1. The three adjusting items
- Depreciation (consumption of fixed capital): the fall in value of fixed assets in a year from normal wear and tear and expected obsolescence. Gross − depreciation = net.
- Net indirect taxes = indirect taxes − subsidies. Market price − net indirect taxes = factor cost. If subsidies exceed indirect taxes, net indirect taxes are negative and factor cost exceeds market price.
- Net factor income from abroad (NFIA) = factor income received by normal residents from abroad − factor income paid to non-residents. Domestic + NFIA = national. Its parts: net compensation of employees, net property and entrepreneurial income, net retained earnings of resident companies abroad.
| Item | What it is | Use |
|---|---|---|
| Depreciation | Fixed capital used up by wear and tear and expected obsolescence | Gross − depreciation = net |
| Net indirect taxes | Indirect taxes − subsidies | Market price − net indirect taxes = factor cost |
| Net factor income from abroad | Factor income received from abroad − factor income paid abroad | Domestic + NFIA = national |
| Imagined Phalguni Desh (₹ crore) | Value |
|---|---|
| NDP at market price | 1,800 |
| Indirect taxes | 90 |
| Subsidies | 150 |
| Net indirect taxes | -60 |
| NDP at factor cost | 1,860 |
| Imagined Tirthapur (₹ crore) | Received from abroad | Paid abroad |
|---|---|---|
| Compensation of employees | 180 | 120 |
| Property and entrepreneurial income | 80 | 190 |
| Total | 260 | 310 |
Key terms
- Depreciation
Expected loss in value of fixed capital through use and obsolescence in a year.
- Net indirect taxes
Indirect taxes minus subsidies.
- Net factor income from abroad
Factor income received from abroad minus factor income paid abroad.
2. The eight aggregates
- Choices: gross or net, domestic or national, market price or factor cost: eight aggregates.
- Domestic income = NDP at factor cost; national income = NNP at factor cost.
- Key relations: GNP mp = GDP mp + NFIA; NDP mp = GDP mp − depreciation; GDP fc = GDP mp − net indirect taxes; NNP fc = GDP mp − depreciation − net indirect taxes + NFIA.
- Imagined Ambarpur (₹ crore): GDP mp 4,800; NDP mp 4,440; GDP fc 4,380; NDP fc 4,020; GNP mp 4,740; NNP mp 4,380; GNP fc 4,320; NNP fc 3,960.
- Working back reverses each sign: imagined Devgiri's national income 2,700 gives GDP mp 3,150.
| Market price | Factor cost | |
|---|---|---|
| Gross domestic | GDP mp | GDP fc |
| Net domestic | NDP mp | NDP fc (domestic income) |
| Gross national | GNP mp | GNP fc |
| Net national | NNP mp | NNP fc (national income) |
| Step (imagined Ambarpur, ₹ crore) | Working | Result |
|---|---|---|
| GDP at market price | given | 4,800 |
| NDP at market price | 4800 − 360 | 4,440 |
| NDP at factor cost | 4440 − (470 − 50) | 4,020 |
| NNP at factor cost | 4020 + (-60) | 3,960 |
Key terms
- Domestic income
NDP at factor cost: factor income earned within the domestic territory.
- National income
NNP at factor cost: factor income earned by normal residents, at home and abroad.
3. Domestic territory, normal residents and per capita income
- Domestic territory: political frontiers, territorial waters and airspace, plus embassies, consulates and military bases abroad, ships and aircraft operating abroad, and fishing vessels and rigs in the country's zone. Foreign embassies and international organisations located here are excluded.
- Normal resident: a person or institution that ordinarily resides in the country and whose centre of economic interest is there. Foreign tourists, crews and diplomats are not normal residents.
- Per capita income = national income ÷ population. It falls if population grows faster than national income. Imagined Saptagiri: ₹25,000 to ₹24,000 although national income rose 8 per cent.
| Inside the domestic territory | Outside it |
|---|---|
| Land, territorial waters and airspace | A foreign country's embassy in our capital |
| Our embassies and consulates abroad | Our citizens' flats or firms in other countries |
| Our ships and aircraft operating abroad | Foreign ships passing through our waters |
| Our fishing vessels and oil rigs in our zone | International organisations located here |
| Imagined Saptagiri | Last year | This year |
|---|---|---|
| National income (₹ crore) | 50,000 | 54,000 |
| Population (crore) | 2 | 2.25 |
| Per capita income (₹) | 25,000 | 24,000 |
Key terms
- Domestic territory
The economic territory of a country, including its embassies, ships and aircraft abroad.
- Normal resident
One who ordinarily resides in a country and whose centre of economic interest lies there.
- Per capita income
National income divided by population.
4. Private, personal and disposable income
- Income from domestic product accruing to the private sector = NDP at factor cost − property and entrepreneurial income of government departments − saving of non-departmental public enterprises.
- Private income = that + NFIA + current transfers from government + net current transfers from abroad + interest on national debt (a transfer).
- Personal income = private income − corporate saving (undistributed profits) − corporation tax.
- Personal disposable income = personal income − direct personal taxes − miscellaneous receipts of government (fees, fines).
- Net national disposable income = NNP at market price + net current transfers from abroad; gross = net + depreciation.
- Imagined Lohitpur (₹ crore): 8,300 → 9,000 → 7,900 → 7,100. Imagined Mandakini: net NDI 5,340, gross 5,740.
| Imagined Lohitpur (₹ crore) | Working | Result |
|---|---|---|
| Income accruing to private sector | 9,000 − 400 − 300 | 8,300 |
| Private income | 150 + 250 + 120 + 180 | 9,000 |
| Personal income | − 600 − 500 | 7,900 |
| Personal disposable income | − 700 − 100 | 7,100 |
| Imagined Mandakini (₹ crore) | Value |
|---|---|
| NNP at market price | 5,200 |
| Net current transfers from abroad | 140 |
| = Net national disposable income | 5,340 |
| Depreciation | 400 |
| = Gross national disposable income | 5,740 |
Key terms
- Private income
Factor income and current transfers received by the private sector from all sources.
- Personal income
Private income less corporate saving and corporation tax.
- Personal disposable income
Personal income less direct personal taxes and miscellaneous receipts of government.
- National disposable income
NNP at market price plus net current transfers from abroad (net); gross adds depreciation.
5. Real and nominal GDP
- Nominal GDP: output valued at current-year prices; it changes with both quantities and prices.
- Real GDP: output valued at base-year prices; it changes only with quantities and is used to measure growth.
- GDP deflator = nominal GDP ÷ real GDP × 100. Real GDP = nominal GDP × 100 ÷ deflator.
- Imagined Ketakipur: nominal 4,000 → 6,000 (up 50 per cent); real 4,000 → 4,800 (up 20 per cent); deflator 125.
| Imagined Ketakipur | Base year | Current year |
|---|---|---|
| Rice: quantity × price | 100 × ₹20 | 120 × ₹25 |
| Cloth: quantity × price | 50 × ₹40 | 60 × ₹50 |
| Nominal GDP | 4,000 | 6,000 |
| Real GDP (base-year prices) | 4,000 | 4,800 |
Key terms
- Nominal GDP
GDP at current prices.
- Real GDP
GDP at constant base-year prices.
- GDP deflator
Nominal GDP divided by real GDP, times 100.
6. GDP and welfare
- Economic welfare: well-being from goods and services that can be measured in money.
- Distribution of income: GDP shows the total, not who gets it; if gains go to a few, most people may not be better off.
- Non-monetary exchanges: unpaid household work, self-produced goods and barter are largely excluded, so GDP understates welfare.
- Externalities: harms (pollution) are not deducted and benefits (a public garden) are not added, so GDP can overstate or understate welfare.
- Conclusion: real GDP is a useful but incomplete index of welfare.
| Limitation | Why GDP misleads | Effect on GDP as a welfare index |
|---|---|---|
| Distribution of income | Shows the total, not who gets it | May overstate welfare if gains go to a few |
| Non-monetary exchanges | Unpaid work and self-produced goods are left out | Understates welfare |
| Externalities | Unpaid harms and benefits to others are not counted | Overstates (harms) or understates (benefits) |
| Negative externality | Positive externality | |
|---|---|---|
| Example (imagined) | A tannery pollutes the river used by fishing families | A family garden freshens the air of the whole street |
| Paid for? | No compensation to those harmed | No payment by those who benefit |
| GDP treatment | Harm not deducted | Benefit not added |
Key terms
- Economic welfare
Well-being from goods and services that can be valued in money.
- Externality
An unpaid harm or benefit to others from an activity.
Exam tips
Common mistakes
- Adding subsidies to indirect taxes instead of subtracting them.
- Dropping the minus sign of a negative NFIA.
- Including interest on national debt in national income (it belongs in private income only).
- Subtracting personal taxes when asked for personal income.
- Comparing nominal GDP across years as if it measured output.
How marks are usually awarded
- 1 mark: a correct option, a definition or a one-step calculation.
- 2 marks: two points, or a formula with its value.
- 3 marks: a calculation in steps with each aggregate named, or three points.
- 5 marks (and ISC 4- and 8-mark questions): working shown in parts, each step named, and a reasoned conclusion.