CBSE Class 12 Economics National Income Accounting Worksheet Set 04

Question. Why should the aggregate final expenditure of an economy be equal to the aggregate factor payments? Explain. 
Answer: Factor payments are equal to factor incomes. Income is either spent on the purchase of final goods and services or is saved. Expenditure of income on the final goods either causes final consumption expenditure or investment expenditure. To the extent income is saved (or not spent), final goods remain unsold. But unsold goods are treated as a part of inventory investment and therefore, a part of total investment expenditure in the economy. Hence, aggregate final expenditure of an economy is equal to aggregate factor payments. Algebraically,
\( Y = C + S \)
\( = C + I \), because \( S = I \).

Question. Write down the three identities of calculating the GDP of a country by the three methods. Also briefly, explain why each of these should give us the same value of GDP. 
Answer: Three Identities of Calculating GDP
Value Addition:
Value of output (Sales + \( \Delta \)Stock) - Intermediate consumption = \( GVA_{MP} \) = \( GDP_{MP} \)
Income Generated:
Compensation of employees + Rent + Interest + Profit + Mixed income of self-employed + Depreciation + Net indirect taxes = \( GDP_{MP} \)
Final Expenditure:
Private final consumption expenditure + Government final consumption expenditure + Gross domestic fixed investment + Inventory investment + Export - Import = \( GDP_{MP} \)
Value added is identical with income generated because value added (in terms of \( NDP_{FC} \)) is distributed as factor incomes among households who are owners of the factors of production. Further \( GDP_{MP} \) (in terms of value addition) is identical with expenditure on final goods and services, because value of expenditure is nothing but market price of the domestically produced final goods and services during an accounting year.

Question. Suppose the GDP at market price of a country in a particular year was Rs. 1,100 crore. Net factor income from abroad was Rs. 100 crore. The value of indirect taxes - subsidies was Rs. 150 crore and national income was Rs. 850 crore. Calculate the aggregate value of depreciation.
Answer: \( GDP_{MP} = \text{Rs. } 1,100 \text{ crore} \), NFIA (Net factor income from abroad) = Rs. 100 crore, NIT (Net indirect taxes) = Rs. 150 crore and \( NNP_{FC} \) (National income) = Rs. 850 crore.
\( NNP_{FC} + NIT = NNP_{MP} \)
\( = \text{Rs. } 850 \text{ crore} + \text{Rs. } 150 \text{ crore} \)
\( = \text{Rs. } 1,000 \text{ crore} \)
\( GDP_{MP} + NFIA = GNP_{MP} \)
\( = \text{Rs. } 1,100 \text{ crore} + \text{Rs. } 100 \text{ crore} \)
\( = \text{Rs. } 1,200 \text{ crore} \)
Depreciation = \( GNP_{MP} - NNP_{MP} \)
\( = \text{Rs. } 1,200 \text{ crore} - \text{Rs. } 1,000 \text{ crore} \)
\( = \text{Rs. } 200 \text{ crore} \)
Depreciation = Rs. 200 crore.

Question. In a single day Raju, the barber, collects Rs. 500 from haircuts; over this day, his equipment depreciates in value by Rs. 50. Of the remaining Rs. 450, Raju pays sales tax worth Rs. 30, takes home Rs. 200 and retains Rs. 220 for improvement and buying of new equipment. He further pays Rs. 20 as income tax from his income. Based on this information, complete Raju's contribution to the following measures of income: (i) Gross Domestic Product, (ii) NNP at market price, (iii) NNP at factor cost. 
Answer: Assuming intermediate consumption = 0 and change in stock (\( \Delta \)Stock) = 0.
(i) \( GVA_{MP} = \text{Rs. } 500 \) (Raju's contribution to GDP)
(ii) \( NVA_{MP} = GVA_{MP} - \text{Depreciation} \)
\( = \text{Rs. } 500 - \text{Rs. } 50 \)
\( = \text{Rs. } 450 \) (Raju's contribution to \( NNP_{MP} \))
(iii) \( NVA_{FC} = NVA_{MP} - \text{Net indirect taxes} \)
\( = \text{Rs. } 450 - \text{Rs. } 30 \)
\( = \text{Rs. } 420 \) (Raju's contribution to \( NNP_{FC} \))

Question. The value of the nominal GNP of an economy was Rs. 2,500 crore in a particular year. The value of GNP of that country during the same year, evaluated at the prices of same base year, was Rs. 3,000 crore. Calculate the value of the GNP deflator of the year in percentage terms. Has the price level risen between the base year and the year under consideration? 
Answer: \( \text{GNP Deflator} = \frac{\text{Nominal GNP}}{\text{Real GNP}} \times 100 \)
\( = \frac{2,500}{3,000} \times 100 \)
\( = 83.33\% \)
The price level falls between the base year and the year under consideration.

Question. Write down some of the limitations of using GDP as an index of welfare of a country. 
Answer: Following are the limitations of using GDP as an index of welfare of a country:
(i) Distribution of GDP is not taken into account.
(ii) Composition of GDP is not accounted for.
(iii) Non-monetary exchanges remain un-recorded, to which extent GDP remains underestimated.
(iv) Externalities are not considered, even when these have considerable impact on social welfare.

Question. Distinguish between microeconomics and macroeconomics.
Answer: Microeconomics:
(i) Microeconomics studies economic issues or economic problems at the level of an individual—an individual firm, an individual household or an individual consumer.
(ii) Allocation of resources to different uses is the central issue in microeconomics.
(iii) There is a smaller degree of aggregation in microeconomics. Example: We study output behaviour of an industry which is aggregate of all the firms producing a particular commodity.

Macroeconomics:
(i) Macroeconomics studies economic issues or economic problems at the level of the economy as a whole.
(ii) Distribution of the level of output and employment is the central issue in macroeconomics.
(iii) There is a larger degree of aggregation in macroeconomics. Example: We study national output which is aggregate of output of all the producing units in the economy.

Question. Distinguish between intermediate goods and final goods.
Answer: Intermediate Goods:
(i) Intermediate goods are those goods which are used as raw material for further production or are purchased for resale.
(ii) These goods are within the boundary line of production.
(iii) Value is yet to be added to these goods by way of further processing or resale.
(iv) These goods are not included in the estimation of national income.

Final Goods:
(i) Final goods are those goods which are used either for final consumption or for investment.
(ii) These goods have crossed the boundary line of production.
(iii) Value is not to be added to these goods by way of further processing or resale.
(iv) These goods are included in the estimation of national income.
Example: A carpenter buys wood worth Rs. 5,000 and converts it into chairs worth Rs. 10,000. Here, chairs are final goods while wood is an intermediate good.

Question. Distinguish between consumption of fixed capital and capital loss.
Answer: Consumption of fixed capital refers to depreciation of fixed assets. It refers to loss of value of fixed assets while these are being used in the process of production. It occurs on account of: (i) normal wear and tear, (ii) accidental damages, and (iii) expected obsolescence.
On the other hand, capital loss is a loss of value of fixed assets when these are not being used. It occurs on account of: (i) natural calamities (like earthquake, floods or fire), and (ii) fall in market value of the assets during periods of economic recession.

Question. Distinguish between depreciation and depreciation reserve fund.
Answer: Depreciation is the loss of fixed assets in use on account of: (i) normal wear and tear, (ii) normal rate of accidental damages, and (iii) expected or foreseen obsolescence.
On the other hand, depreciation reserve fund is a provision of funds to cope with depreciation losses. These funds are used for the replacement of fixed assets when these are worn-out or when these become obsolete/outdated.

Question. Giving reasons, classify the following into intermediate goods and final goods:
(i) Curtain cloth purchased by a household.
(ii) Machinery installed in an office.
Answer: (i) Curtain cloth purchased by a household is a final good because the household is the final user of the curtain cloth and no value is to be added to the curtain cloth.
(ii) Machinery installed in an office is a final good because machinery is finally and repeatedly used by the office for several years and these are of high value.

Question. Giving reasons, classify the following into intermediate goods and final goods:
(i) Ceiling fan purchased by a tailor for his shop.
(ii) Chalks, dusters, etc., purchased by a school.
Answer: (i) Ceiling fan purchased by a tailor for his shop is a final good because tailor is the final user of the ceiling fan and no value is to be added to the ceiling fan. This will be deemed as investment expenditure because ceiling fan is used by the tailor for several years and is of high value.
(ii) Chalks, dusters, etc., purchased by a school are intermediate goods as these are used up in the process of value addition during the year.

Question. Distinguish between money flows and real flows.
Answer: Flow of income refers to flow of goods and services (or their money value) across different sectors of the economy. It is called real flow in case it occurs in the form of goods and services, e.g., households rendering their factor services to the producers and in return producers offering final goods and services to the households.
It is called money flow because there is a flow of money value from one sector to the other, e.g., producers make factor payments to the households and households make payments to the producers for the purchase of goods and services.

Question. Why is the flow of income and product called a circular flow?
Answer: It is because of the following reasons that the flow of income and product is called a circular flow:
(i) Corresponding to each real flow to one direction, there is a money/income flow from the opposite direction. Example: Corresponding to the flow of factor services (which is a real flow) from household to the producer sector, there is a flow of factor payments (which is a money flow) from producer to the household sector.
(ii) In a two sector economy, receipts of one sector are equal to payments to other sector. In case receipts are less than the payments (or payments are less than the receipts), circularity is bound to stop at one point or the other.
(iii) Activities of production, income generation and expenditure never stop in the economy. They keep chasing one another in a circular manner.

Question. How money flows are opposite to real flows?
Answer: Money flows are opposite to real flows. Because money flows are in response to the real flows. Example: There is a real flow of goods and services from the producers to the households. It is in response to it, that the households make payments to the producers. So that money flows from the households to producers in terms of consumption expenditure. Likewise, there is a real flow of factor services from the households to the producers. It is in response to it, that the producers make payments to the households. So that, money flows from producers to the households in terms of factor payments.

Question. Explain the concepts of injections and leakages in the circular flow of income.
Answer: Injections refer to addition of value in the process of circular flow. This causes positive multiplier effect on the level of income and employment in the economy. Important injections are: (i) Consumption expenditure by the government, (ii) Investment expenditure by the government, and (iii) Exports.
Leakages refer to loss of value in the process of circular flow. This has a negative multiplier effect on the level of income and employment in the economy. Important leakages are: (i) Saving, (ii) Taxation, and (iii) Imports.

Question. When will be domestic factor income greater than national income?
Answer: Domestic Factor Income = Wages + Rent + Interest + Profit + Mixed income of self-employed.
National Income = Domestic factor income + Net factor income from abroad.
Thus, domestic factor income is greater than national income when net factor income from abroad is negative.

Question. What are the items that are excluded from GNP? Give reasons.
Answer: Items that are excluded from GNP are: leisure time activities (like gardening), services rendered by housewives and other such activities whose value cannot be measured in monetary terms; income generated through unlawful activities is also not included, because such income is not legally accountable.

Question. Distinguish between gross domestic product at market price and net domestic product at factor cost.
Answer: \( NDP_{FC} = GDP_{MP} - \text{Depreciation} - \text{Net indirect taxes} \)

Gross Domestic Product at Market Price (\( GDP_{MP} \)):
(i) It is the market value of the final goods and services produced within the domestic territory of a country during the period of an accounting year, inclusive of depreciation (consumption of fixed capital).
(ii) It includes depreciation.
(iii) It includes net indirect taxes.

Net Domestic Product at Factor Cost (\( NDP_{FC} \)):
(i) It is the sum total of factor payments (compensation of employees + rent + interest + profit + mixed income of self-employed) generated within the domestic territory of a country during the period of an accounting year.
(ii) It does not include depreciation.
(iii) It does not include indirect taxes.

Question. Distinguish between gross domestic product at market price and net national product at factor cost.
Answer: \( NNP_{FC} = GDP_{MP} - \text{Depreciation} - \text{Net indirect taxes} + \text{Net factor income from abroad} \)

Gross Domestic Product at Market Price (\( GDP_{MP} \)):
(i) It is produced within domestic territory of a country by normal residents as well as non-residents.
(ii) It includes depreciation.
(iii) It includes net indirect taxes.
(iv) It does not include net factor income from abroad.

Net National Product at Factor Cost (\( NNP_{FC} \)):
(i) It is produced both within and outside the domestic territory of a country, but only by normal residents of a country.
(ii) It does not include depreciation.
(iii) It does not include net indirect taxes.
(iv) It includes net factor income from abroad.

Question. Explain briefly the distinction between gross domestic product at factor cost and net national product at market price.
Answer: \( NNP_{MP} = GDP_{FC} - \text{Depreciation} + \text{Net indirect taxes} + \text{Net factor income from abroad} \)

Gross Domestic Product at Factor Cost (\( GDP_{FC} \)):
(i) It is produced within the domestic territory of a country both by normal residents as well as non-residents.
(ii) It includes depreciation.
(iii) It does not include net indirect taxes.
(iv) It does not include net factor income from abroad.

Net National Product at Market Price (\( NNP_{MP} \)):
(i) It is produced both within and outside the domestic territory of a country, but only by the normal residents of a country.
(ii) It does not include depreciation.
(iii) It includes net indirect taxes.
(iv) It includes net factor income from abroad.

Question. Differentiate between factor inputs and non-factor inputs.
Answer: Factor inputs or primary inputs are factors of production and classified as land, labour, capital and enterprise while non-factor or secondary inputs are those non-durable producer goods and services which are used by the producers for production of goods and services. These are also called intermediate goods. Examples: Seeds, manures.

Question. Explain briefly the basis of classification of production units into primary, secondary and tertiary sectors.
Answer: Production units engaged in exploiting natural resources are grouped under primary sector. Example: Crop farming. Those engaged in transforming one type of commodity into another are grouped into secondary sector. Example: Cloth manufacturing. Those rendering services are grouped into tertiary sector. Example: Shipping services.

Question. What type of data is required to measure national income at each of the three phases of its circular flow?
Answer: The following data are required:
(i) Production Phase: The data relating to net value added at factor cost in primary, secondary and tertiary sectors and net factor income from abroad.
(ii) Income Phase: The data relating to net interest, net rent, net profit, net wages and net factor income from abroad.
(iii) Expenditure Phase: The data relating to private consumption expenditure, government consumption expenditure, gross domestic capital formation, net exports, depreciation, net indirect taxes and net factor income from abroad.

Question. What precautions are necessary while using income method of measuring national income?
Answer: Following are the necessary precautions while using income method of measuring national income:
(i) Income from transfer payments should not be included. (Example: Rs. 5,000 given to you by your father as your b'day gift.)
(ii) Income in terms of capital gain should not be included. (Example: Gain from the sale of old property, shares and bonds.)
(iii) Imputed rent of owner-occupied houses must be included.
(iv) Imputed value of self-owned factor inputs (like use of own premises or own funds in business) should be taken account of.

Question. Give an outline of the steps involved in the estimation of national income with the help of value added method.
Answer: Value added method is that method which measures the contribution of each producing enterprise to production in the domestic territory of the country.
Steps in Value Added Method: The following steps are taken while measuring national income with the help of value added method:
(i) First Step: It involves classification of productive enterprises into three categories, viz., (a) Primary sector, (b) Secondary sector, and (c) Tertiary sector.
(ii) Second Step: Value of output (of a producing unit) is determined by multiplying the quantity of the product by its market price. Gross value added is estimated by deducting the intermediate consumption from the value of output. Depreciation is deducted from gross value added to get net value added.
(iii) Third Step: Net indirect taxes are deducted from net value added at market price to get net value added at factor cost which is equal to net domestic income. Net factor income from abroad is added to net domestic income to get national income.

Question. Give an outline of the steps involved in the estimation of national income with the help of income method.
Answer: Income method is that method which measures national income from the side of payments made in the form of wages, rent, interest and profit to the primary factors of production in an accounting year.
Steps in Income Method: The following steps are taken while measuring national income with the help of income method:
(i) First Step: All the producing enterprises are classified broadly in the following three sectors: (a) Primary sector, (b) Secondary sector, and (c) Tertiary sector.
(ii) Second Step: The net domestic income is calculated by adding: (a) Compensation of employees (Wages + Supplementary income + Payments in kind), (b) Operating surplus (Rent + Profit + Interest), and (c) Mixed income.
(iii) Third Step: Net national income is estimated by adding net factor income from abroad to net domestic income.

Question. Briefly outline the steps involved in the estimation of national income with the help of expenditure method.
Answer: The expenditure method involves the following steps:
(i) First Step: Sum total of the following final expenditure incurred in one year gives gross domestic product at market price: (a) Private final consumption expenditure, (b) Government final consumption expenditure, (c) Gross domestic fixed capital formation, (d) Changes in stocks, and (e) Net exports (Exports – Imports).
(ii) Second Step: The net indirect taxes and depreciation are deducted from gross domestic product at market price to get net domestic income.
(iii) Third Step: The net factor income from abroad is added to net domestic income to get national income.
The expenditure method tries to measure the flow of goods and services for the following purposes: (i) For private consumption, (ii) For government consumption, (iii) For gross domestic capital formation, and (iv) For net exports.

Question. Explain the components of domestic factor income.
Answer: Domestic factor income is the sum total of factor incomes generated within the domestic territory of a country during one year.
Components of Domestic Factor Income:
(i) Compensation of Employees: It is the payments by producers, of wages and salaries to their employees in cash and in kind and of contributions paid or imputed in respect of their employees to social security schemes.
(ii) Operating Surplus: It is the total income from property and entrepreneurship in the form of rent, interest and profit. Profit includes dividends, corporation tax and undistributed profits.
(iii) Mixed Income of the Self-employed: It is the total income of own account workers as well as profits generated in the unincorporated enterprises.
To find out national income, net factor income from abroad is added to domestic income.
National Income = Domestic factor income + Net factor income from abroad.
Net factor income from abroad is added to domestic income to find national income because (i) it facilitates the exclusion of factor incomes earned by non-residents within our domestic territory, and (ii) it facilitates inclusion of factor incomes earned by our normal residents in rest of the world.

Question. State the various components of the income method that are used to calculate national income.
Answer: Income method measures domestic income (\( NDP_{FC} \)) in terms of factor payments to the owners of factors of production for rendering their factor services. It includes the following components:
(i) Compensation of Employees: It includes: (a) Wages and salaries in cash, (b) Payment in kind, (c) Employers' contribution to social security schemes, and (d) Pension on retirement.
(ii) Operating Surplus: It refers to income from property and entrepreneurship. It includes the following items: (a) Rent, (b) Interest, and (c) Profit.
(iii) Mixed Income: It refers to the incomes of the self-employed persons using their own labour, land, capital and entrepreneurship to produce goods and services. These incomes are a mixture of wages, rent, interest and profit.
The above three components add up to \( NDP_{FC} \), briefly called domestic income. Thus,
\( NDP_{FC} = \text{Compensation of employees} + \text{Operating surplus} + \text{Mixed income} \)
Domestic income is adjusted as under to find national income (\( NNP_{FC} \)):
\( NDP_{FC} + \text{Net factor income from abroad} = NNP_{FC} \text{ (National Income)} \)

Question. State the various components of the expenditure method that are used to calculate national income. 
Answer: Expenditure method measures \( GDP_{MP} \) in terms of expenditure on the purchase of final goods and services produced in the economy during an accounting year. It includes the following components:
(i) Private Final Consumption Expenditure (\( C_h \)): It refers to expenditure on final goods and services by the individuals, households and non-profit private institutions serving society.
(ii) Government Final Consumption Expenditure (\( C_g \)): It refers to expenditure on final goods and services by the government, like expenditure on the purchase of goods for consumption by the defence personnel.
(iii) Investment Expenditure (I): It refers to expenditure on the purchase of final goods by the producers. These goods are to be further used in the process of production. This includes: (a) expenditure on fixed assets, called fixed investment, and (b) change in stocks called inventory investment.
(iv) Net Exports (NE): It is the difference between exports and imports during an accounting year.
\( C_h + C_g + I + NE = GDP_{MP} \)
\( GDP_{MP} \) is adjusted as under to find national income (\( NNP_{FC} \)):
\( GDP_{MP} - \text{Depreciation} - \text{Net indirect taxes} + \text{Net factor income from abroad} = NNP_{FC} \text{ (National Income)} \)

Question. Explain the problem of double counting in estimating national income with the help of an example. Also, explain two alternative ways of avoiding the problem.
Answer: The counting of the value of commodity more than once is called double counting. This leads to overestimation of the value of goods and services produced. Thus, the importance of avoiding double counting lies in avoiding overestimating the value of domestic product.
For example, a farmer produces one ton of wheat and sells it for Rs. 400 in the market to a flour mill. The flour mill sells it for Rs. 600 to the baker. The baker sells the bread to the shopkeeper for Rs. 800. The shopkeeper sells the entire bread to the final consumers for Rs. 900. Thus,
Value of Output = Rs. 400 + Rs. 600 + Rs. 800 + Rs. 900 = Rs. 2,700
Infact, the value of the wheat is counted four times, the value of services of the miller thrice, and the value of services by the baker twice. In other words, the value of wheat and value of services of the miller and of the baker have been counted more than once. The counting of the value of commodity more than once is called double counting.
To avoid the problem of double counting two methods are used: (i) Final Output Method, and (ii) Value Added Method.
(i) Final Output Method: According to this method, the value of intermediate goods is not considered. Only the value of final goods and services is considered. In the above example, the value of final goods, i.e., bread is Rs. 900.
(ii) Value Added Method: Another method to avoid the problem of double counting is to estimate the total value added at each stage of production. In the above example, the value added at each stage of production is Rs. 400 + Rs. 200 + Rs. 200 + Rs. 100 = Rs. 900.

Question. Differentiate between gross domestic product at current prices and at constant prices.
Answer: Gross domestic product at current prices is the market value of the final goods and services (produced in an economy during the year) and estimated at prices prevailing during the current year. Gross domestic product at constant prices is the market value of the final goods and services (produced in an economy during the year) and estimated at prices prevailing during the base year (which happens to be the year of comparison).

Question. Explain the concepts of Real GDP and Nominal GDP, using a suitable numerical example. 
Answer: Real GDP (or GDP at constant prices) is the value measured at constant prices of the final goods and services produced within the domestic territory of a country during an accounting year.
Nominal GDP (or GDP at current prices) is the value measured at current prices of the final goods and services produced within the domestic territory of a country during an accounting year.
Example:
Year | Output (Units) | Market Price per unit (Rs.)
2015 | 500 | 20
2016 | 550 | 25
Real GDP during the year 2015 = 500 x Rs. 20 = Rs. 10,000
Real GDP during the year 2016 = 550 x Rs. 20 = Rs. 11,000
Nominal GDP during the year 2015 = 500 x Rs. 20 = Rs. 10,000
Nominal GDP during the year 2016 = 550 x Rs. 25 = Rs. 13,750

Question. Use following information of an imaginary country:
Year | Nominal GDP | GDP Deflator
2014-2015 | 6.5 | 100
2015-2016 | 8.4 | 140
2016-2017 | 9 | 125
(i) For which year is real GDP and nominal GDP same and why?
(ii) Calculate Real GDP for the given years. Is there any year for which Real GDP falls? 
Answer: Real GDP or GDP at Constant Prices
Year | Nominal GDP | GDP Deflator | Real GDP (\( = \frac{\text{Nominal GDP}}{\text{GDP Deflator}} \times 100 \))
2014-2015 | 6.5 | 100 | \( \frac{6.5}{100} \times 100 = 6.5 \)
2015-2016 | 8.4 | 140 | \( \frac{8.4}{140} \times 100 = 6 \)
2016-2017 | 9 | 125 | \( \frac{9}{125} \times 100 = 7.2 \)
We find that,
(i) In 2014-2015, real GDP and nominal GDP are the same. This is because, it is the base year, when the GDP deflator = 100.
(ii) Real GDP falls from 6.5 to 6 in 2015-2016. This is because of a high rise in the price level, even when nominal GDP has risen.

Question. State the significance of real GDP.
Answer: Following observations highlight the significance of real GDP or GDP at constant prices:
(i) Change in Availability of Goods and Services: Only real GDP shows a change in the availability of goods and services to the people of a country. Because any change in real GDP implies a corresponding change in the flow of goods and services in the economy.
(ii) Change in Level of Economic Activity: Real GDP shows change in the level of economic activity in the country. Increase in real GDP implies increase in the level of economic activity (in terms of increase in the level of production).
(iii) Inter-regional and International Comparison: Real GDP facilitates inter-regional and international comparison of the level of production. Nominal GDP does not serve this purpose.

Question. Can gross domestic product be used as an index of welfare of the people? Give reasons.
Answer: Often gross domestic product (GDP) is considered as an index of welfare of the people, but there are strong exceptions to this generalisation. Following are the reasons:
(i) If with every increase in the level of GDP, distribution of GDP is getting more unequal, welfare level of the society may not rise. Only fewer people tend to benefit from an unequal distribution. Hence, the gulf between haves and have-nots may increase which results in lesser welfare of the society.
(ii) Composition of GDP may not be welfare oriented even when the level of GDP tends to rise. There is no direct increase in the welfare of the masses if GDP has risen owing largely to the increase in the production of defence goods.

Question. Social welfare may not increase even when real GDP increases. Explain.
Answer: Increase in GDP may not cause increase in welfare in a situation when distribution of income becomes skewed (unequal). If, along with increase in GDP, the percentage of population below poverty line happens to increase, it implies a situation of deprivation on one hand, and concentration of economic power on the other. It is a situation when a rising percentage of GDP is pocketed by a smaller percentage of population. The bulk of population suffers poverty, while only a small segment of society enjoys prosperity owing to a rise in GDP. The rise in GDP is achieved at the cost of social justice.

Question. How 'distribution of gross domestic product' is a limitation in taking gross domestic product as an index of welfare? Explain.
Answer: Increase in gross domestic product (GDP) is often taken as a measure of economic welfare. This is because increase in GDP implies increased flow of goods and services in the economy. However, distribution of GDP acts as a limitation in this context. If with every increase in the level of GDP, distribution of GDP is getting more unequal, welfare level of the society may not rise. Only fewer people tend to benefit from a larger share of the cake. The gulf between haves and have-nots may increase. The bulk of the population may have even lesser goods than before even when the overall level of GDP has tended to rise.

Question. How 'externalities' are a limitation in taking gross domestic product as an index of welfare? Explain.
Answer: Externalities are the good and bad impact of an activity without paying the price or penalty for that. Example: Positive externalities occur when a beautiful garden maintained by Mr. X raises welfare of Mr. Y even when Mr. Y is not paying for it. There is no valuation of it in the estimation of GDP. Negative externalities occur when smoke omitted by factories causes air pollution, or the industrial waste is driven into rivers causing water pollution. Environmental pollution causes a loss of social welfare. But nobody is penalised for it and there is no valuation of it in the estimation of GDP. Impact of externalities (positive or negative) is not accounted in the index of social welfare in terms of GDP. To that extent, GDP as an index of welfare is not an appropriate index. It either underestimates or overestimates the level of welfare.

Question. GDP may not be an appropriate index of welfare of the people. How?
Or
Explain any four limitations of using GDP as a measure/index of welfare of a country. 
Answer: When real GDP rises, flow of goods and services tends to rise. Other things remaining constant, this implies greater availability of goods per person, leading to higher level of welfare. But there are strong exceptions to this generalisation. Following observations/limitations may be noted in this context:
(i) Distribution of GDP: If with every increase in the level of GDP, distribution of GDP is getting more unequal, welfare level of the society may not rise. In this situation, the bulk of the population may have even lesser goods than before (even when the overall level of GDP has tended to rise).
(ii) Composition of GDP: Composition of GDP may not be welfare oriented even when the level of GDP tends to rise. There is no direct increase in the welfare of the masses if GDP has risen owing largely to the increase in the production of defence goods.
(iii) Non-monetary Exchanges: In economies like of India, non-monetary transactions are quite evident in rural areas where payments for farm-labour are often made in kind rather than cash. Such transactions remain unrecorded. To that extent, GDP remains underestimated and is, therefore, not a proper index of welfare.
(iv) Externalities: Externalities refer to good and bad impact of an activity without paying the price or penalty for that. Example: Negative externalities occur when smoke omitted by factories causes air pollution. Environmental pollution causes a loss of social welfare. Impact of externalities is omitted in the estimation of GDP. To that extent, GDP is not an appropriate index of welfare.

Question. Explain the treatment assigned to the following while estimating national income. Give reasons.
(i) Expenditure on maintenance of a building.
(ii) Expenditure on adding a floor to the building.
(iii) Expenditure on fertilisers by a farmer.
Answer: (i) Expenditure on maintenance of a building is not included in national income. It is an intermediate expenditure incurred on the maintenance of an income generating asset.
(ii) Expenditure on adding a floor to the building is included in national income. It is an investment expenditure or capital formation, as an additional floor leads to asset formation.
(iii) Expenditure on fertilisers by a farmer is not included in national income because it is an intermediate cost for the farmer, as fertilisers are used up in the process of production.

Question. Will the following factor incomes be included in domestic factor income of India? Give reasons for your answer.
(i) Compensation of employees to the residents of Japan working in Indian embassy in Japan.
(ii) Rent received by an Indian resident from Russian embassy in India.
(iii) Profits earned by a branch of State Bank of India in England.
Answer: (i) Compensation of employees to the residents of Japan working in Indian embassy in Japan is a part of domestic factor income of India because Indian embassy in Japan is a part of domestic territory of India.
(ii) Rent received by an Indian resident from Russian embassy in India is not a part of domestic factor income of India because Russian embassy in India is not a part of domestic territory of India.
(iii) Profits earned by a branch of State Bank of India in England is not a part of domestic factor income of India because the branch of State Bank of India in England is not a part of domestic territory of India.

Question. Will the following be included in the national income of India? Give reasons.
(i) Profits earned by an Indian bank from its branches abroad.
(ii) Salaries paid to non-resident Indians working in Indian embassy in America.
(iii) Payment of interest on a loan taken by an employee from the employer.
Answer: (i) Profits earned by an Indian bank from its branches abroad is included in national income of India because it is a part of net factor income from abroad.
(ii) Salaries paid to non-resident Indians working in Indian embassy in America is reflected in the national income of India as a negative component because it is a part of factor income to rest of the world.
(iii) Payment of interest on a loan taken by an employee from the employer is not included in the estimation of national income as the loan is not taken for production purposes.

Question. How will the following be treated while estimating national income of India? Give reasons.
(i) Dividend received by an Indian from his investment in shares of a foreign company.
(ii) Money received by a family in India from relatives working abroad.
(iii) Interest received on loans given to a friend for purchasing a car.
Answer: (i) Dividend received by an Indian from his investment in shares of a foreign company is included in national income of India because it is a part of net factor income from abroad.
(ii) Money received by a family in India from relatives working abroad is not included in national income of India because it is a transfer payment.
(iii) Interest received on loans given to a friend for purchasing a car is not included in national income of India because loans are used not for production purpose.

Question. How will the following be treated while estimating national income of India? Give reasons.
(i) Dividend received by a foreigner from investment in shares of an Indian company.
(ii) Payment of interest by a government firm.
(iii) Scholarship given to Indian students studying in India by a foreign company.
Answer: (i) Dividend received by a foreigner from investment in shares of an Indian company is included in national income of India as a negative component. Because it is a part of net factor income to rest of the world.
(ii) Payment of interest by a government firm should be included while estimating national income of India because it is a kind of factor payment.
(iii) Scholarship given to Indian students studying in India by a foreign company is not included in national income of India as it is a transfer payment.