Chapter 18

National Income

Objectives

• To explain the various concepts of national income, like GDP, GNP and NNP.

• To explain the concept of real and nominal national income.

• To discuss and analyze the different methods to measure national income.

• To understand the advantages of national income calculation in global perspective.

• To appreciate the difficulties in estimating national income.

National Income

• "National income or product is the final figure you arrive at when you apply the measuring rod of money to the diverse apples, oranges, battleships and machines that any society produces with its land, labour and capital resources." Paul A. Samuelson

National Income • Calculation of national income requires adding

together all final goods and services produced in a country in a given year.

• Various goods and services produced in the economy cannot be added together in their physical form; hence they need to be converted into monetary terms.

• Thus National income is defined as the money value of all the final goods and services produced in an economy during an accounting period of time, generally one year.

Concepts of National Income• Gross Domestic Product (GDP)

– Gross Domestic Product at factor cost– Gross Domestic Product at market price

• Gross National Product (GNP) • Net Domestic Product (NDP) • Net National Product (NNP)• Per Capita Income• Per Capita Disposable Income

Gross Domestic Product

• Gross Domestic Product (GDP): GDP is the sum of money value of all final goods and services produced within the domestic territories of a country during an accounting year.

GDP (at market price)= C+I+G+(X-M)Gross Domestic Product at factor cost = GDP at Market Prices –Indirect Taxes+ Subsidies

Gross National Product• Gross National Product (GNP): GNP is the aggregate

final output of citizens and businesses of an economy in a year.

• GNP may be defined as the sum of Gross Domestic Product and Net Factor Income from Abroad.

GNP = GDP + NFIAGNP = C+I+G+(X-M)+NFIA

• Net Factor Income from Abroad: difference between income received from abroad for rendering factor services and income paid towards services rendered by foreign nationals in the domestic territory of a country

Net Domestic Product and Net National Product

• Net Domestic Product= GDP-Depreciation

• Net National Product (NNP)= GDP–Depreciation +NFIA

Or =GNP–Depreciation

• Thus NNP is the actual addition to a year’s wealth and is the sum of consumption expenditure, government expenditure, net foreign expenditure, and investment, less depreciation, plus net income earned from abroad. = C+I+G+(X–M)–Depreciation + NFIA

National Income• NNP at Factor Cost is the sum total of

income earned by all the people of the nation, within the national boundaries or abroad

• It is also called National Income. • NNP at Factor Cost = NNP at Market

Prices –Indirect Taxes+ Subsidies

Net Domestic Product and Net National Product

S.No. Item 2003-04 2004-05

1. National income (Net NationalProduct at factor cost)

2268576 2531223

2. Indirect taxes less subsidies 216828 277517

3. Net national product at marketPrices (1+2)

2485404 2808740

4 Other current transfers from rest of the world (Net)

104819 91736

5. Net factor income from abroad -18250 -17916

6. Net domestic product at market prices 2503654 286656

National Income Data for India (Rs Crore)

Real and Nominal National Income

• National income estimated at the prevailing prices, is called national income at current prices or Nominal National Income, or Money National Income or national income at current prices.

• National income measured on the basis of some fixed price, say price prevailing at a particular point of time, or by taking a base year, is known as Real National Income or national income at constant prices

Real National Income• Real GDP measures changes in the physical

output in an economy, between different time periods, by valuing all goods produced in the two periods at the same prices

deflator GDPGDP Nominal=GDP Real

•GDP deflator is the ratio of nominal GDP in a year to real GDP of that year.

•GDP deflator measures the change in prices between the base year and the current year.

National Income Estimates for India (2006-07)

Current prices

1999-2000 Prices

Deflator

Gross national product (GNP)

37,22,669 28,29,349 1.315

Net national product (NNP)

32,96,639 25,22,576 1.306

Gross domestic product (GDP)

37,43,472 28,48,157 1.314

Net domestic product (NDP)

33,17,442 25,41,384 1.305

Real GDP and living standard• Changes in nominal GDP can be due to:

– changes in prices– changes in quantities of output produced

• Changes in real GDP can only be due to– changes in quantities,

• real GDP is constructed using constant base-year prices. • changes in real GDP measure changes in living standard.

Per Capital Income • The average income of the people of a country

in a particular year is called per capita income. In simple words it is income per head of a country for a year.

Population TotalIncome National=Income CapitaPer

•Per capita income for the year 2006-07 may be calculated at the market price prevailing during the financial year 2006-07, i.e. current prices or at prices of a base year say 1999-2000, i.e. constant prices

Per Capita Income of India (at 1999-2000 prices)

2004-05 2005-06 2006-07

Per Capita GNP 21,722 23,313 25,217

Per capita NNP 19,297 20,734 22,483

•PCI is the single most commonly used measure of the standard of living of the people of a nation.

•It is not a very reliable measure because it is a simple arithmetic mean; hence the extreme values dominate.

Personal Disposable Income • Personal income is the total income received by the

individuals of a country from all sources before direct taxes in one year.

• Personal Income = National Income – Undistributed Corporate Profits – Corporate Taxes – Social Security Contributions + Transfer Payments + Interest on Public Debt

• Personal Disposable Income is the income which can be spent on consumption by individuals and families.

• Personal Disposable Income = Personal Income – Personal Taxes

Methods of measuring national income

• In equilibrium Output=Income=expenditure

• Hence there are three approaches to the measurement of GDP:

• Product (or Output) Method: National Income by Industry of Origin – Final Product Method – Value Added Method

• Income Method or National Income by Distributive Shares

• Expenditure Method

Product (or Output) Method• The market value of all the goods and services produced

in the country by all the firms across all industries are added up together.

• Process– The economy is divided on basis of industries, such as

agriculture, fishing, mining and quarrying, large scale manufacturing, small scale manufacturing, electricity, gas, etc.

– The physical units of output are interpreted in money terms – The total values added up. (GDP at market price)– The indirect taxes are subtracted and the subsidies are added.

(GDP at factor cost)– Net value is calculated by subtracting depreciation from the total

value (NDP at factor cost).

Limitations of Product Method

• Problem of Double Counting: – unclear distinction between a final and an

intermediate product.

• Not Applicable to Tertiary Sector:– This method is useful only when output can be

measured in physical terms

• Exclusion of Non Marketed Products– E.g. outcome of hobby or self consumption

• Self Consumption of Output– Producer may consume a part of his production.

Income Method

• The net income received by all citizens of a country in a particular year, i.e. total of net rents, net wages, net interest and net profits. (GDP at factor cost).

• It is the income earned by the factors of production of a country.• Add the money sent by the citizens of the nation from abroad and

deduct the payments made to foreign nationals (individuals and firms) (GNP at factor cost) or Gross National Income (GNI).

Process:• Economy is divided on basis of income groups, such as

wage/salary earners, rent earners, profit earners etc.• Income of all the gruops is added, including income from abroad

and undistributed profits.• The income earned by foreigners and transfer payments made in

the year are subtracted. GNI = Rent + Wage + Interest +Profit + Net Income from Abroad-

Transfer payments

Limitations of Income Method

• Exclusion of non monetary income: Ignores the non-monetized section of economic activities. – Economic activities that contribute to national income, but due to

their non monetary nature, they go unrecorded. For e.g. a farmer and family working in their own field.

• Exclusion of Non Marketed Services: People undertake a particular activity that are difficult to ascertain in money value. E.g. mother’s services to the family.

Expenditure Method of Measuring National Income

• The total expenditure incurred by the society in a particular year is added together to get that year’s national income.

• Components of Expenditure:– personal consumption expenditure – net domestic investment – government expenditure on goods and services, and – net foreign investment

Limitations • Ignores Barter System • Ignores Own Consumption • Affected by Inflation

Uses of National Income Data

• National income is the most dependable indicator of a country’s economic health.

• Difference between GDP and GNP indicates the contribution of net income earned abroad

• Necessary for Economic planning: useful aid in judging which sectors should be given more emphasis

• A measure of economic welfare. – higher aggregate production implies more and more goods and

services being available to people

• Helps in determining the regional disparities, income inequality and level of poverty in a country.

• Helps in comparing the situations of economic growth in two different countries.

Difficulties in Measurement of National Income

• Non monetized transactions: Exchange of goods and services which have no monetary payments, like services rendered out of love, courtesy or kindness are difficult to include in the computation of national income.

• Unorganized sector: Contribution of unorganized sector are unrecorded. It is very difficult to identify income of those who do not pay income tax.

• Multiple sources of earnings: Part time activity goes unrecognized and such income is not included in national income.

• Categorization of goods and services: In many cases categorization of goods and services as intermediate and final product is not very clear.

• Inadequate data: Lack of adequate and reliable data is a major hurdle to the measurement of national income of underdeveloped countries.

Key Equations• AD = C+I• AS=C+S• AD=AS=C+S=C+I• Y=E=O • Y=O=C+I• Y=E=C+S• C+I=Y=C+S• Total Expenditure (E) = C + I + G• National Income=C+I+G+(X-M)• GDP at Market Price = C+I+G+(X-

M)• GDP at Factor Cost = GDP at

Market Prices –Indirect Taxes+ Subsidies  

• GNP = GDP + NFIA • GNP = C+I+G+(X-M) +NFIA

• NNP = C+I+G+(X–M)–Depreciation + NFIA

• NNP=GDP–Depreciation +NFIA• NNP at Market Price = GNP –

Depreciation • NNP at Factor Cost = NNP at Market

Prices –Indirect Taxes+ Subsidies • NNP at Factor Cost = National Income=

FID+NFIA• NNP at Factor Cost = Rent + Wage +

Interest +Profit + Net Income from Abroad- Transfer payments

• Personal Income =National Income–Undistributed Corporate Profits–Corporate Taxes–Social Security Contributions+ Transfer Payments+ Interest on Public Debt

• Personal Disposable Income=Personal Income – Personal Taxes

Summary• GDP is the sum of money values of all final goods and services produced

within the domestic territories of a country during an accounting year. It can be measured at current or constant prices.

• GNP is the aggregate final output of citizens and businesses of an economy in one year. NNP is GNP less depreciation.

• The average income of the people of a country in a particular year is per capita income for that year.

• National income can be measured by product method, income method and expenditure method.

• National income accounting data are of utmost importance for the economy of any country; such data reveal the aggregate production of the economy and also help to determine the total expenditure and total income of that country.

• Difficulties in measuring national income include multiple counting, exclusion of non market transacted services, self consumption of output, inflation or deflation, confusion about informal sector, etc.

• National income is considered as a measure of economic welfare. As national income rises, the aggregate production of goods and services rises. Therefore, there is a positive relation between increase in national income and welfare.