1. Consider the economy of Petronia that earns national income from extraction of petrol.
Most of the petrol is consumed at home but a part of its production (20%) is sold
illegally every year so that proprietors’ income is under-reported. Use the following
data (in billion USD) for a given year:
Compensation of employees: 𝑊 = 850
Corporate profits: Π = 420
Proprietors’ income: Π = 210
Rental income: 𝑅 = 160
Net interest income: 𝐼 = 140
Additional information:
Depreciation (Consumption of Fixed Capital): 𝐷 = 120
Indirect taxes: 𝐼𝑇 = 200
Subsidies: 𝑆 = 40
Net factor income from abroad: 𝑁𝐹𝐼𝐴 = −30
Undistributed corporate profits: 90
Corporate income taxes: 70
Social security contributions by employers: 60
Statistical discrepancy: 𝑆𝐷 = 15
Questions
(a) Using the income approach, compute Net Domestic Product at factor cost (NDP FC).
(b) Derive GDP at market prices (GDPMP).
(c) Calculate Gross National Product at market prices (GNPMP).
(d) Suppose policymakers discover that 10% of proprietors’ income actually reflects corporate
profits rather than factor income. And additional corporate profits will be taxed at 50%.
Adjust the NDPFC calculation.
Recompute GDPMP.
(e) In a certain year like 2026, when Petronia is at war, the Government severely increases
taxes to fund the war expenditure. Depreciation rate has also increased. How will this
affect GDPMP and GDPFC?
Answer:
Compensation of employees: 𝑊 = 850
Corporate profits: Π = 420
Proprietors’ income: Π = 210
Rental income: 𝑅 = 160
Net interest income: 𝐼 = 140
Additional information:
Depreciation (Consumption of Fixed Capital): 𝐷 = 120
Indirect taxes: 𝐼𝑇 = 200
Subsidies: 𝑆 = 40
Net factor income from abroad: 𝑁𝐹𝐼𝐴 = −30
Undistributed corporate profits: 90
Corporate income taxes: 70
Social security contributions by employers: 60
Statistical discrepancy: 𝑆𝐷 = 15
NDPFC = Compensation + Corporate profits + Proprietors’ income + Rental income + Net
interest income + Undistributed corporate profits + Social security contributions by
employers + Statistical discrepancy
= 850 + 420 + 210 + 160 + 140 + 90 + 60 + 15 = 1945
Most of the petrol is consumed at home but a part of its production (20%) is sold illegally
every year so that Proprietors’ income is under-reported.
So, the new corrected proprietor’s income will be 210 + 20% of 210 = 210 + 42 = 252
So, the new corrected NDPFC = 1945 + 42 = 1987
GDPFC = NDPFC + Depreciation
= 1987 + 120
= 2107
GDPMP = GDPFC + Taxes – Subsidies
= 2107 + 200 + 70 – 40 = 2337
GNPMP = GDPMP + Net factor income coming from abroad
= 2337 – 30 = 2307
In a certain year like 2026, when Petronia is at war, the Government severely increases
taxes to fund the war expenditure. Depreciation rate has also increased. As taxes and
depreciation are increased and it’s not a part of NDPFC so it will not be changed. But
depreciation is a part of GDPFC so it will be increased definitely. As GDPFC is changed now
and the tax is also increased so GDPMP will also be increased in this phase.
2. Consider the economy of Republic of Petrovia, a resource-rich country whose economy
heavily depends on crude oil extraction. Due to weak regulation, a significant portion of
economic activity takes place in the underground economy.
The following data (in billion USD) are reported for a given year.
Component
Compensation of employees 920
Corporate profits (before tax) 480
Proprietors’ income (mixed income) 260
Rental income 180
Net interest income 160
Additional Information
Component Value
Depreciation (Consumption of Fixed Capital) 150
Indirect taxes 240
Subsidies 50
Net factor income from abroad -40
Statistical discrepancy 20
Corporate income taxes 90
Undistributed corporate profits 110
Social security contributions by employers 70
Transfer payments by government 120
• 25% of proprietors’ income is generated from illegal oil exports and is not reported.
• 15% of corporate profits actually represent capital gains from asset price
appreciation (not production).
• The government later discovers that 10% of wages were paid in cash to undocumented
workers and were not initially reported.
Questions
(a) Using the income approach, calculate Net Domestic Product at factor cost (NDPFC) based
on the officially reported data.
(b) Derive GDP at market prices (GDPMP).
(c) Calculate Gross National Product at market prices (GNPMP).
(d) Adjust the national income accounts after the statistical authority discovers the underground
economy components:
• Include the unreported proprietors’ income.
• Include the unreported wage payments.
• Remove capital gains from corporate profits.
Then compute the corrected NDPFC.
(e) Using the corrected NDPFC, recompute:
• GDPMP
• GNPMP
(f) Suppose the government introduces a windfall profit tax of 40% on oil companies,
increasing indirect taxes by 60 billion USD, while subsidies remain unchanged.
Analyse:
• The effect on GDPMP
• The effect on GDPFC
• Whether real production changes
Explain economically.
Answer:
NDPFC = Compensation + Corporate profits + Proprietors’ income + Rental income + Net
interest income + Undistributed corporate profits + Social security contributions by employers
+ Statistical discrepancy
= 920 + 480 + 260 + 180 + 160 + 20 + 110 + 70 = 2200
GDPFC = NDPFC + Depreciation
= 2200 + 150
= 2350
GDPMP = GDPFC + Indirect taxes – Subsidies
= 2350 + 240 + 90 – 50 – 120
= 2510
Later on, it is found that
25% of proprietors’ income is generated from illegal oil exports and is not reported.
New proprietor’s income = 260 + 25% of 260
= 260 + 65
= 325
15% of corporate profits actually represent capital gains from asset price appreciation
(not production).
480 – 15% of 480
= 480 – 72
= 408
The government later discovers that 10% of wages were paid in cash to undocumented
workers and were not initially reported.
= 920 + 10% of 920
= 920 + 92
= 1012
So new corrected NDPFC = 2200 + 65 + 92 – 72
= 2285
New corrected GDPFC = 2285 + 150
= 2435
GDPMP = 2435 + 240 + 90 – 50 – 120
= 2595
GNPMP = 2595 – 40
= 2555
Government introduces a windfall tax of 60 billion USD
So, the NDPFC and GDPFC will not change but the GDPMP and GNPMP will change
definitely.
GDPMP = 2435 + 60
= 2495
GNPMP = 2495 – 40
= 2455
As only the net indirect tax is changed, real output would not change.
3. There are plenty of fish in the Dull Lake. Boats can be rented by fishermen to catch fish and
sell them at the market. The total money earned each month from X boats is: 10,000(4x – ½
x2). Each boat costs ₹20,000 per month to run.
(i) The Dull Municipality is considering giving out fishing permits for free to anyone who asks.
If there is no limit and permits cost nothing, how many boats will enter the lake before the
profit for the individual fishermen community is completely wiped out?
(ii) If the Dull Municipality wants to manage the lake to ensure the Total Profit is at the
maximum possible level, how many boats should they allow to fish every month?
Answer:
TR = 10,000(4x – ½ x2)
TC = 20000x
(i) If there is no limit and permits cost nothing, how many boats will enter
In an open-access scenario where permits are free and unlimited, new boats will continue to
enter the lake as long as there is any individual profit to be made.
Entry stops only when Average Revenue equals Average Cost, which is the point where total
profit is zero.
AverageRevenue:
AR= TR/x = 40,000 - 5,000x
AverageCost:
AC= TC / x = 20,000
AR = AC
40,000 - 5,000x = 20,000
20,000 = 5,000x
x = 4 boats
At 4 boats, the individual profit for fishermen is completely wiped out.
(ii) To ensure the Net Benefit is at the maximum possible level, how many boats should they
allow to fish every month?
To maximize the Net Benefit for the lake, the Municipality needs to find the point where
MB=MC
MB = [Link] / dx = d(40,000x - 5,000x^2) / dx = 40,000 - 10,000x
MC= [Link] / dx = d (20,000x) / dx = 20,000
MB = MC 40,000 - 10,000x = 20,000
20,000 = 10,000x
X=2
d.TR2 / dx2= - 10000 < 0
The Municipality should allow 2 boats to fish every month to maximize total profit.
At x = 2, the maximum Profit= 10,000(4*2 – ½ 22) - 20000*2 = 20000
4. Suppose the Marginal Social Cost (MC) of producing a specific good is MC = 10 + 0.4X,
and the Marginal Social Benefit (MB) is MB = 30 - 0.6X, where X represents the quantity of
output. Due to an unforeseen natural calamity, the Marginal Cost rise by 10 units across all
levels of output. Calculate the exact change in output caused by this disaster.
Answer:
Optimum output Before the Calamity
The equilibrium output occurs where the Marginal Social Benefit (MB) equals the initial
Marginal Social Cost (MC1):
MB = MC1
30 - 0.6X = 10 + 0.4X
30 - 10 = 0.4X + 0.6X
X0* = 20
Optimum output After the Calamity
The problem states that the Marginal Cost rises by 10 units across all levels of output. We create
the new cost function (MC2):
MC2 = (10 + 0.4X) + 10
MC2 = 20 + 0.4X
Set the new Marginal Cost equal to the Marginal Benefit:
MB = MC2
30 - 0.6X = 20 + 0.4X
10 = 1.0X
X*1 = 10 units
3. Calculate the Change in Output
The change in output (ÆX) is the difference between the new output and the initial output:
Change in X = X2 - X1
Change in X = 10 - 20
Change in X = -10 units
Conclusion:
The natural calamity caused the equilibrium output to decrease by exactly 10 units.