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Karnataka Class 12 Commerce Economics National Income And Welfare Notes

Karnataka Class 12 Commerce Economics National Income And Welfare Notes

Karnataka Class 12 Commerce Economics National Income And Welfare : In this Article we provides Karnataka Class 12 Commerce Economics National Income And Welfare in PDF Format with notes and read well.

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Karnataka Class 12 Commerce Economics National Income And Welfare Notes

Karnataka Class 12 Commerce Economics National Income And Welfare :  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.

Karnataka Class 12 Commerce Economics National Income And Welfare Notes

Karnataka Class 12 Commerce Economics National Income And Welfare : National income of a country means the sum total of incomes earned by the citizens of that country during a given period, say a year. It should be noted that national income is not the sum of all incomes earned by all citizens, but only those incomes which accrue due to participation in the production process. Individuals participate in the production process by supplying factors of production which they possesThere are four factors of production: natural resources or land; human resources or labour; produced means of production or capital; and entrepreneurs or organisation. The payment for the use of land is called rent. Payment for the use of labour is known as wages and payment for the use of capital is known as interest. The factors of production — land, labour and capital are primary factors of production and their contractual payments are called factor incomes. The surplus—what is left after the payment of these primary factors — is called the profit. This residual income is paid to the organiser of production as profit.

Karnataka Class 12 Commerce Economics National Income And Welfare : Thus, income for the participation in the production process may take four forms: rent, wages, interest and profit. By national income we mean the sum-total of all rent, wages, interest and profit earned in the production process during a given period by all the citizens, which is known as the factor payments total. From this definition of national income, we exclude two types of personal income. The first is transfer payments and the second is capital gains. When a citizen receives a certain sum of money without participating in the production process it is called transfer payments. For example, the unemployment benefit, income of a beggar, etc. are personal incomes but not national income because they provide no services against their receipts. Again, when we sell out assets which has appreciated in value, and realise a gain it is known as capital gain which is excluded from the calculation of national income because it renders no productive service for reaping this gain.

Measurement Problems of National Income:

Karnataka Class 12 Commerce Economics National Income And Welfare : Problems arise in aggregation largely because of the difficulty of finding an appropriate unit of measurement. In adding up the total output of a country, there is no single physical unit of measurement that can be used: the millions of different types of goods and services are all measured in different units, for example, steel is measured in tonnes and cloth is measured in metres and it is, of course, impossible to add tonnes to metres!

The problem is partially overcome by using money as the unit of measurement — this greatly simplifies the adding up, but it gives rise to the problem of distinguishing between real and nominal values.

In addition, there are many problems of measuring national income of an economy. These problems may be stated as follows: Firstly, there is the problem of which goods and services should be included. We know that gross domestic product (GDP) is the money value of all goods and services currently produced within an economy involving economic activity which means transforming scarce resources to satisfy human wants.

Total Output, National Product, National Income and National Expenditure:

Karnataka Class 12 Commerce Economics National Income And Welfare : The value of the economy’s total output can be measured in three ways which can be seen by examining Fig. 3.1. The figure shows the flows of income and expenditure in this simple model. The two main economic agents are households and firms.

The households are the owners of factors of production, the services of which they sell to firms in exchange for income (such as rent + wages + interest + profit). We assume for simplicity that all profits to be distributed to households and not retained by the firms.

The firms use the factors of production to produce many different goods and services which they sell to households, foreigners, the government and other firms and receive in return the values of goods and services they produced. The figure also shows that the part of household income which is not spent on consumption is either saved, spent on imports or is taken in taxes by the government.

The government itself uses its tax revenue (as well as money from other sources) to finance government spending, including transfer payments (such as pension, unemployment benefit and student grants and loans). Before pro­ceeding further we want to define the terms consumption (C), investment (I) and savings (S).


Consumption (C):

It is regarded as total expenditure by households on goods and services which yield utility in the current period.

Savings (S) are that part of the disposable income which is not spent in the current period. It follows that disposable income (Y -T) minus saving equals consumption.

Investment (I) is the production of or expenditure by firms on goods and services which arc not for current consumption: that is, real capital goods, like factors-machines, bridges and motorways, all goods which yield a flow of consumer goods and services in future period.

There are three ways of measuring the annual value of total output in an economy — are by calculating its national product, national expenditure and national income.

National Product:

Karnataka Class 12 Commerce Economics National Income And Welfare : This is found by adding up the value of all final goods and services produced by firms during the year. It is to be noted that all final goods and services produced must be included, whether they are to be sold to consumers or to the government, whether they are to be sold to foreigners as exports, or whether they are capital goods to be sold to other firms.

It is important to include only final goods and services: all intermediate goods must be excluded so that double-counting is avoided. For example; in production of a woollen coat, only the value of the final cost should be counted. The value of the raw wool and woollen cloth are included in the value of the coat.

If we were to count them as well we should be guilty of double-counting. If all intermediate goods were included in the calculation of the national product, we would seriously overestimate the value of the country’s total output.

National Expenditure:

This is found by adding up all the spending on the final goods and services produced by firms. Such an aggregate will only equal the value of total output if those goods which are produced but not sold are also included—this item, which is called ‘net changes in stocks and work in progress’, is normally counted as part of firms’ investment spending.

National expenditure is the sum of consumption of domestically produced goods, investment, government expenditure and exports (C + I + G + X). It must be noted that, in order to avoid double-counting, only spending on final goods and services is included.

National Income:

It is because goods and services are produced by factors of production that income is created in the economy, so another way of calculating the value of total output is to add up all the incomes paid out to the owners of the factors of production. Moreover, it comes to the same thing to add the values- added by all firms at the different stages of production.

This may be illustrated by a simple example in which production of woollen coat involves the following three stages of production:

(a) A sheep farmer produces raw wool and sells it to a mill for £100. This represents an income of £100.00 for the farmer. Value-added = £100.00.

(b) The mill uses the raw wool to produce cloth which it sells to a coat factory for £210. This represents income of £110 for the mill — remember that £100.00 has had to be paid for the raw wool. Value-added = £110.00.

(c) The coat factory produces the coat and sells it for £400. This includes £210 to cover the cost of cloth and £190 to pay incomes including profits. Value-added = £190.

The total value-added in this example (£400.00) is just equal to the value of the final coat; it is also equal to the sum of all incomes paid at each stage of production. The value of a country’s total output can be found either by adding the values-added by all firms or by adding up the incomes (that is, wages + rents + interest + profits) of all factors of production, those producing intermediate goods as well as those producing final goods.

In either case, double- counting will be avoided. It is important to exclude all transfer payments as these represent nothing more than a redistribution of income from taxpayers to the transfer recipients, including them would involve double counting.


(a) that all measures are calculated accurately; (b) that only final goods and services are counted in the national expenditure and national product figures; (c) that any change in unsold stocks are included in the national income figures; (d) that all incomes (including profits but excluding transfer payments) are counted in the national income figures, then it must follow that all three measures will provide an identical figure for the value of national income and output. That is

National Income = National Expenditure = National Product In principle, these three aggregates simply represent different ways of measuring the flow of output or income being created in an economy over a period of time.

Components of Expenditure:

Economists and policymakers care not only about the economy’s total output of goods and services but also about the allocation of this output among alternative uses. National income accounts allocate GDP among four broad categories: Consumption (C). Investment (I), Government expenditure (G), and Net exports (X – M) or (NX).

Thus, let Y stand for GDP. Y=C + I + G + X- M or Y = C+ I + G + NX. Each pound of GDP is placed in one of these categories. This equation is an identity. It is called the national income accounts identity.

We have already defined almost all of the components of GDP except NX, net exports, that is, trade with other countries in an open economy. Here we will give the definition of NX and explain in detail about open economy later on. Net exports are the value of goods and services exported to other countries minus the value of goods and services imported from other countries. It represents the net expenditure from abroad for our goods and services, which provides income for domestic producers.

Other Measures of Income:

Karnataka Class 12 Commerce Economics National Income And Welfare : The national income accounts include other measures of income that differ slightly from GDP and GNP. It is important to be aware of various measures because economists and the press often refer to them.

We like to see how the alternative measures of income relate to one another by starting with GNP and subtracting various quantities. To get net national product (NNP), we subtract the depreciation of capital — the amount of capital depreciates during the year: NNP = GNP – Depreciation.

Depreciation is called the consumption of fixed capital. It is about 10 per cent of GNP in many economies. Since the depreciation of capital is a cost of producing the output of the economy, subtracting depreciation shows the net result of economic activity. For this reason, some economists believe that NNP is a better measure of economic well-being.

Market Price and Factor Cost:

The next adjustment in the national income accounts is for indirect taxes. Market prices are very often distorted by indirect taxes and subsidies: indirect taxes have the effect of raising the prices of goods above its costs, while subsidies lower such prices. National income and national product are both measured at ‘factor costs’.

To ensure that national expenditure is also the same as the national income and national product, it is necessary to convert market prices to factor cost by adding subsidies and subtracting indirect taxes. Thus, we get national expenditure at market price, minus indirect taxes plus subsidies = Net National Expenditure at factor cost.

It is preferable to measure the value of total output at factor cost rather than in Market prices so as to remove the influence of indirect taxes and subsidies

Stock Appreciation:

We know that all three measures of total output include the value of the net change in stocks of unsold goods. If prices are rising, the value of firms’ stocks well rise too. To take account of this so-called “stock appreciation’. It is necessary to subtract that amount in computing the national income.

GDP Deflator:

From nominal GDP and real GDP we can compute the GDP deflector. The GDP deflator is defined as: GDP deflator = Nominal GDP/Real GDP. The GDP deflator is the ratio of nominal GDP to real GDP.

To understand better nominal GDP, real GDP, and the GDP deflator, consider an economy with only one good, bread. In any year, nominal GDP is the amount of sterling spent on bread in that year. Real GDP is the number of loaves of bread produced in that year times the price of bread in some base year. The GDP deflator is the price of bread in that year relative to the price of bread in the base year.

Q the quantity, and a superscript “92” the base year 1992; then the GDP deflator would be:

The numerator is nominal GDP, and the denominator is real GDP. Both nominal GDP and real GDP can be viewed as the price of a basket of goods; in this case, the basket consists of the quantities of apples and oranges. The GDP deflator compares the current price of this basket to the price of the same basket in the base year.

The definition of the GDP deflator allows us to separate nominal GDP in two parts: one part measures quantities and the other measures prices. That is, Nominal GDP – Real GDP x GDP Deflator.

Nominal GDP measures the pound value of the output of the economy. Real GDP measures the amount of output — that is output valued at constant (base-year) prices. The GDP deflator measures the price of the typical unit of output relative to its price in the base year.

Measuring the Cost of Living: Consumer Price Index:

A pound today does not buy as much as it did 20 years ago. The cost of almost everything has gone up. This increase in the overall level of prices is called inflation.

Consumer Price Index (C.P.I.):

The most commonly used measure of the level of prices is the consumer price index (CPI). The Department of Employment has the job of computing the CPI or Retail Price index (RPI). It begins lay collecting the prices of thousands of goods and services. Just as GDP turns the quantities of many goods and services into a single number measuring the value of production, the CPI or RPI turns the prices of many goods and services into a single index measuring the overall level of prices.

The CPI or RPI is:

In this CPI or RPI, 1992 is the base year. The index tells us how much it costs now to buy 5 apples and 2 oranges relative to how much it cost to buy the same basket in 1992.

The CPI or RPI is the most closely watched index of prices, but it is not the only index. Another is the producer price index, which measures the price of a typical basket of goods bought by firms rather than consumers. In addition to these overall price indexes, the Department of Employment computes price indexes for specific types of goods, such as food, housing and energy.

Estimation of National Income in the Presence of Government Activities:

The government is undertakes several economics activities in a mixed economy. The government is engaged in mainly four types of economic activities which should be constituted while calculating the national income of a country. Firstly, the government may be engaged in the production of goods and services which are sold in a market like private firms. For example, transport, utility services, etc.

The conceptual problem can be dealt with as follows:

Now the question is whether these services — the maintenance of law and order and defence — are to be regarded as services which satisfy the wants of the consumers directly, or are they to be regarded as facilitating the production of other goods and services? If we accept the first proposition then it becomes a final product and should be included in the national production.

Thus taking into consideration the government activity we get the following identities:

GDP ≡ Gross value of output of the private sector + Gross value added by private enterprises + value of public sector’s common services.

GDE ≡ Consumption expenditure on domestically produced good + investment expenditure + public sector expenditure on common services.

GDI ≡ (wage bill of public and private sectors) + (rents paid by public sector and private sector) + (gross profit of private enterprises and gross profit of public sector enterprises) + (interest received by both sectors).

National Income Estimate in an Open Economy:

As in a closed economy, in an open economy also we can look at the national income from three sides — the production side, the income side and the expenditure side. Let us first consider the expenditure side of the national income account. Gross National Expenditure (GNE) at market prices ≡ Consumption (C) + Gross Investment + government expenditure on goods and services ≡ C + I + G.

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