenditure 400
(iii) Net imports 30
(iv) Gross domestic capital formation 250
(v) Change in stock 50
(vi) Net domestic fixed capital formation 180
(vii) Net indirect taxes 100
(viii) Net factor income from abroad (–)40
(ix) Profits 100
(b) Explain the circular flow of income in a two-sector economy. (3)
OR
(a) Calculate Net National Product at market price. (`in crore) (3)
(i) Gross domestic fixed capital formation 350
(ii) Private final consumption expenditure 8000
(iii) Government final consumption expenditure 3000
(iv) Value of output produced in the economy 150
(v) Current replacement cost of fixed capital 40
(vi) Net exports (–) 60
(vii) Net factor income from abroad 80
(viii) Sales by all firms in the economy 100
(b) Explain any two precautions while calculating National Income by Product Method. (3)
Q.17 What is ‘Effective Demand’ principle? Explain with the help of a numerical example. (6)
366 Macroeconomics XII – by Subhash Dey
ANSWER KEY
Sample Question Paper-1 (b) In most of the economies across the world there exists a
centralised system of currency issues. Central Bank of a
1. False
country has monopoly over the currency issue. It has the
2. Current Account Surplus (CAS) refers to excess of the receipts
sole responsibility of printing and putting in circulation
from value of export of visible items, invisible items and
all types of currency notes (with a few exceptions). This
unilateral transfers over the payments for value of import of
centralised and monopolised system of currency notes issue
visible items, invisible items and unilateral transfers.
ensures uniformity of the currency system. It also helps in
OR easier control over the monetary system.
zero 15.
3. 1/Legal Reserve Ratio
4. True Fiscal Deficit Revenue Deficit
5. Tax is compulsory payment imposed by the government on Fiscal deficit is the excess of the The revenue deficit
individual and firms. government’s total estimated refers to the excess of
6. Fees 7. release expenditure and its total government’s estimated
8. (c) 9. (a) estimated receipts excluding revenue expenditure over its
borrowing estimated revenue receipts
10. increase
Fiscal Deficit = Total Revenue Deficit = Revenue
11. (a) The given statement is not correct and is thus refuted. Final
Expenditure – (Revenue Expenditure – Revenue
goods are those goods which are purchased/consumed
Receipts + Non-debt creating Receipts
either by households or by the producers for investment
capital receipts)
purpose, i.e., these are the goods which have crossed the
production boundary. 16. (a) The services of a school teacher will be included in the
(b) The given statement is refuted. Gross investment includes national income of the country as it contributes to the
addition to capital stock which also includes replacement current flow of services in the economy.
for the normal wear and tear (depreciation). Whereas, (b)
addition to capital stock in an economy is measured by Real GDP Nominal GDP
net investment. So, in an accounting sense, if the value of
depreciation becomes zero, only then gross investment will Real Gross Domestic Product Nominal Gross Domestic
be equal to net investment. (GDP) is defined as the market Product (GDP) is the market
(c) The given statement is refuted. Net factor income from value of all final goods and value of all final goods and
abroad is the difference between factor income earned services produced in a year, services, produced in a year,
from rest of the world and factor income paid to rest of measured at the prices of a measured at the prices of
the world. If the value of factor income paid to rest of the given base year. current year.
world is greater than the factor income earned from rest (c) The money received from the sale of a second hand car will
of the world, the resulting value (net factor income from not be included in the national income of the country as
abroad) can be negative. it does not contributes to the current flow of goods in the
12. (a) We know that: economy.
Consumption expenditure C = C + bY = 500 + 0.6 (5,000) 17. (a) The steps taken by the Central Bank to boost the falling
= `3,500 crores demand in the economy are justified as the reduction in the
(b) Also, at equilibrium level, Y = C + I Repo rate and Reverse Repo Rate will increase the availability
5,000 = 3,500 + I of funds in the market through the commercial banks.
I = `1,500 crores Rationale: A decrease in Repo/Reverse Repo Rate will
13. If a country deliberately keeps the value of its currency low as push the commercial banks to reduce the lending rate
compared to the foreign exchange, to keeps its currency cheaper and will eventually make the borrowings cheaper for the
vis-a-vis foreign currency, under the managed floating system. general public. As a result the consumption demand in the
Such a step ensures international competitiveness of the goods economy may increase.
and services of the country in the international market leading to (b) Involuntary Unemployment refers to a situation in which
an increase in the exports of the country to the rest of the world. all those people who are willing and able to work at the
OR existing wage rate do not get work.
‘Foreign investment in India’ will be recorded on the credit side OR
of the Capital account in the Balance of Payment account. Deflationary gap is the amount by which the actual aggregate
‘Foreign investment in India’ is of capital nature (increasing the assets of demand falls short of the level of aggregate demand required
the country) also leading to inflow of foreign currency of the country. to establish the full employment equilibrium.
14. (a) Central Bank performs similar banking functions for the Two monetary measures to control deflationary gap are as under:
government as commercial banks perform for its customers. (i) Cash Reserve Ratio (CRR): Lowering the CRR may raise
Its functions include providing loans to the government, the lending capacity of the commercial banks. This may
working as an agent of the government, managing the lead to rise in the aggregate demand in the economy.
public debts for the government etc. The Central Bank (ii) Open Market Operation (OMO): The Central Bank may
also advises the government regarding the money market, purchase the government securities in the open market to
capital market and also on policy matters. pump additional funds into the hands of the general public.
CBSE New Sample Question Papers 2021 375
The real GDP declined in the year 2017. It is due to high (b) Two sector model consists of production sector and
rate of inflation. Price level has risen by 40% between household sector. Households are the owners of factors
2016 and 2017. production and supply factor services to production
13. Working of the credit creation process: Total credit creation = sector. The production units in return make factor
Initial deposits ×1/LRR payment. Households spend the entire income on the
Initially, customer deposits `5,000 and LRR is 10%. Bank purchase of goods and services produced by firms. Thus,
keeps `500 as reserves to meet customers’ obligations and give consumption expenditure flow from household to firms,
loans of `4,500. Those who borrow will spend this money completing the circular flow of income.
and same `4,500 will ultimately come back to bank as fresh OR
deposits. Out of these `4,500, bank keeps 10%, i.e. `450 as (a) NNPmp = (ii) + (iii) + (i) + Change in stocks (iv – viii)
reserves and give loans of `4,050. In this way, in every round + (vi) – (v) + (vii) = 8000 + 3000 + 350 + (150 – 100) +
80% of loans are converted into fresh deposits. (– 60) – 40 + 80 = `11380 crore
Rounds Deposits (`) Loans (`) Reserves (`) (b) Precautions in calculating national income by production
I 5,000 4,500 500 method
II 4,500 4,050 450 (i) Avoid double counting. Value of intermediate goods is
III 4,050 3,645 405 not included in the estimation of value added because
value of intermediate goods is reflected in the value
of final goods. So, avoid double counting of goods
Total 50,000 45,000 5,000
and services as these tend to inflate national income
Total deposits creation (or credit creation or money creation) estimates.
= Initial deposits × 1/LRR = 5,000 × 1/0.1 = 5,000 × 10 = (ii) Do not include sale of second hand goods. Value of
`50,000 second hand goods being sold should not be included
14. Components of capital receipts are: in national income as their value was accounted for at
(i) Debt creating capital receipts — When government takes the time of first production. However, any brokerage
fresh loans, e.g. market borrowings, borrowing from RBI or commission paid to sell the second hand goods is a
and borrowing from abroad, these loans will have to be fresh production activity, so brokerage or commission
returned and interest will have to be paid on these loans. is included.
So, borrowings are debt creating capital receipts of the 17. Effective Demand refers to that level of employment/income/
government. output where ex-ante aggregate demand is equal to the ex-
(ii) Non-debt creating capital receipts — Those receipts which ante aggregate supply, i.e. AD = AS.
are not borrowings and therefore, do not give rise to Numerical Example:
debt. For example, proceeds from sale of shares in Public Determination of Equilibrium Income or Output (C = 100,
Sector Undertakings (PSUs) which is referred to as PSU MPC = 0.8 and I = 300)
disinvestment and Recovery of loans reduce the assets of
Income Consumption Savings Investments Aggregate Aggregate
the government. (Y) (C) (S =Y – C) (I) Demand Supply
15. Incentives for exports are aimed at increasing exports.
(AD = C + I) (AS = Y)
Increase in exports will bring more foreign exchange into 0 100 –100 < 300 400 > 0
the country (i.e. increase in supply of foreign exchange).
1000 900 100 < 300 1200 > 1000
This situation may result into excess supply of foreign currency
in the economy at the prevailing foreign exchange rate. 2000 1700 300 = 300 2000 = 2000
As a result, a new equilibrium rate of foreign exchange will 3000 2500 500 > 300 2800 < 3000
be determined which will be lower than the prevailing foreign 4000 3300 700 > 300 3600 < 4000
exchange rate, leading to appreciation of domestic currency.
Thus, foreign exchange rate is likely to fall. At Y = 0, and Y = 1,000; AD > AS. This causes decrease in
planned inventories inducing producers to produce more
OR
output.
(i) Interest on Loan received from Nepal will be recorded on
At Y = 2,000; AD = AS. This keeps the inventory level
the credit side of the current account as it brings in funds
unchanged. Thus, Effective Demand (AD = AS) is obtained at
to the country.
`2,000 crores level of income/output which is the equilibrium
(ii) Import of mobile phones from China will be recorded level of income/output.
in the debit/payment side of the current account as it is
At Y = 3,000 and Y = 4,000; AD < AS. This causes unplanned,
represents outflow of the foreign currency through visible
undesired increase in inventory of unsold goods inducing
imports.
producers to produce less.
16. (a) National income = (i) + (ii) + (vi) + (v) – (iii) – (vii) +
(viii) = 900 + 400 + 180 + 50 – 30 – 100 + (– 40) =
`1360 crore