CBSE Class 12 Economics National Income Revision Notes

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National Income – The money value of all the final goods and services produced by normal residents of a country during a financial year is called national income.

Features of National Income –

  1. National Income always takes the monetary value which can be obtained by multiplying quantity of commodity by their respective prices.
  2.  It includes only the value of final good. The value of intermediate goods is not taken into consideration.
  3. It includes only factor income, transfer income is not included in it.
  4.  It is a flow variable as it is measured during a period of one year.
  5.  It is always measured during a financial year i.e. from 1 April to 31 March.

Consumption Goods- The goods which are purchased by consumer to satisfy their wants are called consumption goods. These goods satisfy human wants directly such as pen, pencil, bread, butter etc. These goods can be further divided into following categories- Durable Goods: These are the goods which can be used again and again in consumption over a long period of time. Such as T.V., Computer, Fan etc. Semi-durable Goods: The goods which can be use for limited period of time are known as Semi durable Goods. These goods have a life span of around one year. Such as clothes, crockery, shoes etc. Non-durable Goods: The goods which are used up in a single act of consumption are called non durable Goods or perishable good. Services –Services are produced and consumed simultaneously; it means there is no time gap between their production and consumption. These are rendered for direct consumption. Such as services of doctor, teacher etc. Capital goods - The goods which help in production of other goods and services and added in the capital stock of a country at the end of an accounting year are called capital goods. It includes durable goods like car, fridge, road etc. Stock of semi finished, finished goods and raw material are also part of it.

 

Stock and flow variable

Stock -The economic variables that are measured at a particular point of time are called stock variables. Stock is static concept. It has no time dimensions. E.g. bank balance as on 1st Oct 2011 is 5000.

Flow-The economic variables that are measured during a period of time are called flow variables. Flow is a dynamic concept. It has time dimensions. E.g. Interest earned on bank deposits for 1 year, i.e. from 1st April 2011 to 31st March 2012.

 

Difference between Intermediate Goods and Final Goods

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Investment or Capital Formation-

The addition in the capital stock of a country is called investment or capital formation. E.g. - Construction of building, purchase of machinery, addition to the inventories of goods etc.

Investment can be of two types1-

1.Gross Investment: The total addition made to the capital stock of economy in a given period is termed as gross investment. It consists fixed assets and unsold stock.

2.Net Investment: The actual addition made to the capital stock of economy in a given period of time is called net investment. It can be obtained by subtracting depreciation or consumption of fixed capital from gross investment.

Net Investment = Gross Investment – Depreciation

QUES 1. What do you mean by circular flow of income? Briefly explain its various types.

Ans: - Circular flow of income- The flow of income among different sectors of the economy is called circular flow of income.

Circular flow is of two types: money flow and real flow

Money flow – It refers to the flow of money in the form of factor payment and consumption expenditure.

In other words money flow refers to the flow of factor payments from firms to household for their factor services and corresponding flow of consumption   expenditure from household to firm for purchase of goods and services produced by the firms. It is also called nominal flow.

  • ♦ Payment for factor services
  • ♦ Household Firms
  • ♦ Payment for goods & services

Real flow- It refers to the flow of factor services from household to firms and the corresponding flow of goods and services from firms to households. It is also known as product flow.

  • ♦ Goods & services
  • ♦ Household Firms
  • ♦ Factor services

 

QUES 2. Briefly explain the production method of measuring national income.

Ans: - Production Method: This method measures the national income by taking the value of final goods and services produced by the different industrial sectors of the economy.

Steps of Measurement:

i) Classify all the production units- It means grouping production units into different sectors in the domestic (or economic) territory. The production units are classified into primary, secondary and tertiary sectors.

ii) Estimate NVAFC of each industrial sector by taking the following sub-steps-

(A) Estimate gross value of output: Gross value of output (GVO) is the total worth of goods produced .It can be estimated in two ways:

(a) As sum of sales and net addition to stocks

Value of output = Sales + change in stock

Where, Change in stock = Closing stock – Opening stock

(b) Quantity of output multiplied by price.

Value of output = Price × Quantity

(B) Estimate value of intermediate consumption and deduct the same from gross value of output (GVO) to arrive at GVAMP.

Gross value added (GVAMP) = GVO - Intermediate consumption

(C) Estimate consumption of fixed capital (depreciation) and deduct it from

GVAMP to arrive at NVAMP.

NVAMP = GVAMP - consumption of fixed capital (depreciation)

(D) Find out net indirect tax by subtracting subsidies from indirect taxes    (NIT= indirect tax – Subsidies) and deduct it from NVAMP to arrive at NVAFC of an industrial sector.

NVA FC = NVAMP – Net Indirect Tax (NIT)

iii)Take the sum of NVA FC of all the production units of all the industrial sectors of the economy to get NDPFC.

NDPFC =Σ NVA FC

iv) Estimate net factor income from abroad and add the same to NDPFC to get the NNP FC or national income.

NNP FC (N.I) = NDP FC + Net factor income from abroad (NFIFA)

Precautions : While estimating national income by the production method / value added method the following precautions must be taken:

i) Avoid double counting of output.

ii) Value of own-account production should be included in total output.

iii) The value of intermediate goods should not be included.

iv) Do not include sale of second hand goods.

 

QUES 3. Briefly explain the income method of measuring national income.

Ans: - Income Method:-This method is also called income distribution method, because in this method we measure the factor incomes paid out (i.e., distributed) to the owners of factors of production by the various industrial sectors of the economy.

Steps in Measurement

i) Classify all the production units - It means grouping production units into different sectors in the domestic (or economic) territory. The production units are classified into primary, secondary and tertiary sectors.

ii) Estimate domestic factor income by each industrial sector: -There are three components of domestic factor income— compensation of employees, operating surplus and mixed income of the self-employed.

a) Compensation of employees refers to all payments by producers to their employees  in the form of wages and salaries both in cash and kind. It also includes social security contributions such as pension, provident fund, gratuity etc.

b) Operating Surplus is the sum of income from property (interest and rent) and income from entrepreneurship (profits = dividend, corporate tax, and undistributed profits). Thus, it is the sum of interest, rent and profits.

Operating Surplus = Rent + Interest + Profits

c) Mixed income of the self-employed is the income earned by self-employed people like doctors, lawyers, chartered accountants, cobblers, barbers, shopkeepers, farmers etc. A part of their income is wage income and another part is property income. Thus it is called mixed income.

NVAFC = COE +OS+MI

iii) Estimation of NDPFC: Take the sum of NVAFC i.e., the factor incomes of all the industrial sectors to arrive at NDPFC

NDPFC=∑ NVAFC

Iv ) Estimation of NNPFC - Add net factor income from abroad (NFIA) to NDPFC to get NNPFC or National Income.

NNPFC (National Income) = NDPFC + NFIA

Precautions-The following precautions are required to be taken while estimating national income by the expenditure method:

4) The imputed value of factor services rendered by the owners of production units should be included in NI.

ii) Do not include any transfer incomes.

iii) Do not include income from sale of second hand goods.

iv)  Do not include income arising from the sale of financial assets.

v) Do not include income from illegal sources.

 

QUES 4. Briefly explain Expenditure Method of measuring national income.

Ans:- Expenditure Method- In expenditure method we measure the expenditures incurred on final goods and services produced by production units located within the domestic (economic) territory of a country during a given year.

Steps of Measurement -

i) Identify and classify production units: Classify all the production units into primary, secondary and tertiary sectors.

ii) Estimate final expenditure on goods and services produced by these industrial sectors. These final expenditures are categorized as follows:

a) Private final consumption expenditure (PFCE) - It is the expenditure of household and non-profit making institutions serving households for durable goods (T.V., Fan etc.), semi-durable goods (clothes, shoes etc.) and non-durable goods (vegetable, bread etc.).

b) Government’s final consumption expenditure (GFCE) - It is the expenditure incurred by government on the purchase of goods and services which are needed to provide facilities to the general public, such as, expenditure on road, school, bridge, hospital etc.

c) Gross domestic capital formation (GDCF) - It refers to the expenditure incurred on the purchase of capital goods, such as plant, equipments, buildings, machine etc. It has two parts- Gross Domestic Fixed Capital

Formation (GDFCF) and Inventory Investment or Change in Stock.

d) Net exports (X-M) - It is the difference between exports of goods & services and imports of goods & services during the given period of time. It refers to the demand of foreigners for our goods & services over domestic demand for foreign countries’ goods & services.

iii) Estimation of GDPMP - The sum of these final expenditures is GDPMP

GDPMP =PFCE + GFCE + GDCF + Net Exports

iv)   Estimation of NDPFC - Estimate the consumption of fixed capital

(Depreciation) and net indirect taxes and deduct these from GDPMP to get NDPFC.

NDPFC=GDPMP – Consumption of fixed capital (CFC) – Net indirect tax (NIT)

v) Estimation of NNPFC- Add net factor income from abroad (NFIA) to NDPFC to get               

        NNPFC or National Income.

        NNPFC (National Income) =NDPFC + NFIA

Precautions:-The following precautions are required to be taken while estimating national income by the expenditure method:

i) Do not include expenditure on intermediate goods and services.

ii) Include imputed expenditure on self-consumed or own account produced output used for consumption and investment.

iii) Do not include expenditure on transfer payments.

iv) Do not include expenditure on financial assets such as share, bond, debenture etc.

v) Do not include expenditure on purchase of second hand goods.

 

QUES 5. Explain the following concepts::-

a) Sectors of economy

b) Injection

c) Withdrawal

d) Double Counting

e) Depreciation

Ans: -

a) Different sectors of economy - There are three sectors of the economy

i) Primary sector- It includes all those production units which exploit natural resources for production. Such as Agriculture, mining, quarrying etc.

ii) Secondary sector- It includes all those production units which transform one good in to another. Such as Industries, construction etc.

iii) Tertiary sector- It includes all those production units which provide services. Such as banking, insurance, transport, communication etc.

b) Injection: The amount of money which is added in the circular flow of income is called injection. Injections increase the speed of flow of income. Some examples of injections are investment (I), government expenditure (G) and export (X).

c) Withdrawal: The amount of money which is taken out from the circular flow of income is called withdrawal. Withdrawals decrease the speed of flow of income. Some examples of withdrawals are savings (S), taxes (T) and import (M).

d) Double Counting – If the value of an item is estimated more than one time in estimation of national income is called double counting. It leads to over estimation of national income.

It can be avoided by two ways

i)             By taking the value added by each enterprise

ii)            By taking the value of final product

e) Depreciation: The reduction in the value of capital assets due to normal wear and tear is called depreciation. These are the foreseen losses so cannot be insured. It is also called consumption of fixed capital. Whenever we subtract net value from the gross value we get depreciation.

Depreciation = Gross – Net

 

QUES 6. Distinguish between domestic product and national product.

Ans: - Difference between domestic product and national product

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QUES 7. (a) When will the domestic income be greater than the national income?

Ans: - If net factor income from abroad (NFIFA) is negative.

b) Why are net exports (X-M) a part of domestic income, and not a part of NFIFA?

Ans: - Exports are goods produced within the domestic territory so treated as a part of domestic income.

 

QUES 8. 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) Profits earned by a branch of foreign bank in India.

(iii) Rent received by an Indian resident from Russian embassy in India.

(iv)  Profits earned by a branch of State Bank of India in England.

Ans : - (i) Yes, It will be included in domestic factor income of India because the Indian embassy in Japan is a part of domestic territory of India.

(ii) Yes, It will be included in domestic factor income of India because the foreign bank is located in the domestic territory of India.

(iii) No, It will not be included in domestic factor income of India because Russian embassy in India is not a part of domestic territory of India.

(iv)  No, It will not be included in domestic factor income of India because branch of State Bank of India which is earning profit is in England which is not a part of domestic territory of India.

 

QUES 9. What is meant by gross domestic product? Explain any three limitations of gross domestic product as a measure of economic welfare.

Ans :- Gross domestic product (GDP) refers to the money value of all then final goods and services produced with in domestic territory of a country during a financial year inclusive of consumption of fixed capital or depreciation. Welfare means sense of material well  being among the people. This depends upon greater availability of goods and services. So it may be concluded that higher level of GDP is an index of greater well being of people. But this generalisation is not correct due to some limitations.

 

QUES 10.Limitations of GDP as a measure of economic welfare.

Ans :- Distribution of GDP- If with increase in GDP inequality of income increase ,poor become poorer while rich become richer. This may lead to decline in welfare even though GDP has increased.

ii) Non-monetary transactions- GDP remains underestimated as non-monetary transactions like services of housewife, barter exchanges, enjoyment from hobbies like gardening, painting etc. are not included in GDP. Although they increase economic welfare.

iii) Composition of GDP- If GDP increases due to more production of war goods like weapons, tanks etc. it will not increase economic welfare.

iv) Externalities- Externalities refer to the benefits (or harms) a firm or an individual causes to another for which they are not paid (or penalized). Externalities do not have any market in which they can be bought and sold. Such as carrying out the production of refinery may also be polluting the nearby river and create pollution. This may cause harm to the people who use the water of the river. Such harmful effects that the refinery is inflicting on others, for which it does not have to bear any cost, are called externalities.

Therefore, if we take GDP as a measure of welfare of the economy we shall be overestimating the actual welfare. This was an example of negative externality. There can be cases of positive externalities as well. In such cases GDP will underestimate the actual welfare of the economy.


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