SAMPLE PDF Macroeconomics XII 2021-22 Edition by Subhash Dey

Completely based on Latest CBSE Syllabus and NCERT Book
Introductory
Introductory MACRO ECONOMICS
MACROECONOMICS
A Textbook for Economics Class XII
Edition 2021-22
XII
SUBHASH DEY
Subhash Dey
Shree Radhey Publications

Completely based on Latest CBSE Syllabus and NCERT Book
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)
Shree Radhey Publications

C-3/6, Yamuna Vihar, Delhi-110053 (India)
UNIT 1: National Income and Related Aggregates 7
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
Introduction National Income and Related Aggregates
National income accounting is a branch of macroeconomics of which estimation of national income

and related aggregates is a part. National income or any aggregate related to it, is a measure of the
value of production activity of a country. There are three methods of estimation of national income–
value added or product method, income method and expenditure method. To understand these, we
must know how the macroeconomy (it refers to the economy that we study in macroeconomics)
works in a circular way? It begins with the question—‘how does the flow of production arise?’
In a closed economy, without a government or external trade, there are only two sectors, namely firms
and households. The production units are called firms. In a firm the entrepreneur (or entrepreneurs)
is at the helm of affairs. He hires wage labour from the market, he employs the services of capital and
land as well. After hiring these inputs he undertakes the task of production. His motive for producing
goods and services (referred to as output) is to sell them in the market and earn profits. In the process
he undertakes risks and uncertainties. For example, he may not get a high enough price for the goods
he is producing; this may lead to fall in the profits that he earns. The households, on the other hand,
consist of people who work in firms as workers and earn wages or they are the owners of firms and
earn profits. Moreover, they can also earn rent by leasing land or earn interest by lending capital.
Thus, goods and services are produced by firms with the combined efforts of factors of production
(labour, land, capital and entrepreneurship). The output produced is sold to the consumers, who may
be an individual or an enterprise and the good or service purchased by that entity may be for final
use (e.g., bread purchased by households) or for use in further production. When it is used in further
production, it loses its characteristics as that specific good and is transformed through a productive
process into another good. For example, a farmer producing cotton sells it to a spinning mill where
the raw cotton undergoes transformation to yarn; the yarn is, in turn, sold to a textile mill where it
is transformed into cloth; the cloth is, in turn, transformed into an article of clothing which is then
ready to be sold to the ultimate consumers for final use. Why do we call this a final good? Because
once it has been sold, it will not undergo any further transformation at the hands of any producer.
It may, however, undergo transformation by the action of the ultimate consumer, e.g. the tea leaves
purchased by the consumer are not consumed in that form – they are used to make drinkable tea,
which is consumed. Similarly, most of the items that enter our kitchen are transformed through the
process of cooking. But cooking at home is not an economic activity because home cooked food is
not sold to the market. However, if the same cooking or tea brewing was done in a restaurant where
the cooked product would be sold to customers, then the same items, such as tea leaves, would cease
to be final goods and would be counted as raw materials or inputs to which economic value addition
can take place. Thus, it is not in the nature of the good but in the economic nature of its use that a
good becomes a final good.
The above discussion is the basis for estimation of national income and the related aggregates.
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.
1.1 Some Basic Concepts of National Income Accounting

Final Goods and Intermediate Goods
Goods are classified as final goods and intermediate goods on the basis of the end use of the goods.
Final Goods
If goods are purchased for consumption, i.e., for satisfaction of wants, or for investment, these are called final
goods (or final products). Expenditure on them is called final expenditure.
Examples:
(i) Machine purchased by a firm for installation in factory is a final good because it is purchased for investment.
(ii) Milk purchased by households is a final good as it is purchased for consumption.
(iii) Furniture purchased by a school is a final product because it is purchased for investment.
(iv) Computers installed in an office is a final product because it is purchased for investment.
(v) Printer purchased by a lawyer for office use is a final product because it is purchased for investment.
(vi) Blackboard used in a school is a final good because it is for investment. It is not used up completely in a
year but remains for production of educational services.
(vii) Second hand car purchased by a house hold is a final good because it is purchased for consumption.
Intermediate Goods
Goods and services 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 are called intermediate goods (or intermediate products).
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.
(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.
Consumption Goods and Capital Goods

Final goods produced in an economy in a given period of time are either in the form of consumption goods (both
durable and non-durable) or capital goods. As final goods they do not undergo any further transformation at the
hands of any producer. Thus, of the final goods, we can distinguish between consumption goods and capital goods.
Consumption Goods
The final goods which are consumed (or used) for satisfaction of wants by the consumers are called consumption
goods or consumer goods*, e.g., food, clothing, television sets, etc.
 Those consumer goods like television sets, automobiles, home computers, etc. which are of durable
character are called consumer durables.
 Those consumer goods like food, clothing, etc. which are extinguished by immediate or short period
consumption are known as consumer non-durable goods.
Capital Goods
The final goods of durable character which are used in the production of other goods and services are called
capital goods or investment goods, e.g., machines, tools and equipments.
Capital goods are also called durable use producer goods having a long span of life, say 5 years or 10 years.
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.
Stocks and Flows

Stocks
Stocks are economic variables measured at a given point of time.
For example, Capital, Wealth, Money supply, Population, Inventories, Foreign debts, Buildings and machines
in a factory, Balance in a bank account, etc. are stock variables since they are measured at a particular point
of time.
* This also includes services like recreation which are consumed but for convenience we may refer to them as consumer goods.
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.
Gross Investment and Depreciation

Investment
In economics, the term ‘investment*’ is defined as addition to the stock of fixed capital (such as machines) and
change in inventories during a year.
That part of final output which comprises of capital goods constitutes gross investment of an economy. For
example, machines, tools and implements, buildings, office spaces, store houses or infrastructure like roads,
bridges, airports or jetties, etc.
Depreciation
A part of the capital goods produced this year goes for maintenance or replacement of existing capital goods
because the existing capital stock suffers wear and tear and needs maintenance and replacement. This portion of
the capital goods produced is not an addition to the stock of capital goods and its value needs to be subtracted
from gross investment to arrive at net investment. This deletion made from the value of gross investment in
order to accommodate regular wear and tear of capital, is called depreciation.
Depreciation is an annual allowance for normal wear and tear and foreseen obsolescence of a fixed capital asset.
New addition to capital stock in an economy is called net investment (or net capital formation).
Net Investment = Gross investment – Depreciation
Thus, investment is defined as capital formation, a gross or net addition to capital stock.
Let us examine the concept of depreciation a little more in detail:
Cost of the capital asset − Scrap value
Depreciation on capital =
Estimated life of the capital asset (in years)
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.
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
Industrial classification – Primary, Secondary and Tertiary Sectors

Industrial classification means grouping production units into distinct industrial groups,or sectors. This is the first
step required to betaken in estimating national income, irrespective of the method of estimation. It is statistically
more convenient to estimate national income originating in a group of similar production units rather than for
each production unit separately. It is now a matter of general practice to group all the production units of a country
into three broad groups – primary sector, secondary sector and tertiary sectors. Each of these sector can be further
subdivided into smaller groups depending upon the requirement. Let us now explain each sector.
Primary Sector
Primary sector includes production units exploiting natural resources like land, water, subsoil assets, etc. Growing
crops, catching fish, extracting minerals, animal husbandry, forestry, etc. are some examples.
Primary means of first importance. It is primary because it is a source of basic raw materials for the secondary sector.
Secondary Sector
Secondary sector includes production units which are engaged in transforming one physical good into another
physical good. Such an activity is called manufacturing activity. These units convert raw materials into finished
goods. Factories, construction, power generation, water supply, etc. are some examples.
It is called secondary because it is dependent upon the primary sector for raw materials.
Tertiary Sector
Tertiary sector includes production units engaged in producing services. Transport, trade education, hotels and
restaurant, finance, government administration, etc. are some examples.
This sector finds third place because its growth is mainly dependent on the primary and secondary sectors.
Indirect Tax and Subsidy
Indirect Tax
Indirect tax is a tax imposed by government on production and sale of goods and services. It is a tax where
the payer and the bearer of the tax are different people. Examples: Goods and services tax (GST)*, excise tax,
customs duties (export duty and import duty), service tax, sales tax etc.
Imposition of indirect taxes by the government increases the market prices of goods and services.
Subsidy
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 granted by the government reduce the market prices of goods and services.
Net indirect tax = Indirect taxes – Subsidies
* 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.
Market Price and Factor Cost

Market Price
Market prices are the prices as paid by the consumers. Market prices also include indirect taxes.
Factor Cost
Factor cost refer to the prices of products as received by the producers. In other words, factor cost is what is
actually available to production units for distribution of income among the owners of factors of production.
Indirect taxes are deducted from and subsidies are added to market price to calculate what production units
actually receive.
Factor cost = Market price – Indirect taxes + Subsidies
or, Factor cost = Market price – Net indirect taxes
Factor Income and Transfer Income

Factor 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. Examples: Wages and salary, rent, interest profit, etc.
Transfer Income
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.
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.
Inventory and Change in Inventories

Inventory
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.
Inventory is measured at a given point of time, e.g. value of inventory in the beginning of the year or value of
inventory at the end of the year. So, it is a stock variable.
Change in Inventories
Change in inventories equals closing inventory minus opening inventory.
Net change (or increase) in inventories = Closing inventory – Opening inventory
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.
Net product taxes and Net production taxes

Net product taxes
Product taxes and subsidies are paid or received per unit of product, e.g., excise tax, service tax, export and
import duties, etc.
Net product taxes = Product taxes – Product subsidies
Net production taxes

Production taxes and subsidies are paid or received in relation to production and are independent of the
volume of production, e.g. land revenues, stamp and registration fee.
Net production taxes = Production taxes – Production subsidies
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.
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
Numerical 1
Calculate ‘Depreciation on Capital Asset’ from the following data:

(CBSE Sample Question Paper 2020) (4 marks)
S. No Particulars Amount (in `crore)
i. Capital value of the asset 1,000
ii. Estimated life of the asset 20 years
iii. Scrap Value Nil
Cost of the capital asset - Scrap value 1, 000 - 0

Solution: Depreciation on capital asset = = = `50 crore
Estimated life of the capital asset 20
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]
Additional NCERT Content Extracted from latest NCERT Book

 Consumer durables are not extinguished by immediate or even short period consumption; they have a relatively long life as compared to
articles such as food or even clothing. They undergo wear and tear with gradual use and often need repairs and replacements of parts.
 Capital goods purchased by business enterprises such as machines make production of other goods feasible, however, they themselves
don’t get transformed in the production process.
 Capital goods gradually undergo wear and tear, and thus are repaired or gradually replaced over time.
 Capital goods are used either for maintenance or replacement of the existing capital stock because there are wear and tear of it, or they are
used for addition to their capital stock.
 Total final output produced in an economy includes output of consumer goods and services and output of capital goods. The consumer
goods sustain the consumption of the entire population of the economy. Purchase of consumer goods depends on the capacity of the
people to spend on these goods which, in turn, depends on their income. The other part of the final goods, the capital goods, are
purchased by business enterprises. They are used either for maintenance of the capital stock because there are wear and tear of it, or
they are used for addition to their capital stock. In a specific time period, say in a year, the total production of final goods can thus be
either in the form of consumption or investment. This implies that there is a trade-off. If an economy, produces more of capital goods, it is
producing less of consumer goods and vice-versa.
 At a particular period, given a level of total output of the economy, it is true if more capital goods are produced less of consumer goods would be
produced. But production of more capital goods would mean that in future the labourers would have more capital equipments to work with.
 Depreciation is an accounting concept. No real expenditure may have actually been incurred each year yet depreciation is annually
accounted for.
 Unplanned Accumulation and Decumulation of Inventories: In case of an unexpected fall in sales, the firm will have unsold stock of goods
which it had not anticipated. Hence, there will be unplanned accumulation of inventories. In the opposite case, where there is unexpected
rise in the sales there will be unplanned decumulation of inventories.
This can be illustrated with the help of the following example. Suppose a firm produces shirts. It starts the year with an inventory of 100
shirts. During the coming year it expects to sell 1000 shirts. Hence, it produces 1000 shirts, expecting to keep an inventory of 100 at the end
of the year. However, during the year, the sales of shirts turn out to be unexpectedly low. The firm is able to sell only 600 shirts. This means
that the firm is left with 400 unsold shirts. The firm ends the year with 400 + 100 = 500 shirts. The unexpected rise of inventories by 400 is an
example of unplanned accumulation of inventories.
If, on the other hand, the sales had been more than 1000 we would have unplanned decumulation of inventories. For example, if the sales
had been 1050, then not only the production of 1000 shirts will be sold, the firm will have to sell 50 shirts out of the inventory. This 50
unexpected reduction in inventories is an example of unexpected decumulation of inventories.
 Planned Accumulation and Decumulation of Inventories: Suppose the firm wants to raise the inventories from 100 shirts to 200 shirts during
the year. Expecting sales of 1000 shirts during the year (as before), the firm produces 1000 + 100 = 1100 shirts. If the sales are actually 1000
shirts, then the firm indeed ends up with a rise of inventories. The new stock of inventories is 200 shirts, which was indeed planned by the
firm. This rise is an example of planned accumulation of inventories.
On the other hand, if the firm had wanted to reduce the inventories from 100 to 25 (say), then it would produce 1000 – 75 = 925 shirts. This
is because it plans to sell 75 shirts out of the inventory of 100 shirts it started with (so that the inventory at the end of the year becomes 100
– 75 = 25 shirts, which the firm wants). If the sales indeed turn out to be 1000 as expected by the firm, the firm will be left with the planned
decumulation of inventory of 25 shirts.
Objective Type Questions 1.1
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)
21. New addition to capital stock in an economy is ________________.

22. Which of the following does not explain the concept of depreciation? (Choose the correct alternative)
(a) An annual allowance for wear and tear of a capital good.
(b) Cost of the capital good (minus scrap value) divided by number of years of its useful life.
(c) Unexpected or sudden destruction or disuse of capital as can happen with accidents, natural calamities etc.
(d) Maintenance and replacement cost of existing capital goods.
23. Depreciation is an accounting concept. True/False? Give reason.
24. Which of the following define ‘investment’ in Economics ? (Choose the correct alternative)
(a) Purchase of share or property.
(b) Having an insurance policy.
(c) Using money to buy physical or financial assets.
(d) Capital formation ,i.e. a gross or net addition to capital stock.
25. In economics, investment implies using money to buy physical or financial assets. True/False? Give reason.
26. Total final output produced in an economy in a given year are used : (Choose the correct alternative)
(a) To substain the consumption of the entire population of the economy.
(b) For maintenance and replacement of the existing capital stock.
(c) For new addition to the capital stock.
(d) All of the above
27. More capital goods would always mean more consumer goods. True/False?
28. _________ add to, or maintain, the capital stock of an economy and thus make production of other commodities
possible. (Fill in the blank)
29. Match the following:
(i) Fertilisers or pesticides used by (a) Intermediate goods
a farmer to produce wheat
(ii) Bread produced by a baker for (b) Final goods
selling it to consumers or restaurants
30. Depreciation is also known as: (Choose the correct alternative)
(a) Consumption of fixed capital
(b) Annual replacement cost
(c) Value of capital consumption
(d) All of the above
31. Inventory is a stock variable. True/False? Give reason.
32. Change in inventories is a stock variable . True/False? Give reason.
33. ‘Exports’ is a flow variable. True/False? Give reason.
34. Which of the following is a flow concept? (Choose the correct alternative)
(a) Foreign exchange reserves (b) Inventory
(c) Capital (d) Exports
35. Which of the following is a stock variable? (Choose the correct alternative)
(a) Money supply (b) Depreciation
(c) Interest (d) Output
36. Losses are classified as: (Choose the correct alternative)
(a) Stock variable (b) Flow variable
(c) Either (a) or (b) (d) Neither (a) nor (b)
37. Which of the following is not a flow? (Choose the correct alternative)
(a) Capital (b) Income
(c) Investment (d) Depreciation
38. Which of the following is a stock? (Choose the correct alternative)
(a) Wealth (b) Saving
(c) Exports (d) Profits
39. Which of the following is a flow? (Choose the correct alternative)

(a) Deposits in a bank (b) Capital
(c) Depreciation (d) Wealth
40. Which one of the following is an intermediate product? (Choose the correct alternative)
(a) Purchase of pulses by consumers (b) Machine purchased by a firm
(c) Wheat used by a flour mill (d) Wheat used by households
41. Which of the following is an example of an intermediate good? (Choose the correct alternative)
(a) Copper purchased for making utensils (b) Steel and cement used to construct a flyover
(c) Fertilizers purchased by a farmer (d) All of these
42. Depreciation of fixed capital assets refers to: (Choose the correct alternative)
(a) Normal wear and tear
(b) Foreseen obsolescence
(c) Normal wear and tear and foreseen obsolescence
(d) Unforeseen obsolescence
43. Unforeseen obsolescence of fixed capital assets during production is: (Choose the correct alternative)
(a) Consumption of fixed capital (b) Capital loss
(c) Income loss (d) None of the above
44. Refrigerator purchased by a confectionery shop is an example of: (Choose the correct alternative)
(a) Final good (b) Intermediate good
(c) Capital good (d) Both (a) and (c)
45. Which of the following is an example of consumer non-durable good? (Choose the correct alternative)
(a) Milk (b) Bread
(c) Both (a) and (b) (d) Clothes
46. Addition to the capital stock of an economy is termed as: (Choose the correct alternative)
(a) Investment (b) Capital loss
(c) Consumption of fixed capital (d) All of these
47. Goods purchased for the following purpose are final goods : (Choose the correct alternative)
(a) For satisfaction of wants (b) For investment in firm
(c) Both (a) and (b) (d) None of these
48. Match the following: (Choose the correct alternative)
(i) Profits (a) Stock variable
(ii) Savings (b) Flow variable
(iii) Balance in a bank account
(iv) Gross Domestic Product (GDP)
49. State giving reason whether the following statement is True or False:
Capital formation is a flow concept.
Bread is always a consumer good.
Savings are a stock.
Butter is only a final product.
National income of a country is a stock variable.
Capital goods are used up to produce other goods.
HOTS Analysing, Evaluating & Creating Type Questions

1. 'Machine purchased is always a final good.' Do you agree with the given statement? Give reasons. (3 marks)
Ans. The given statement is not correct. Whether ‘machine’ is a final good or not depends on how it is being used.
• If the machine is bought by a household, then it is a final good because it is used for final consumption.
• If the machine is bought by a firm for its own use, then also it is a final good because it is used for investment.
• If the machine is bought by a firm for re-sale, then it is an intermediate good.
2. Which of the following is a stock variable and which is a flow variable? Give reasons. (3 marks)
(a) Inventory
(b) Change in inventory
Ans. (a) Inventory is a stock variable because it is measured at a particular point of time, i.e., at the beginning or
end of the year.
Inventories are treated as capital and hence it is a stock variable.
(b) Change in inventory (closing inventory – opening inventory) is a flow variable because it takes place over
a period of time.
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.
3. Distinguish between stock and flow. Between net investment and capital which is a stock and which is a
flow? Compare net investment and capital with flow of water into a tank. (NCERT) (3 marks)
Ans. Stocks are defined at a particular point of time; whereas flows are defined over a period of time.
Capital is a stock variable as it is measured on a particular day, i.e., at the beginning of the year or at the end of
the year. On the other hand, net investment, i.e., net addition to the stock of capital is a flow variable as it takes
place over a period of time.
For example, 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. On the other hand, how much water there is in the
tank at a particular point of time is a stock.
4. Which among the following are final goods and which are intermediate goods ? Give reasons.
(a) Milk purchased by a tea stall
(b) Bus purchased by a school
(c) Juice purchased by a student from the school canteen (CBSE 2018) (3 marks)
Ans. (a) Intermediate good
Reason: Since it is used up completely in the production process (making tea) in the same year.
(b) Final good
Reason: Since it is for final investment.
(c) Intermediate good
Reason: Since it is for resale.
5. Which of the following products are intermediate products and final products? Give reasons. (3 marks)
(i) Wheat and rice purchased by households
(ii) Purchase of ticket for train journey by an individual
(iii) Purchase of a car by an employer for office use by his employees
Ans. (i) Final products; because these are used for consumption.
(ii) Final product; because it is a final consumption expenditure.
(iii) Final product; because it is a final investment expenditure.
1.2 Domestic Territory and Resident: Implications

Domestic territory (or Economic territory)
The first thing to note is that economic territory of a country is not simply political frontiers of that country.
The two may have common elements, but still they are conceptually different. Let us first see how it is defined.
According to the United Nations:
Economic territory (or Domestic territory) is the geographical territory administered by a government within
which persons, goods and capital circulate freely.
The above definition is based on the criterion "freedom of circulation of persons, goods and capital." Clearly,
those parts of the political frontiers of a country where the government of that country does not enjoy the above
'freedom' are not to be included in economic territory of that country. One example is embassies. Government
of India does not enjoy the above freedom in the foreign embassies located within India. So, these are not treated
as a part of economic territory of India. They are treated as part of the economic territories of their respective
countries. For example, the U.S. embassy in India is a part of economic territory of the U.S.A. Similarly, the
Indian embassy in Washington is a part of economic territory of India.
Based on the criterion ‘freedom of circulation of persons, goods and capital’, the scope of domestic territory is
defined to cover:
1. Political frontiers or geographical boundaries including territorial waters and air space.
For example:
(i) Branch of an American Bank in India is included in the domestic territory of India because it is located
within the geographical boundaries of India.
(ii) Office of Tata Industries in America is not included in the domestic territory of India because it is outside
the geographical boundaries of India.
2. Embassies, consulates, military bases, etc. located abroad.
For example:
(i) Indian embassy in Japan is a part of the domestic territory of India.
(ii) Russian embassy in India is not a part of the domestic territory of India. It is a part of domestic territory of Russia.
3. Ships, aircrafts etc. operated by the residents between two or more countries.
For example, aircrafts operated by Air India between Russia and Japan are treated as a part of the domestic
territory of India.
4. Fishing vessels, oil and natural gas rigs, etc. operated by the residents in the international
waters or other areas over which the country enjoys the exclusive rights or jurisdiction.
For example, fishing vessels operated by Indian fishermen in international waters of Indian Ocean are treated as a
part of the domestic territory of India.
Resident
A resident is defined as follows:
A resident, whether a person or an institution, is one whose centre of economic interest lies in the domestic
territory of the country in which he lives.
The ‘centre of economic interest’ implies two things:
(i) the resident lives or is located within the domestic territory, and
(ii) the resident carries out the basic economic activities of earnings, spending and accumulation from that location.
Examples:
(i) Indians working in the office of the United Nations Organisation (UNO) in India are normal residents
of India since they live in India and their centre of economic interest also lies in India.
(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.
Implications of the Concepts of Economic Territory and Resident

National income and related aggregates are basically measures of production activity. There are two categories of
national income aggregates: domestic income and national income, or domestic product and national product.
Domestic product
Domestic product includes production activity of the production units located in the economic territory
irrespective of whether carried out by the residents or non-residents.
Gross Domestic Product (GDP), Net Domestic Product (NDP) are some examples.
Illustrative example:
How will you treat the following while estimating domestic product (or domestic factor income) of India?
(i) Rent received by an Indian resident from his property in Singapore
(ii) Salaries received by Indian residents working in Russian embassy in India
(iii) Profits earned by a foreign company or a foreign bank in India
(iv) Salaries paid to Koreans working in Indian embassy in Korea
(v) Compensation of employees to the resident of Japan working in Indian embassy in Japan
(vi) Profits earned by a branch of State Bank of India in Japan
Answer:
(i) No, it will not be included in domestic factor income of India because this income is earned outside the
domestic territory (economic territory) of India. It is factor income from abroad.
(ii) No, it will not be included in domestic factor income of India because Russian embassy in India is not a
part of domestic territory of India. So, this income is not earned within the domestic territory of India. It
is factor income from abroad.
(iii) Yes, it will be included in domestic factor income of India because the foreign company or the foreign
bank is located within the domestic territory of India. So, it is an income earned within the domestic
territory of India.
(iv) Yes, it will be included in domestic factor income of India because this income is earned within the
domestic territory of India. Indian embassy in Korea is a part of the domestic territory of India.
(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.
Relation between national product and domestic product

The concept of domestic product is based on the production units located within economic territory, operated
both by residents and non-residents.
The concept of national product is based on residents, and includes their contribution to production both within
and outside the economic territory.
Normally, in practical estimates, domestic product is estimated first. National product is then derived from the
domestic product by making certain adjustments. Let us see how?
National product is derived in the following way:
National product = Domestic product
+ Residents' contribution to production outside the economic territory
– Non-residents' contribution to production inside the economic territory
In practical estimates, the residents' contribution outside the economic territory is called "factor income received
from abroad" and the non-residents' contribution inside the economic territory is called "factor income paid
to residents". Therefore:
National product = Domestic product
+ Factor income received from abroad
– Factor income paid to 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)
Net factor income from abroad

It is the excess of factor incomes (rent, wages, interest, profit) earned from abroad over factor incomes (rent,
wages, interest, profit) paid to abroad.
NFIA can be positive, negative or zero.
1. Positive NFIA: NFIA is positive when factor income from abroad is more than factor income paid to abroad.
Note that if NFIA is positive, national product (or national income) will be greater than domestic product
(or domestic income).
2. Negative NFIA: NFIA is negative when factor income from abroad is less than factor income paid to abroad.
If NFIA is negative, national income will be less than domestic income.
3. Zero NFIA: NFIA is zero when factor income from abroad is equal to factor income paid to abroad.
If NFIA is zero, national product (or national income) will be equal to domestic product (or domestic income).
It is important to note that ‘Net factor income paid to abroad’ is opposite/negative of NFIA. If Net factor
income to abroad = `100 crore, then NFIA = (–) `100 crore.
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.
RECAP
Domestic territory (or Economic territory)

Domestic territory (or Economic territory) is the geographical territory administered by a government within which persons,
goods and capital circulate freely. For example, (i) Branch of an American Bank in India, (ii) Embassies located abroad, e.g.
Indian embassy in America, etc. are included in the domestic territory of India.
Resident
Resident is a person or an institution whose centre of economic interest lies in the domestic territory of the country in which
he lives, for example, Indian officials working in the Indian Embassy in USA, etc. are normal residents of India.
Implications of the Concepts of Domestic territory and Resident.
Domestic product includes production activity of the production units located in the domestic territory of the country
irrespective of whether carried out by the residents or non-residents, for example, (i) Profits earned by a foreign company
or a foreign bank in India (ii) Salaries paid to Koreans working in Indian embassy in Korea (iii) Compensation of employees to
the residents of Japan working in Indian embassy in Japan are included in domestic product as it is a factor income earned in
domestic territory of the country.
National product includes production activity of residents only irrespective of whether performed within the domestic
territory of the country or outside it, for example, (i) Salaries received by Indian residents working in Russian Embassy in India
(ii) Dividend received by an Indian from his investment in shares of a foreign company are included in national product as it is
a factor income earned by Indian residents from abroad.
Net factor Income from Abroad (NFIA)
Net Factor Income from Abroad is the difference between factor income earned from abroad and factor income paid to
abroad. (NFIA = Factor income from abroad – Factor income to abroad)
In other words, NFIA = Residents’ contribution to production outside the domestic territory – Non-residents’ contribution to
production inside the economic territory.
NFIA is negative when factor income from abroad is less than factor income paid to abroad (i.e., Net factor income paid to abroad).
Relation between Domestic Product and National Product
National product = Domestic Product + Factor income received from abroad – Factor income paid to abroad
• Factor income received from abroad is added to domestic product to calculate national 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.
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
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.

1. Will the following factor income be included in domestic factor income of India? Give reasons.
(i) Compensation of employees to the resident of Japan working in Indian embassy in Japan.
(ii) Rent received by an Indian resident from Russian embassy in India.
Ans. (i) Yes, it will be included as it is part of factor income earned in domestic territory of the country.
(ii) No, as rent received by Indian resident from Russian embassy will be part of Factor Income received from
abroad as Russian Embassy is not part of domestic territory of the country.
2. How will you treat the following in the calculation of Gross Domestic Product of India? Give reasons.
(i) Profits earned by a branch of foreign bank in India.
(ii) Salaries of Indian employees working in embassy of Japan in India.
(iii) Salary of resident of Japan working in Indian embassy in Japan. (3 marks)
Ans. (i) Yes, it will be included because profits are earned within the domestic territory of India.
(ii) No, it will not be included because the embassy of Japan is not a part of the domestic territory of India.
(iii) Yes, it will be included because the Indian Embassy is a part of the domestic territory of India.
3. Will the following be included in domestic factor income of India? Give reasons.
(i) Profits earned by a resident of India from his company in Singapore.
(ii) Profits earned by a company in India which is owned by a non-resident.
(iii) Profits earned by a branch of State Bank of India in England. (3 marks)
Ans. (i) No, it will not be included as the company is located outside the domestic territory of India.
(ii) Yes, it will be included as profits are earned within the domestic territory of India.
(iii) No, it will not be included as State Bank of India is located outside the domestic territory of India.
4. How will you treat the following in the calculation of Domestic Income of India? Give reasons.
(i) Compensation of employees to the residents of Japan working in Indian embassy in Japan.
(ii) Rent paid by the embassy of Japan in India to a resident Indian.
(iii) Salaries to Indian residents working in the Russian embassy in India.
(iv) Profits earned by Indian employees working in the US embassy in India. (4 marks)
Ans. (i) Yes, it will be included as the Indian embassy in Japan is a part of the domestic territory of India.
(ii) No, it will not be included as the Japanese embassy is not a part of the domestic territory of India.
(iii) No, it will not be included as the Russian embassy is not a part of the domestic territory of India.
(iv) No, it will not be included as the US embassy is not a part of the domestic territory of India.
1.3 Circular Flow of Income (Two- Sector Model)

Circular flow of income refers to flow of income across different sectors of an economy in a circular way.
In a closed economy* without a government, external trade or any savings, there are only two sectors, namely,
households and firms.
Households are owners of factors of production. They
provide factor services (in the form of labour, capital,
land and entrepreneurship) to the firms (producing
units). Income is generated in production units in the
form of value of total final goods and services produced
in the economy.
Firms distribute the entire income generated to make
factor payments (in the form of wages and salaries,
interest, rent and profit). Thus, factor payments flow
from firms to households.
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.
RECAP
Circular flow of income in a two sector economy

In a two sector economy, households are owners of factors of production. They provide factor services (in the form of labour,
capital, land and entrepreneurship) to the firms. Firms produce goods and services and make factor payments (in the form of
wages and salaries, interest, rent and profit) to the households. So, factor payments flow from firms to households.
The factor income earned by the households will be used to buy the goods and services produced by the firms, for which they
make payment to the firms. So, consumption expenditure (i.e., spending on goods and services) flows from households to
the firms. Thus, aggregate final consumption expenditure by the households in the economy is equal to the aggregate factor
income received by the households.
Hence, circular flow of income in a two sector economy is based on the axiom that one’s expenditure is other’s income.

Contribution made by factors of production Remuneration
(i) Human labour (a) Rent
(ii) Capital (b) Wage
(iii) Fixed natural resources (called ‘land’) (c) Interest
(iv) Entrepreneurship (d) Profit
2. In a two sector economy, in which of the following way the households may dispose off their entire earning or income?
(Choose the correct alternative)
(a) Spending on the goods and services produced by the domestic firms.
(b) Payment of taxes to the government.
(c) To buy imported goods.
(d) Savings
3. The sum of final expenditure in the economy must be equal to ___________________. (Fill in the blank)
4. In __________________ method we calculate the aggregate value of all final goods and services produced by all the firms
within the domestic territory of the country in a year. (Fill in the blank)
(a) Sum total of all factor payments (i) Product method
(b) Aggregate value of final goods and services produced by all the firms. (ii) Income method
(c) Aggregate value of spending that the firms receive for the final goods and (iii) Expenditure method
services which they produce.
6. Flow of factor payments and payments for goods and services between households and firms is called ______________ .
(Fill in the blank)
7. Looking at the demand side of the final goods and services to calculate the GDP is referred to as the __________ .
(Product method / Expenditure method / Income method) (Choose the correct option)

1. "Circular flow of income in a two sector economy is based on the axiom that one’s expenditure is other’s
income." Do you agree with the given statement? Support your answer with valid reasons.
Ans. Yes, the given statement is correct. In a two sector economy, the firms produce goods and services and make
factors payments to the households. The factor income earned by the households will be used to buy the
goods and services which would be equal to income of firms. The aggregate consumption expenditure by the
households in the economy is equal to the aggregate expenditure on goods and services produced by the firms
in the economy (Income of the producers).
1.4 Production Method of Calculating National Income

In product method or value added method, we calculate the aggregate annual value of goods and services
produced during a year. How to go about doing this? Do we add up the value of all goods and services produced
by all the firms in an economy? The following example will help us to understand.
Let us suppose that there are only two kinds of producers in the economy – wheat producers (or the farmers)
and the bread makers (the bakers). The wheat producers grow wheat and they do not need any input other
than human labour. They sell a part of the wheat to the bakers. The bakers do not need any other raw materials
besides wheat to produce bread. Let us suppose that in a year the total value of wheat that the farmers have
produced is `100. Out of this they have sold `50 worth of wheat to the bakers. The bakers have used this
amount of wheat completely during the year and have produced `200 worth of bread.
What is the value of total production in the economy? If we follow the simple way of aggregating the values of
production of the sectors, we would add `200 (value of production of the bakers) to `100 (value of production
of farmers). The result will be `300.
A little reflection will tell us that the value of aggregate production is not `300. The farmers had produced `100
worth of wheat for which it did not need assistance of any inputs. Therefore, the entire `100 is rightfully the
contribution of the farmers. But the same is not true for the bakers. The bakers had to buy `50 worth of wheat
to produce their bread. The `200 worth of bread that they have produced is not entirely their own contribution.
To calculate the net contribution of the bakers, we need to subtract the value of the wheat that they have bought
from the farmers. If we do not do this we shall commit the mistake of ‘double counting’. This is because `50
worth of wheat will be counted twice. First, it will be counted as part of the output produced by the farmers.
Second time, it will be counted as the imputed value of wheat in the bread produced by the bakers.
Therefore, the net contribution made by the bakers is, `200 – `50 = `150.
Hence, aggregate value of goods produced by this simple economy is `100 (net contribution by the farmers) +
`150 (net contribution by the bakers) = `250.
The term that is used to denote the net contribution made by a firm is called its 'value added'. We know that
the raw materials that a firm buys from another firm which are completely used up in the process of production
are called ‘intermediate goods’. Therefore:
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
Problem of 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.
There are two approaches/methods to avoid the problem of double counting:
(i) Take the value of final goods and services only ignoring all intermediate products.
(ii) Take value added at different stages in production process instead of total output.
Steps for calculation of national income by product method

Step 1: Estimation of value of output produced by each firm in all the sectors of the
economy during the year.
Value of output is the market value of goods and services produced by a firm during an accounting year.
Value of output = Output produced (in units) × Market price
(a) If a firm had no initial unsold stock in the beginning of the year:
Value of output produced = Sales + Value of unsold stock
Note: Sales = Output sold (in units) × Market price

Sales = Sale of goods and services to domestic buyers + Exports of goods and services.
(b) If a firm had some unsold stock in the beginning of the year:
Value of output = Sales + Net change in stock
or, Value of output = Sales + Closing stock – Opening stock

Example: Suppose that a firm had an unsold stock worth `100 at the beginning of the year. During
the year it produced `1000 worth of goods by using raw materials and other inputs worth `400 and
managed to sell `800 worth of goods.
(i) Value of closing stock = Opening stock + Value of output produced – Sales
= 100 + 1000 – 800 = `300
(ii) Change in stock = Closing stock – Opening stock = 300 – 100 = `200
or, Change in stock = Value of output produced – Sales = 1000 – 800 = `200
(iii) Value of output produced = Sales + Change in stock = 800 + 200 = `1000
Step 2: Calculation of Value Added/Value Addition (VA) and Gross Domestic Product at
market price (GDPmp)
Value added/value addition is the difference between value of output and intermediate consumption.
Value added = Value of output – Intermediate consumption
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.
Why is GDPmp called gross?

GDPmp is final products valued at market price. This is what buyers pay. But this is not what production units
actually receive. Out of what buyers pay, the production units have to make provision for depreciation and
payment of indirect tax like excise, sales tax, etc. This explains why GDPmp is called 'gross'. It is called gross
because no provision has been made for depreciation. However, if depreciation is deducted from the GDP, it
becomes Net Domestic Product (NDP). Naturally, depreciation does not become part of anybody’s income.
Why is GDPmp called ‘at market price’ ?
Out of what buyers pay, the production units have to make payments of indirect taxes, if any. Indirect taxes
accrue to the government, and not to the production units. Payment of indirect taxes to the government is a
transfer payment as no good or service is provided in return. Hence, indirect taxes are deducted from GDPmp
to calculate what production units actually receive.
Sometimes production units receive subsidy on production. This is in addition to the market price which
production units receive from the buyers. Therefore, what production units actually receive is not the 'market-
price' but "market price – indirect tax + subsidies".
Step 3: Calculation of Net Domestic Product at factor cost (NDPfc)
If we make adjustment of depreciation, indirect taxes and subsidies in GDPmp, we get Net Domestic
Product at Factor Cost (NDPfc).
NDPfc = GDPmp – Depreciation – Indirect taxes + Subsidies
or, NDPfc = GDPmp – Depreciation – Net indirect taxes

or, NDPfc = GDPmp – Depreciation – Net product taxes – Net production taxes
NDPfc 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. This is also called domestic income because this is the income generated in
the production process within the domestic territory of the country.
Step 4: Calculation of Net National Product at factor cost (NNPfc) or National Income (NI)
Net National Product at factor cost (NNPfc) is the net domestic factor income added with the net
factor income from abroad. In other words:
National income (NNPfc) = NDPfc + NFIA
or, NNPfc = GDPmp – Depreciation – Net indirect taxes + NFIA

or, NNPfc = GDPmp – Depreciation – Net product taxes – Net production taxes + NFIA
NNP at factor cost is the sum of income earned by all factors in the production in the form of wages, profits,
rent and interest, etc., belonging to a country during a year. It is the National Product and is not bound by
production in the national boundaries.
Top Tip
Other Basic National Income Aggregates

1. Net Domestic Product at Market Price (NDPmp)
NDPmp = GDPmp – Depreciation
This measure allows policy-makers to estimate how much the country has to spend just to maintain their current
GDP. If the country is not able to replace the capital stock lost through depreciation, then GDP will fall.
2. Gross National Product at Market Price (GNPmp)
GNPmp = GDPmp + Net factor income from abroad (NFIA)
GNPmp 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. GNP refers to all the economic output produced by a nation’s normal
residents, whether they are located within the national boundary or abroad. Everything is valued at the market prices.
3. Net National Product at Market Price (NNPmp)
NNPmp = GDPmp – Depreciation + NFIA
This is a measure of how much a country can consume in a given period of time. NNP measures output
regardless of where that production has taken place (in domestic territory or abroad).
4. Gross Domestic Product at Factor Cost (GDPfc)
GDP at factor cost is gross domestic product at market prices less net indirect taxes.
GDPfc = GDPmp – Net indirect taxes
or GDPfc = GDPmp – Net Product Taxes – Net Production Taxes
GDP at factor cost measures money value of output produced within the domestic boundaries of a country in a
year, as received by the factors of production.
5. Gross National Product at Factor Cost (GNPfc)
GNP at factor cost is gross domestic product at market prices less net indirect taxes plus NFIA.
GNPfc = GDPmp – Net Indirect taxes + NFIA
or GNPfc = GDPmp – Net Product Taxes – Net Production Taxes + NFIA
GNP at factor cost measures value of output received by the factors of production belonging to a country in a year.
Precautions in calculating national income by value added method
1. Avoid double counting.
Value of intermediate goods is 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 and services as these tend to
inflate national income estimates.
2. Do not include sale of second hand goods.
Value of second hand goods (or used goods) being sold should not be included in national income as their value
was accounted for at the time of first production. Sale of the second hand goods is not a production activity. The
second hand good should not be treated as fresh production, and therefore is not included in national income.
However, any brokerage or commission paid to facilitate the sale of second hand goods is a fresh production
activity. It should be included in production but to the extent of brokerage or commission only.
3. Self-consumed output must be included.
Output produced but retained for self-consumption, rather than selling in market, is output and must be included
in estimates. Services of owner-occupied buildings, farmer consuming its own produce, etc. are some examples.
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
Steps for calculation of national income by product method

Step 1: Estimation of value of output produced by each firm in all the sectors of the economy during the year.
Value of output is the market value of goods and services produced by a firm during an accounting year.
Value of output = Sales + Change in stock
Step 2: Calculation of Value Added (VA) and Gross Domestic Product at market price (GDPmp)
Value added/Value addition is the excess of value of output over the value of intermediate consumption.
Sum of Value added of all firms in the economy is Gross Domestic Product (GDP), which refers to the money value of all final
goods and services produced in an economy during an accounting year.
GDPmp = Value of output of all the sectors – Intermediate consumption
Step 3: Calculation of Net Domestic Product at factor cost (NDPfc)
NDPfc (net domestic factor income) = GDPmp – Depreciation – Indirect taxes + Subsidies
NDPfc is the income earned by the factors in the form of wages, profits, rent, interest, etc., within the domestic territory of a
country.
Step 4: Calculation of Net National Product at factor cost (NNPfc) or National Income (NI)
National income or NNPfc = NDPfc + NFIA
Precautions in calculating national income by production method (or value added method)
1. Avoid double counting. Value of intermediate goods is not included in the estimation of value added because it is reflected in
the value of final goods. So, avoid double counting of goods and services as these tend to inflate national income estimates.
2. Do not include sale of second hand goods. Their value was accounted for at the time of first production. However, any
brokerage or commission paid to sell the second hand goods is a fresh production activity, so included.
3. Self-consumed output must be included. Output produced but retained for self-consumption rather than selling in the
market should be included since output has been produced during the year. E.g. Farmer consuming its own produce,
services of owner occupied buildings etc.
1. Though intermediate goods are crucial inputs to any production process, yet we measure final goods only. This is because
_________________. (Complete the sentence)
(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
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
(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
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.
(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)
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)

1. What is the difference between planned and unplanned inventory accumulation? Write down the relation
between change in inventories and value added of a firm. (NCERT) (4 marks)
Ans. In case of an unexpected fall in sales, a firm will have unsold stock of goods which it had not anticipated.
Hence, there will be unplanned inventory accumulation.
On the other hand, if the firm wants to raise the inventory during the year and produces goods accordingly;
and the sales also happen to be the same as expected, then there will be planned accumulation of inventories.
Relation between change in inventories and value added of a firm:
Value added of a firm = Sales during the year + Change in inventories – Value of intermediate goods used
2. Explain why subsidy is added to and indirect tax is deducted from domestic product at market price to
arrive at domestic product at factor cost. (3 marks)
Ans. Domestic product at market price is what buyers pay. But this is not what production units actually receive.
Out of what buyers pay the production units have to make payment of indirect tax, e.g., Goods and Services
Tax (GST). Therefore, indirect tax is deducted. Sometimes, production units get subsidy on production from
the government. Therefore, subsidy is added.
What production units actually receive is not the ‘Market Price’ but ‘Market Price – Indirect tax + Subsidies’.
This is what is actually available to production units for distribution of income among the owners of factors of
production. Therefore, Market Price (mp) – Indirect Tax (IT) + Subsidies = Factor Cost (fc) or factor payments
3. State, giving reason, whether the following will be included in the estimation of national income: (3 marks)
(i) Services of owner-occupied building
(ii) Payment of indirect taxes by a firm
(iii) Wheat grown by a farmer but used entirely for his family’s consumption.
Ans. (i) Yes, imputed value of free services provided by the owners of production units must be included in national income.
(ii) No, it is not included in national income because an indirect tax paid to the government is a transfer
payment as no good or service is provided in return.
(iii) Yes, its imputed value is included in national income because it adds to the current flow of goods and services.
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]
Numerical 3
In an economy, the following transactions took place.

(i) Firm A sold to firm B goods of `80 crore; to firm C `50 crore; to households `30 crore and goods of value `10
crore remains unsold.
(ii) Firm B sold to firm C goods of `70 crore; to firm D `40 crore; goods of value `30 crore were exported and
goods of value `5 crore was sold to government.
Calculate: (i) Value of output of Firm A and Firm B.
(ii) Value added by Firm B (CBSE Sample Question Paper 2019) (3 marks)
Solution: (i) Value of output of Firm A = Total sales + Value of unsold stock
= (Sales to Firm B + Sales to Firm C + Sales to Households) + Value of unsold stock
= (80 + 50 + 30) + 10 = `170 crore
Value of output of Firm B = Sales to Firm C + Sales to Firm D + Exports + Sales to Government
= 70 + 40 + 30 + 5 = `145 crore
(ii) Value added by Firm B = Value of output of Firm B – Purchases by Firm B from Firm A
= 145 – 80 = `65 crore
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
[Ans. (a) `165 lakh (b) `205 lakh ]
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
Do it yourself 4
From the following data about a firm, calculate the firm’s net value added at factor cost. 3 marks

(i) Subsidy 40
(ii) Sales 800
(iii) Depreciation 30
(iv) Exports 100
(v) Closing stock 20
(vi) Opening stock 50
(vii) Intermediate purchases 500
(viii) Purchase of machinery for own use 200
(ix) Import of raw material 60
[Ans. `280 lakh]
Numerical 5
Calculate GVA at factor cost of a firm: (3 marks)

S. No. Items (`)
(i) Net production taxes 600
(ii) Product taxes 400
(iii) Price per unit of output 10
(iv) Net change in stocks (–)50
(v) Purchases of raw materials 10,000
(vi) Import of raw materials 3,000
(vii) Import of machines 20,000
(viii) Product subsidies 100
Additional information: Output sold is 2000 units.
Solution:
Particulars (`)
Sales (note 1) 20,000
(+) Net change in stocks (–) 50
Value of output 19,950
(–) Intermediate consumption (Purchases of raw materials) (–)10,000
GVA at market prices 9,950
(–) Net product taxes (note 3) (–) 300
GVA at basic prices 9,650
(–) Net production taxes (–) 600
GVA at factor cost 9,050
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
Do it yourself 5
Find net value added at factor cost: 3 marks

(i) Sales 100
(ii) Closing stock 20
(iii) Excise 15
(iv) Opening stock 10
(v) Current replacement cost 12
(vi) Intermediate consumption 50
[Ans. `33 lakh]
Numerical 6
Find NVA at factor cost of a firm. (3 marks)

S. No. Items (`)
(i) Durable use producer goods with a life span of 10 years 10
(ii) Single use producer goods 5
(iii) Sales 20
(iv) Unsold output produced during the year 2
(v) Net indirect taxes 1
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
cost of fixed capital good - scrap value 10 - 0

Note: Depreciation = = = `1 Lakh
life (in years) 10
Do it yourself 6
Find Net Value Added at market price of a firm: 3 marks

(i) ixed capital good with a life span of 5 years
F 15
(ii) Raw materials 6
(iii) Sales 25
(iv) Net change in stock (–)2
(v) Taxes on production 1
[Ans. `14 lakh]

Numerical 7
Calculate ‘Sales’ from the following: (3 marks)

S. No. Items (`)
(i) Subsidies 200
(ii) Opening stock 100
(iii) Closing stock 600
(iv) Intermediate consumption 3000
(v) Consumption of fixed capital 700
(vi) Profit 750
(vii) Net value added at factor cost 2000
(viii) Exports 100
Solution: Net value added at factor cost
= Sales + Closing stock – Opening stock – Intermediate consumption – Consumption of fixed capital + Subsidies
2,000 = Sales + 600 – 100 – 3,000 – 700 + 200
Sales = 2,000 – 600 + 100 + 3,000 + 700 – 200
Sales = `5,000 lakh
Do it yourself 7
Calculate ‘Value of output’ from the following: 3 marks

(i) Net value added at factor cost 100
(ii) Intermediate costs 75
(iii) Excise duty 20
(iv) Subsidy 5
(v) Depreciation 10
[Ans. `200 lakh]
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
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

(i) Value of output in primary sector 1,000
(ii) Net factor income from abroad (–)20
(iii) Value of output in tertiary sector 700
(iv) Intermediate consumption in secondary sector 400
(v) Value of output in secondary sector 900
(vi) Intermediate consumption in primary sector 500
(vii) Intermediate consumption in tertiary sector 300
(viii) Net Indirect Taxes 300
(ix) Consumption of fixed Capital 100
[Ans. (a) `1,380 crore (b) `980 crore]
1.5 Income Method of Calculating National Income

Steps for calculating national income by income method
Step 1: Estimate the factor payments by each firm in all the sectors of the economy during
the year.
The sum of factor payments equals Net Value Added at Factor Cost (NVAfc) of a firm.
Step 2: Take the sum total of NVAfc by all firms in all the sectors of the economy to arrive
at NDPfc.
The components of NDPfc are compensation of employees, operating surplus and mixed income.
1. 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.
The main components of compensation of employees are:

(a) Wages and salaries in cash and in kind. For example,
• Payment of bonus by a firm to its employees
• Free medical facilities, free meals and rent-free house given by the employer
• House rent allowance or leave travel allowance paid by the employer
• Medical treatment of employee’s family
(b) Social security contributions by the employers. For example,
• Contribution to provident fund by the employer
• Insurance premium paid by the employer
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.
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
Precautions in making estimates of national income by income method

1. Avoid transfers.
National income includes only factor payments, i.e. payment for the services rendered to the production units
by the owners of factors of production.
Any payment for which no service is rendered is called a transfer (e.g. gifts, donations, charity, etc.), and not a
production activity. Hence, transfer payment is not included in national income.
2. Avoid capital gain.
Capital gain refers to the income from the sale of second hand goods and financial assets.
Income from the sale of old cars, old house, bonds, debentures, etc are some examples.
These transactions are not production transactions. So, any income arising to the owners of such things is not a
factor income.
3. Include income from self-consumed output.
When a house owner lives in that house, he does not pay any rent. But in fact he pays rent to himself. Since
rent is a payment for services rendered,even though rendered to the owner itself,it must be counted as a factor
payment.
4. Include free services provided by the owners of the production units.
Owners work in their own unit but do not charge salary. Owners provide finance but do not charge any interest.
Owners do production in their own buildings but do not charge rent.
Although they do not charge, yet the services have been performed. The imputed value of these must be included
in national income.
Treatment of Items in the Estimation of National Income by Income Method

S. No. Items Treatment Reason
1. Value of bonus shares received by No, it will not be included As bonus shares are financial assets and
shareholders of a company in the national income. do not contribute to the production of
goods and services.
2. Payment of interest on a loan taken by an No, it is not included in Because the individual is a consumer, and
employee from the employer/Payment of national income. the loan is taken to meet consumption
interest by an individual to a bank on a expenditure. There is no contribution
loan to buy a car/Interest received on loans to production of goods and services.
given to a friend for purchasing a car. Therefore, it is not a factor payment.
3. Payment of interest by banks to its Yes, it is included in national Because it is a factor income paid by
depositors/Payment of interest by a firm income. a production unit (bank or firm).
to households. Banks borrow for carrying out banking
services./The firms borrow money for
carrying out production.
4. Payment of interest by a firm Yes, it is included in national Because it is a factor payment by the
(government firm or a private firm) to income. firm. The firm borrows money for
a bank carrying out production of goods and
services.
5. Interest received on loan given to a Yes, it will be included in the As it is a factor income from abroad.
foreign company in India. national income.
6. Interest received on debentures. Yes, it will be included in the Because interest received on debentures
national income. is a factor income because debenture
is a sort of loan taken by a production
unit, which uses the money in producing
goods and services.
7. Payment of interest on borrowings by No, it will not be included Because it is a transfer payment as
general government (National debt in the national income. general government borrows only for
interest) consumption purpose.
8. Money received by a family in India No, it will not be included As it is a transfer payment, which is
from relatives working abroad, i.e., in national income. received without any contribution to
remittances from abroad/Scholarship production of goods and services. It is
given to Indian students studying in not a factor income.
India by a foreign company/Financial
help received by flood victims/
Expenditure on old age pensions
by government/Gift received from
employer, e.g. festival gift, gifts on
independence day, etc.
9. Free medical facilities or free meals or house Yes, it will be included in the As it is a part of the compensation of
rent allowance or leave travel allowance national income. employees.
paid by the employer/Rent-free house
given to an employee by an employer/
Expenditure on medical treatment of
employee’s family/Payment of bonus by
a firm to its employees/Contribution to
provident fund by employer
10. Payment of corporate tax by a firm No, it is not included in As it is a transfer payment. Corporate tax
national income. accrues to the government. It is not received
by the owners of factors of production.
Hence, it is not a factor income.
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.
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
National income by income method

In this method, we first estimate factor payments by each sector. The sum of such factor payments equals Net Value Added
at factor cost (NVAfc) by that sector.
Then we take sum total of NVAfc by all the sectors to arrive at NDPfc. The components of NDPfc are:
(i) Compensation of employees: It includes:
(a) Wages and salaries in cash and in kind, e.g. bonus, free medical facilities, free meals, house rent allowance, etc.
(b) Social security contributions by the employers, e.g., provident fund or insurance premium paid by employers.
(ii) 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'.
Note: Profit = Corporation tax + Dividend + Retained earnings/undistributed profits.
Alternately, Profit = Corporation tax + After tax profit
(iii) Mixed income: The income of self employed people like doctors etc. has two or more factor incomes; total income is
estimable, but not its different components. So, mixed income is another factor payment.
Once we estimate NDPfc, we can find NNPfc or national income, by adding net factor income from abroad.
National income = Compensation of employees
+ Operating surplus
+ Mixed income of self employed
+ Net factor income from abroad
Precautions in making estimates of national income by income method
1. Avoid transfers. National income includes only factor payments, i.e. payment for the services rendered to the production
units by the owners of factors of production.
Any payment for which no service is rendered is called a transfer, e.g. gifts, donations, charity, etc. Since transfers are not
a production activity it must not be included in national income.
2. Avoid capital gain. Capital gain refers to the income from the sale of second hand goods and financial assets. Income from
the sale of old cars, old house, bonds, debentures, etc are some examples.
These transactions are not production transactions. So, any income arising to the owners of such things is not a factor
income.
3. Include income from self-consumed output. When a house owner lives in that house, he does not pay any rent. But in
fact he pays rent to himself. Since rent is a payment for services rendered,even though rendered to the owner itself,it
must be counted as a factor payment.
4. Include free services provided by the owners of the production units. Owners work in their own unit but do not charge
salary. Owners provide finance but do not charge any interest. Owners do production in their own buildings but do not
charge rent.
Although they do not charge, yet the services have been performed. The imputed value of these must be included in
national income.
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:
(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)

1. State the various components of the Income Method that are used to calculate national income.
Ans. The various components that are used under the income method to calculate national income are:
(i) Compensation of employees which includes wages and salaries in cash and kind and employers’
contribution to social security benefits.
(ii) Operating surplus which includes rent and royalties, interest and profit earned by a firm.
(iii) Mixed income of self-employed which includes any income that has two or more factor income, which
cannot be accounted for separately.
(iv) Net factor income from abroad, which is the difference between factor income from abroad and factor
income to abroad.
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.
Numerical 9
From the following data relating to a firm:

(a) Estimate the net value added at market prices.
(b) Show that net value added at factor cost is equal to the sum of factor incomes. (6 marks)
(i) Purchase of raw materials and other inputs from the domestic market 600
(ii) Increase in stocks 200
(iii) Domestic sales 1800
(iv) Imports of raw materials 100
(v) Exports 200
(vi) Depreciation 75
(vii) Salaries and wages 600
(viii) Interest payments 450
(ix) Rent 75
(x) Dividends 150
(xi) Undistributed profits 80
(xii) Corporate profit tax 20
(xiii) Indirect taxes 50
Solution: (a) Net value added at market prices

= (Domestic sales + Exports + Increase in stocks)
– (Purchase of raw materials and other inputs from the domestic market
+ Imports of raw materials) – Depreciation
= (1800 + 200 + 200) – (600 + 100) – 75 = `1425 lakh
(b) Net value added at factor cost
= Net value added at market prices – Indirect taxes
= 1425 – 50 = `1375 lakh
Factor Incomes
= Salaries and wages + Interest + Rent + Dividends + Undistributed profits + Corporate tax
= 600 + 450 + 75 + 150 + 80 + 20 = `1375 lakh
Hence, net value added at factor cost is equal to the sum of factor incomes.
Do it yourself 9
Calculate: (a) Net value added at factor cost and

(b) Value of output at market price from the following data. 6 marks
S. No. Items (` in arab)

(i) Subsidies 40
(ii) Intermediate costs 200
(iii) Compensation of employees 400
(iv) Depreciation 50
(v) Royalty 5
(vi) Interest 25
(vii) Indirect taxes 100
(viii) Rent 10
(ix) Profits 60
(x) Net change in stocks 20
[Ans. (a) `500 arab (b) `810 arab]

Numerical 10
Calculate national income: (4 marks)

(i) Compensation of employees 2,000
(ii) Interest paid by production units 500
(iii) Rent 700
(iv) Profits 800
(v) Employers’ contribution to social security schemes 200
(vi) Dividends 300
(vii) Consumption of fixed capital 100
(viii) Net indirect taxes 250
(ix) Net exports 70
(x) Net factor income to abroad 150
(xi) Mixed income of self-employed 1,500
Solution:
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
Calculate national income from the following data. 4 marks

(i) Rent 80
(ii) Interest 100
(iii) Profits 210
(iv) Tax on profits 30
(vi) Mixed income of self-employed 250
(vii) Net indirect taxes 60
(viii) Employees’ contribution to social security schemes 50
(ix) Compensation of employees 500
(x) Net factor income from abroad (–)20
[Ans. `1120 crore]

Numerical 11
Calculate Domestic Income: (4 marks)

(i) Dividends 50
(ii) Social security contributions by employers 40
(iii) Corporate profit tax 30
(iv) Consumption of Fixed Capital 60
(v) Retained earnings of private corporate sector 20
(vi) Interest paid by firms 150
(vii) Rent 70
(viii) Royalty 30
(ix) Wages and salaries 600
(x) Interest paid by households 10
Solution:
Compensation of employees 640
(+) Interest paid by firms 150
(+) Rent 70
(+) Royalty 30
(+) Profits 100
Domestic income (NDPfc) 990
Note: (i) Compensation of employees = Wages and salaries + Social security contributions by employers
= 600 + 40 = `640 crore
(ii) Profits = Dividends + Corporate profit tax + Retained earnings of private corporate sector
= 50 + 30 + 20 = `100 crore
Do it yourself 11
Calculate Net national product at market price 4 marks

(i) Net current transfers from abroad (–)10
(ii) Wages and salaries 1,000
(iii) Net factor income to abroad (–)20
(iv) Social security contributions by employers 100
(v) Net indirect tax 80
(vi) Rent 300
(vii) Consumption of fixed capital 120
(viii) Corporation tax 50
(ix) Dividend 200
(x) Undistributed profits 60
(xi) Interest 400
[Ans. `2,210 crore]

Numerical 12
Calculate Net Domestic Product at market price: (4 marks)

(i) Interest received by households 600
(ii) Consumption of fixed capital 800
(iii) Rent and royalty 700
(iv) Net factor income from abroad 100
(v) Net indirect tax 850
(vi) Profit 1,200
(vii) Social security contributions by employees 700
(viii) Mixed income of self-employed 8,000
(ix) Wages and salaries 5,000
(x) Dividend 400
Solution:
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

(i) Wages and Salaries 700
(ii) Rent 100
(iii) Current replacement cost 50
(iv) Net factor income from abroad (–)10
(v) Mixed income 400
(vi) Subsidies 100
(vii) Profits 400
(viii) Indirect taxes 300
(ix) Employers’ contribution to social security schemes 50
(x) Interest 40
[Ans. `1,930 crore]

Numerical 13
Calculate Gross National Product at market price: (4 marks)

(ii) Profits after tax 500
(iii) Mixed income of self-employed 7,500
(iv) Net addition to capital stock 400
(v) Rent and royalty 400
(vi) Interest 350
(vii) Factor income from abroad 150
(viii) Goods and Services Tax 200
(ix) Gross investment 470
(x) Net exports 40
(xi) Factor income paid to abroad 100
(xii) Subsidies 50
(xiii) Corporation tax 200
Solution:
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
Do it yourself 13
Calculate Gross National Product at Market Price from the following data. 4 marks

(i) Wages and Salaries 500
(ii) Net Capital formation 100
(iii) Exports 50
(iv) Imports 60
(v) Gross capital formation 120
(vi) Employers’ contribution to social security schemes 20
(vii) Net factor income from abroad (–) 10
(viii) Rent and interest 250
(ix) Profits after tax 300
(x) Goods and Services Tax 50
(xi) Subsidies 10
(xii) Corporate Tax 100
[Ans. `1220 crore]
Numerical 14
Calculate compensation of employees: (3 marks)

(i) Rent 20
(ii) Interest 35
(iii) Profits 15
(iv) Gross domestic product at factor cost 250
(v) Consumption of fixed capital 60
Solution: Gross domestic product at factor cost

= Compensation of employees + Rent + Interest + Profits + Consumption of fixed capital
250 = Compensation of employees + 20 + 35 + 15 + 60
Compensation of employees = 250 – 20 – 35 – 15 – 60 = `120 crore
Do it yourself 14
Calculate operating surplus: 3 marks

(i) Gross value added at market price 15,000
(ii) Wages and salaries 5,000
(iii) Net indirect taxes 750
(iv) Consumption of fixed capital 250
[Ans. `9,000 crore]

Numerical 15
From the following data, calculate:

(a) Gross domestic product at market price and
(b) Factor income from abroad (6 marks)

(i) Gross national product at factor cost 6,150
(ii) Net exports (–) 50
(iii) Compensation of employees 3,000
(iv) Rent 800
(v) Interest 900
(vi) Profit 1,300
(viii) Net domestic capital formation 800
(ix) Gross fixed capital formation 850
(x) Change in stocks 50
(xi) Dividend 300
(xii) Factor income to abroad 80
Solution: (a) Gross domestic product at market price (GDPmp)

= Compensation of employees + Rent + Interest + Profit + Depreciation + Net indirect taxes
= 3,000 + 800 + 900 + 1,300 + 100 + 300
= `6,400 crore
Note: Depreciation = Gross fixed capital formation + Change in stocks – Net domestic capital formation
= 850 + 50 – 800 = `100 crore
(b) Gross national product at factor cost
= GDPmp + Factor income from abroad – Factor income to abroad – Net indirect taxes
6,150 = 6,400 + Factor income from abroad – 80 – 300
Factor income from abroad = 6,150 + 80 + 300 – 6,400
= `130 crore
Do it yourself 15
Calculate: (a) Net national product at factor cost and (b) Gross Domestic product at market prices. 6 marks

(i) Net indirect taxes 38
(ii) Consumption of fixed capital 34
(iii) Net factor income from abroad (–)3
(iv) Rent 10
(v) Profits 25
(vi) Interest 20
(vii) Royalty 5
(viii) Wages and salaries 170
(ix) Employers’ contribution to social security schemes 30
[Ans. (a) `257 crore (b) `332 crore]

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
Calculate the value of “Interest” from the following data 4 marks

(i) Indirect tax 1,500
(ii) Subsidies 700
(iii) Profits 1,100
(v) Gross domestic product at market price 17,500
(vi) Compensation of employees 9,300
(vii) Interest ?
(viii) Mixed income of self-employed 3,500
(ix) Rent 800
[Ans. 1,300 crore]
Numerical 17
Calculate compensation of employees from the following data: (CBSE Sample Question Paper 2020) (3 marks)
(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
Do it yourself 17
Calculate the value of “Mixed Income of Self-Employed” from the following data: (CBSE 2019) (4 marks)
(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]
1.6 Expenditure Method of Calculating National Income

In this method, we take the sum of final expenditures on consumption and investment. This sum equals
GDPmp. These final expenditures are on the final goods and services (both consumption goods and capital
goods) produced within the domestic territory of the country.
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
Main components of GDPmp or final expenditures in the economy

1. Private final consumption expenditure (PFCE)
It is the consumption expenditure of households on the final goods and services produced in the economy.
For example, purchase of car by a household, expenditure on education of children by a family (school fee or
purchase of books), etc.
2. Government final consumption expenditure (GFCE)

It is the consumption expenditure that the government makes on the final goods and services produced in
the economy. For example, government expenditure on free services provided such as education, health, police
service, defense services, etc.
3. Gross domestic capital formation (GDCF)
It is the final investment expenditure incurred by firms and the government. For example, purchase of tractor by
a farmer, purchase of taxi by a taxi driver, purchase of a truck to carry goods by a firm, purchase of a machine or
refrigerator installed in a production unit by a firm.
Note that GDCF is composed of the following:
GDCF = Gross domestic fixed capital formation + Net change in stocks
or GDCF = (Net fixed capital formation + Depreciation) + (Closing Stock – Opening Stock)
4. Net exports (= Exports – Imports) (X–M)
Net export refers to the excess of the value of exports over the value of imports of a country in an accounting year.
Exports, though purchased by non-residents, are produced within our domestic territory, and therefore, a part of
domestic product and thus, included in GDPmp and hence national income.
Imports, however, are deducted because goods and services imported are not produced within the domestic
territory of the country.
GDPmp = Private final consumption expenditure
+ Government final consumption expenditure
+ Gross domestic capital formation
+ Net exports
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
Precautions in making estimates of national income by expenditure method

1. Avoid intermediate expenditure.
By definition, the expenditure method includes only final expenditures, i.e. expenditure on consumption and
investment. Like in the value added method, inclusion of intermediate expenditure like that on raw materials,
etc. will mean double counting.
2. Do not include expenditure on second hand goods and financial assets.
Buying second hand goods is not a fresh production activity. Buying financial assets is not a production activity because
financial assets are neither goods nor services. Therefore, they should not be included in estimates of national income.
3. Avoid transfer expenditures.
A transfer payment is a payment against which no services are rendered. Therefore, no production takes place.
Since no production takes place, it has no place in national income. Charities, donations, gifts, scholarships, etc.
are some examples.
4. Include the self use of own produced final products.
For example, a house owner using the house for self. Although explicitly he does not incur any expenditure,
implicitly he is making payment of rent to himself. Since the house is producing a service, the imputed value of
the housing service must be included in national income.
Treatment of Items in the Estimation of National Income by Expenditure Method

S. No. Items Treatment Reason
1. Expenditure on education of Yes, it is included in national Because it is a private final
children by a family, e.g. purchase income. consumption expenditure.
of books etc.
2. Purchase of car by a household Yes, it will be included in the Because it is a private final
national income. consumption expenditure.
3. Fees received from students Yes, it will be included in the Because it is a private final
national income. consumption expenditure.
4. Expenditure on free services Yes, it is included in national Because it is government final
provided by the government, income. consumption expenditure.
e.g., free educational services,
free treatment of the poor in
government hospitals, etc.
5. Purchase of tractor by a farmer/ Yes, it is included in national Because it is gross domestic capital
Purchase of taxi by a taxi driver/ income. formation or final investment
Purchase of a truck to carry expenditure.
goods by a firm.
6. Purchase of a machine or Yes, it is included in national Because it is gross domestic capital
refrigerator installed in a income. formation or final investment
production unit by a firm. expenditure.
7. Construction of a house by Yes, it is included in national Because it is a part of gross fixed
an individual/Expenditure on income by expenditure method. capital formation, i.e. a final
adding a floor to the building investment expenditure.
8. Addition to the machinery, Yes, it is included in national Because it is a part of gross fixed
factory buildings and equipments income by expenditure method. capital formation, i.e. a final
by the firms investment expenditure.
9. Net addition to capital stock Yes, it is included in national Because it is net investment or net
income by expenditure method. capital formation, which is an item
of final expenditure.
10. Purchase of goods by foreign Yes, it is included in national Because these are exports, i.e.
tourists income. demand for goods produced in the
domestic territory, an item of final
expenditure.
11. Purchase of second hand No, it is not included in national Because the value of imports are
machinery from abroad income. deducted while estimating the
national income of a country.
12. Expenditure on fertilizers by a No, it is not included in national Because it is an intermediate
farmer income. expenditure for the farmer and hence
deducted from value of output while
calculating national income.
13. Payment of electricity bill by a No, it is not included in national Because it is an intermediate cost
school income. for the school.
14. Purchase of uniforms for nurses No, it is not included in national Because it is an intermediate cost
by a hospital income. for the hospital.
15. Expenditure on engine oil by car No, it is not included in national Because it is an intermediate cost
service station income. or intermediate expenditure for the
car service station.
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
Expenditure Method of Calculating National Income

In this method, we take the sum of final expenditures on consumption and investment. This sum equals GDPmp. These final
expenditures are on the final goods produced within the domestic territory of the country. Main components of GDPmp or
final expenditures in the economy are:
(i) Private final consumption expenditure (PFCE)
(ii) Government final consumption expenditure (GFCE)
(iii) Gross domestic capital formation (GDCF) (= Gross domestic fixed capital formation + Net change in stocks)
(iv) Net exports (X–M) refers to the excess of the value of exports over the value of imports of a country in an accounting year.
Exports, though purchased by non-residents, are produced within our domestic territory, so included in GDPmp; whereas
Imports are deducted because imported goods are not produced within our domestic territory.
GDPmp = PFCE + GFCE + GDCF + Net Exports (or – Net Imports)
By making the usual adjustments we can arrive at national income:
National Income (NNPfc) = GDPmp – Depreciation – Indirect taxes + Subsidies + NFIA
Precautions in making estimates of national income by expenditure method
1. Avoid intermediate expenditure. National income includes only final expenditures, i.e. expenditure on consumption and
investment.
2. Do not include expenditure on second hand goods and financial assets. Buying second hand goods is not a fresh production
activity. Buying financial assets is not a production activity because financial assets are neither goods nor services.
3. Avoid transfer expenditures, e.g. Charities, donations, gifts, scholarships, etc. since no production takes place.
4. Include the self use of own produced final products. For example, a house owner using the house for self. Although
explicitly he does not incur any expenditure, implicitly he is making payment of rent to himself. Since the house is
producing a service, the imputed value of the housing service must be included in national income.


 Three categories of investment
(a) Fixed business investment: Addition to the machinery, factory buildings, and equipments employed by the firms.
(b) Residential investment: Addition of housing facilities, e.g., construction of a house by an individual, expenditure on adding a floor to
the building, etc.
(c) Change in inventories: Addition to the stock of capital. The increase in value of inventories of a firm over a year is treated as
investment expenditure undertaken by the firm.
Gross investment = Fixed business investment + Residential investment + Change in stock
 Expenditure Method of calculating GDP
An alternative way to calculate the GDP is by looking at the demand side of the products. This method is referred to as the expenditure
method.
In the farmer baker example that we have described before, the aggregate value of the output in the economy by expenditure method will be
calculated in the following way:
In this method, we add the final expenditures that each firm makes. Final expenditure is that part of expenditure which is undertaken not for
intermediate purposes. The `50 worth of wheat which the bakers buy from the farmers counts as intermediate goods, hence it does not fall
under the category of final expenditure. Therefore, the aggregate value of output of the economy is `200 (final expenditure received by the
baker) + `50 (final expenditure received by the farmer) = `250 per year.
A firm can make the final expenditure on the following accounts:
(a) Final consumption expenditure on the goods and services produced by the firm. We may note that mostly it is the households
which undertake consumption expenditure. There may be exceptions when the firms buy consumables to treat their guests or for their
employees.
(b) Final investment expenditure incurred by other firms on the capital goods produced by the given firm. Observe that unlike the
expenditure on intermediate goods which is not included in the calculation of GDP, expenditure on investments is included. The reason
is that investment goods remain with the firm, whereas intermediate goods are consumed in the process of production.
(c) Expenditure that the government makes on the final goods and services produced by the given firm. We may point out that the
final expenditure incurred by the government includes both the consumption and investment expenditure.
(d) Export revenues that the given firm earns by selling its goods and services abroad. Thus, the sum total of the revenues that the given
firm earns is given by the sum total of final consumption, investment, government and exports expenditures received by the given firm.
GDPmp = Sum total of final consumption, investment, government and exports expenditures received by all the firms in the economy
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.
(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.
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

1. Should the following be treated as final expenditure or intermediate expenditure? Give reason.
(i) Purchase of furniture by a firm
(ii) Expenditure on maintenance by a firm (3 marks)
Ans. (i) It is a final expenditure if it is purchased by the firm for its own use because it is an investment expenditure.
However, if it is purchased by the firm for re-sale, then it is an intermediate expenditure.
(ii) It is an intermediate expenditure because it is an expenditure on single use producer goods.
2. State the various components of the Expenditure Method that are used to calculate national income.
Ans. The components of the Expenditure Method that are used to calculate national income are:
(a) Private Final Consumption Expenditure: The final consumption expenditure of households on the goods
and services produced by all the firms in the economy.
(b) Government Final Consumption Expenditure: The expenditure that the government makes on the final
goods and services produced by all the firms in the economy.
(c) Investment Expenditure: The final investment expenditure incurred by firms on the capital goods produced
by other firms in the economy.
(d) Net Exports: Exports minus imports. (Net exports = Exports – Imports)
3. Write down the three identities of calculating GDP of a country by the three methods. Also briefly explain
why each of these give us the same value of GDP. (NCERT) (6 marks)
Ans. GDPmp (by Product Method)
= Value of output produced by all firms in the economy during the year – Value of intermediate goods
used by all firms in the economy during the year
GDPmp (by Income method)
= Compensation of employees + Interest + Rent and royalty + Profits + Mixed income of self-employed
+ Depreciation + Net indirect taxes (Indirect taxes – Subsidies)
GDPmp (by Expenditure Method)
= Private final consumption expenditure + Government final consumption expenditure + Gross domestic
capital formation + Net Exports (Exports – Imports)
All the three methods give equal value of GDP because the same amount of money, representing the aggregate
value of final goods and services moves in the economy in a circular way. Income generated in production units
in the form of aggregate value of final goods and services produced in the economy is distributed among factor
owners as factors payments, which in turn spent on consumption and investment expenditure on final foods
and services produced by all the firms in the economy.
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
Compute National Income. (4 marks)

(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
(viii) Net factor income from abroad (–)40
(ix) Profits 100
Solution:
Private final consumption expenditure 900
(+) Government final consumption expenditure 400
(+) Gross domestic capital formation 250
(–) Net imports (–)30
Gross Domestic Product at market price (GDPmp) 1520
(–) Depreciation (–)20
(–) Net indirect taxes (–)100
(+) Net factor income from abroad (NFIA) (–)40
Note: Depreciation = Gross domestic capital formation (iv) – Net domestic capital formation (vi + v)
= 250 – (180 + 50) = 250 – 230 = `20 crore
Do it yourself 18
Calculate National income from the following data. (4 marks)

(ii) Profit 100
(iii) Government final consumption expenditure 400
(iv) Net indirect taxes 100
(v) Gross domestic capital formation 250
(vi) Change in stock 50
(vii) Net factor income from abroad (–)40
(viii) Consumption of fixed capital 20
(ix) Net imports 30
[Ans. `1,360 crore]
Numerical 19
Find National Income from the following using expenditure method. (4 marks)
(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
(ix) Government final consumption expenditure 400
(x) Profit 220
(xi) Mixed income of self-employed 400
(xii) Interest 230
Solution:
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
Do it yourself 19
Calculate Net National Product at factor cost by expenditure method from the data given below. (4 marks)

(i) Private final consumption expenditure 1,020
(ii) Net fixed capital formation 180
(iii) Indirect taxes 180
(iv) Government current transfers to households 25
(v) Government final consumption expenditure 100
(vi) Net factor income from abroad (–)10
(vii) Mixed income of the self-employed 560
(viii) Change in stocks 60
(ix) Current replacement cost 80
(x) Rent, interest and profits 190
(xi) Subsidies 20
(xii) Exports 100
(xiii) Imports 120
[Ans. `1,170 crore]
Numerical 20
Calculate Net National Product at market price. (4 marks)

(i) Gross domestic fixed capital formation 350
(ii) Private final consumption expenditure 8,000
(iii) Government final consumption expenditure 3,000
(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
Solution:
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
Do it yourself 20
Calculate Gross National Product at factor cost from the following data. (4 marks)
(i) Net domestic fixed capital formation 310
(ii) Closing stock 100
(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
[Ans. `2,030 crore]
Numerical 21
Calculate Net Domestic Product at factor cost. (4 marks)

(i) Private final consumption expenditure 8,000
(ii) Government final consumption expenditure 1,000
(iii) Exports 70
(iv) Imports 120
(v) Annual allowance for wear and tear of capital stock 60
(vi) Fixed business investment 300
(vii) Residential investment 200
(viii) Change in stock 100
(ix) Factor income to abroad 40
(x) Factor income from abroad 90
(xi) Net product taxes 400
(xii) Net production taxes 250
Solution:
Private final consumption expenditure 8,000
Government final consumption expenditure 1,000
Gross investment (note 1) 600
Net exports (note 2) (–)50
Gross Domestic Product at market price 9,550
(–) Depreciation (Annual allowance for wear and tear of capital stock) (–)60
(–) Net product taxes (–)400
(–) Net production taxes (–)250
Net Domestic Product at factor cost 8,840
Note: 1. Gross investment = Fixed business investment + Residential investment + Change in stock
= 300 + 200 + 100 = `600 crore
2. Net exports = Exports – Imports
= 70 – 120 = (–) `50 crore
Do it yourself 21
Find out Gross National Product at market price from the following data. (4 marks)
(i) Consumption of fixed capital 60
(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
[Ans. `1,200 crore]
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
Thus, GDP = Sum total of factor incomes paid by Firms A and B

= Total wages received by workers of Firms A and B
+ Total profits of Firms A and B
= 80 + 120 = `200 lakh
(iii) GDP by Expenditure Method (Disposition phase)
GDP = Sum of final expenditures, i.e. expenditures on goods and services for end use
In the given question, the final expenditure is expenditure by consumers on cloth.
Therefore, GDP = `200 lakh
Thus, all the three methods of estimating GDP give us the same answer.
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).
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)
(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)
(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
[Ans. (a) `260 crore (b) `255 crore]

Numerical 24
From the data given below, calculate :

(a) National income by income method.
(b) Gross Domestic Product at factor cost by expenditure method. (6 marks)

(ii) Net domestic fixed capital formation 25
(iii) Consumption of fixed capital 2
(iv) Closing stock 10
(v) Opening stock 5
(vi) Government final consumption expenditure 10
(vii) Net exports (–)5
(viii) Wages and salaries 80
(ix) Contribution of employers towards social security 10
(x) Operating surplus 20
(xi) Net factor income received from abroad (–)5
(xii) Net indirect taxes 10
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)
(i) Rent 50
(ii) Net factor income from abroad 5
(iii) Compensation of employees 500
(iv) Indirect taxes 100
(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
[Ans. `735 crore]

Numerical 25
Calculate from the following data, net national product at market price by (a) income method and (b) expenditure
method. (6 marks)

(ii) Mixed income of the self-employed 800
(iii) Gross fixed capital formation 430
(vi) Operating surplus 1,000
(vii) Net capital formation 450
(viii) Exports 10
(ix) Imports 40
(x) Indirect taxes 140
(xi) Subsidies 20
(xii) Private final consumption expenditure 2,100
(xiii) Government final consumption expenditure 600
(xiv) Purchase by non-residential households in the domestic market 50
(xv) Net factor income to abroad 20
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
Calculate national income by expenditure and income methods. (6 marks)

(i) Operating surplus 110
(ii) Private final consumption expenditure 300
(iii) Net factor payment made abroad 20
(iv) Social security contribution by employees 20
(v) Compensation of employees 230
(vi) Change in stocks 10
(vii) Government final consumption expenditure 60
(viii) Net exports (–)10
(ix) Net domestic capital formation 40
(x) Consumption of fixed capital 30
(xi) Net indirect taxes 50
[Ans. `320 crore]

Numerical 26
Calculate from the following data, Net National Product at market price by (a) income method and (b) expenditure
method. (6 marks)

(i) Compensation of employees paid by the Government 40
(ii) Mixed income of the self-employed 50
(iii) Wages and salaries 400
(iv) Employers’ contribution to social security schemes 80
(v) Operating surplus 300
(vi) Indirect taxes 30
(vii) Subsidies 10
(viii) Net capital formation 150
(ix) Net factor income to abroad 10
(x) Government final consumption expenditure 230
(xi) Private final consumption expenditure 500
(xii) Exports 15
(xiii) Imports 45
(xiv) Consumption of fixed capital 20
(xv) Profits 130
Solution: (a) Net National Product at market price (Income method) = Wages and salaries + Employers’ contribution to social
security schemes + Operating surplus + Mixed income – Net factor income to abroad + Indirect taxes – Subsidies
= 400 + 80 + 300 + 50 – 10 + 30 – 10 = `840 crore
(b) Net National Product at market price (Expenditure Method) = Private final consumption expenditure
+ Government final consumption expenditure + Net capital formation + Exports – Imports – Net factor
income to abroad = 500 + 230 + 150 + 15 – 45 – 10 = `840 crore
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)
(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
[Ans. `2,580 crore]

Numerical 27
Calculate gross national product at market price by income method and expenditure method from the following data.
(6 marks)

(i) Rent 40
(iii) Net exports 20
(iv) Interest 60
(v) Profit 120
(vi) Government final consumption expenditure 200
(vii) Net domestic capital formation 100
(viii) Compensation of employees 800
(ix) Consumption of fixed capital 20
(x) Net indirect taxes 100
(xi) Net factor income from abroad (–)20
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)
(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
(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
[Ans. `340 crore]

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)

(i) National Income 71,000
(ii) Gross Domestic Capital Formation 10,000
(iii) Government Final consumption Expenditure ?
(iv) Mixed Income of self-Employed ?
(v) Net Factor Income from abroad 1,000
(vi) Net Indirect Taxes 2,000
(vii) Profits 1,200
(viii) Wages and Salaries 15,000
(ix) Net Exports 5,000
(x) Private Final Consumption Expenditure 40,000
(xi) Consumption of fixed Capital 3,000
(xii) Operating Surplus 30,000
Solution: Mixed income of self-employed = (i)–[(viii)+(xii)+(v)]

= 71,000 – (15,000 + 30,000 + 1,000)
Mixed income of self-employed = `25,000 crore
Government Final consumption expenditure = (i)–[(x)+(ii)+(v)+(ix)]+(vi)+(xi)
= 71,000 –(40,000 + 10,000 + 1,000 + 5,000) + 2,000 + 3,000
= `20,000 crore
Do it yourself 28
Given the following data, find the missing values of ‘Private Final Consumption Expenditure’ and ‘Operating
surplus’. (CBSE 2019) (6 marks)

(ii) Net Indirect Taxes 1,000
(iii) Private Final Consumption Expenditure ?
(iv) Gross Domestic Capital Formation 17,000
(v) Profits 1,000
(vi) Government Final Consumption Expenditure 12,500
(vii) Wages & Salaries 20,000
(viii) Consumption of Fixed Capital 700
(ix) Mixed Income of Self Employed 13,000
(x) Operating Surplus ?
(xi) Net Factor Income from Abroad 500
(xii) Net Exports 2,000
[Ans. Private final Consumption expenditure `19,700 crore; Operating surplus `16,500 crore]
Numerical 29
Given the following data, find the missing values of ‘Gross Domestic Capital Formation’ and ‘Wages and Salaries’.
(CBSE 2019) (6 marks)

(i) Mixed Income of Self Employed 3,500
(ii) Net Indirect Taxes 300
(iii) Wages & Salaries ?
(iv) Government Final Consumption Expenditure 14,000
(v) Net Exports 3,000
(vi) Consumption of Fixed Capital 300
(vii) Net Factor Income from Abroad 700
(viii) Operating Surplus 12,000
(ix) National Income 30,000
(x) Profits 500
(xi) Gross Domestic Capital Formation ?
(xii) Private Final Consumption Expenditure 11,000
Solution: Wages and salaries = ix–[(i)+(viii)+(vii)]

= 30,000 – (3,500 + 12,000 + 700)
= `13,800 crore
Gross domestic Capital formation = (ix)–[(iv)+(v)+(vii)+(xii)]+(ii)+(vi)
= 30,000 – (14,000 + 3000 + 700 + 11,000) + 300 + 300
= `1,900 crore
Do it yourself 29
Given the following data, find the values of “Gross Domestic Capital Formation” and “Operating Surplus. (6 marks)

(ii) Wages and Salaries 12,000
(iii) Private Final Consumption Expenditure 7,200
(iv) Net Indirect Taxes 700
(v) Gross Domestic Capital Formation ?
(vi) Depreciation 500
(vii) Government Final Consumption Expenditure 6,100
(viii) Mixed Income of Self-Employed 4,800
(ix) Operating Surplus ?
(x) Net Exports 3,400
(xi) Rent 1,200
(xii) Net Factor Income From Abroad (–) 150
[Ans. Gross Domestic Capital Formation `6,750 crore; Operating surplus `5,450 crore]
Numerical 30
Given the following data, find the missing values of ‘Gross Domestic Capital Formation’ and ‘Wages and Salaries’.

(i) Mixed Income of Self-Employed 700
(ii) Net Factor Income from Abroad 150
(iii) Private Final Consumption Expenditure 2,200
(iv) Profits 200
(v) Net Indirect Taxes 150
(vi) National Income 5,000
(vii) Gross Domestic Capital Formation 1,100
(viii) Wages and Salaries 2,200
(ix) Net Exports ?
(x) Government Final Consumption Expenditure 1,300
(xi) Consumption of Fixed Capital 200
(xii) Operating Surplus ?
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)

(i) Wages and Salaries 2,400
(ii) National Income 4,200
(iii) Net Exports ?
(iv) Net Factor Income from Abroad 200
(v) Gross Domestic Capital Formation 1,100
(vi) Mixed Income of Self-Employed 400
(vii) Private Final Consumption Expenditure 2,000
(viii) Net Indirect Taxes 150
(ix) Operating Surplus ?
(x) Government Final Consumption Expenditure 1,000
(xi) Consumption of Fixed Capital 100
(xii) Profits 500
[Ans. Operating surplus `1,200 crore; Net exports `150 crore]

1.7 Real and Nominal GDP

Nominal GDP, Real GDP and GDP Deflator
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. In other words, Nominal GDP (or GDP at current
prices) is measured as the product of current year’s output (Q1) of final goods and services and their current
year’s price (P1).
Change in nominal GDP may include both change in prices and change in flow of goods and services. Thus,
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
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. In other words, Real GDP (or GDP at
constant prices) is measured as product of current year output (Q1) and their base year’s price (P0).
Since base year’s prices remaining constant, real GDP will increase only if the output of goods and services
produced in the economy is increasing.
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.
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.
Given the Nominal GDP, how to find out Real GDP?

Given the Nominal GDP, we can find out Real GDP 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 GDP can be eliminated in the following way:
Nominal GDP
Real GDP = ¥100
Price Index
Example: Suppose Nominal GDP = `288 and Price index = 120, then Real GDP can be calculated as:
Nominal GDP 288
Real GDP = ¥100 = ¥ 100 = `240
Price Index 120
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
Nominal and Real Income

Nominal National Income (or National Income at current prices)
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).
In other words, nominal national income is measured as the product of current year’s output (Q1) of final goods
and services and their current year’s price (P1).
Change in nominal national income may include both change in prices and change in flow of goods and services.
Thus, 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, due to rise in general price level during
the current year.
Real National Income (or National Income at constant prices)
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 (or national income at constant prices).
In other words, real national income is measured as product of current year output (Q1) and their base year’s price (P0).
Since base year’s prices remaining constant, real national income will increase only if the output of goods and
services produced in the economy is increasing.
Thus, 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.
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
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.

 NOMINAL AND REAL GDP
One implicit assumption in all this discussion is that the prices of goods and services do not change during the period of our study. If prices
change, then there may be difficulties in comparing GDPs. If we measure the GDP of a country in two consecutive years and see that the
figure for GDP of the latter year is twice that of the previous year, we may conclude that the volume of production of the country has doubled.
But it is possible that only prices of all goods and services have doubled between the two years whereas the production has remained
constant. Therefore, in order to compare the GDP figures (and other macroeconomic variables) of different countries or to compare the GDP
figures of the same country at different points of time, we cannot rely on GDPs evaluated at current market prices. For comparison we take
the help of real GDP.
Real GDP is calculated in a way such that the goods and services are evaluated at some constant set of prices (or constant prices). Since
these prices remain fixed, if the Real GDP changes we can be sure that it is the volume of production which is undergoing changes.
Nominal GDP, on the other hand, is simply the value of GDP at the current prevailing prices.
For example, suppose a country only produces bread. In the year 2000 it had produced 100 units of bread, price was `10 per bread.
GDP at current price was `1,000. In 2020 the same country produced 110 units of bread at price `15 per bread. Therefore, nominal GDP
in 2001 was `1,650 (=110 × `15). Real GDP in 2020 calculated at the price of the year 2019 (2019 will be called the base year) will be
110 × `10 = `1,100.
Notice that the ratio of nominal GDP to real GDP gives us an idea of how the prices have moved from the base year (the year whose prices
are being used to calculate the real GDP) to the current year. 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.
The ratio of nominal to real GDP is a well known index of prices. This is called GDP Deflator. GDP Deflator = Nominal GDP/Real GDP × 100
In the previous example, the GDP deflator is 1,650 /1,100 × 100 = 150%. This implies that the price of bread produced in 2020 has increased
by 50% as compared to the price in 2019. Which is true because price of bread has indeed gone up from `10 to `15.
 Consumer Price Index (CPI) and Wholesale Price Index (WPI)
There is another way to measure change of prices in an economy which is known as the Consumer Price Index (CPI). This is the index of
prices of a given basket of commodities which are bought by the representative consumer. CPI is generally expressed in percentage terms.
We have two years under consideration – one is the base year, the other is the current year. We calculate the cost of purchase of a given
basket of commodities in the base year. We also calculate the cost of purchase of the same basket in the current year. Then we express the
latter as a percentage of the former. This gives us the Consumer Price Index of the current year vis-á-vis the base year.
For example, let us take an economy which produces two goods, rice and cloth. A representative consumer buys 90 kg of rice and 5 pieces
of cloth in a year. Suppose in the year 2019 the price of a kg of rice was `10 and a piece of cloth was `100. So the consumer had to spend
a total sum of `10 × 90 = `900 on rice in 2019. Similarly, she spent `100 × 5 = `500 per year on cloth. Summation of the two items is,
`900 + `500 = `1,400.
Now suppose the prices of a kg of rice and a piece of cloth has gone up to `15 and `120 in the year 2020. To buy the same quantity of rice
and clothes the representative will have to spend `1,350 and `600 respectively (calculated in a similar way as before). Their sum will be,
`1,350 + `600 = `1,950. The CPI therefore will be 1,950/1,400 × 100 = 139.29 (approximately). It is worth noting that many commodities
have two sets of prices. One is the retail price which the consumer actually pays.
The other is the wholesale price, the price at which goods are traded in bulk. These two may differ in value because of the margin kept by
traders. Goods which are traded in bulk (such as raw materials or semi-finished goods) are not purchased by ordinary consumers. Like CPI,
the index for wholesale prices is called Wholesale Price Index (WPI). In countries like USA it is referred to as Producer Price Index (PPI).
 Consumer Price Index (CPI) versus GDP Deflator
1. The goods purchased by consumers do not represent all the goods which are produced in a country. GDP deflator takes into account all
such goods and services.
2. CPI includes prices of goods consumed by the representative consumer, hence it includes prices of imported goods. GDP deflator does
not include prices of imported goods.
3. The weights are constant in CPI – but they differ according to production level of each good in GDP deflator.
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:
(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)

1. When can Real GDP be greater than Nominal GDP? (1 mark)
Ans. When base year’s prices are higher than the current year’s prices.
2. Discuss any two differences between GDP at constant prices and GDP at current Prices.
Ans. Two main difference between GDP at current prices and at constant price are:
(i) GDP at current prices are measured at current year’s prices whereas GDP at constant prices are measured
at base year’s prices.
(ii) GDP at current prices may increase due to rise in prices even if there is no flow of goods and services whereas
GDP at constant prices will only increase when there is an increase in the flow of goods and services.
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%]
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
(ii) = Nominal GDP

GDP deflator × 100
Real GDP
5000
For the year 2019: GDP deflator = × 100 = 100
5000
Since real and nominal GDP in 2019 are same, GDP deflator is 100. This is because 2019 is the base year.
6050
For the year 2020: GDP deflator = × 100 = 110
5500
It means prices have risen by 10% between the two periods. Which is true because price of product X has
indeed gone up from `50 to `55.
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]
1.8 GDP and Welfare

Is GDP a perfect index of economic welfare?
Generally it is considered that an increase in the Gross Domestic Product (GDP) of any economy ensures
increase in welfare of the people of the country. However, this may not always be correct. Following are some of
the limitations of using GDP as an index of welfare of a country:
1. Distribution of GDP
If the GDP of the country is rising, the welfare of people may not increase if there is inequalities in the
distribution of GDP. Increase in inequalities means that rich become richer and poor become poorer.
Since utility of money is higher among poor and lower among the rich, therefore, if the distribution of GDP is
not uniform, inequalities may not lead to increase in welfare of the entire country people.
2. Non-monetary exchanges (or non-monetary production)
Non-monetary exchanges are those activities in an economy which cannot be evaluated in terms of money due
to non-availability of data. For example, domestic services of a housewife/family members, hobbies like painting,
gardening, etc. are not paid for. Similarly, barter exchanges take place without the help of money. But these
activities do contribute to welfare of the people.
Since GDP does not account for such activities, it is a major cause of underestimation of GDP in the economy.
As a result, welfare of the people is also underestimated.
Thus, GDP may not give us a clear indication of the production activity and welfare of people of the country.
3. Externalities
Externalities refer to the harms (or benefits) a firm or an individual causes to another for which they are not
penalised (or not paid).
Examples of negative externalities:
(i) Pollution caused by vehicles and smoke out of chimneys of factories
(ii) Traffic jams
Such externalities may cause harm to the people. Hence, their welfare will fall. However, GDP does not account
for such negative externalities. Thus, GDP overestimates the actual welfare.
Examples of positive externalities:
(i) Introduction of metro rail has saved the time and money of general public and has provided safe means
of transport.
(ii) Saving of commuting time due to construction of a fly-over
Positive externalities increase welfare of people or general public. However, GDP does not account for such
positive externalities. Thus, GDP as an index underestimates welfare.
4. Composition of GDP
• If the production of tobacco products, liquor, etc. increases in the country, GDP will increase since it is
counted in GDP. However, these harmful goods adversely affect the health of people.
• If the government imposes a ban on consumption of tobacco products, liquor, etc., it will bring the
production of tobacco products, liqour, etc. Since it is counted in GDP, GDP will fall. However, the ban
will improve the health in general. It will thus increase welfare.
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).
RECAP
Limitations of using GDP as an index of welfare of a country:

1. Distribution of GDP: If the GDP of the country is rising, the welfare of people may not increase if there is inequalities in the
distribution of GDP, i.e. rich become richer and poor become poorer.
2. Non-monetary exchanges: Non-monetary exchanges refer to the goods and services produced but not exchanged for any
monetary value. For example, value of household chores (cooking, washing, cleaning etc.) by a millions of home-makers is
not included in the GDP of the economy. It is major cause of undervaluation of GDP in the economy. As result, welfare of
the people is also underestimated.
3. Externalities: Externalities refer to the harms (or benefits) a firm or an individual causes to another for which they are not
penalised (or not paid). Negative externalities: (i) Air pollution caused by vehicles (ii) Traffic jams. Such externalities reduce
welfare. However, GDP does not account for such negative externalities. Thus, GDP overestimates the actual welfare.
Positive externalities: (i) Introduction of metro rail has saved the time and money of general public (ii) Saving of commuting
time due to construction of a fly-over. Positive externalities increase welfare of people. However, GDP does not account for
such positive externalities. Thus, GDP as an index underestimates welfare.

Can the GDP of a country be taken as an index of the welfare of the people of that country? If a person has more income he or she can buy
more goods and services and his or her material well-being improves. So it may seem reasonable to treat his or her income level as his or her
level of well-being. GDP is the sum total of value of goods and services created within the geographical boundary of a country in a particular
year. It gets distributed among the people as incomes (except for retained earnings). So we may be tempted to treat higher level of GDP of a
country as an index of greater well-being of the people of that country (to account for price changes, we may take the value of real GDP instead
of nominal GDP). But there are at least three reasons why this may not be correct.
1. Distribution of GDP – how uniform is it: If the GDP of the country is rising, the welfare may not rise as a consequence. This is because
the rise in GDP may be concentrated in the hands of very few individuals or firms. For the rest, the income may in fact have fallen. In such a
case the welfare of the entire country cannot be said to have increased. For example, suppose in year 2019, an imaginary country had 100
individuals each earning `10. Therefore the GDP of the country was `1,000 (by income method). In 2020, let us suppose the same country
had 90 individuals earning `9 each, and the rest 10 individual earning `20 each. Suppose there had been no change in the prices of goods
and services between these two periods. The GDP of the country in the year 2020 was 90 × `9 + 10 × `20 = `810 + `200 = `1,010. Observe
that compared to 2019, the GDP of the country in 2020 was higher by `10. But this has happened when 90 per cent of people of the country
have seen a drop in their real income by 10 per cent (from `10 to `9), whereas only 10 per cent have benefited by a rise in their income
by 100 per cent (from `10 to `20). 90 per cent of the people are worse off though the GDP of the country has gone up. If we relate welfare
improvement in the country to the percentage of people who are better off, then surely GDP is not a good index.
2. Non-monetary exchanges: Many activities in an economy are not evaluated in monetary terms. For example, the domestic services women
perform at home are not paid for. The exchanges which take place in the informal sector without the help of money are called barter exchanges.
In barter exchanges, goods (or services) are directly exchanged against each other. But since money is not being used here, these exchanges
are not registered as part of economic activity. In developing countries, where many remote regions are underdeveloped, these kinds of
exchanges do take place, but they are generally not counted in the GDPs of these countries. This is a case of underestimation of GDP. Hence,
GDP calculated in the standard manner may not give us a clear indication of the productive activity and well-being of a country.
3. Externalities: Externalities refer to the benefits (or harms) a firm or an individual causes to another for which they are not paid (or penalised).
Externalities do not have any market in which they can be bought and sold. For example, let us suppose there is an oil refinery which refines
crude petroleum and sells it in the market. The output of the refinery is the amount of oil it refines. We can estimate the value added of the
refinery by deducting the value of intermediate goods used by the refinery (crude oil in this case) from the value of its output. The value
added of the refinery will be counted as part of the GDP of the economy. But in carrying out the production the refinery may also be polluting
the nearby river. This may cause harm to the people who use the water of the river. Hence their well being will fall. Pollution may also kill
fish or other organisms of the river on which fish survive. As a result, the fishermen of the river may be losing their livelihood. Such harmful
effects that the refinery is inflicting on others, for which it will not bear any cost, are called externalities. In this case, the GDP is not taking
into account such negative externalities. Therefore, if we take GDP as a measure of welfare of the economy we shallbe overestimating the
actual welfare. This was an example of negative externality. There can be cases of positive externalities as well. In such cases, GDP will
underestimate the actual welfare of the economy.
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

1. Give one example of ‘externality’ which reduces welfare of the people. (CBSE 2013) (1 mark)
Ans. Smoke of a factory polluting the air or release of contaminated water into river or traffic jams, etc. (any one)
2. Define externalities. Give an example of negative externality. What is its impact on welfare?
Ans. Externalities refer to the benefits (or harms) a firm or an individual causes to another for which it is not paid (or penalised)
Example of negative externality: Smoke of a factory polluting the air.
Impact: Reduces welfare through negative effect on health.
3. ‘GDP as an index of welfare may understate or overstate welfare.’ Explain the statement using examples
of a positive and a negative externality. (CBSE Sample Question Paper 2017) (3 marks)
Ans. GDP doesn’t account for externalities
Positive Externality: e.g. saving commuting time due to construction of a fly-over, increases welfare. GDP as an
index understates welfare.
Negative Externality: e.g. pollution from factories, decreases welfare. GDP overstates welfare.
4. How do the negative externalities affect the welfare of the people ? Explain by taking an example.
Ans. Pollution by factories, vehicles, etc is an example of negative externalities, i.e. harm caused by a firm or a person to
others for which they are not paid for. Gross domestic product does not take into account such harms caused.
5. Suppose a ban is imposed on consumption of tobacco. Examine its likely effects on (a) gross domestic
product and (b) welfare. (CBSE 2017) (3 marks)
Ans. (a) Ban on consumption of tobacco will bring down production of tobacco. Since it is counted in GDP, GDP
will fall.
(b) The ban will improve the health in general. It will thus increase welfare.
6. How does increase in inequalities in distribution of income affect welfare of the society ? Explain.
Ans. Increase in inequalities means that rich become richer and poor become poorer. Since utility of money is higher
among poor and lower among the rich, any increase in inequalities may not lead to increase in welfare.
7. Government incurs expenditure to popularise yoga among the masses. Analyse its impact on gross
domestic product and welfare of the people. (CBSE 2016) (3 marks)
Ans. Government expenditure on popularising yoga raises GDP because it is government’s final consumption
expenditure. It also raises welfare of the people because yogic exercises improve health and thus, raise efficiency
of the people.
8. Sale of petrol and diesel cars is rising particularly in big cities. Analyse its impact on gross domestic
product and welfare. (CBSE 2016) (3 marks)
Ans. Sale of cars raises GDP, because sales are of final products. Cars provide convenience in transportation but at
the same time, it causes traffic jams, air pollution and noise pollution, which reduces the welfare of the people.
Pollution has bad effects on the health of the people.
9. State, giving reasons, whether the following will be included in national income: (3 marks)
(i) Growing vegetables in a kitchen garden of the house/Services rendered by family members to each other.
(ii) Production of tobacco products, liquor, etc.
(iii) Harmful effects of air pollution caused by factories or vehicles.
Ans. (i) No, it will not be included in the national income as it is difficult to estimate the market value of
production. It is a non-monetary production or non-monetary exchange.
(ii) Yes, it is included in the national income since output is produced.
(iii) No, national income does not include negative externalities though they reduce welfare of people.
Self Assessment Test 1
National Income and Related Aggregates

Time allowed : 1 hour Maximum Marks : 25
Q.1 What is Macroeconomics? (1 mark)
Q.2 Give any two examples of flow concept. (1 mark)
Q.3 According to a report forwarded by the Reserve Bank of India, there was a fall in rate of inflation as measured by
Consumer Price Index (CPI) on year-on-year basis to 5% from 8% in the precious year. Which of the following
statements represents the situation? (1 mark)
(a) CPI has fallen (b) CPI has risen at a rate lower than the preceding year
(c) CPI is constant (d) None of the above
Q.4 Depreciation is also known as: (1 mark)
(a) Capital loss (b) Unforeseen obsolescence
(c) Capital allowance (d) Both (a) and (b)
Q.5 Calculate “Intermediate Consumption” from the following data: (3 marks)
(i) Gross value of output 300
(ii) Net value added at factor cost (NVAfc) 100
(iii) Subsidies 15
(iv) Depreciation 30
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

Q.1 Define an intermediate good. (1 mark)
Q.2 Wages received by an Indian working in the British Embassy in India will be included in Gross Domestic Product
(GDP) of India. True/False? Give reason. (1 mark)
Q.3 If the national income is `2,800 crore and NDPfc is `3,000 crore, which of the following option will be
correct? (1 mark)
(a) Factor income from abroad `500 and factor income to abroad is `200
(b) Factor income from abroad `400 and factor income to abroad is `600
(c) Factor income from abroad `600 and factor income to abroad is `400
(d) Factor income from abroad `700 and factor income to abroad is `700
Q.4 Which of the following would be the normal resident of India? (1 mark)
(a) An Indian working in an American embassy in India
(b) An Indian working in Singapore branch of an Indian bank.
(c) A team of German engineers in India on official job for six months.
(d) Five Afghan student pursing law in India for the last four years
Q.5 "Circular flow of income in a two sector economy is based on the axiom that one’s expenditure is other’s income."
Do you agree with the given statement? Support your answer with valid reasons. (3 marks)
Q.6 “India’s GDP is expected to expand 7.5% in 2019-20: World Bank” — The Economic Times.
Does the given statement mean that welfare of people of India increase at the same rate? Comment with reason.
(3 marks)
Q.7 Calculate “Depreciation” from the following data: (3 marks)
(i) Gross value of output 300
(ii) Net value added at factor cost (NVAfc) 100
(iii) Subsidies 15
(iv) Intermediate Consumption 185
Q.8 Using numerical example, distinguish between Real National Income and Nominal National Income.
OR
Explain any three precautions while calculating GDP by Value Added Method. (6 marks)
Q.9 (a) Distinguish between net factor from abroad and net exports. (2 marks)
(b) Calculate the value of “Mixed Income of Self-Employed” from the following data : (4 marks)
(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

Q.1 What are 'non-monetary exchanges'? (1 mark)
Q.2 Define 'Value Addition'? (1 mark)
Q.3 When national income (product) of the current year is estimated on the basis of prices prevailing in the current
year, it is called (i)_________ whereas when it is estimated on the basis of prices prevailing in the base year, it
is called (ii)__________. (real national income/nominal national income) (Fill in the blanks with the correct
options) (1 mark)
Q.4 If Real GDP = `240 crore and Price Index = 120, Nominal GDP = __________? (1 mark)
Q.5 Calculate “Gross value of output” from the following data: (3 marks)
(i) Net value added at factor cost (NVAfc) 100
(ii) Depreciation 30
(iii) Subsidies 15
(iv) Intermediate Consumption 185
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)
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

Q.1 The problem of _________ arises when the value of some goods and service are counted more than once while
estimating national income. (1 mark)
Q.2 Higher GDP always means greater per capital availability of goods in the economy. True/False? (1 mark)
Q.3 Which of the following is used for calculating National Income by income method? (1 mark)
(a) Income Tax (b) Corporation Tax
(c) Sales Tax (d) Net Indirect Tax
Q.4 If GDPmp is `5,000 crore, intermediate consumption is `2,500 crore and the ratio of sales to change in stock is
2 : 1, then sales will be: (1 mark)
(a) `4,000 (b) `5,000
(c) `3,000 (d) `2,000
Q.5 How is Real Gross domestic Product (GDP) different from Nominal Gross Domestic Product (GDP)? Given the
Nominal GDP, how is Real GDP computed? Explain using a numerical example. (3 marks)
Q.6 Explain the circular flow of income in a two sector economy. (3 marks)
Q.7 Distinguish between final goods and intermediate goods. Give suitable examples. (3 marks)
Q.8 Define the following: (6 marks)
(a) Value addition (b) Gross Domestic Product
(c) Flow variables (d) Income from property and entrepreneurship
(e) Net factor income from abroad (f ) Net exports
OR
Explain any four precautions while calculating national income by expenditure method. (6 marks)
Q.9 Given the following data, find the value of ‘Government Final Consumption Expenditure’ and ‘Mixed Income
of Self-Employed’: (6 marks)
i National Income 7,100
ii Government Final Consumption Expenditure ?
iii Gross Domestic Capital Formation 1,000
iv Mixed Income of Self-Employed ?
v Net Indirect Taxes 200
vi Net Factor Income from Abroad 100
vii Private Final Consumption Expenditure 4,000
viii Consumption of Fixed Capital 300
xi Profits 120
x Wages and Salaries 1,500
xi Net Exports 500
xii Operating Surplus 3,000

Q.1 National income and money creation are examples of stock concept. True/False? (1 mark)
Q.2 To avoid double counting , we should: (1 mark)
(a) Take the value of final goods and services only ignoring all intermediate products.
(b) Take the value added at different stages in production process instead of total output.
(c) Either (a) or (b)
(d) Neither (a) nor (b)
Q.3 Goods which are not bought for meeting immediate needs of the consumers but are producing other goods are
called _____________. (1 mark)
Q.4 How will you treat the following in the calculation of Net Domestic Product (NDP) of India? Give reasons for
your answer. (3 marks)
(a) Factor income from abroad.
(b) Remittances from non-resident Indians to their families in India.
Q.5 What are ‘non-monetary exchange’? Discuss with suitable example. (3 marks)
Q.6 State under what conditions in the following statements may be true: (4 marks)
(a) Domestic Income is equal to National Income.
(b) Value of output is equal to Value Added.
(c) Gross domestic capital formation = Gross domestic fixed capital formation
(d) Operating surplus = Rent + Royalty + Profit
Q.7 Explain the meaning of Real Gross Domestic Product and Nominal Gross Domestic Product. Which of the two
indicates economic welfare? Explain using a numerical example. (6 marks)
Q.8 Calculate Gross Domestic Product at market prices and national income from the following data. (6 marks)

(i) Net imports (–) 30
(iii) Subsidies 5
(iv) Net domestic fixed capital formation 50
(vi) Net factor income from abroad (–)10
(vii) Closing stock 10
(ix) Indirect taxes 55
(x) Opening stock 20
Check List to Objective Type Questions
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,
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
Preparing for Examinations

The aim of this guide is to help you prepare for your examinations by:
 informing you about the various skills and abilities that are assessed in the CBSE Economics XII examinations.
 helping you with a few tips on how to plan your preparation for examinations in an effective way.
 telling you why some students do not succeed or perform to their true ability in the CBSE examinations.
 making you feel confident in tackling CBSE examination questions and knowing what examiners expect when
marking your script.
FORMULAE – National Income Accounting and Keynesian Theory of Income and Employment
DIAGRAMS AND SCHEDULES – Keynesian Theory of Income and Employment
Important tips for attempting CBSE Economics XII Examination
CBSE Sample Question Paper 2020 with Solutions through Author’s Pen
25 Sample Question Papers (based on new sample question paper design of CBSE)
You can help yourself greatly in preparing for the final CBSE Economics XII Examination by following some important
steps. No one likes examinations but there is no need to be afraid of them if you prepare yourself well. The seeds for
success are sown long before you enter the examination room. The key thing is to be prepared. It is worth remembering:
‘If you fail to prepare, you are preparing to fail.’
Why not put this on your wall? But if you do, remember to practice what it says.
A few hints on how to study effectively

 Read through your book on a daily basis and feel confident that you have understood the main subject
content. When reading, underline or highlight the key points. They make notes on what you have read.
Writing and working in this way greatly enhances your understanding of a topic.
Tick off each topic (from the syllabus given at the start of each unit) as you revise and understand it.
When you have completed a chapter, Attempt ‘Self-Assessment Tests’—ideally without referring to the
book—so as to evaluate the understanding of concepts of the chapter.
 Revision is not something that is only confined to the last week or so before an examination. So:
‘make study a habit; make revision a habit.’
 Managing your time in an effective way is crucial. Remember:
‘it is not how much time you have but how you manage it.’
There should be regular periods in the week when you have spare blocks of time that you can devote to
studying Economics. Even if it is only 1 hour, if this is spent effectively, it will be of much value to you.
Remember:
‘it is not so much how long you study but how effective you are in your studying.’
 You should also try to have set places where you can study, ideally free from distractions such as loud
music, talking, television noise and so on. This may not be easy but try to have set times and places for
your study and stick to a routine. Put yourself in a position where you can concentrate on your study.
This is most unlikely to happen if your favourite television programme is on in the same room.
 Short sessions, but lots of them. Psychological studies have shown that our learning abilities decline
sharply after around 50 minutes of intensive study. The attention span of most people is 40-60 minutes.
After such a period, have a drink and a rest, may be do something else before studying for a further
period. Be as detailed as possible in your timetable; for example:
‘Saturday–revise Money and Banking is not detailed enough. Better to lay out your timetable like this:
Saturday: 9.00 am to 9.40 am – Money: its meaning, and supply of money.
Break – 10 minutes
9.50 am to 10.50 am – Money creation by the commercial banking system.
Break – 20 minutes
11.10 am to 12.10 pm – Central bank and its functions (Bank of issue, Government’s bank,
Banker’s bank)
12.10 pm – lunch and rest
1:30 pm to 2:30 pm – Central bank as controller of credit through Bank Rate, CRR, SLR,
Repo Rate and Reverse Repo Rate, Open Market Operations, Margin
requirement.
All of these simple things should help you feel relaxed and confident when you take the examinations.
FORMULAE – National Income Accounting

 Basic Concepts
• Net Investment = Gross investment – Depreciation
Cost of the capital asset − Scrap value
• Depreciation on capital =
Estimated life of the capital asset (in years)
• Net indirect tax = Indirect taxes – Subsidies
• Factor cost = Market price – Indirect taxes + Subsidies
• Net change (or increase) in inventories = Closing inventory – Opening inventory

• Net Factor Income from Abroad (NFIA) = Factor Income from Abroad – Factor Income to Abroad
 National income by product method

• Value added of a firm = Value of output produced by the firm – Cost of intermediate goods used
• Value of output = Output produced (in units) × Market price
• Sales = Output sold (in units) × Market price
Sales = Sale of goods and services to domestic buyers + Exports of goods and services.
• If a firm had no initial unsold stock in the beginning of the year:
Value of output produced = Sales + Value of unsold stock
• If a firm had some unsold stock in the beginning of the year
Value of output = Sales + Net change in stock
• GVAmp of a firm = Value of output – Intermediate consumption
• 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
• NDPfc = GDPmp – Depreciation – Indirect taxes + Subsidies
• National income (NNPfc) = NDPfc + NFIA
 Other Basic National Income Aggregates
• NDPmp = GDPmp – Depreciation
• GNPmp = GDPmp + Net factor income from abroad (NFIA)
• NNPmp = GDPmp – Depreciation + NFIA
• GDPfc = GDPmp – Net indirect taxes
• GNPfc = GDPmp – Net Indirect taxes + NFIA
 National income by income method

• Compensation of employees = Wages and salaries in cash and in kind
+ Social security contributions by the employers
• Profits = Corporation tax + Dividend + Undistributed profits/Retained earnings
or, Profits = Corporate profit tax + After-tax profit
(Note: After-tax profit = Dividend + Retained earnings)
• Operating surplus = Rent and royalty + Profit + Interest
• National Income (NNPfc) = Compensation of employees + Operating surplus + Mixed income + NFIA
 Expenditure Method of Calculating National Income
• GDCF = Gross domestic fixed capital formation + Net change in stocks
or, GDCF = (Net fixed capital formation + Depreciation) + (Closing Stock – Opening Stock)
• GDPmp = Private final consumption expenditure + Government final consumption expenditure
+ Gross domestic capital formation + Net exports
• National Income (NNPfc) = GDPmp – Depreciation – Indirect taxes + Subsidies + NFIA
 Real and Nominal GDP
• Nominal GDP = ΣP1Q1 and Real GDP = ΣP0Q1
Nominal GDP
• GDP Deflator = × 100
Real GDP
No min al GDP
• Real GDP = ¥ 100
Price Index
∆ in real GDP 500
• 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
 Real and Nominal National Income
• Nominal National Income = ΣP1Q1 and Real National Income = ΣP0Q1
Nominal national income
• Real national income = × 100
Price Index
FORMULAE – Keynesian Theory of Income and Employment

 Consumption function:
C = C + bY
where, C = Consumption expenditure by households
Y = National Income = C + S (where S = Savings)
C = Autonomous consumption (i.e. consumption expenditure at zero income)
b = Slope of consumption function = Marginal Propensity to Consume (MPC) = DC/DY
• DC + DS = DY
• C = C + bY consists of the two components:
(i) Autonomous consumption (C)
(ii) Induced consumption ( bY )
• Average Propensity to Consume (APC) = C/Y

• At Break-even point: C = Y
 Savings Function
S = Y – C ⇒ S = Y – (C + bY) ⇒ S = Y – C – bY ⇒ S = – C + (1 – b)Y
⇒ S = – C + sY
There is negative savings C at zero level of income. It is equal to autonomous consumption .
s = (1 – b) is the slope of the savings function = Marginal Propensity to Save (MPS) =DS/DY
• Relationship between MPC and MPS: MPC + MPS = 1
• Average propensity to save (APS) = S/Y
• Relationship between APC and APS: APC + APS = 1.
Therefore, APS = 1 – APC and APC = 1 – APS
 Aggregate Demand
AD = C + I
Substituting the values of C = C + bY and I = I, ex-ante aggregate demand for final goods can be written as:
AD = C + bY + I ⇒ AD = ( C + I ) + bY ⇒ AD = A + bY
where, A = C + I is the total autonomous expenditure.
Note that the slope of aggregate demand function AD = A + bY is given by ‘b’, i.e. MPC.
 Aggregate Supply
Aggregate Supply (AS) = National Income (Y) = C + S
 Equilibrium level of income/output Condition (also called ‘effective demand principle’)
AD = AS
Since AS = Y and AD = C + I, therefore equilibrium condition is: Y = C + I
Savings and Investment Approach – Equilibrium condition: S = I
 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
 Deflationary gap and Inflationary gap

Deflationary gap = Full employment level of income – Actual aggregate demand
Inflationary gap = Actual aggregate demand – Full employment level of income
DIAGRAMS – Keynesian Theory of Income and Employment

Diagrams are very important and a relevant means of economic explanation. Many of the topics you come
across in Economics can be illustrated by a diagram or by means of an explanation supported by a diagram. So,
a relevant, correctly drawn diagram, used effectively and referred to in your answer, will impress an examiner
reading your examination script.
Common errors which students often make is in the way they use diagrams in their answers:
 Labeling axis incorrectly or not labeling them at all or making diagrams to small.
 Failure to use a diagram in an answer when asked for one to be included

Suppose a question is: “Explain the determination of equilibrium level of national income with the help of
saving and investment curves.”
Here, a student has to make clear the determination of equilibrium level of national income by saving
and investment approach supported by a diagram.
 Including a diagram when one is not needed
Suppose a question is: “Explain ‘deflationary gap’. Also explain how the bank rate policy of the central
bank helps to correct deflationary gap in an economy.”
Here, a student has to give detailed explanation of the deflationary gap, i.e., its meaning, cause and
effects. Then, an explanation how bank rate policy of the central bank helps to combat deflationary gap.
Diagram is not required.
Include a diagram only when asked for one to be included.
Important Diagrams which are likely to be asked in CBSE Economics XII Examination:
Consumption and savings curves Equilibrium level of income/output

asd
Project Work 319
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.
Role of the teacher:

The teacher plays a critical role in developing thinking skills of the learners. A teacher should:
 help each learner select the topic based on recently published extracts from the news media, government policies,
RBI bulletin, NITI Aayog reports, IMF/World Bank reports etc., after detailed discussions and deliberations of
the topic
 play the role of a facilitator and supervisor to monitor the project work of the learner through periodic discussions
 guide the research work in terms of sources for the relevant data
 educate learner about plagiarism and the importance of quoting the source of the information to ensure authenticity
of research work
 prepare the learner for the presentation of the project work
 arrange a presentation of the project file
Scope of the project:

Learners may work upon the following lines as a suggested flow chart:
Choose a title/topic
Collection of the research material/data
Organization of material/data
Present material/data
Analysing the material/data for conclusion
Draw the relevant conclusion
Presentation of the Project Work
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.
Mode of presentation/submission of the Project:

At the end of the stipulated term, each learner will present the research work in the Project File to the External and
Internal examiner. The questions should be asked from the Research Work/ Project File of the learner. The Internal
Examiner should ensure that the study submitted by the learner is his/her own original work. In case of any doubt,
authenticity should be checked and verified.
Project Work 321
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
Suggestive List of Projects:

• Micro and Small Scale Industries • Food Supply Channel in India
• Contemporary Employment situation in India • Disinvestment policy of the government
• Goods and Services Tax Act and its Impact • Health Expenditure (of any state)
on GDP
• Human Development Index • Inclusive Growth Strategy
• Self-help group • Trends in Credit availability in India
• Monetary policy committee and its functions • Role of RBI in Control of Credit
• Government Budget & its Components • Trends in budgetary condition of India
• Exchange Rate determination – Methods and • Currency War – reasons and repercussions
Techniques
• Livestock – Backbone of Rural India • Alternate fuel – types and importance
• Sarwa Siksha Abhiyan – Cost Ratio Benefits • Golden Quadrilateral- Cost ratio benefit
• Minimum Support Prices • Relation between Stock Price Index and
Economic Health of Nation
• Waste Management in India – Need of the • Minimum Wage Rate – approach and Appli-
hour cation
• Digital India- Step towards the future • Rain Water Harvesting – a solution to water
crises
• Vertical Farming – an alternate way • Silk Route- Revival of the past
• Make in India – The way ahead • Bumper Production- Boon or Bane for the
farmer
• Rise of Concrete Jungle- Trend Analysis • Organic Farming – Back to the Nature
• Any other newspaper article and its • Any other topic
evaluation on basis of economic principles
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.
PRE MONEY ERA – BARTER EXCHANGE SYSTEM

A barter system is an age old practice and its history dates back to 6000 BC introduced by Mesopotamia tribes and well
adopted by Phoenicians where they traded goods across cities and oceans.
Bartering was officially first recorded in Egypt in 9000 B.C., when farmers would go to the market to exchange cows for
sheep, with grains passing through the hands of harvesters in exchange for oil.
Barter is a system of exchange where goods or services are directly exchanged for other goods or services with mutual
consent on the value of goods, by the people involved.
HOW MONEY CAME INTO EXISTENCE
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).
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.
BANK NOTES AND PAPER CURRENCY

The paper based money came into existence in China and was popularised by Song Dynasty in 11th century but the real
development happened in 17th century for bank notes when Tang Dynasty(618–907)who used it as merchant receipts to
avoid heavy and bulk of coinage, credit notes were used to trade which had certain time frame and certain discounts.
In Europe, paper note came into picture in 13th century due to travellers like Marco Polo & William Rubruck about
which you can find the mentioning in Marco Polo's book 'The Travels of Marco Polo'. Stockholms Banco issued the first
banknotes in Europe in 1661. Before bank notes, gold standards were into practice which with the advent of 19th century
in Europe started to be replaced by bank notes currency. By the beginning of the 20th century almost all countries had
adopted the gold standard, backing their legal tender notes with fixed amounts of gold.
The use of banknotes issued by private commercial banks as legal tender has gradually been replaced by the issuance of
bank notes authorised and controlled by national governments. The Bank of England was granted sole rights to issue
banknotes in England after 1694. In USA, the Federal Reserve Bank was granted similar rights after its establishment in
1913. Until recently, these government-authorised currencies were forms of representative money, since they were partially
backed by gold or silver and were theoretically convertible into gold or silver.
Currently as we are living in 21st century we mostly use currency (Bank Notes+ Coins) which is issued and governed
by government fiat. In England, The Bank of England was granted sole right to issue banknotes in 1694. In 1913, The
Federal Reserve Bank was granted the rights to issue bank notes in USA. The Reserve Bank of India was founded on
1 April 1935 to respond to economic troubles after the First World War and gradually after India went independent it
became the authorised authority which controls the printing and circulation of Indian currency called rupees and also
drafts various economic policy to control the Indian economy.
Coins initially derived their value from the precious metal used to mint them. This posed a problem for sovereigns who
did not possess the requisite gold or silver to prevent a drastic devaluation of their currency. Paper money solved this
problem as it bore a promise to pay its possessors the equivalent value of gold or silver from the public treasury. Soon, it no
longer mattered that paper money was not backed by anything of tangible value, and it was simply accepted as a medium
of exchange for goods and services. But while paper currency was popularised in Asia by Genghis Khan as early as the 11th
century, it only gained traction in India a few centuries later.
In the late 18th century, silver and gold coins gave way to hundis , bonds, and shares, and paper currency was introduced
in India for the first time. Both private and semi-government Presidency banks could print notes — the General Bank of
Bengal and Bihar (1773-75) and The Bank of Hindostan (1770-1832) were among the earliest issuers of paper currency in
India. In 1861, the Government of India enacted the Paper Currency Act which granted it a monopoly over the issue of
notes and ended the issuance of notes by private and Presidency Banks.
Subsequently, the ‘Victoria Portrait Series’ of notes — in denominations of Rs. 10, 20, 50, 100, and 1,000 — entered
circulation. The Indian Independence Movement soon began gathering steam, and its nationalist and economic strategy
arm, the Swadeshi Movement, made a big impact on Indian banking. Inspired by the message of reviving domestic processes
and products, businessmen and politicians founded several local banks — Canara Bank, Bank of India, Corporation Bank,
Indian Bank, and Bank of Baroda — for the Indian community from 1906 to 1911.
Soon after, the British Empire faced an acute shortage of silver due to the outbreak of World War I in 1914 and hence
began issuing paper currency of smaller denominations (one and two Rupees) hitherto issued only as coins. Meanwhile,
India got its first printing press in Nashik in 1928 which soon began printing currency for the entire country.
The rupee underwent several iterations under British rule, including this ten rupee note from the 1920s and this one rupee
coin from 1918. The First World War left the Indian economy in dire straits, and the need for an apex monetary authority
was identified. The Central Legislative Assembly, acting on the guidelines recommended by the 1926 Royal Commission
of Indian Currency and Finance, set up the Reserve Bank of India to separate the control of currency and credit from the
government and to regulate banking and note issuance throughout the country.
Project Work 325

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.
The Latest Demonetisation

Demonetisation was a new initiative taken by the Government of India in 8 November 2016 to tackle the problem of
corruption, black money, terrorism and circulation of fake currency in the economy.
Old currency notes of `500, and `1000 were no longer legal tender. New currency notes in the denomination of `500
and `2000 were launched.
The public were advised to deposit old currency notes in their bank account till 31 December 2016 without any declaration
and upto 31March 2017 with the RBI with declaration.
Further to avoid a complete breakdown and cash crunch, notes government had allowed exchange of `4000 old currency
the by new currency per person and per day. Further till 12 December 2016, old currency notes were acceptable as legal
tender at petrol pumps, government hospitals and for payment of government dues, like taxes, power bills, etc.
This move received both appreciation and criticism. There were long queues outside banks and ATM booths. The
shortage of currency in circulation had an adverse impact on the economic activities. However, things improved with
time and normalcy returned.
This move has had positive impact also. It improved tax compliance as a large number of people were bought in the tax
ambit. It is a demonstration of State’s decision to put a curb on black money, showing that tax evasion will no longer
be tolerated. Tax evasion will result in financial penalty and social condemnation. Tax compliance will improve and
corruption will decrease.
The savings of an individual were channelised into the formal financial system. As a result, banks have more resources at
their disposal which can be used to provide more loans at lower interest rates.
Demonetisation could also help tax administration in another way, by shifting transactions out of the cash economy into
the formal payment system. Households and firms have begun to shift from cash to electronic payment technologies.
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.
THE ROAD AHEAD

The recent demonetisation cycle has increased
adoption of digital and cashless payment systems
in India. Is paper money on the way out? Only
time will tell!
Project Work 327
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.
INDIA– A DIGITAL ECONOMY

Computerisation first entered the Indian banking industry in 1988, and internet banking in the 1990s. But it was only in
the 2000s when online payment systems — like Electronic Funds Transfer (EFT), Real Time Gross Settlement (RTGS),
National Electronic Funds Transfer (NEFT), and Interbank Mobile Payment System (IMPS) — started being used.
While NEFT and other forms of online payment required a computer and often featured lengthy transaction times, the
new wave of e-payments brought about by digital wallets has made transferring money a lot easier and quicker. Since
internet availability and smartphone usage have become virtually ubiquitous, e-wallets like PayU, Paytm, and MobiKwik
are being used by millions for financial transactions, both personal and commercial.
The government too is pushing its ‘cashless economy’ missive with the Unified Payments Interface (UPI) system backed up by
the BHIM App — an Aadhaar-based mobile wallet which can be used to make digital payments directly from bank accounts.
The demonetisation move by the Narendra Modi-led government saw a sharp uptake in cashless transactions in November
and December 2016 — mobile wallet transactions recorded a 114 percent rise, Point of Sale (PoS) transactions an 88
percent rise, and mobile banking transactions a 30 percent rise. From November 2016 to May 2017, the total digital
transactions in India went up by 23 percent, from 22.4 million to 27.5 million. A Google-BCG study also predicts that
the Indian digital payments industry will grow to $500 billion by 2020, accounting for 15 percent of the GDP.
But in a country whose economy was 90 percent cash-reliant pre-demonetisation, cash remains the most commonly used
medium for financial transactions. RBI data shows that as of April 2017, Rs 2,171 billion was withdrawn via ATMs, while
UPI transactions at that point were at Rs 22.41 billion, meaning that UPI replaced cash by merely one percent. Cash
withdrawals, which were at a low of Rs 850 billion in November 2016, increased to Rs 2,262 billion in March 2017.
Pre-demonetisation in October 2016 and September 2016, this was at Rs 2,223 billion and Rs 2,551 billion respectively.
Unlike digital payments, which rely on a steady internet connection and acceptance from both buyer and seller, cash
is quick, easy, and instantly available for further offline transactions. That makes it the mode of payment of choice for
Indians right now. This is unlikely to change until the digital infrastructure in the country is improved to the extent that
every Indian, no matter how remote their location, can make digital transactions as easily as they can pay with cash.
Project Work 329
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.
BITCOIN : AGE OF CRYPTOCURRENCY

Bitcoin is a digital currency of 21st century. It’s a cryptocurrency now accepted worldwide
especially in digital payment systems. The Digital currency ( Bitcoin )uses a system
which is peer-to-peer, and where transactions take place between users directly, without
any intermediary. These transactions are verified by network nodes and recorded in
a public distributed ledger called a blockchain. Bitcoin was first invented by Satoshi
Nakamoto as an open source technology released in 2009. So the latest form of money
is a cryptocurrency like bitcoin it is becoming popular because it has no third party to
authorise the transactions. It handles direct transaction between two parties using peer
to peer technology and is theoretically tamper-proof decentralised ledger system called as
blockchains. Since the inception of bitcoin, the very first succesful cryptocurrency. Now
there are many other types of crypto-backed digital coins which are gradually being adopted as official legal currency in
many countries/territories like European Union, Nigeria, southern african countries like South Africa, Namibia, Zimbabwe.
It is also legal in America to transact in cryptocurrency. India has not regularised cryptocurrency so people are involved
in selling and purchasing of this digital currency. There are only few countries which have passed some kind of regulation
against cryptocurrency. So we can say bitcoins like digital currency is here to stay to transform into a completely new way
of transacting between two people of party which gives them trust , save some unwanted taxes and most importantly saves
their time and energy.
According to Bank of England: "Bitcoin revolution could be the next internet"
This cashless forms of payment in collaboration with mobility is going to reshape the entire mechanism of secure payment
transactions. This modern age money is already being employed in digital contract signing, lending money in the form of
bitcoins, etc. and is also accepted as a mode of payment against any property or services. The digital currency is being used
to buy and sell digital goods in many countries. The arrival of electronic currencies could revolutionise the way Britons pay
for goods and services, in much the same way as the internet shook up how we access information.
In India, the use of cryptocurrency was declared illegal, but till that time a lot of people had already invested in them.
Even Indian companies had bought them for profit. Most was reinvested in countries where the usage was legal.
CONCLUSION
Being human we should always look for new ways of transacting either it is goods or service making sure the transaction
is for the mutual benefit of each other and is done with lots of trust, transparency and security. I hope thisjourney from
barter to bitcoin continues to evolve for the betterment of the human being where everyone(government agencies too)
works together to exchange love , values and trust as larger cause. The exchange of metals and notes will stay and change
with time but should be only for the well-being of humanity at large.
Glossary of Key Terms 331
MACRO
Economics
XII
Key terms used in CBSE

Economics XII Exam
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.
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.
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.
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.
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.
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.
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.
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
RBI Monetary Policy 2020

The key indicators of RBI Monetary Policy along with their current rates in the table given below:
Indicator Current Rate
CRR 3%
SLR 18.50%
Repo Rate 4.00%
Reverse Repo Rate 3.35%
Bank Rate 4.65%
n 9th October 2020, RBI has kept the Repo Rate unchanged at 4.00% and reduced reverse repo rate to 3.35%. In
O
addition to that, the bank rate stands at 4.65%. This has been done to limit the damage to the economy caused by the
Covid-19 and subsequent lockdowns.
9. What does RBI Monetary Policy 2020 mean?
(a) It is the policy formulated by the RBI in 2020 related to expenditure and taxation of the government.
(b) It is the policy formulated by the RBI in 2020 related to money matters of the country,
(c) It is the policy formulated by the RBI in 2020 related to the government budget.
(d) It is the policy formulated by the RBI in 2020 related to the distribution of credit among users as well as the rate
of interest on borrowing and lending.
10. What does the ‘Bank Rate’ mean?
11. Which of the following is a quantitative credit control technique of RBI?
(a) CRR (b) SLR
(c) Repo Rate (d) All of these
12. Cut in Reverse Repo Rate is likely to __________ (increase/decrease) the demand for goods and services in the
economy during Covid-19 lockdowns.
CBSE New Sample Question Papers 2021 343
CBSE New Sample

Question Papers 2021
(As per CBSE Sample Question Paper 2021)
CBSE Sample Question Paper 2020-21

Part-A Macroeconomics
Q.1 Inventory is a ____________ concept whereas the change in inventory is a ____________ concept.
(Fill up the blank with correct alternative) (1)
(a) stock, flow (b) flow, stock (c) stock, stock (d) flow, flow
OR
If in an economy the value of Net Factor Income from Abroad is `200 crores and the value of Factor Income to Abroad is
`40 crores. Identify the value of Factor Income from Abroad. (Choose the correct alternative) (1)
Q.2 In the present COVID-19 times, many economists have raised their concerns that Indian economy may have to face a
deflationary situation, due to reduced economic activities in the country. Suppose you are a member of the high powered
committee constituted by the Reserve Bank of India (RBI). You have suggested that as the supervisor of commercial banks,
___________ (restriction/release) of the money supply be ensured, by the Reserve Bank of India (RBI).
(Choose the correct alternative) (1)
Q.3 Supply of money refers to ______________ . (Choose the correct alternative) (1)
(a) currency held by the public
(b) currency held by Reserve Bank of India (RBI)
(c) currency held by the public and demand deposits with commercial banks
(d) currency held in the government account
Q.4 Identify the correct pair of formula from the following column I and II: (Choose the correct alternative) (1)
Column I Column II
A. Current Account Surplus (i) Receipts < Payments
B. Current Account Surplus (ii) Receipts > Payments
C. Balance Current Account (iii) Receipts ≠ Payments
D. Current Account Deficit (iv) Receipts ≤ Payments
(a) A – (i) (b) B – (ii) (c) C – (iii) (d) D – (iv)
Q.5 Identify which of the following statements is true? (Choose the correct alternative) (1)
(a) The flexible exchange rate system gives the government more flexibility to maintain large stocks of foreign
exchange reserves.
(b) In the Managed floating exchange rate system, the government intervenes to buy and sell foreign currencies.
(c) In the Managed floating exchange rate system, the central bank intervenes to moderate exchange rate fluctuations.
(d) In the Fixed exchange rate system, market forces fix the exchange rate.
Q.6 An Indian real estate company receives rent from Google in New York. This transaction would be recorded on
_____________ side of _____________ account. (Fill up the blanks with correct alternative) (1)
(a) credit, current (b) credit, capital
(c) debit, capital (d) debit, current

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.
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:
(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)
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.
Sample Question Paper 1 (for Practice)

Q.1 State whether the following statement is true or false:
‘‘Industrial waste driven into rivers is an example of positive externality.’’ (1)
Q.2 Define Current Account Surplus. (1)
OR
Equilibrium in Balance of Payments is achieved when the net value of all the receipts and payments is ____________ (zero/
positive). (1)
Q.3 The value of Money Multiplier is equal to _____________. (1)
Q.4 State whether the following statement is true or false:
‘‘Devaluation of currency is said to occur when the exchange rate is increased under the fixed exchange rate system.’’ (1)
Q.5 Define ‘Tax’. (1)
Q.6 ____________ is an example of a non-tax revenue receipt. (1)
Read the following News Report and answer Q. 7-10 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.
Q.7 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. (1)
Q.8 “The Monetary Policy Committee of the RBI kept interest rates on hold...” Which of the following is highlighted above by
the term ‘interest rates’? (1)
(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
Q.9 What does the ‘Repo Rate’ mean? (1)
Q.10 ‘Reduction in Repo Rate by RBI’ is likely to _________ (increase/decrease) the demand for goods and services in the
economy. (1)
Q.11 Defend or refute the given statements with valid arguments. (3)
(a) ‘‘Final goods are those goods which are consumed only by the households.’’
(b) ‘‘Gross investment is always greater than net investment.’’
(c) ‘‘Net factor income from abroad can never be negative.’’
Q.12 From the following data, calculate the (a) Consumption Expenditure and (b) Investment Expenditure for the economy. (3)
S. No. Particulars Amount (in `)
(i) Equilibrium level of income 5,000
(ii) Autonomous consumption 500
(iii) Marginal Propensity to Save 0.4
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)
Sample Question Paper 10 (for Practice)

Q.1 To control recession, which of the following can be appropriate: (1)
(a) Reducing Repo Rate (b) Reducing CRR
(c) Both (a) and (b) (d) None of (a) and (b)
Q.2 The impact of ‘Excess Demand’ under the Keynesian theory of income and employment, in an economy are: (1)
(a) Decrease in output, income, employment and price level.
(b) Increase in output, income employment and price level.
(c) Rise in the price level and the nominal income but no change in the output and employment.
(d) Increase in output, income and employment; but no change in the price level.
Q.3 Which of the following is the equilibrium condition in a two sector economy? (1)
C C C+ I C+ I
(a) Y= (b)
Y= (c)
Y= (d)
Y=
MPS 1 - MPS 1 - MPC MPC
OR
Y
AS = Y
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
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. (ìn crore) (3)
(iii) Net imports 30
(iv) Gross domestic capital formation 250
(v) Change in stock 50
(vi) Net domestic fixed capital formation 180
(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. (ìn crore) (3)
(i) Gross domestic fixed capital formation 350
(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)
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.
Here, the final expenditure is expenditure by

On the contrary, production of socially useful goods is
consumers on cloth, therefore, GDP = `200 lakh
encouraged through subsidies. If the private sector does
not take initiative in certain activities, government directly Thus, all the three methods give the same value of GDP.
controls them like water supply, sanitation etc. 17. The given statement is true. When aggregate demand is

15. Increasing import duty on gold will make imports of
more than the full employment level of aggregate supply, it
gold costly. It will reduce demand for import of gold and is a situation of excess demand. Excess demand gives rise to
consequently of foreign exchange. This situation may result inflationary gap. It is called inflationary because it leads to rise
into excess supply of foreign currency in the economy at the in general price level.
prevailing foreign exchange rate. Fiscal policy measure – Increase in taxes: The government may
As a result, a new equilibrium rate of foreign exchange will increase the rate of taxes (both direct and indirect taxes). This
be determined which will be lower than the prevailing foreign will reduce purchasing power in the hands of general public.
exchange rate, leading to appreciation of domestic currency. This will help to decrease aggregate demand and reduce the
inflationary gap.
Thus, foreign exchange rate is likely to fall.
Monetary policy measure – Decrease in money supply: Central
OR
Bank can decrease the money supply in the economy. Central
(a) Indians lending abroad is recorded in capital account of bank can use tools like bank rate, cash reserve ratio, repo and
the Balance of Payments because it is an international reverse repo rates etc. to ensure lesser money in the hands of
transaction of assets. It is recorded on the debit side because general public which would in turn decrease the aggregate
it leads to outflow of foreign exchange. demand in the economy and be helpful in reducing/removing
(b) Lending abroad increases demand for foreign exchange. the inflationary gap.
Supply of foreign exchange remaining unchanged, the
exchange rate may rise. Sample Question Paper-10
16. (a) Yes, given statement is defended. As GDP may not take 1. (c)
into account 2. (c)
(i) Non-monetary exchanges like services of housewife 3. (c) OR Decrease in MPC
(ii) Externalities i.e. benefits and harms which are caused 4. False: MPC = DC/DY. When income changes, change in
due to economic activities consumption (DC) can never exceed the change in income
(iii) Distribution of income. (Explain briefly) (DY).
(b) (i) Value of output of Firm A 5. (a)
= Total sales + Value of unsold stock 6. Depreciation
= (Sales to Firm B + Sales to Firm C + Sales to 7. indirect
Households) + Value of unsold stock 8. (b)
= (80 + 50 + 30) + 10 = `170 crore 9. capital
Value of output of Firm B 10. (b)
= Sales to Firm C + Sales to Firm D + Exports + Sales 11. S = –250 + 0.25Y (Given)
to Government = 70 + 40 + 30 + 5 = `145 crore (a) Equilibrium level of income in the economy exist when: S = I
(ii) Value added by Firm B = Value of output of Firm B Substituting the values of saving and investment,
– Purchases by Firm B from Firm A = 145 – 80 –250 + 0.25Y = 2000 ⇒ 0.25Y = 2250
= `65 crore Y = 2250/0.25 ⇒ Y = `9000 crores
OR (b) C = C + b(Y) = 250 + 0.25 (5000)
(i) GDP by Value Added Method = 250 + 1250 = 1,500
Value added (VA) = Value of output – Intermediate AD = C + I ⇒ AD = 1500 + 2000 = `3500 crores.
consumption
OR
VA by Firm A = 50 – 0 = `50 lakh
Given, APC=1, which means that income (Y) is equal to the
VA by Firm B = 200 – 50 = `150 lakh consumption (C), i.e. Y=C.
GDP = VA by Firm A + VA by Firm B = 50 + 150 = C= 40+0.8Y ⇒ Y = 40+0.8Y (since Y=C)
`200 lakh
Y – 0.8Y = 40 ⇒ 0.2Y = 40 ⇒ Y = `200 crores
(ii) GDP by Income Method
12. (i) For the year 2016, real GDP and nominal GDP are same
= Sum total of factor incomes paid by Firms A and B as it is the base year and thus, GDP deflator is 100.
= Total wages received by workers of Firms A and B + Year 2016 2017 2018
Total operating surplus distributed by Firms A and B Nominal GDP 6.5 8.4 9
= (20 + 60) + (30 + 90) = 80 + 120 = `200 lakh GDP deflator 100 140 125
(iii) GDP by Expenditure Method = Sum of final Real GDP = (Nominal GDP/GDP 6.5 6 7.2
expenditures, i.e. expenditures on goods and services deflator) × 100
for end use.
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

SAMPLE PDF Macroeconomics XII 2021-22 Edition by Subhash Dey

Uploaded by

Document Information

Original Description:

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

SAMPLE PDF Macroeconomics XII 2021-22 Edition by Subhash Dey

Uploaded by

Copyright:

Available Formats

Completely based on Latest CBSE Syllabus and NCERT Book

Shree Radhey Publications

Shree Radhey Publications

Introduction National Income and Related Aggregates

National income accounting is a branch of macroeconomics of which estimation of national income

1.1 Some Basic Concepts of National Income Accounting

Consumption Goods and Capital Goods

Stocks and Flows

Gross Investment and Depreciation

Industrial classification – Primary, Secondary and Tertiary Sectors

Market Price and Factor Cost

or, Factor cost = Market price – Net indirect taxes

Factor Income and Transfer Income

Inventory and Change in Inventories

Net change (or increase) in inventories = Closing inventory – Opening inventory

Net product taxes and Net production taxes

Net product taxes = Product taxes – Product subsidies

Net production taxes

Net production taxes = Production taxes – Production subsidies

Calculate ‘Depreciation on Capital Asset’ from the following data:

Cost of the capital asset - Scrap value 1, 000 - 0

Additional NCERT Content Extracted from latest NCERT Book

Objective Type Questions 1.1

21. New addition to capital stock in an economy is ________________.

39. Which of the following is a flow? (Choose the correct alternative)

HOTS Analysing, Evaluating & Creating Type Questions

1.2 Domestic Territory and Resident: Implications

Implications of the Concepts of Economic Territory and Resident

Relation between national product and domestic product

Net factor income from abroad

Domestic territory (or Economic territory)

Objective Type Questions 1.2

HOTS Analysing, Evaluating & Creating Type Questions

1.3 Circular Flow of Income (Two- Sector Model)

Circular flow of income in a two sector economy

Objective Type Questions 1.3

1. Match the following:

HOTS Analysing, Evaluating & Creating Type Questions

1.4 Production Method of Calculating National Income

Problem of Double Counting

Steps for calculation of national income by product method

Note: Sales = Output sold (in units) × Market price

or, Value of output = Sales + Closing stock – Opening stock

Why is GDPmp called gross?

or, NDPfc = GDPmp – Depreciation – Net indirect taxes

or, NNPfc = GDPmp – Depreciation – Net indirect taxes + NFIA

Other Basic National Income Aggregates

Steps for calculation of national income by product method

Objective Type Questions 1.4

HOTS Analysing, Evaluating & Creating Type Questions

In an economy, the following transactions took place.

[Ans. (a) `165 lakh (b) `205 lakh ]

S. No. Items (` in lakh)

[Ans. `280 lakh]

Calculate GVA at factor cost of a firm: (3 marks)

Find net value added at factor cost: 3 marks

S. No. Items (` in lakh)

[Ans. `33 lakh]

Find NVA at factor cost of a firm. (3 marks)

cost of fixed capital good - scrap value 10 - 0

Find Net Value Added at market price of a firm: 3 marks

S. No. Items (` in lakh)

[Ans. `14 lakh]