Depreciation Calculation – A First Look

You own a smartphone you bought for ₹30,000. After a year, if you tried to sell it, you’d get maybe ₹20,000. That ₹10,000 drop isn’t a loss of cash from your pocket — it’s the wear and tear of the phone’s value. In economics, when a factory buys a machine for ₹10 lakh, that machine doesn’t stay worth ₹10 lakh forever. It rusts, breaks down, becomes outdated. The gradual loss in value is depreciation.

The Precise Meaning

In your NCERT Class 12 Macroeconomics textbook (Chapter 2, National Income Accounting), depreciation is defined as:

Depreciation is the fall in the value of a fixed asset due to normal wear and tear, passage of time, or expected obsolescence.

It is not a cash expense — no money leaves the firm when depreciation happens. But it is a cost that must be accounted for, because using a machine today reduces its future usefulness. Without depreciation, a firm would overstate its profit and a country would overstate its national income.

Why It Matters

• For a firm: Depreciation is subtracted from revenue to find true profit. If you ignore it, you think you earned more than you really did.
• For the economy: Gross Domestic Product (GDP) counts all final goods produced. But some of that production is just replacing worn-out machines. Net Domestic Product (NDP) = GDP – Depreciation. NDP tells us how much new value was actually added.

The Formula (NCERT Standard)

The NCERT textbook gives one standard method for calculating depreciation — the Straight Line Method. It is simple and exam-relevant.

Where:

• Cost of Asset = purchase price + installation/transport costs (the total initial investment)
• Scrap Value = the estimated resale value at the end of its life (could be zero)
• Estimated Life = number of years the asset is expected to be used

Example: A machine costs ₹1,00,000, has a scrap value of ₹10,000, and a life of 10 years.

Each year, the firm records ₹9,000 as depreciation. After 10 years, the machine’s book value becomes ₹10,000 (the scrap value).

A Word on Other Methods …

You have probably heard someone say, "We need more workers" or "We don't have enough raw materials." That is the real-world root of this idea. Every single thing you consume — a phone, a plate of rice, a bus ride — was produced. And to produce anything, you need four basic ingredients. Economists call these ingredients the factors of production.

Think of it like baking a cake. You need the flour and sugar (raw materials), an oven (machinery), a baker (labour), and someone to decide what cake to bake and how to sell it (entrepreneurship). Without any one of these, no cake. The same logic applies to an entire economy.

The Four Factors (as per NCERT Class 11/12)

The NCERT textbook divides these into four clear categories. Memorise them by name and by what they earn, because that link — factor → reward — is a recurring exam question.

Let’s unpack each one.

1. Land (and all natural resources)

Land does not mean just the plot of soil. In economics, it means every gift of nature used in production: the soil, minerals, forests, water, even sunlight. It is a passive factor — it does nothing by itself. Its reward is rent.

2. Labour (human effort)

Labour is any physical or mental work done for a reward. The person who digs a ditch, the software engineer writing code, the teacher in a classroom — all are labour. The key point: labour is perishable (a lost hour of work cannot be stored) and inseparable from the worker. Its reward is wages.

3. Capital (man-made aids)

Capital is everything produced earlier that helps produce more now. Machines, tools, factories, roads, computers — even money used to buy these things (though money itself is not capital; it is just a medium). Capital is a produced factor of production. Its reward is interest.

4. Entrepreneurship (the organiser)

This is the factor that combines land, labour, and capital. The entrepreneur decides what to produce, how to produce, and who to sell to. They bear the risk of loss. Without an entrepreneur, the other three factors just sit idle. Its reward is profit (which can be positive or negative — that is the risk).

Why This Matters (The Big Picture)

These four factors are the building blocks of National Income. When you add up all the rent, wages, interest, and profit earned in a country in one year, you get the National Income (by the income method). That is why the NCERT chapter on National Income Accounting starts with factors of production — because every rupee earned in the economy is a reward to one of these four factors.