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Karnataka Class 12 Commerce Economics Basic Concepts Of National Income Notes

Karnataka Class 12 Commerce Economics Basic Concepts Of National Income Notes

Karnataka Class 12 Commerce Economics Basic Concepts Of National Income : Karnataka State Open University is located in Manasagangotri, Mysore. It is recognized as one of the best Open Universities in India imparting Distance Education. The University was established during 1996 and the library started functioning in the same year. It has a glorious record of worthy service with a multi disciplinary resource collection of more than one lakh volumes.

Karnataka Class 12 Commerce Economics Basic Concepts Of National Income Notes

Karnataka Class 12 Commerce Economics Basic Concepts Of National Income :National income consists solely of services as received by ultimate consumers, whether from their material or from their human environments. A national income estimate measures the volume of commodities and services turned out during a given period counted without duplication- National Income Committee of India (1951). Gross national product at market prices is the market value of the produce before deduction of provisions for the consumption of fixed capital distributable to the factors of production supplied by the normal residents of the given country- United Nations Department of Economic Affairs

National income is a collection of goods and services reduced to a common basis by being measured in terms of money. Therefore, all the above definitions make it clear that national income is the monetary measure of-

·         The net value of all products and services

·          In an economy during a year

·         Counted without duplication

·         After allowing for depression

·         Both in the public and private sector of products and services

·         In consumption and capital goods sector

·         The net gains from international transactions.

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Karnataka Class 12 Commerce Economics Basic Concepts Of National Income Notes

Karnataka Class 12 Commerce Economics Basic Concepts Of National Income :The circular flow of income is a way of representing the flows of money between the two main groups in society – producers (firms) and consumers (households). These flows are part of the fundamental process of satisfying human wants.

As we have already seen, a free market economy consists of two components, or sectors, as they are called. These are firms and households. People in households work for firms (selling their factor services) and receive wages in exchange. On the scale of the whole economy, this is known as national income – the total amount of income earned over a given time period. This money is spent on food, clothing, transport, entertainment etc, and so it returns to the firms. This is the circular flow.

National income is the total value a country’s final output of all new goods and services produced in one year. Understanding how national income is created is the starting point for macroeconomics.

The creation of national income

The simplest way to think about national income is to consider what happens when one product is manufactured and sold. Typically, goods are produced in a number of ‘stages’, where raw materials are converted by firms at one stage, then sold to firms at the next stage. Value is added at each, intermediate, stage, and, at the final stage, the product is given a retail selling price. The retail price reflects the value added in terms of all the resources used in all the previous stages of production.

Final output

In accounting terms, only the value of final output is recorded. To avoid the problem of double counting, only the value of the final stage, the retail price, is included, and not the value added in all the intermediate stages – the costs of production, plus profits.  In short, national income is the value of all the final output of goods and services produced in one year.

Example

For example, consider the production of a motor car which has a retail price of £25,000. This price includes £21,000 for all the costs of production (£6,000 for components, £10,000 for assembly and £5,000 for marketing) plus £4,000 for profit. To avoid double-counting, the national income accounts only record the value of thefinal stage, which in this case is the selling price of £25,000.

When goods are bought second-hand, the transaction does not add new value and will not be included in national output. If second-hand goods are included, double-counting will occur, and this would falsely inflate the value of national income.

For example, if the car in question is sold in two year’s time for £15,000 it would provide the owner with money, but the sale will not add to national income. If it were included in national income, it would make the value of the car £35,000  – the initial £25,000 plus the second hand value of £15,000. This is clearly not the case, so any future second-hand sales are not included when valuing national income. Such second-hand transactions are calledtransfers.

Calculating national income

Any transaction which adds value involves three elements – expenditure by purchasers, income received by sellers, and the value of the goods traded. For example, if a student purchases a textbook for £30, spending = £30, income to the bookseller = £30, and the value of the book = £30. All of the transactions in an economy can be looked at in this way, giving us three ways to measure national income.

There are three methods of calculating national income:

  1. The income method, which adds up all incomes received by the factors of production generated in the economy during a year. This includes wages from employment and self-employment, profits to firms, interest to lenders of capital and rents to owners of land.
  2. The output method, which is the combined value of the new and final output produced in all sectors of the economy, including manufacturing, financial services, transport, leisure and agriculture.
  3. The expenditure method, which adds up all spending in the economy by households and firms on new and final goods and services by households and firms.

Karnataka Class 12 Commerce Economics Basic Concepts Of National Income Notes

Karnataka Class 12 Commerce Economics Basic Concepts Of National Income : National income is an uncertain term which is used interchangeably with national dividend, national output and national expenditure. On this basis, national income has been defined in a number of ways. In common parlance, national income means the total value of goods and services produced annually in a country.

In other words, the total amount of income accruing to a country from economic activities in a year’s time is known as national income. It includes payments made to all resources in the form of wages, interest, rent and profits.

Contents:

  1. Definitions of National Income
  2. Concepts of National Income
  3. Methods of Measuring National Income
  4. Difficulties or Limitations in Measuring National Income
  5. Importance of National Income Analysis
  6. Inter-Relationship among different concept of National Income

Karnataka Class 12 Commerce Economics Basic Concepts Of National Income Notes

Karnataka Class 12 Commerce Economics Basic Concepts Of National Income : There are a number of concepts pertaining to national income and methods of measurement relating to them.

Basic Concepts Of National Income

(A) Gross Domestic Product (GDP):

GDP is the total value of goods and services produced within the country during a year. This is calculated at market prices and is known as GDP at market prices. Dernberg defines GDP at market price as “the market value of the output of final goods and services produced in the domestic territory of a country during an accounting year.”

There are three different ways to measure GDP:

Product Method, Income Method and Expenditure Method.

These three methods of calculating GDP yield the same result because National Product = National Income = National Expenditure.

1. The Product Method:

In this method, the value of all goods and services produced in different industries during the year is added up. This is also known as the value added method to GDP or GDP at factor cost by industry of origin. The following items are included in India in this: agriculture and allied services; mining; manufacturing, construction, electricity, gas and water supply; transport, communication and trade; banking and insurance, real estates and ownership of dwellings and business services; and public administration and defense and other services (or government services). In other words, it is the sum of gross value added.

2. The Income Method:

The people of a country who produce GDP during a year receive incomes from their work. Thus GDP by income method is the sum of all factor incomes: Wages and Salaries (compensation of employees) + Rent + Interest + Profit.

3. Expenditure Method:

This method focuses on goods and services produced within the country during one year.

GDP by expenditure method includes:

(1) Consumer expenditure on services and durable and non-durable goods (C),

(2) Investment in fixed capital such as residential and non-residential building, machinery, and inventories (I),

(3) Government expenditure on final goods and services (G),

(4) Export of goods and services produced by the people of country (X),

(5) Less imports (M). That part of consumption, investment and government expenditure which is spent on imports is subtracted from GDP. Similarly, any imported component, such as raw materials, which is used in the manufacture of export goods, is also excluded.

Thus GDP by expenditure method at market prices = C+ I + G + (X – M), where (X-M) is net export which can be positive or negative.

(B) GDP at Factor Cost:

GDP at factor cost is the sum of net value added by all producers within the country. Since the net value added gets distributed as income to the owners of factors of production, GDP is the sum of domestic factor incomes and fixed capital consumption (or depreciation).

Thus GDP at Factor Cost = Net value added + Depreciation.

GDP at factor cost includes:

(i) Compensation of employees i.e., wages, salaries, etc.

(ii) Operating surplus which is the business profit of both incorporated and unincorporated firms. [Operating Surplus = Gross Value Added at Factor Cost—Compensation of Employees—Depreciation]

(iii) Mixed Income of Self- employed.

Conceptually, GDP at factor cost and GDP at market price must be identical/This is because the factor cost (payments to factors) of producing goods must equal the final value of goods and services at market prices. However, the market value of goods and services is different from the earnings of the factors of production.

In GDP at market price are included indirect taxes and are excluded subsidies by the government. Therefore, in order to arrive at GDP at factor cost, indirect taxes are subtracted and subsidies are added to GDP at market price.

Thus, GDP at Factor Cost = GDP at Market Price – Indirect Taxes + Subsidies.

(C) Net Domestic Product (NDP):

NDP is the value of net output of the economy during the year. Some of the country’s capital equipment wears out or becomes obsolete each year during the production process. The value of this capital consumption is some percentage of gross investment which is deducted from GDP. Thus Net Domestic Product = GDP at Factor Cost – Depreciation.

(D) Nominal and Real GDP:

When GDP is measured on the basis of current price, it is called GDP at current prices or nominal GDP. On the other hand, when GDP is calculated on the basis of fixed prices in some year, it is called GDP at constant prices or real GDP.

Nominal GDP is the value of goods and services produced in a year and measured in terms of rupees (money) at current (market) prices. In comparing one year with another, we are faced with the problem that the rupee is not a stable measure of purchasing power. GDP may rise a great deal in a year, not because the economy has been growing rapidly but because of rise in prices (or inflation).

On the contrary, GDP may increase as a result of fall in prices in a year but actually it may be less as compared to the last year. In both 5 cases, GDP does not show the real state of the economy. To rectify the underestimation and overestimation of GDP, we need a measure that adjusts for rising and falling prices.

This can be done by measuring GDP at constant prices which is called real GDP. To find out the real GDP, a base year is chosen when the general price level is normal, i.e., it is neither too high nor too low. The prices are set to 100 (or 1) in the base year.

Now the general price level of the year for which real GDP is to be calculated is related to the base year on the basis of the following formula which is called the deflator index:

Calculation of General Price Level

Suppose 1990-91 is the base year and GDP for 1999-2000 is Rs. 6, 00,000 crores and the price index for this year is 300.

Thus, Real GDP for 1999-2000 = Rs. 6, 00,000 x 100/300 = Rs. 2, 00,000 crores

(E) GDP Deflator:

GDP deflator is an index of price changes of goods and services included in GDP. It is a price index which is calculated by dividing the nominal GDP in a given year by the real GDP for the same year and multiplying it by 100. Thus,

Calculation of GDP deflator

It shows that at constant prices (1993-94), GDP in 1997-98 increased by 135.9% due to inflation (or rise in prices) from Rs. 1049.2 thousand crores in 1993-94 to Rs. 1426.7 thousand crores in 1997-98.

(F) Gross National Product (GNP):

GNP is the total measure of the flow of goods and services at market value resulting from current production during a year in a country, including net income from abroad.

Karnataka Class 12 Commerce Economics Basic Concepts Of National Income Notes

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