Preface UNIT 5: NATIONAL INCOME AND RELATED AGGREGATES 1. Circular Flow of Income 2. Basic Concepts of Macroeconomics 3. National Income and Related Aggregates 4. Measurement of National Income UNIT 6: MONEY AND BANKING 5. Money 6. Banking: Commercial Banks and The Central Bank UNIT 7: DETERMINATION OF INCOME AND EMPLOYMENT 7. Aggregate Demand and Related Concepts 8. Income Determination and Multiplier 9. Excess Demand and Deficient Demand UNIT 8: GOVERNMENT BUDGET AND THE ECONOMY 10. Government Budget and the Economy UNIT 9: BALANCE OF PAYMENTS 11. Foreign Exchange Rate 12. Balance of Payments REVISION SECTION * Scanner CBSE (2007-2016) * Important Questions * Value Based, Evaluation & Multi-Disciplinary Questions * CBSE Sample Paper 2016-17 (with Answers) * CBSE Examination Paper 2016 (Delhi) (with Marking Scheme) {All India) Question Paper Appendix-1: Demonetisation in India * CBSE Examination Paper 2016 Contents (i) 14-414 24 -2.20 3.1-3.57 41-4125 5.1 -5.20 6.1-6.22 741 8.1 - 8.46 9.1-9.19 10.1 - 10.33 14.1-11.20 12.1-12.18 Ra -R24 R25 -R.28 R.29-A.34 R35 - R38 R39- AAS R.46-R48 R49 - R52 ‘scannea witn vamscanner1 CIRCULAR FLOW OF INCOME LEARNING GBJECTIVES' INTRODUCTION 1,2. MEANING OF CIRCULAR FLOW OF INCOME 1.3, STOCK AND FLOW 1.4 TYPES OF CIRCULAR FLOW 1.5 CIRCULAR FLOW IN A SIMPLE ECONOMY (TWO-SECTOR ECONOMY) 1.1 INTRODUCTION The unlimited and recurring wants of human beings have made the production process, a continuous process. In this process, different factors of production: Land, Labour, Capital and Enterprise are combined together for production of goods and services. * Firms produce goods and services with collective efforts of factors of production supplied by the household sector * Firm makes payment to the factors of production in the form of rent, wages, interest and profit (known as factor incomes). * The household sector spends this money on the purchase of goods and services produced by the firms. Thus, income flows first from firms to households in the form of factor payments and then, from households) to firms in the form of consumption expenditure. Such a flow of money is known as the circular flow of income. 41.2 MEANING OF CIRCULAR FLOW OF INCOME It refers to cycle of generation of income in the production process, its distribution among the factors of production and finally, its circulation from households to firms in the form of consumption expenditure on goods and services produced by them, Phases of Circular Flow of Income There are 3 different phases (generation, distribution and disposition) in circular flow of income, as shown in the given diagram: Ww Sexe tgs cannes witn vamscannerae Introductory Macroeconomi 1, Generation Phase: In this phase, firms produce goods and services with the help of factor services. Distribution Phase: This phase involves the flow of factor income (rent, wages, interest and profit) from firms to the households. Production Phaso {Goneration of incor) r 3, Disposition Phase:In this phase, the income received by factors of production, is spent on the goods and services produced by firms. In this way, income generated in production units Fail reaches back to production units and makes the circular flow complete. Expenditure Phaso (Disposition of Income) 41.3 STOCK AND FLOW The concepts of stock and flow are used frequently in macroeconomics. Some of the macro is important to understand variables relate to stock, while others relate to flow. Therefore, it their meaning so that variables can be categorised as stock or flow. Stock Stock variable refers to that variable, which is measured at a particular point of time, For example stock of goods in the gadown as on 31* January, 2019, It means, stock variables are not time dimensional. Some more examples of stock variables are National wealth, National capital, Money supply etc. Flow Flow variable refers to that variable, which is measured over a period of time. For example, production of goods during the month of January 2019, birth rate in the year 2018, National Income in the year 2018 are flow variables. The ‘period of time’ could be a day, a week, a year, etc. It means, flow variables are time dimensional as they are measured for a period of time. Examples for Better Clarity + The amount of water in tank is the quantity of water in Ste of water ina tank the tank at a given point of time. On the other hand, water flowing into the tank from a tap is a flow of water being, added to the tank per unit of time. © The total number of houses as on December 31, 2018 is the stock concept, while the number of houses constructed during the year 2018 is a flow variable. Flow of wate from tank Seavey tgs cannes witn vamscannerCircular Flow of come Difference het Basis | 2 Stock and Flow Stock Meaning | Stock variable reters to that variable, | which is measured at a particular pein! oftime, “Flow Flow variable refers to that variable, Which is measured over a period of uno, Time Ndoes not have atime dimension. | it has a time dimension as iie| imension magnitude can be measured over a Period of time. Nature of Itls a static ‘concept. Itis a dynamic concept. concept Examples | 1. Population of india as on 31.03.18, |1. Nomberol births during 2018. 2. Total number of Maruti cars in Delhi. |2. Maruti cars manufactied during January, 2019, 3. Money supply (money in circulation). | 3. Exponditure or transactions in money. 4, National Wealth, 4, National Income. 5. Quantity of wheat stored, 5, Quantity of wheat produced, 1.4 TYPES OF CIRCULAR FLOW There are two types of circular lows: (i) Real flow; (i) Money Flow. Real Flow Real flow refers to the flow of factor services from households to firms and the correspondiny flow of goods and services from firms to households. As seen in the diagram, households provide factor services Factor Services ——_ to the firms which, in turn, provide goods and services to itand Labo Capt ar Crerprve) them as a reward for their productive services. Wousanoiae Ga * Itis also known as ‘Physical flow’. t * There is only exchange of goods and services between Goods and Services —! the two sectors without involvement of any money. Fig. 1.2 * Real flow determines the magnitude of growth process in an economy. For example, wher more factor services are offered to firms, then volume of production will be more and i speeds up the process of economic growth. Money Flow Money Flow refers to flow of factor payments from firms to cenungun households for their factor services and corresponding flow eae — of consumption expenditure from households to firms for purchase of goods and services produced by the firms. Househorde os As seen in the diagram, firms make factor payments to t - 7 i i ischolds spend this 12 —| households for their factor services and house reco Deyn tinction purchase of goods and services produced by the or om ae firms. cannes witn vamscanner4 Introductory Macroeconomics * Itis also known as ‘Nominal flow’. + Itinvolves exchange of money between the two sectors. Difference between Real Flow and Money Flow Basis Real Flow Money Flow Meaning |Ilis the flow of goods and services |Itis the flow of money between firms between firms and households. and households. Kind of {It involves exchange of goods and | It involves exchange of money. exchange _| services. Difficulty in There may be difficulties of barter There is no such difficulty in case of exchange _ | systemin exchange of goods and factor | money flow. services. Alternative | Itis also known as Physical Flow. Itis also known as Nominal Flow. Name 4.5 CIRCULAR FLOW IN A SIMPLE ECONOMY (TWO-SECTOR ECONOMY) —_ A simple economy assumes the existence of only two sectors, i.e. household sector and firm sector. * Households are the owners of factors of production and consumers of goods and services. * Firms produce goods and services and sell them to the households. Itis the simplest form of closed economy"*, in which there is no government sector and foreign trade. *Closed Economy san economy which has no economic relations with rest of the world. Qpen Economy Is an economy which has economic relations with rest of the world. In order to make our analysis simple, we take some assumptions: 1. There are only 2 sectors in the economy: Households and Firms. It means, there is no government and foreign sector. Household sector supplies factor goctor Services services only to firmsand the firms hire [e0P tm four Domestic concepts. The term (+) Dop nr ‘Domestic’ signilies that contribution of only those producers (whether resident (NOP MP (cop at Fc) or non-resident) is lo be included who are within the domestic territory of the country. (+) NIT (-)Dep Gross National Product at Market Price (GNP, up) 1 refers to gross market value ofall the final goods and services produced by the normal residents of country during a period of one year. GNP p= GDP yp + Net factor income from abroad Seamed tps cannes witn vamscannerNational Income and Related Aggregates 33 Mmust be noted that GNP, pcan be less than GDP, when NFIA is negative. However r, GNP, il be ‘more than GDP,» when NFIA is positive. ” ene "GNP Gross National Product at Factor Cost (GNP) It refers to gross money value of all the final goods and services produced by the normal residents of a country during a period of one year. GNP, = GNP\yp— Net Indirect Taxes Net National Product at Market Price (NNPyyp) I refers to net market value of all the final goods and services produced by the normal residents of a country during a period of one year. NNP\yp= GNPyyp~ Depreciation Net National Product at Factor Cost (NNP;c) It refers to net money value of all the final goods and services produced by the normal residents of a country during a period of one year. NNPro NP \yp~ Net Indirect Taxes - Depreciation itmust be noted that NNP,- is also known as National Income. Relationship Between Four National Concepts GNP yp GNP,c, NNPyp and NNP,c > (GHP ame}, are tour National concepts. The term (+) Dop (Nr ‘National’ signifies that production of ‘only normal residents of the country isto LNNP at MP GNP at FC be included even if they are outside the [, domestic territory of the country. (+) NIT (-) Dep Domestic Income (NDP, .) Vs National Income (NNP}.) Bas Domestic Income National Income i tudes itis a terntorial concept as it includes | It is a national concept as it incl | eae the value 1 final goods and services | the value of final goods and services produced within domestic territory of | praduced in the entire world. country, r iti it considers all producers who are of | It considers all producers within the | | I Paxducera domestic territory of the country. normal residents of the country. ; NFIA I does not include NFIA. Itincludes NFIA. Seamed TpSomeer cannes witn vamscanner3.4 Introductory Macroeconomic, DOMESTIC INCOME fl (NOP) | | (-) Not Factor income from abroad (+) Depreciation | () Net inarect Taxes, | NP at MP GDP at FC T T ] (-) Depreciation (+) Not Indirect Taxes, GNP at MP GDP at MP | (+) Net Indirect Taxes (-) Depreciation | 1 GNP at Fo) NOP at MP_ t T (+) Net Factorincome (+) Depreciation trom abroad (-) Net Indirect Taxes NATIONAL INCOME (NNP,<) Gross Domestic Product at Market Price Vs National Income, Basis Gross Domestic Product at | National Income (NNPpc) te Market Price (GDPyp) Nature of His aterntonal concept as includes Itis a national concept as it includes Concept value of final goods and services the value of final goods and services produced within domestic torntory of | produced in the entire world. a country + Catagory of | i considers all the producers within | It considers the producers who are Producers _| the domestic territory of the country. | normal residents of the country. Net Indirect | itis at market pice, .e includes net | Its at factor cost, 1. it excludes net taxes indirect taxes. indirect taxes Depreciation | It is inclusive of depreciation. Itdoes not include depreciation. Steps for Calculating Practicals of Basic Aggregates of National Income ight basic aggregates of National Income: | 4Domestic Concepts : GDPyp GDPp¢ NOPy» NOP ro ' 4National Concepts: GNPyp GNPpe NNPyp NNPre While solving practicals of National Income, we are often required to calculate one of the basi aggregate out of the other 7 aggregates. For better understanding of the steps, let us asad that we have to calculate NDPy¢ from GNPyyp? ‘The various steps are: Step 1. Formulate an equation by putting “Aggregate to be calculated on the left hand side’ and “Aggregate given on the right hand side’. Considering the given example, the equation will be: NDPr< = GNPyyp = Adjustments. Seamed tps cannes witn vamscannerNational income and Related Aggregates i Step 2. Identity the “Adjustments and calculate the answer, AS we have to calculate NOP, from GNPyp, there are thiee adjustments required * [Glin GNP yo signties Gross, ie. it includes depreciation. So, Depreciation will be subtracted fom GNP yp to arrive at NNPyp * Nin GNP yp signifies National, 1 @. includes Net Factor Income trom Abroad (NFIA). So, NFIA ‘ill be subtracted from NNPyp to arrive at NDP yp * MP" in GNP yp signifies Market Price. ie. it includes Net Indirect Taxes (NIT). So, NIT will be subtracted trom NDP yp to arnve at NDP. The equation will become: NDP,< = GNP» Depreciation - NFIA NIT. Alter putting the respective values of GNPyp, Depreciation, NFIA and NIT, we can calculate NDP... Let us understand this with the help of following illustrations: Illustration 1. Calculate NDP at FC. () GNP atMP (i) Depreciation (iii) Net Factor Income from Abroad (iv)_Net indirect taxes inthe gran question, NDP, is to be calculated from GNP,,.. It can be calculated through following steps: Step 1. Formulate an equation by putting 'NDP,.,on the left hand side’ and “GNPyp on the right hand side’. NDP, ¢ = GNPyp + Adjustments Step 2. Identity the Adjustments’ and calculate the answer. Depreciation, Net Factor Income from Abroad (NFIA) and Net indirect taxes (NIT) wilbe subtracted from GNP,» to arrive at NDP,<. NDP,, = GNPyp — Depreciation - NFIA - NIT = 8,000 - 600 - 300 - 700 NDP,< = 26,400 crores. Illustration 2. Calculate GDP at MP. () NNPat FC (ii) Depreciation (iii), Subsidies (iv) Factor Income from Abroad (v) Indirect Taxes (vi) Factor Income to Abroad Sexe tps scannea witn vamscannerIntroductory Macroeconomic, 3.6 Solution: inthe given question, GOP yp is to be calculated trom NNP,c. ltcan be calculated through following step, Step 1. Formulate an equation by putting GOPypon the Jetthand side’and'NNP,,on the right hand side. GDP yp = NNPre Adjustments Step 2. Identity the Adjustments’ and calculate the answer Depreciation and Net Indirect taxes (NIT) wil be addi (NFIA) willbe subtracted trom NNP,, to arrive al GDP yp GDP yp = NNP,, + Depreciation - NFIAY + NIT? = 2000 + 200 — ~ (110-50) + (180-70) GDP yp = 72,250 crores. ‘Note: NFIA* = Factor Income from Abroad - Factor Income to Abroad, NIT? = indirect Taxes ~ Subsidies ‘Solved Practicals’. led while Net Factor Income from Abroag For more practicals of Basic Aggregates of National Income, refer ‘Section 3.7: 3.3 SOLVED PRACTICALS _____———————————————————————————————— | Important Formulae ata Glance Net Indirect Taxes = Market Price - Factor Cost Depreciation = Gross Value - Net Value Net Factor Income from Abroad = National Value - Domestic Value GDP,¢ = GDP yp — Net Indirect Taxes NDPyp = GOPyp ~ Depreciation Domestic Income or NDP,- = GDP yp - Depreciation ~ Net Indirect Taxes GNPyp = GOP, + Net Factor Income from Abroad GNP ye = GNPyp~ Net Indirect Taxes NNPyp = GNP,» ~ Depreciation National Income or NP, = GNP,,»- Depreciation - Net Indirect Taxes Example 1. Calculate Domestic Income or NDP at FC Particulars Zin crores _| () GNP at MP 6,000 (i) Subsidies 200 (ii) Depreciation 100 (iv) Net Factor income from abroad 400 (v)_ Indirect tax 300 Solution: NDP at FC GNP at MP — Depreciation - Net Factor i i di enh oD pr a mone — income from abroad - (Indirect tax - Subsidies} Ans. NDP at FC = 75,400 crores Seamed tps cannes witn vamscannerNational Income and Related Aggregates 3? The Solution of Example 1 can also be presented as: i) — (ii) - ivy - 0) - (iy) 6,000 - 100 ~ 400 - 1300 - 200) = & 5,400 crores Ans. NDP at FC = Example 2. Calculate National Income or NNP at FC. 400 crores Particulars in crores (0 GOP at MP 5,500 (i) Consumption of Fixed Capital 300 (iil) Goods and Services Tax 120 (iv) Factor income from abroad 150 (v) Subsidies 70 (vi)_Factor income to abroad 250 Solution: National Income or NNP at FC = GDP at MP - Consumption of Fixed Capital + (Factor income from abroad - Factor income to abroad) - (Goods and Services Tax - Subsidies) = 5,500 ~ 300 + (150 - 250) - (120-70) = 5,050 crores Ans. NNP at MP = @ 5,050 crores Wwcrwo4aSorys Example 3. Calculate GNP at FC. NOP at MP Depreciation 4 (iii) Subsidies Factor income from abroad Factor income to the rest of the world Solution: Note: In the given example, only subsidies are (Add subsidies (as factor cost 1s to be calculated trom the market price): or taxes - Subsidies) and put value of indirect taxes as zero. given. There can be two ways to solve this: (ii) Write formula as: (Indirect GNP at FC / = NDP at MP + Depreciation + (Factor income from abroad — Factor income to the rest of the world) + Subsidies = 25,000 + 5,000 + (400 - 600) + 30 29,830 crores ‘The Solution of Example 2 can also be presented = NDP at MP + Depreciation + (Factor income of the world) - (Indirect tax - Subsidies) as: from abroad — Factor income to the rest Sexe tgs cannes witn vamscanner