Introductory Microeconomics Chapter 6 Non-Competitive Markets

Meaning of macroeconomics — 'Macroeconomics is the study of overall averages and aggregates covering the whole economy and examines the interrelationship among various aggregates.' Simply put 'it is study of the economy as a whole'. It is that part of economic theory which deals with the behaviour of national aggregates. It studies not an individual economic units like a household or a firm or an industry (i.e. small group of firms) but deals with the study of broad economy-wide aggregates like total output, size of national income, level of employment, aggregate consumption, aggregate saving, aggregate investment, general price level, balance of payment, rate of inflation, size of poverty etc. It helps to solve the central problem of 'full employment of resources' in an economy.

Be it noted that macroeconomic theory is also called 'Theory of Income and Employment' because it tries to explain how level of income and employment is determined in an economy and how unemployment can be removed. Study of problem of unemployment in India or general price level is a macroeconomic study because they relate to Indian economy as a whole.

Let it be known that an English economist J.M. Keynes whose book titled 'General Theory of Employment, Interest and Money', published in 1936 brought about a revolution in economic thought is called the Father of Modem Macroeconomics

Distinction between microeconomics and macroeconomics.

Simply put, microeconomics is the study of individual economic units of an economy such as individual households, individual firms or industries whereas macroeconomics is the study of an economy as a whole, i.e., study of broad economy-wide aggregates. For instance, when we study an individual car manufacturing firm (like Maruti), our study is micro analysis but if we study the entire car manufacturing sector of the economy, our analysis is macro analysis. Similarly, if we study production of a firm (or of an industry), our analysis is micro study but if we study problems of production of the whole economy, our analysis is macro study. The former (Micro) is like dealing with individual trees in the economic forest whereas the latter (Macro) is like analysing the economic forest. Still both microeconomics and macroeconomics are interdependent and complementary. However, the main differences between the two are as under :

National Income (NI)

Human wants can be satisfied through consumption of goods and services only. (A good is a tangible or material object like pen, book, shoes, etc. which has economic value whereas service is intangible object like services of teacher, doctor, judge, etc.) Therefore, production of goods and services has been going on since the dawn of economic history to meet unending wants of a society. Thus broadly speaking national income is a measure of value of production activity of a conutry. How? Production generates income, how? Production of goods and services is the result of combined efforts of factors of production (land, labour, capital and enterprise). The net output emerging from production process gets distributed among factors of production in the form of money income (rent, wages, interest and profit). Thus production generates income. With this income factors of production (i.e., factor owners) purchase goods and services for final consumption and investment. Thus income creates expenditure. In short, production generates income, income creates expenditure and expenditure calls forth production. Hence national income can be defined (expressed) in three ways, i.e., in the form of final goods and services (Production Phase), generation of factor income (Income Phase) and consumption of final goods and services (Expenditure Phase) as shown below.

(i) From production point of view, 'National income is the sum total of money value of net flow of all the final goods and services produced by normal residents of a country during a period of account.' (National income is basically a measure of production activity.)

(ii) From income point of view CSO has defined, 'National income is the sum total of factor incomes earned by normal residents of a country in the form of rent, wages, interest and profit in an accounting year.'

(iii) From expenditure (disposition of national income) point of view, Simon Kuznets defines thus, 'National product is the net output of commodities and services flowing during the year from the country's productive system into the hands of ultimate consumers or into the net addition to the country's capital goods'.

In short, national income is cither money value of all the final goods and services produced or sum total of all factor incomes earned or sum total of final expenditure (consumption expenditure + investment expenditure) in a year.

Final Goods and Intermediate Goods    

Simply put, Goods purchased and used up in production process are intermediate goods. Goods purchased for consumption or for investment are final goods. The distinction is based on whether the good is purchased for final use or for use in further production.

(i)    Final goods. All goods which are meant either (i) for consumption by consumers or (ii) for investment by firms are called final goods. They are meant for final use and the final use of a product is only for consumption or investment. Thus they do not undergo any further transformation (change) in the production pracess nor are resold. In other words final goods are acquired for own use i.e. by consumers for statifaction of their wants and by producers for capital formation.

(ii)    Intermediate goods. All goods which are used (i) as raw material for further production of other goods, or (ii) for resale in the same year are known as intermediate goods. Such goods are purchased by one firm from the other for use as raw material or for resale.

It needs to be noted that no good is always final or intermediate because it is the use made of the good which makes it final or intermediate. Let us consider manufacturing of biscuits. Biscuits are final goods but flour, milk, sugar, salt, fuel, etc. used in making biscuits are intermediate goods. Similarly cloth purchased by the household for the daily use is a final good but acquired by dress makers for making dresses is an intermediate good. Likewise bread when purchased by a household is a final good but purchased by bakery for making pattis is an intermediate good.

(i) Furniture purchased by a school is a final product because it is purchased for investment.

(ii) Chalks purchased by a school is an intermediate product as it is meant to be used completely in the same year.

Significance of distinction lies in the fact that national income includes value of only final goods (and not of intermediate goods).

Final expenditure and intermediate expenditure — The distinction between the two depends on nature of the demand. Final expenditure is the expenditure made on purchase of goods and services for final consumption and investment. On the other hand, intermediate expenditure is the expenditure made by a firm on purchase of goods and services from other firms to be used as raw material or for resale in the same year.

Consumption Goods and Capital Goods

All final goods (i.e., goods ready for use by their final users) produced in the economy are either in the form of consumption goods or capital goods.

(i) Consumption goods. Goods which are consumed by the ultimate consumers or which meet the immediate needs of the consumers directly are called consumption (or consumer) goods. For example, food, shirt, shoes, cigarettes, T.V. set, radio, pen, etc. are all consumer goods because when used they satisfy the immediate needs of the consumers. Similarly services rendered to consumers by hotels, retailers, barbers, cobblers, etc. are consumer services So are the services of police, courts, parks, street lighting consumed collectively by the people. Consumption goods meet the basic objective of an economy, i.e., to sustain the consumption of entire population of the economy. Human beings must consume in order to survive and work. Remember, it is consumption of basic necessities of life-food, clothing and shelter — that make us function.

Consumer goods may be durable and non-durable. Cars, T.V. sets, home computers, fridge, etc. are durable consumer goods (called consumer durables) as they have relatively long life and undergo wear and tear with gradual use. Food, vegetables, clothes, shoes, etc. are non-durable consumer goods as their life time of use is comparatively small and are not of high value. Services such as rendered by hired servants, medical care, recreation and transport services availed by consumers are like non-durable/single use consumer goods.

(ii) Capital goods. Durable goods which are bought for producing other goods and not for meeting immediate needs of the consumer are called capital goods. Examples are tools, implements, plants, machines, buildings. These are used for generating income by production units. In this regard some points are worth noting (i) While capital goods make production of other goods possible, they themselves do not get transformed (or merged) in the production process. (ii) Capital goods gradually undergo wear and tear and need repaiis or replacement over time. (iii) They are crucial backbone of production process as they aid and enable production process to continue cycles of production. Capital goods are purchased by business enterprises either for maintenance or addition to their capital stock so as to maintain or expand flow of production.

Capital Formation (Investment). 'Capital formation is the net addition to the capital stock of an economy during a given period.' In a growing economy, all that is produced in a year is not consumed usually. And that part of production which is not consumed during a year is investment. In other words, excess of production over consumption is called capital formation or investment.

Flows and Stocks

The distinction between a stock and a flow is very significant and we should clearly understand it since national income itself is a flow. The basis of distinction is measurability at a point of time or period of time. Be it noted that both stocks and flows are variables. A variable is a measurable quantity which varies (changes).

(a)    Flow Variables. A flow is a quantity which is measured with reference to a period of time. Thus flows are defined with reference to a specific period (length of time), e.g., hours, days, weeks, months or years. It has time dimension. National income is a flow. It describes and measures flow of goods and services which become available to a country during a year. Similarly all other economic variables which have time dimension, i.e., whose magnitude can be measured over a period of time are called flow variables. For instance, income of a person is a flow which is earned during a week or a month or any other period. Likewise investment (i.e., addition to the stock of capital) is a flow as it pertains to a period of time. Other examples of flows are : expenditure, savings, depreciation, interest, exports, imports, change in inventories (not mere inventories), change in money supply, lending, borrowing, rent, profit, etc. because magnitude (size) of all these are measured over a period of time.

(b)    Stock Variables. A stock is a quantity which is measurable at a particular point of time, e.g., 4 p.m., 1st January, Monday, 2007, etc. Capital is a stock variable. On a particular date (say, 1st April, 2007), a country owns and commands stock of machines, buildings, accessories, raw materials, etc. It is stock of capital. Like a balance sheet, a stock has a reference to a particular date on which it shows stock position. Clearly a stock has no time dimension (length of time) as against a flow which has time dimension. A flow shows change during a period of time whereas a stock indicates the quantity of a variable at a point of time. Thus wealth is a stock since its magnitude is measured at a point of time but income is a flow because it can be measured over a period of time. Examples of stocks are : wealth, foreign debts, loan, inventories (not change in inventories), opening stock, money supply (amount of money), population, etc.

The distinction between stocks and flows can be easily understood by comparing the actions of a still camera (which records position at a point of time) with that of video camera (which records position during a period of time).

(i) Loss is a flow because losses are always with reference to a period of time.
(ii) Capital is a stock because it is measured at a point of time.
(iii) Production is a flow as it is always with reference to a period of time.
(iv) Wealth is a stock because it is always measured at a point of time.

Gross Investment and Net Investment

Investment means addition to the stock of capital goods such as structures, equipment or inventory that adds to the future productive capacity of the economy. It implies creation or addition of physical assets which are used to augment the productive capacity of the economy in future. This should not be confused with layman's notion of investment which generally denotes purchase of shares or financial assets. Remember in economic analysis, investment always means capital formation — a gross or net addition to capital stock of the economy.

Gross investment. That part of total final output which comprises of capital goods like machinery, plants, buildings constitutes gross investment of an economy. It is addition to the capital stock which also includes replacement cost for the wear and tear that the capital stock undergoes over a period of time. When investment is expressed as gross investment, it includes depreciation.

Depreciation. Depreciation means loss in the value of fixed asset due to its normal wear and tear in the process of production. We know that fixed capital like machine, tools, building, rail engine, etc. wear out over time when repeatedly used leading to fall in value. This depreciation or fall in value due to normal wear and tear is called consumption of fixed capital. When the assets wears out completely, it needs replacement. Therefore, every enterprise makes annual provision of funds called depreciation provision to the tune of estimated value of depreciation. The fund thus accumulated over the life time of asset is used to replace the asset when it wears out completely. That is why depreciation is also sometimes called current replacement cost. (See subpart 9 of this Question)

In short, gross investment is inclusive of depreciation or consumption of fixed capital.

Net investment. By deducting depreciation from gross investment, we get net investment. Symbolically:

Net investment = Gross investment - Depreciation

Remember, new addition to the capital stock in the economy is measured by net investment (and not by gross investment).

Domestic (Economic) Territory

According to United Nations, 'Economic territory is the geographical territory administered by a government within which persons, goods and capital circulate freely.' Remember, income generated within domestic territory of a country during a year is called domestic income. Domestic territory is also called economic territory. The following items are included in domestic territory :

What domestic (economic) territory includes.

(i)    Territory lying within the political frontiers of a country. It includes territorial waters also.

(ii)    Ships and aircrafts owned and operated by the resident between two or more countries. For instance, Indian ships moving between U.K. and Pakistan regularly or passenger planes operated by Air India between Russia and Japan are parts of domestic territory of India.

(iii)    Fishing vessels, oil and natural gas rigs and floating platforms operated by the residents of a country in the international waters or engaged in extraction in areas where the country has exclusive rights of operation. For example, fishing boats operated by Indian fishermen in the international waters of the Indian Ocean will be considered as a part of domestic territory of India.

(iv)    Embassies, consulates and military establishments of the country located abroad. To illustrate, Indian embassies in Russia, America and other countries will form parts of domestic territory of India. Similarly embassies of other countries like Russia, America, Japan, etc. located in India are parts of domestic territories of their own countries and not of India.

What domestic (economic) territory does not include.

(i)    Territorial enclaves (like embassies) used/administered by foreign governments.

(ii)    International organisations which are physically located within economic territory of a country. Their offices form a part of international territory.

National Income at Current Prices and Constant Prices (Nominal NI and Real NI) National income can be measured in terms of money in two ways :

(a)    at current prices, and (b) at constant prices.

(a)    National income at current prices. If goods and services produced in a year are valued at current prices, i.e., prices prevailing in that particular year, we get national income at current prices. Current prices refer to the prices prevailing in the year in which goods and services are produced. For example, when goods and services produced during the year 2007-2008 are valued at prices of the same year, i.e., 2007-2008, it will be called national income at current prices for the year 2007-2008. Clearly in determining national income at current prices, not only physical output produced during the year is important but also the prices prevailing in that year are equally important. National income at current prices is called Nominal National Income.

(b)    National income at constant prices. If goods and services produced in a year are valued at fixed prices, i.e., prices of the base year, we get national income at constant prices. Constant prices refer to the prices prevailing in the base year. A base year is carefully chosen year which is a normal year free from price fluctuations. (Note that in India now 2004 - 2005 is treated as base year). For instance, if goods and services produced during the year 2006-2007 are valued at the prices of the base year (i.e., 2004-2005), it will be called national income at constant prices. Evidently it is change in volume of physical output produced during the year which affects national income at constant prices because prices remain fixed (constant). National income at constant prices is called Real National Income.

(c)    Significance of NI at constant prices (or Real National Income). (i) National income measured at constant prices truly reflects the real change in physical output of a country whereas national income at current prices does not. How? National income at current prices is affected by two factors namely (a) change in prices, and (b) change in physical output (amount of goods and services produced). If the current prices rise fastly, national income at current prices will also inflate even if there is no increase in the level of physical output. On the contrary, National income at constant prices is affected by only one factor namely, change in physical output. It can rise only when there is an increase in the level of physical output because here prices are kept constant or fixed. Since a country is interested in its physical output, it is considered proper and desirable to estimate national income at constant prices because it reflects truly the real change in physical output of a country.

(ii) Real national income (or for that matter GNP) enables us to make a year to year comparison of changes in the volume of output of goods and services.

(iii) Real national income is also helpful in making international comparison of economic performance of different countries.

Consumption of Fixed Capital (Depreciation)

Fixed capital assets (like machinery, building) depreciate in value in the process of production. Simply put, depreciation means loss of the value of fixed capital assets during production. In other words, depreciation is the value of existing capital stock that has been consumed (used up) in the process of producing output.

Fall in value of fixed assets due to normal wear and tear, and expected obsolescence is called consumption of fixed capital. This is sometimes also called current replacement cost. The loss of value in capital goods is mainly due to two reasons : (i) normal wear and tear, and (ii) expected obsolescence. Let us understand how fixed capital goods depreciate in value.

(i)    Normal wear and tear. We know that during production process, capital goods like machines, tools, buildings, trucks, rail engines, roads, etc. wear out. In other words, production of goods and services involves wear and tear of fixed capital. It is a regular feature of fixed capital. You cannot use a machine forever. Its productive capacity goes on declining with normal use in production leading to fall in its value. This depreciation or fall in value due to normal wear and tear is called consumption of fixed capital.

(ii)    Expected obsolescence. Obsolescence is another reason for depreciation. Obsolescence refers to the loss of value of a fixed asset due to change in technology or due to change in demand for goods and services. Sometimes capital goods like machines become obsolete (disused) due to (a) change in technique of production, or (b) due to change in fashion resulting in fall in demand for goods and services which the machine produces. Take the case of steam engine of railways which is becoming obsolete due to introduction of diesel engine which, in turn, is giving place to electric engine. Thus fall in value of steam engine is due to expected obsolescence. This is called technological obsolescence. Similarly we have seen that demand for nylon cloth went down because it went out of fashion when terylene blends appeared in the market. Thus machine which was producing nylon cloth became obsolete (discarded) which led to fall in its value. Loss in value due to expected or foreseen obsolescence is called depreciation (in value) or consumption of fixed capital.

Significance (To distinguish between Gross and Net). In national accounting, gross variable (like gross income, gross profit, gross investment) are inclusive of depreciation (or consumption of fixed capital). When we deduct depreciation from gross value of output, we get net value of output. Therefore, depreciation is used to differentiate net from gross. Thus to find out net domestic capital formation, depreciation should be deducted from gross domestic capital formation. If we add depreciation to net, we get gross. In short, difference between gross and net is the value of depreciation. The following statements further clarify it.

Net product = Gross product - Depreciation

Gross value added = Net value added + Depreciation

Net domestic capital formation = Gross domestic capital formation - Depreciation

Factor Cost vs. Market Price (or Net Indirect Taxes)

Money value of final goods and services produced can be estimated in two ways — at factor cost (FC) and at market price (MP). Simply put, difference between FC and MP is 'net indirect tax'. Net indirect tax is the difference between indirect tax and subsidy.

(i)    Factor cost refers to all factor payments made by the producing unit (firm) to the factors of production involved in the production of goods and services. It is called factor cost because it is cost incurred by the producer (firm) who pays to factors in the form of rent, wages, interest and profit. (i.e., rent for land, wages for labour, interest for borrowed money (capital) and profit for undertaking risks involved in production — a reward for entrepreneur). If sum of factor payments in production of a commodity is, say र 1 lakh, then value of the product at factor cost is र 1 lakh.

(ii)    Market price is the price at which a commodity is sold and purchased in the market. The point to be noted is that when a product goes to the market for sale, government levies indirect tax (like sale tax, excise duty, etc.) which is added to the factor cost of the commodity. Similarly sometimes government gives subsidy on sale of certain commodities (like kerosene oil, sugar, rice at ration shops) which is subtracted from factor cost. As a result market price becomes higher than factor cost in case of levy of indirect tax and lower than factor cost in case of grant of subsidy. In short MP includes Net indirect taxes (Indirect taxes - Subsidies) whereas FC does not. Put in the form of an equation :

Market price = Factor cost + Indirect taxes - Subsidies

= Factor cost + Net indirect taxes

Net indirect tax is the difference between indirect taxes and subsidies as explained below. Let us be clear about the concepts of indirect taxes and subsidies.

(a)    Indirect taxes. Taxes which are levied by the government on production and sale of commodities are called indirect taxes, e.g., excise duty, sale tax, custom duty, octroi, etc. The buyer of a taxed commodity pays the tax indirectly because the tax is included in the price which the buyer pays. What is the effect of indirect tax on the price of a commodity on which it is levied? The impact of indirect tax is that it increases the price of a commodity.

(b)    Subsidies. These are cash grants given by the government to the enterprises to encourage production of certain commodities or to promote exports or to sell goods at prices lower than the free market prices. Subsidies are opposite of indirect taxes.

What is the impact of a subsidy on the price of a commodity on which it is granted? The effect of subsidy is fall in the price of a commodity. For example, Delhi Milk Scheme sells 1 litre poly bag of toned milk for र 20.00 whereas the same costs it र 21.00. The difference or loss of र 1.00 is made good by the Government by giving subsidy of Re. 1.00 per litre of toned milk. Thus the market price of a subsidised commodity is lower than its factor cost.

Why are subsidies added and indirect tax deducted from domestic product at MP to arrive at domestic product at FC?    (D 2010C)

Significance of Net Indirect Taxes. It is used to make distinction between MP and FC. To find out market prices (MP), indirect taxes are added and subsidies are subtracted from factor cost (FC). Algebraically :

MP = FC + Net indirect taxes

Net Factor Income from Abroad (NFIA)

Simply put, NFIA is the difference between factor income received from abroad and factor income paid abroad. Simply put it is the difference between the factor income earned from abroad by normal residents of a country (say India) and the factor income earned by non-residents (foreigners) in the domestic territory of that country (i.e. India). CSO defines it as 'Income attributable to factor services rendered by the normal residents of the country to the rest of the world, less factor services rendered to them by the rest of the world.' Symbolically :

NFIA = Factors income earned from abroad by residents - Factor income of non-residents in domestic territory
The normal residents of a country earn factor income not only within the domestic territory of a country but outside it also. Income from outside can be earned mainly in two ways, namely, (i) income from work, and (ii) income from property and entrepreneurship as shown below. Mind, it is a two-way affair since foreigners also earn similar income by working in domestic territory of other country.

(i)    Income from work (Compensation of employees). Income from work can be earned by working in the domestic territories of other countries earning thereby wages and salaries (or compensation of employees). For instance, suppose in 2006-2007, Indian resident scientists, engineers, doctors, dancers, masons, carpenters employed abroad earned factor income of र 10,000 crores whereas similar payments made to non-resident workers employed in domestic territory of India was to the tune of र 8,000 crores. Net compensation of employees from abroad to India would be र 2,000 (10,000 - 8,000) crores.

(ii)    Income from property and entrepreneurship (Rent, interest, profit). Factor income from abroad is also earned by owning property (like buildings, shops, factories, financial assets like bonds and shares in foreign countries) earning thereby rent and interest, Also profit is earned for undertaking entrepreneurial activities of producing goods and services. For instance suppose in 2006-2007, normal residents of India living temporarily abroad earned र 25,000 crores by way of rent, interest and profit and similar payments made to the rest of world were, say र 20,000 crores. Net income from property and entrepreneurship from abroad would be र 5,000 (25,000 - 20,000) crores.
(iii)    Net retained earning of resident companies abroad. This refers to the difference between retained earnings of foreign companies located in a country and the retained earnings of resident companies located abroad. Retained earning of a company is in fact its 'undistributed profit'. For instance suppose in 2006-2007, Indian companies working abroad, after paying profit tax and distributing dividend out of their total profits, retained the balance profit (known as Reserve fund or Undistributed profit) of र 50,000 crores and foreign companies in India retained similar profit of र 65,000 crores. Net retained earning of resident companies abroad would be र (-) 15,000 (= 50,000 - 65,000) crores.
From above-mentioned data, India's net factor income from abroad in 2006-2007 would be equal to र -8,000 [= 2,000 + 5,000 + (-15,000)] crores.
Components of net factor income from abroad. These are as under :
(i)    Net compensation of employees.
(ii)    Net income from property and entrepreneurship (rent, interest, profit).
(iii)    Net retained earning of resident companies abroad.
Significance. Net factor income from abroad is used to differentiate between National income and Domestic income. By adding NFIA to domestic income, we get national income. Symbolically:
National income = Domestic income + NFIA
Domestic income = National income - NFIA

Value of Output vs. Value Added

(i) Value of output. The goods and services produced by an enterprise during an accounting year constitutes its output. (Output is also called gross output because it includes depreciation.) Value of output of an enterprise is the market value of all the goods and services produced by an enterprise during an accounting year. (Mind, value of output means value of gross output at MP unless stated otherwise.) Money value of output of an enterprise is obtained by multiplying its physical output of goods and services with its market price.
Symbolically :
Value of output = Quantity of output × Price
Alternatively value of output can be expressed as sum of sales and change in stock because output is either sold or accumulated as unsold stock. Symbolically :

Value of output = Sales + Change in stock
In short value of output is money value of (i) Gross output calculated at (ii) Market prices. It includes values of intermediate goods like raw material,etc.
Remember, value of output is not the actual contribution of the enterprise in the production process, because this amount includes also the value of intermediate goods which the enterprise has purchased from other producing units. So a firm's actual contribution is its value added in the production process.
(ii) Value added. It refers to the addition of value to the raw material (intermediate goods) by a firm by virtue of its productive activities. Alternatively, value added is defined as the difference between value of output of a firm and value of its inputs bought from other firms. Thus value added is firm's contribution to the flow of final goods and services produced by it during a period of account. Alternatively, value added is a measure of firm's contribution to domestic product.

For production of goods and services a firm uses two types of inputs — factors inputs (services of land, labour, capital, enterprise) and non-factor inputs (i.e., intermediate goods like raw material). A firm purchases intermediate goods from other firms and hires factor services to produce goods and services. During production process, raw material purchased from other firms is completely used up. Thus a firm merely adds value to intermediate goods when it transforms available intermediate goods into final goods (output) with the help of factors of production. This is called value added by a firm. Hence to find out value added by a firm, value of intermediate inputs (i.e., intermediate consumption) should be deducted from value of firm's output because intermediate inputs are not produced by it but purchased from some other firms. Symbolically :
Value added = Value of output - Intermediate consumption
Simply put, excess of value of output over value of intermediate inputs purchased from other enterprises is called value added.
(iii) Steps to get 'Net Value added at FC' from Value of output. Recall value of output is the market value of gross output produced by an enterprise in an accounting year. Being gross, it includes depreciation and being at MP, it includes net indirect taxes. Following steps are taken to derive net value added at FC from value of output. (Mind, output means gross output.)

Value of output = Output × Market price

Gross value added at MP = Value of output - Intermediate consumption
Net value added at MP = Gross value added at MP - Depreciation
Net value added at FC = Net value added at MP - Net indirect taxes
(Net value added at FC = Sum of factor incomes)

In short, by substracting intermediate consumption, depreciation and net indirect taxes from value of output, we get NVA at FC.

Factor Payment vs. Transfer Payment (or Factor Income vs. Transfer Income)

(i) Factor Payment. Payment made to a factor of production in return for rendering productive (or factor) services is called factor payment. This is reward or compensation to factors of production for productive services rendered by them in the production process and for them these are factor incomes. Examples are rent, wages, interest and profit. Income of land is rent, of labour wages, of capital interest and of enterprise profit. Without production we cannot conceive of factor income. All factor payments are included in national income.

Factor incomes earned by factors of production and factor payments made by an enterprise to factors for rendering productive service are, in fact, the same. The former is viewed from the side of factors of production and the latter from the side of an enterprise.

(ii) Transfer payment. Payment which is received without rendering any service or good in return is called transfer payment (or transfer income). These are unilateral payments which have no obligation of any return. For recipients these are unearned incomes. These are received for free, without having to make any present or future payments in return. Transfer payments are basically welfare-oriented expenditure of the government. This is a receipt concept as compared to factor income which is an earning concept. Thus transfer payment is the payment which one gets without adding anything to the current flow of goods and services. Examples are : old age pension, unemployment allowance, gifts in cash, scholarship amount, subsidies, taxes (compulsory transfer payment), etc. All transfer payments (incomes) are kept out (excluded) of national income because no corresponding goods and services are produced against such payments.

Mind, only factor payments (incomes) are included in estimation of national income.

Both factor payments and transfer payments are compared below.

Sources of Domestic Income

Domestic income is the sum of factor incomes generated by all the producing units located within domestic territory of a country in an accounting year. It is sum of net value added at FC of all producing units in the domestic economy irrespective of whether the producing unit is owned by a normal resident or a non-resident (foreigner). It should be understood that sources of income are (i) income from work (i.e., compensation of employees), (ii) income from property (i.e., operating surplus), and (iii) income from self-employed (i.e., mixed income). Accordingly from view point of sources, following are the three components of domestic income.

(i)    Compensation of employees. It refers to all payments and other measurable benefits which the employees receive directly and indirectly in return for rendering productive services. It consists of (a) Wages and salaries in cash. (b) Compensation in kind (like rent-free quarter, free ration, etc.), and (c) Employer's contribution to social security schemes (like provident fund, maternity benefits, Life insurance, etc.).

(ii)    Operating Surplus. Simply put, operating surplus is Net value added at FC minus Compensation of employees (traditionally called wages). In other words, operating surplus is sum of rent, interest and profit. Alternatively, operating surplus is income from property (rent + interest) and income from entrepreneurship (profit). Royalty is included in rent.

(iii)    Mixed income of self-employed. Income of self-employed persons and unincorporated enterprises which use their own resources (land, labour, capital. etc.) is called mixed income of self-employed. Such income is justifiably called mixed income because it is mixture of rent, wages, interest and profit.

Circular flow of money is of two types — real flow and monetary flow. Simply flow of goods and services is called real flow and flow of money (income) is called money flow.

(i)    Real Flows. Real flows refer to flows of goods and services. These are called real flows because they consist of actual goods and services. In the context of national accounting, real flow implies flow of factor services from household sector to the firm (or producing) sector and the corresponding flow of goods and services from firm sector to the household sector. Thus flows of goods and services between firm sector and household sector are real flows. Such flows are continuous and there is no beginning or end point in these flows. In Fig. 6.1, the inner two arrows indicate real flows.

(ii)    Money Flows. These refer to flows of money in the form of factor payments and consumption expenditure. The monetary flows occur because it is through money that various transactions are conducted bringing flows of money from one sector to another. When factor incomes (rent, wages, interest and profit) flow from firm sector to the households as reward for their factor services, these are called money flows. Similarly when households spend their incomes on purchase of goods and services produced by the firm sector, money flows back to the firm sector as household expenditure. These also indicate money flows. In short, flows of money between firm sector and household sector are monetary flows.

Based on the simplified model of two sectors (household and firm sectors), all these flow's are depicted in the following Fig. 6.1. The inner two arrows (anticlockwise) indicate real flows and the outer two arrows (clockwise) reflect monetary flows.

Fig. 6.1

Dual role (of buyer and seller) of each sector perpetuates the circular flow between two sectors.

Value Added (Product) Method, Steps and Precautions
We study it under three sub-headings (a) Method, (b) Steps involved, and (c) Precautions.
Value Added (Product) Method. Under this method, domestic income is first calculated by totalling 'net value added at FC' by all the producing units during an accounting year within the domestic territory. This total is called Net Domestic Product at FC or Domestic Income. Then by adding 'net factor income from abroad' to Domestic Income (NDP at FC), we get National Income (NNP at FC). In value added method national income is measured at the stage of production. In sub-part 12 of Q. 6.2, it has been explained that net value added at FC is derived by subtracting intermediate consumption, depreciation and net indirect taxes from value of gross output. Symbolically :
Net value added at FC = Gross output - Intermediate consumption - Depreciation - Net indirect taxes

Significance of value added method is that it avoids problem of double counting. What is the problem of double counting?

Problem of double counting (A 2010). Double counting means counting value of the same commodity more than once. How? According to output method (an alternative to value added method) of calculating national income, value of only final goods and services produced by all the production units in the economy during a year should be taken. In other words value of intermediate goods should not be taken into account. But in actual practice, value of intermediate goods which have entered as inputs in production of final goods (e.g., wheat used in bread, raw cotton used in garments) also gets included separately because every producer treats sale of its commodity as final product irrespective of what happens to it after sale. As a result there occurs double counting leading to overestimation of national income. Two alternative ways of avoiding double countring are (i) Value of only final goods be included in estimating national income. (ii) Value added method be used in estimating national income.

Steps involved. Following steps are involved in estimating national income by Value added method.
(i)    Identify all the producing units located in the domestic economy and classify them into three industrial sectors such as primary, secondary and tertiary sectors on the basis of similarity of their activities. (Primary sector produces goods by exploiting natural resources like fishing mining, logging; secondary sector produces manufactured goods by transforming one type of commodity into another type of commodity like construction dectricting generation and tertiary sector produces services like educational, medical, banking etc.)
(ii)    Estimate net value added at FC by each producing unit. By deducting intermediate consumption, depreciation and net indirect taxes from value of output, we get net value added at FC.
(iii)    Estimate net value added of each industrial sector by summing up net value added at FC of all producing units falling in each industrial sector.
(iv)    Compute Domestic Income (NDP at FC) by adding up NVA at FC of all industrial sectors.
(v)    Estimate net factor income from abroad and add it to Domestic income for deriving National Income (NNP at FC).

Precautions (Item to be included/excluded). While calculating national income by value added method, value of following items should be included :

(i)    Imputed rent of owner occupied houses because all houses have rental value irrespective of its use by self or tenant.

(ii)    Imputed value of goods and services produced for self-consumption or for free distribution;

(iii)    Value of own-account production of fixed assets by enterprises, government and the households;

(iv)    Only value added and not value of output by production units should be included;

(v)    Do not include sale of second-hand goods as they are not fresh production activity. However, brokerage or commission paid to facilitate sale is included because it is a fresh production activity.

Since national income measures and reflects the current achievements of an economy during a year, value of following items should be excluded from its purview.

(i)    Sales and purchases of second-hand goods. They are not a part of production of the current year. Moreover, their value had already been included in national income of the year in which they were produced. However, if the transaction has been made through a broker, his commission or brokerage should be included because he has rendered productive service. Again services for self-consumption like those of housewives are not included as it is difficult to estimate their market value.

(ii)    Sale of bonds by a company. This is merely a financial transaction which does not contribute directly to the flow of goods and services. Again services for self consumption like those of house wife are not included as it is difficult to estimate their market value.

(iii)    Income of a smuggler. It is an illegal activity and all illegal activities (like smuggling, gambling, black marketing, etc.) are excluded from national income.

Let us briefly recall here concepts of Value Added.

(i)    Value of output = Sales + Change in stock (It is always at MP)

(i.e. gross output)
(ii)    Value added = Value of output - Value of intermediate goods
= Gross product = Gross Value Added at MP
(iii)    NVA at MP = GVA at MP - Depreciation
(iv)    NVA at FC = NVA at MP - Net indirect taxes
= Sum of factor incomes.

Value added by firm X = 100 + 20 - 70 + 200 = 250 lakhs
Value added by firm Y = 500 + 10 - 250 - 200 = 60 lakhs

GDP at MP = Value added by Primary sector  + Secondary sector + Tertiary sector
= (2000 - 1000) + (1800 - 800) + (1400 - 600)
= 2800 crores.

Gross value added = (i) + (iii - ii) - (iv)
= 500 + (20 - 30) - 300 = 190
Gross value added at FC = 190 + 40 subsidy = 230 thousands.

NVA at MP = (700 + 40) - 400 - 80 = 260 thousands.
Note : Purchase of machinery is not included as it is a durable asset to be used in future production.

GVA at MP = 100 + 10 - 15 - 50 = 45 lacs
GVA at FC = 45 + 2 - 10 = 37 lacs.

NVA at MP = 100 + (-10) - 70 - 5 = 15 crores.

NVA at FC = 800 + 20 - 50 - 500 + 40 - 30
= र 280 crores. (Exports are a part of sale.)

Value of output = 100 + 75 + 20 - 5 + 10 = र 200 lakhs.
Note : Value of output always means value of gross output at MP unless stated otherwise.

Gross value added = Value of output - Intermediate consumption
Intermediate consumption = Value of output (at MP)
- Gross value added at MP
= 200 - (80 + 20 + 15 - 5) = र 90 lacs

Gross value added at MP = Sales + Change in stocks - Intermediate consumption
Sales = (NVA at FC + Depreciation + Indirect tax) - Change in stocks + Intermediate consumption
= (300 + 30 + 20) - (-50) + 200
= र 600 lacs.

NVA at FC = 140 + (-10) - 90 + 5 - 20 = र 25 lakhs.
Note : Sales include exports also and Intermediate cost includes import of raw material.

NVA at FC = 800 + (40 -50) - 500 - dep. (200 - 180) + 60
= र 330 lakhs.

(a) Gross value added by sector A = 1000 + 50 - 100 - 500 = 450
Gross value added by sector B = 2000 - 200 - 600 = 1200
(Sales include exports also)
Total = 450 + 1200 = 1650 crores
(b) National income (NNP_FC) = 1650 - Indirect tax - Dep. + NFIA
= 1650 - 120 - 180 + 20 = 1370 crores

Net value added at FC = (ii) + (vi) - (i) - (iv) - (v)
= 750 + (-30) - 500 - 60 - 100 = 60 crore.
(Note: Sales include exports and purchase of intermediate goods includes imports.)
Note : For more numericals, see Q. 6.26 on combined methods.

Private income = (i) + (iii) + (iv) + (v) - (ii)
= 254 + 10 + 10 + (-3) - 4
= 267 crores

Private income = (i) + (iii) + (v) + (vi)
= 4000 + 150 + 50 + (-40)
= 4160 crores

(a) Private income = (iv) + (v) + (vi) + (ix)
= 4,500 + 200 + (-50) + 80 = 4,730 crores
(b)    PDI = 4,730 (Private income) - 80 - 150 - 500
= 4,000 crores.

Private income = GNP at MP - (vi) + 30 + 20 + (-10) - 40 - 70
= 400 - 50 + 30 + 20 - 10 - 40 - 70 = 280 crores

(a) Private income = Private sector income + NFIA + All transfers
= 3500 + (- 30) + (40 + 100)
= 3610 crores
(b)    PDI = Private Income - Corporation tax - Savings of corporate sector - Personal taxes
= 3610 - 150 - 500 - 110
= 2850 crores

Private income = (ii) + (iii) + (iv) + (v)
= 150 + 50 + 25 + 5
= 230 crores

(i) NDP at FC = (ii) + (iv) + (v) + (vii) + (ix) + (x) + (xi)
= 1000 + 100 + 130 + 50 + 200 + 100 + 20 = 1600 crore.
(ii) Private income = NDP at FC - (i) - (iii) + (vi) + (viii) + (xii)
= 1600 - 300 - (-20) + 30 + 40 + (-0) = र 1390 crore.

The income of a country may be stated in the context of (i) its territory, and (ii) its residents. The concept of domestic product is based on production units located within domestic (economic) territory operated by both residents and non-residents. In comparison the concept of national product is based on residents and includes their contribution to production both within and outside the domestic territory.

Domestic Income. 'It is the sum total of factor incomes generated by all the production units located within domestic (economic) territory of a country during an accounting year'. The point to be noted is that factor incomes should be generated within the domestic territory of a country irrespective of the fact whether producers are normal residents (citizens) or non-residents (i.e., foreigners). It is a territorial concept since it is defined with reference to domestic (economic) territory. For example, many non-residential companies and foreign banks operate within domestic territory of India. Income generated by them is included in India's domestic income.

National Income. 'It is the sum total of factor incomes accruing to the normal residents both from within and outside the country during an accounting year'. The point to be noted is that national income includes factor incomes earned by normal residents within and outside the country. It is an economic concept since it is defined with reference to productive efforts of normal residents.

Difference. Simply put, income generated by residents and non-residents within domestic territory of a country is called domestic income and income generated by normal residents within and outside the country is called national income. The difference between the two is net factor income from abroad (see sub-part 11 of Q. 6.2) which is added to domestic income to get national income. Symbolically :

National Income = Domestic Income + Net factor income from abroad

In short, domestic income or product is attributed to all the producers within domestic territory of a country whether they are resident producers or non-resident producers. National income or product is attributed to only normal residents of the country within the country or outside.

Private Income. 'Private income is the total of factor incomes and transfer incomes received from all sources by private sector within and outside the country'. Clearly it includes net factor income from abroad. Private sector consists of private enterprises and workers (factor owners). Thus private income consists of not only factor incomes earned within the domestic territory and abroad but also all current transfers from government and ROW. In this way it is the sum of earned incomes and transfer incomes received by private sector. Thus concept of private income is broader than that of personal income because private income consists of personal income + profit tax + undistributed profit (Refer chart in Q. 6.14). Again it should be kept in mind that conventionally 'net factor income from abroad' is allocated to private sector and not to government sector. Put in the form of equations :

Private Income = Income from domestic product accruing to private sector + Net factor income from abroad + All current Transfers.

= National Income - Income from domestic product accruing to Government Sector + Transfer incomes

= Personal income + Corporate tax + Undistributed profit.

Difference between Private income and Private sector income. Both are different. Private sector income includes only factor income earned within domestic territory by private sector whereas private income includes private sector income, NFIA and all current transfers from within and outside the country. Symbolically :

Private income = Private sector income + NFIA + All Transfer incomes

Three main forms of transfer income used in numericals are : (i) interest on national debt, (ii) current transfers from government administrative departments, and (iii) net current transfer from rest of the world.

The concept of private income is illustrated with the help of following numericals :

GDP at MP (Expenditure method)
= 500 + 200 + {120 + 20 + (- 20)} + (- 30) = 790
National income (NNP at FC) = 790 - 20 - 100 - (- 10) = 670 + 10 = 680 crore
GNDI = NNP at FC + dep + NIT - Net current transfers to ROW
= 680 + 20 + 100 - (- 5) = 800 + 5 = 805 crore.

National Income = Rent + Wages + Interest + Mixed income + Profit tax + Dividend + Undistributed profit + Surplus of public sector + Net assets income from abroad.
= 5,000 + 30,000 + 8,000 + 4,000 + 2,000 + 12,000 + 3,000 + 15,000 + 7,000
= 86,000
Domestic Income = National income - Net assets income from abroad
= 86,000 - 7,000 = 79,000
Personal Income = National income - Profit tax - Undistributed profit - Surplus of public sector + Transfer payment by government + Transfers from abroad
= 86,000 - 2,000 - 3,000 - 15,000 + 1,000 + 2,500
= 69,500
Personal disposable income = Personal income - Personal tax
= 69,500 - 15,00 = 68,000

Mind, expenditure method gives us the value of GDP at MP when measured at the point of expenditure. From expenditure point of view, GDP is gross expenditure on the final use of domestically produced goods and services during a period of account. Basically final use or disposition of goods and services is for two purposes : consumption purposes for direct satisfaction of wants and investment purposes for expanding productive capacity. And expenditure on them is called final consumption expenditure and final investment expenditure. They are further subdivided into five components as shown below. Total final expenditure is equal to GDP at MP. By subtracting depreciation and net indirect taxes from GDP_MP, we get NDP_FC (Domestic Product) and by adding to it net factor income from abroad to NDP_FC, we get national product (NNP_FC).

The following components of GDP are given to help solve numerical sums by expenditure method. Symbolically :

GDP_MP = Private final consumption expenditure + Government final consumption expenditure + Gross fixed capital formation + Change in stocks + Net exports.

Let us discuss briefly each component and see how final expenditure on GDP is arrived at. Mind, final expenditure is that part of expenditure which is incurred on final use of goods and services and not for intermediate purpose.

1. Private final consumption expenditure. It measures the money value of goods and services purchased by households and non-profit institutions for current use during a time period. In this category we include consumption expenditure by consumer households and private non-profit institutions serving households on all types of consumer goods (i.e., durable, semi-durable, non-durable goods and services). Goods are tangible (which can be seen and touched) whereas services are intangible since they have no volume and shape. Private final consumption expenditure includes all categories of consumer goods and services.

2.    Government final consumption expenditure. It is defined as "Current expenditure on goods and services incurred in providing services of government administrative departments less sales." It is incurred by general government to satisfy collective needs of the people. For example, Government expenditure on health, education, general administration, law and order, etc. belongs to this category.

3.    Gross fixed capital formation. This refers to increase in stock of fixed capital during a year which includes depreciation. Expenditure on it consists of the following three main items.

(i) Business fixed investment. It is defined as addition to machinery, factory, building and equipment.

(ii) Residential construction investment. It refers to addition of housing facilities.

(iii) Public investment. It refers to capital formation by government in the form of schools, hospitals, roads, bridges, canals, etc.

4.    Change in stocks. This refers to the physical change in stocks of inventories like raw material, semi-finished goods and finished goods lying with the producers for smooth working of production process. It is the difference between the stocks in the beginning and in the end of the year. Expenditure on it is found out by multiplying the physical change in stocks (lying with the producers) with the market prices. It should be noted that value of change in stock of goods lying with consumers should not be included because all consumer goods are deemed as consumed the moment they are purchased by consumers.

Note : According to SNA. 1993 'net acquisition of valuables' is also a part of gross domestic capital formation, and therefore, it should be treated as component of GDP in expenditure phase.

5, Net exports. (Exports less imports). This refers to the difference between value of exports (e.g., expenditure by foreigners on direct purchase of Indian products) and value of imports (i.e., expenditure by Indians on direct purchase of foreign goods). Be it noted that from expenditure point of view, value of exports is added and that of imports deducted. Mind, exports and imports include both material goods as well as services (non-factor services). Remember, when value of imports is greater than that of exports, it is called net imports. Again exports are treated as investment in foreign country by exporting country and imports as disinvestment. Thus net exports (exports less imports) indicate net investment abroad.

Is export a part of domestic product? Yes, because all the goods and services which are exported are produced by the producers in the domestic economy. For instance, Indian tea, coffee, jute goods, etc. which are purchased by foreigners are produced in India and it is called India's export. In short, since exported goods and services are produced in domestic territory of a country, therefore, export of goods and services is a part of gross domestic product (GDP). Mind export receipts are not 'net factor income from abroad' as they are revenue of the firms from sale of their products.

Components of GDP in expenditure phase are illustrated with the help of the following extract from statement-5 of Government of India publication NAS, 2007.

Consolidated Account of the Nation

Gross Domestic Product and Expenditure

(at current prices)    (र in crores)

Source : NAS, 2007 of Government of India.

 Primary, Secondary and Tertiary Sectors

In India, a government agency, named, Central Statistical Organisation (CSO) which computes official estimates of national income and related aggregates has divided the entire economy into following three sectors. Broadly primary sector exploits natural resources; secondary sector transforms one type of commodity into other; and tertiary sector renders services as explained below.

(i) Primary sector (also called Agricultural sector). This sector includes all production units which produce goods by exploiting natural resources. These include resources like water, forests, agricultural land, coal, iron ore and other minerals, etc. Thus, this sector consists of man's primary occupations such as farming, fishing, mining, etc. This sector supplies basic raw material to secondary sector.

(ii)    Secondary sector (also called Manufacturing sector). This sector includes all production units which are engaged in producing goods by transforming raw material (received from primary sector) into finished products or one type of commodity into another type of commodity. Examples are cloth mills, sugar mills, steel industry, shoe factory, biscuit factory, etc.

(iii)    Tertiary sector (also called Service sector). This sector consists of producing units which are engaged in producing services. For example, banks, transport companies, insurance companies, educational and medical institutions, etc. Thus, tertiary sector provides useful services to the other two sectors.

(a) Real GDP and Nominal GDP. GDP is broadly sum total of value of goods and services produced within domestic (economic) territory of a country in a particular year. GDP can be measured in two ways — at current prices (prices of the year in which goods and services have been produced) or at constant prices (prices prevailing in the base year).

(i) Nominal GDP. When goods and services included in GDP are valued at current prices, i.e., prices prevailing in the year for which GDP is being measured, it is called nominal GDP. For example, Nominal GDP of 2010 is the value of output produced in 2010 calculated at the market prices prevailing in 2010. In short Nominal GDP values current year's output in an economy at current year prices.

(ii) Real GDP. When GDP is measured at constant (fixed) prices, i.e., prices of the base year, it is called real GDP. Constant prices refer to prices prevailing in some carefully chosen year which is treated as base year. It is a normal year devoid of price fluctuations. In short Real GDP values current year output in an economy at base year prices (i.e., constant prices). Real GDP is the indicator economic welfare. In India presently 2004-2005 is taken as base year for constant prices.

Can Nominal GDP be ever less than Real GDP? Yes, when prices in current year are less than the prices in base year.

Significance of distinction. Real GDP truely reflects the level of economic growth whereas nominal GDP does not. Its reason is that nominal GDP is affected by two factors, namely, change in physical output and change in prices whereas real GDP is affected only by change in physical output. If current market prices rise by 100%, nominal GDP will also rise by 100% even though physical output remains the same. On the contrary, real GDP can change only when physical output changes because prices are fixed or constant. Thus, real GDP is a better and more reliable index of growth of an economy.

(b) Conversion of Nominal GDP into Real GDP. To neutralise the effect of price increases and to know the real change in physical output, Nominal GDP is converted into Real GDP. For this purpose GDP deflator is used. GDP deflator measures the average level of prices of all the goods and services that make up GDP. It is calculated as the ratio of nominal GDP to real GDP multiplied by 100. Algebraically:

For example, if nominal GDP (quantity of goods × current prices) is र 21000 crores and real GDP is र 20000 crores, then:

To eliminate the effect of rise in price, we convert nominal GDP into real GDP with the help of GDP deflator on the basis of above data.

(c) Is GDP a correct Index of Welfare? Often GDP (real GDP) is considered as an index of welfare of the people. Welfare means sense of material well-being among the people. This depends upon availability of goods and services per person for consumption. When GDP (or GNP) rises, it shows increase in flow of goods services. Greater availability of goods and services implies higher standard of living which increases economic welfare. So one may conclude that higher level of GDP is an index of greater well-being of the people. But this may not be correct due to following limitations or reasons.

(i) Distribution of GDP. A mere rise in GDP (or GNP or National Income) may not lead to rise in economic welfare if its distribution results in concentration of income in the hands of very few individuals or firms. A mere increase in GDP does not mean that every individual automatically gets this much of increase. Distribution of GDP might have resulted in making the rich richer and the poor poorer leading to further increase in the gap between rich and poor.

(ii) Non-monetary exchanges or transactions. Many economic activities in the economy are not evaluated in monetary terms. Thus non-market transactions like services of housewife, exchanges through barter, enjoyment from hobbies like painting, gardening, etc. which increase economic welfare are not included in measuring GDP. Hence GDP may not reflect actual productive activities and wellbeing of the country.

(iii)    Externalities. These refer to the benefits or harms which a firm or an individual causes to other in the process of production but for which they are not paid or penalised. For example, negative externalities occur when smoke of a factory pollutes the air or its industrial wastes causes water pollution in the nearby river resulting in loss of social welfare. But nobody is penalised for it nor it is accounted in GDP. GDP does not take into account these externalities. Similarly, positive (beneficial) impact of beautiful garden remains outside of realm of GDP. To that extent GDP is not a correct index of welfare as GDP is then underestimated or overestimated.

(iv)    Composition of GDP. In case increase in GDP is due to more production of war material like tanks, weapons, etc., it will not increase economic welfare.

(v)    Rate of population growth. If rate of population growth is higher than the rate of growth of Real GDP, this will lead to fall in per capita availability of goods and services. This may reduce the overall welfare of the society.

Conclusion. GNP may not be an adequate index due to above-mentioned limitations, yet it does reflect some index of economic welfare. Mere enhancement of GNP at any cost may create economic bads like poverty and pollution. That is why some economists have suggested an alternative measure by the name of Green GNP to widen the scope of GDP as a measure of welfare.

(d) Green GNP. Mind, GNP does not take into consideration the cost in terms of (i) environmental pollution, and (ii) depletion of natural resources caused by production of output. Mere increase in GNP will not reflect improvement in quality of life if it increases environmental pollution or reduces available resources for future generations. That is why concept of Green GNP has been introduced while measuring economic welfare.

Green GNP is defined as "GNP which is indicator of a sustainable use of natural environment and equitable distribution of benefits of development." This concept denotes the following characteristics (i) Sustainable economic development, i.e., development which should not cause environmental degradation (pollution) and depletion of natural resources (ii) Equitable distribution of benefits of its of development. (iii) Promotes economic welfare for a long period of time.

Expressed in the form of an equation :
Green GNP = GNP - Net fall in stock of national capital.

GDP - (i) + (ii) + (iii) + (iv) + (v) - (vi)
= 45,000 + 5,000 + 5,000 + 1,000 + 6,000 - 7,000
= 55,000

GDP_MP = (i) + (ii) + (iii) + (v) - (vi)
= 1,00,000 + 12,500 + 25,000 + 6,000 - 9,000
= 1,34,500
NNP_MP = GDP_MP - (iv) + (vii)
= 1,34,500 - 6,000 + 750
= 1,29,250

GDP at MP = 400 + 100 + 50 + 40 + 10 - 20 - 30
= 550 crores
National income = 550 + 5 - 55 - 40 + (- 10)
= 450 crores

GDP_MP (Set I) = 100 + 80 - 50 + 120 + 400 + 50 - 40
= 660 crores
(Set II) = 150 + 100 - 80 + 130 + 600 + 60 - 70
= 890 crores
National Income (NNP_FC)
Set I = 660 - 20 + (- 10) - 60 + 10 = 580 crores
Set II = 890 - 20 + (- 10) - 70 + 10 = 800 crores

GDP - (i) + (ii) + (iii) + (iv) + (v) - (vi)
= 45,000 + 5,000 + 5,000 + 1,000 + 6,000 - 7,000
= 55,000

GDP_MP = (i) + (ii) + (iii) + (v) - (vi)
= 1,00,000 + 12,500 + 25,000 + 6,000 - 9,000
= 1,34,500
NNP_MP = GDP_MP - (iv) + (vii)
= 1,34,500 - 6,000 + 750
= 1,29,250

(a) GNP at MP (Income method)
Set I = 20 + 30 + 45 + 5 + 10 + 400 + 10 + 50 + (-10)
= 560 crores
Set II = 20 + 30 + 45 + 5 + 10 + 400 + 20 + 40 + (10)
= 580 crores
Set III = 20 + 30 + 45 + 5 + 10 + 400 + 10 + 50 + (-20)
= 550 crores
(b) GNP at MP (Expenditure method)
Set I = 10 + 400 + 100 + 50 + 10 + (-10) = 560 crores
Set II = 10 + 400 + 100 + 50 + 20 + 10 = 590 crore
Set III = 10 + 400 + 100 + 50 + 10 + (-20) = 550 crores

(a) National income (NNP at FC) by income method :
Set I = 500 + 20 + 40 + 50 + 100 + 20 + (-5) = 725 crores
Set II = 500 + 20 + 40 + 50 + 100 + 20 + (+5) = 735 crores
Set III = 500 + 20 + 40 + 50 + 100 + 20 + (-10) = 720 crores
(b) National income by expenditure method :
Set I = 120 + 600 + 10 - 100 + 30 + 60 + (-20) + 30 + (-5)
= 725 crores
Set II = 120 + 600 + 10 - 100 + 30 + 60 + (-20) + 30 + 5 = 735 crores
Set III = 120 + 600 + 10 - 100 + 30 + 60 + (-20) + 30 + (-10)
= 720 crores

(a) GNP at FC (Income method)

= (i) + (ii) + (iii) + (viii) + (ix) + Depreciation (v - vii)

= 800 + 160 + 600 + 100 + (-20) + 30 = 1670 crores

(b) GNP at FC (Expenditure method)

= (v) + (ix) + (x) - (xi) + (xii) + (xiii) - (xiv)

= 330 + (-20) + 30 - 60 + 1000 + 450 - 60 = 1670 crores

 (i) NNP at MP (by income method)
= (ii) + (iii) + (iv) + (v) + (vi) - (vii) - (ix)
= 50 + 400 + 80 + 300 + 30 - 10 - 10 = 840 crores
(ii) NNP at MP (by expenditure method)
= (vii) - (ix) + (x) + (xi) + (xii) - (xiii)
= 150 - 10 + 230 + 500 + 15 - 45 - 840 crores

(a) GNP at MP (by income method)
= 90 + 210 + 100 + 20 + 55 - 40 - 25 + 20 + 450 = 880 crores
(b) GNP at MP (by expenditure method)
= 250 + 150 + 20 - 40 + 60 - 80 + 20 + 500 = 880 crores

(a) GDP at FC (Expendiure method)
= 700 + (60 + 60 + 40 + 20) + 200 + (40 - 20) + (10 - 20)
= 1090 crores
(b) GDP at FC (Income method)
= 700 + 100 + 50 + 50 + 100 + 20 = 1020 crores

Income method
GNP at MP (Set I) = 400 + 500 - 20 + 100 + 120 + 350 + 100 + 150
= 1,700 crores
(Set II) = 300 + 400 - 10 + 60 + 100 + 250 + 80 + 70
= 1,250 crores
(Set III) = 500 + 600 - 15 + 150 + 115 + 450 + 200 + 250
= 2,250 crores
Expenditure method
GNP at MP (Set I) - 900 - 20 + 120 + 280 - 30 + 450
= 1,700 crores
(Set II) = 700 - 10 + 100 + 120 - 10 + 350
= 1,250 crores
(Set III) = 1,100 - 15 + 115 + 375 - 25 + 700
= 2,250 crores

(a) NI (by income method) = DI + NFIA
Set I = 1,200 - 20 + 800 + 400 + 620 + 700
= 3,700 crores
Set II = 600 - 10 + 400 + 200 + 310 + 350
= 1,850 crores
Set III = 500 - 10 + 220 + 90 + 100 + 400
= 1,300 crores
(b) NNP_FC (by expenditure method) = GDP_MP - NIT - Dep. + NFIA
Set I = 2,000 + 1,100 + 770 - 30 - 120 - 20
= 3,700 crores
Set II = 1,000 + 550 + 385 - 15 - 60 - 10
= 1,850 crores
Set III = 900 + 400 + 200 - 25 - 165 - 10
= 1,300 crores

GDP at MP = 400 + 120 + 100 + 20 + 30 - 40 = 630 crores
(a) NI (NNP at FC) = GDP_MP - Dep. + NFIA - Indirect tax + Subsidies
= 630 - 20 + (-10) - 65 + 5 = 540 crores
(b) GNDI = GDP_MP + NFIA + Net current transfers from ROW
= 630 + (-10) + (-5) = 6,15 crores

(a) Personal disposable income = 3,000 - 600 - 350 - 300
= 1,750 crores
(b) National income (NNP_FC) = 800 + 900 + (- 50) + 350 + 600 + 450
= 3,050 crores

(a) National income = 1,200 + 400 + 800 + 1000 + (-50) + 250
= 3,600 crores
(b)    Personal incme = 3,600 - 200 - 100 = 3,300 crores
Personal disposable income = 3,300 - 150 = 3,150 crores