National Income Accounting Class 12 Economics Notes and Questions

Please refer to Economics National Income Accounting Class 12 Economics Notes and important questions below. The Class 12 Economics Chapter wise notes have been prepared based on the latest syllabus issued for the current academic year by CBSE. Students should revise these notes and go through important Class 12 Economics examination questions given below to obtain better marks in exams

National Income Accounting Class 12 Economics Notes and Questions

The below Class 12 National Income Accounting notes have been designed by expert Economics teachers. These will help you a lot to understand all important topics given in your NCERT Class 12 Economics textbook.

National Income & Related Aggregates

Question. Differentiate between factor income & transfer income. (DCNIE)
Ans.

Factor Income	Transfer Income
It refers to that income which is earned by providing factor services.	It refers to that income which is received without providing any services.
It is an earning concept.	It is a receipt concept.
It is bilateral in nature. (Give & Take)	It is unilateral in nature. (Take)
It is included in the estimation of national income.	It is not included in the estimation of national income
Eg. Rent, salary, profits, retirement pensions, etc.	Eg. Gifts, donations, scholarships, old age pensions, etc.

Question. Differentiate between intermediate goods & final goods.
Ans. Intermediate goods: Those goods which are used as a raw material for further production or purchased for resale in the market in the same financial year. These goods are inside the production boundary & they are not included in the estimation of national income.

Final goods: Those goods which are used either for final consumption or for final investment, are called final goods.
These goods are outside the production boundary & these are included in the estimation of national income.
Classification of any product into intermediate or final good does not depend upon product itself rather it depends upon ultimate use of the product.

Eg.
a) If a car is available for sale in showroom, then it will be considered as an intermediate good.
b) If a car is purchased by on individual for his personal use, then it will be considered final good as consumption.
c) If a car is purchased by a taxi driver for commercial purpose, then it will be considered final good as an investment.

Circular flow of Income

Question. Explain circular flow of income in a two-sector economy.
Ans. Circular flow of income in a two-sector economy consists following assumption: –
1. There are only two sectors, i.e. firm and household sector in the economy.
2. Household sector is the owner of all factors of production.
3. Firm sector hire factor services from households for the production of goods and services.
4. Household sector spends entire income on consumption.
5. Firm sector sells all the products to household sector.
6. There is no identity of government and rest of the world sector.

Economic interdependence or circular flow of income between firm and household sector is explained as below: –
1. Real flow- All factors of production are owned by household sector. Therefore, firm sector hire factor services from households for the production of goods and services. In exchange, firm sector sells whatever it produces to households for their consumption. Thus, exchange of goods and services between firms and household sector is called real flow.
2. Money flow- As a reward of factor services from households, firm sector makes payment in the form of rent, interest, wages and profit to households which is called their factor income.
This income is used by household on the purchase of goods and services. Therefore, money flows from household to firm sector. It is called money flow.

Introduction of financial market in the economy may either increase or decrease the flow of income.
Generally, household sector does not spend entire income on consumption. Rather some part of income is saved for future. Similarly, firm sector may also save to increase production capacity. Thus, savings by firm and household sector in the financial market results leakage in the flow of income.
Similarly, borrowings by firm and household sector in the financial market results injection in the flow of income.

Formulas based on Value added

• Value added= Value of output – Intermediate consumption
• Value of output=Price X Quantity produced
(GVOMP) OR
=Sales + Change in stock + Production for self consumption
(Closing – Opening)
• Net= Gross – Depreciation/ consumption of fixed capital/ Replacement cost
• Factor cost + (Indirect tax – Subsidies) = Market price
Factor cost + Net Indirect tax = Market price

Domestic Income (NDPFC)
It refers to sum of income earned within economic domestic territory of the country in an accounting year.
The term domestic territory is a wider concept as it includes political boundary as well as all ships, oil rigs operating in the international part of the sea, plane of normal resident operating in abroad, army of domestic country located in abroad.
It is to be noted that domestic income includes income of both normal residents and non-residents of the country, but the income must be earned within domestic boundary country.

National Income (NNPFC)
It refers to the sum of income earned by normal residents of a country in an accounting year.
It is to be noted that national income includes only income of normal residents which is earned either within the boundary or outside the country.

Methods to calculate National Income
Value added Method OR Net output Method OR Product Method
Value added by Primary Sector
+Value added by Secondary Sector
+Value added by Tertiary Sector
= GDPMP
National Income (NNPFC) = GDPMP (-) Depn (+) NFIA (-) NIT

Question.

Note: Interest on loan taken for production purpose is considered factor income & included in the estimation of national income but interest on loan taken for consumption purpose is considered transfer income so not included in estimation of national income.
Eg. Interest on public debts or national debts is considered transfer income because loan taken by government is assumed to be used on public consumption.
Therefore, such interest is not included in the estimation of national income.

Expenditure Method
↓
Final Expenditure
1. Household Sector- Private final consumption expenditure
2. Government Sector- Government final consumption expenditure
3. Firm Sector- Gross domestic capital formation
i. Gross fixed capital formation
ii. Change in stock(closing-opening)
4. Rest of the World Sector- Net Exports (Export-Imports)
Household sector + Government sector + Firm sector + ROW sector = GDPMP
NI (NNPFC) = GDPMP – Depreciation + NFIA – NIT

Question. Distinguish between stock and flow variable.
Ans. Those variables which are measured at a particular point of time, are called stock variables. So, it has no time dimensions.
Eg., Wealth, capital, etc.
Those variables which are measured with respect to given period of time are called flow variables. So, it has time dimensions.
Eg., National income, capital formation, etc.

Question. Distinguish between nominal and real GNP.
Ans.

Question. Distinguish between nominal and real GDP.
Ans.

Question. Explain the steps involved in calculating national income by value added method.
Ans. Steps: –
1. Identify all the producing units within domestic territory of country and classify in them in primary, secondary and tertiary sector.
2. Estimate value added of each sector by subtracting intermediate consumption from value of output of respective sector.
3. By adding value added of all producing sectors within domestic territory of a country in a year, we get GDP_MP.
4. From the estimates of GDP_MP, depreciation and NIT are subtracted, Net Factor Income from abroad is added to get national income (NNP_FC).

Question. What precautions should be taken while estimating national income by value added method?
Ans. 1. Only final goods and services produced by an economy are included in the national income whereas intermediate goods are excluded otherwise it will create problem of double counting.
2. Sale and purchase of second-hand goods are not included in the national income because such goods have already taken in the national income in the year of their production.
3. Goods produced for self-consumption are included in the national income whereas services produced for self-consumption are not included as it is very difficult to estimate their value. Eg., Services of housewives.
4. Own account production of assets by households and government are included in the national income.

Question. What do you mean by double counting? How is it solved?
Ans. It refers to counting the value of a product more than once in the measurement of national income.
Problem of double counting arises because every seller considers his product as a final product whereas same product might be used as an intermediate good for further

Eg. Let firm A produces cotton and sells to firm B for ₹500 then firm B converts the same into yarn and sells it to firm C for ₹800 then firm C produces clothes and sells to firm D for ₹1000 and finally firm D produces shirts and sells to final consumer for ₹1500

In the above example, gross value of output is ₹3800 as the value of final product is ₹1500. If national income includes ₹3800 as the value of final product, then there will be double counting and overestimation of National income.

How to solve

The problem of double counting can be solved by the following two approaches: –
(i) Value added approach
(ii) Final product approach

In the final product approach, value of only final goods produced are taken and intermediate goods are not included but there is still possibility of double counting as every seller consider his product as a final product for sale, but the same product can be used as an intermediate for further production. So, this problem should be solved by value added approach.

In this approach, value added generated by all the producers at each stage of production is measured and the sum of value added of all the firms will estimate value of final product.
Value added by A= 500-0= 500
Value added by B= 800-500= 300
Value added by C= 1000-800= 200
Value added by D= 1500-1000= 500
Value of final product= 1500

Question. What steps are taken while estimating national income by income method?
Ans. Steps: –
1. Identify all producing units within domestic territory of country.
2. Classify factor payment mode to factors of production in the form of rent, interest, wages and profit or compensation of employees, operating surplus and mixed income.
3. Estimate all above components of factor payments made by each producing unit within domestic territory of a country in a year and the sum of such factor payments will estimate NDPFC.
4. Estimate the value of NFIA and then add it into NDPFC to get NNPFC (National Income).

Question. What precautions should be taken while estimating national income by income method?
Ans. 1. Only factor incomes are included whereas transfer incomes like gifts, donations, old age pensions etc. are not included in national income because there is no production activity against such income.
2. Income from sale of second-hand goods are not included in national income because such goods have already been taken in national income, but any brokerage/ commission given to a dealer in such transactions is included in national income as it is the reward for factor services.
3. Income for sale of financial assets like shares, debentures, bonds etc. are not included in the national income because it only includes transfer of ownership and doesn’t contribute in the production of goods and services.
4. Any windfall game like lottery income, capital gains etc. are not included in the national income.
5. Imputed rent of self-occupied houses is included in national income.

Question. Define: –
1. GDPMP- It is the market value of all final goods and services produced within the domestic boundary of a country in an accounting year.
2. NDPMP- It is the market value of all net final goods and services produced within the domestic boundary of a country in an accounting year. It excludes depreciation.
3. GNPMP- It is the market value of all final goods and services produced by the normal residents of a country in an accounting year. It includes NFIA.
4. NNPMP- It is the market value of all net final goods and services produced by the normal residents of a country in an accounting year. It includes NFIA and excludes depreciation.
5. GDPFC- It is the money value of all final goods and services produced within domestic boundary of country in an accounting year. It includes NIT.
6. NDPFC- It is the money value of all net final goods and services produced within domestic boundary of a country in an accounting year. It excludes depreciation and NIT.
7. GNPFC- It is the money value of all final of goods and services produced by the normal residents of a country in an accounting year. It includes NFIA and excludes NIT.
8. NNPFC- It is the money value of all net final goods and services produced by the normal residents of a country in an accounting year. It includes NFIA and excludes depreciation and NIT.

Method to Learn –
G- Final
N– Net Final
MP– Market Value
FC– Money Value
DP– Domestic
NP– Normal Resident

Question. What steps are taken while estimating national income by expenditure method?
Ans. Steps: –
1. Identify all economic units which incurs final expenditure and classify them as
(i)Household sector
(ii)Government sector
(iii)Firm sector
(iv) ROW sector

2. Classify final expenditure incurred by all economic units as
(i)private final consumption expenditure
(ii)government final consumption expenditure
(iii)gross domestic capital formation
(a)gross fixed capital formation
(b)change in stock
(iv)net exports

3. Estimate the value of all above components of final expenditure incurred by all economic units within domestic territory of country in a year and their sum will estimate GDPMP.

4. From the estimates of GDPMP, value of depreciation and NIT are subtracted and NFIA is added to get NNPFC (National Income).

Question. Explain the components of domestic factor income.
Ans. 1) Compensation of employees: It is the reward paid to an employee for his physical or mental services rendered in the process of production. It can be paid in three ways: –
i) Wages and salaries in cash
ii) Wages and salary in kind
iii) Social security schemes by employer
2) Operating surplus: It refers to income from property and entrepreneurship. It is the sum of rent, interest and profit.
i) Rent and Royalty- Rent is the income earned by landlord by providing the services of land, building or any sub-soil assets. It is to be noted that domestic income also includes imputed rent of self-occupied houses. Royalty is the income earned from intangible assets like copyright, patents, trademarks etc.
ii) Interest- It is the cost of capital sacrificed for a particular period of time. In other words, it refers to that amount which debtor is liable to pay to creditors for the use of funds borrowed.
It is to be noted that interest on loan taken for consumption purpose is considered transfer income so not included in domestic income.
iii) Profits- It is the reward given to factor input ‘entrepreneur’ for undertaking the risk and organising other factors of production.
3) Mixed Income- It is the income of those self-employed persons who provide all factor services of land, labour, capital in their own business so their income includes rent, interest, wages and profit which is difficult to classify individually. So, their income is called mixed income.

Question. Define NFIA. What are the components?
Ans. It refers to difference between factor income earned by normal residents of a country in abroad and factor income earned by non-residents within domestic territory of a country in a year.
Components
1. Net compensation of employees from abroad.
2. Net income from property and entrepreneurship from abroad.
3. Net retained earnings of resident company in abroad.

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