National Income: One Mark Questions, Book Back Answers and Notes

About National Income

Medium ~90 min study

National income is the money value of all final goods and services produced in a country during a year, after allowing for depreciation. It is the single figure most often used to judge how an economy is doing, to compare years and to plan development.

The unit moves in a clear order. First come the definitions and aggregates: GDP, GNP, NDP, NNP, per capita income, personal income and disposable income, each at market prices or at factor cost. Then come the three ways of measuring national income, which look at the same economy from the side of production, the side of income earned and the side of spending. Because every rupee spent on output becomes someone's income, the three methods should give the same total.

MCQs from this unit often turn on small details. Is depreciation deducted? Are indirect taxes included? Does a pension count? Is a second-hand car sale part of GDP? Learn the conversion steps between aggregates and the list of items excluded from national income, and most questions become straightforward. Numerical problems also reward a clear head on which figure to add and which to subtract.

What you'll learn

• Define GDP, GNP, NDP, NNP, personal income and disposable income and state how each is derived.
• Estimate national income using the product, income and expenditure methods.
• Convert a market price aggregate to factor cost using indirect taxes and subsidies.
• List the conceptual and statistical difficulties in measuring national income in India.
• Explain why per capita income is a limited measure of economic welfare.
• Describe social accounting and the sectors it uses.

Before you start

• Demand, supply and market price from Class 11 Economics.
• The circular flow of income in a two sector economy from Unit 1.
• Basic arithmetic and the idea of an average.

National Income explained

Overview of National Income Analysis

Aggregates and How They Connect

Gross Domestic Product (GDP) is the market value of all final goods and services produced within the domestic territory of a country in a year. Adding net factor income from abroad (NFIA) gives Gross National Product (GNP). Subtracting depreciation from either gives the net figures, Net Domestic Product (NDP) and Net National Product (NNP).

• \(GNP = GDP + NFIA\)
• \(NNP = GNP - \text{Depreciation}\)
• \(NNP_{FC} = NNP_{MP} - \text{Indirect taxes} + \text{Subsidies}\)

NNP at factor cost is national income. Market price figures include indirect taxes and exclude subsidies; factor cost figures show what is actually paid to land, labour, capital and organisation. From national income we move to personal income (income actually received by households) and disposable income (personal income minus direct taxes). To remove the effect of rising prices, nominal GDP is converted to real GDP using the GDP deflator.

The Three Methods of Measurement

Product (value added) method: for each sector, subtract the value of intermediate goods from the value of output. Adding up value added at every stage counts each product only once and avoids double counting. For example, if a farmer sells wheat for ₹50, a miller sells flour for ₹80 and a baker sells bread for ₹120, the value added is 50 + 30 + 40 = ₹120, the price of the final product.

Income method: add up factor incomes earned in production: wages and salaries, rent, interest and profits, plus mixed income of the self-employed.

Expenditure method: add up spending on final goods and services: private consumption, gross investment, government purchases and net exports, \(C + I + G + (X - M)\).

Since output, income and spending are three views of the same circular flow, all three methods should arrive at the same figure.

Difficulties in Measuring National Income

In a country like India, a large part of output comes from the unorganised and non-monetised sector. Many farmers keep part of their produce for their own use or exchange it through barter, so it is hard to put a value on it. Services of housewives are left out because they are not paid for in the market. Transfer payments such as old age pensions and interest on public debt are excluded because they are not payments for current production. Estimators also face problems in fixing depreciation, in leaving out windfall gains and capital gains, and in collecting data when respondents do not cooperate and field staff lack training.

Social Accounting and Welfare

Social accounting divides the economy into sectors such as firms, households, government, the rest of the world and the capital sector, and records the transactions between them in a set of accounts. National income per head is often used as a sign of the standard of living, but it has limits as a measure of welfare. It says nothing about how income is distributed, it counts a rupee spent on weapons the same as a rupee spent on food, and it ignores pollution and the depletion of natural resources. For this reason economists argue for adjusting national accounts for environmental costs.

Common mistakes to avoid

• Adding intermediate goods in the product method. Count only final goods, or count value added at each stage, never both.
• Including transfer payments. Old age pensions, scholarships and unemployment allowances are not payments for current production, so they are left out.
• Getting the conversion backwards. Factor cost = market price minus indirect taxes plus subsidies, not the other way round.
• Counting sales of second-hand goods. A used car sold this year was already counted in the year it was made; only the dealer's commission counts now.
• Forgetting depreciation. Gross figures become net figures only after deducting depreciation (capital consumption allowance).

Test yourself on these with the practice test, then check the worked reasoning in the solved MCQs.

Frequently asked questions

What is the difference between GDP and GNP?

GDP measures final goods and services produced within the country's borders, whoever produces them. GNP measures output produced by the country's normal residents, wherever they are, so GNP = GDP + net factor income from abroad.

How do you avoid double counting in national income?

Use either the final product approach, which counts only goods sold to the final user, or the value added approach, which adds only the value added at each stage. In the wheat, flour and bread example, you count the ₹120 bread or add 50 + 30 + 40, not 50 + 80 + 120.

Why are transfer payments excluded from national income?

Old age pensions, scholarships and unemployment allowances are paid without any good or service being produced in return. They only shift purchasing power from the government to individuals, so adding them would overstate the value of production.

What is the relation between market price and factor cost?

Market price is what the buyer pays, so it includes indirect taxes such as GST and is reduced by subsidies. Factor cost is what the factors of production receive. So factor cost = market price minus indirect taxes plus subsidies.

What is the GDP deflator?

It is a price index covering all goods and services produced in the country. GDP deflator = (nominal GDP ÷ real GDP) × 100. If nominal GDP is ₹220 crore and real GDP is ₹200 crore, the deflator is 110, meaning prices have risen 10 per cent over the base year.

Why are services of housewives omitted from national income?

Cooking, cleaning and childcare done by a housewife are not bought and sold in the market, so there is no price to value them at. They are left out because they cannot be measured reliably in money terms, even though they are real and useful work.

How is per capita income calculated?

Per capita income = national income of a year ÷ population in that year. It gives the average income per person and is used as a rough indicator of the standard of living, though it hides how unevenly income is shared.