National Income and its Measurement

 

National income is the sum of the total income of all the citizens of a nation which is earned from various productive resources, within the specific time period, generally.

National income accounting is the process of measuring aggregate output and income. National income includes payments made to all productive resources like land, labor, capital, and organization in the form of wage, interest, rent, and profits. National income is one of the most important parts of macroeconomics. It is calculated as;

National Product= Wage+Rent+Interest+Profit+National income

 

Basic Concepts of National Income:

1. Gross Domestic Product (GDP):

Gross Domestic Product is the total market value of all currently produced final goods and services within the geographical boundary of a country during a fixed period of time, generally in one year. GDP does not require NFIA for its calculation. The calculation of GNP. It is calculated as;

GDP= P1*Q2+P2*Q2+…+Pn*Qn

Where,

P= Price of goods and services

Q= Quantity of goods and services

2. Gross National Product (GNP):

Gross National Product is the total market value of all currently produced goods and services in a country plus net factor income from abroad (NFIA). GNP is a broader concept than GDP. The calculation of GNP supports the calculation of NNP. It is calculated as;

GNP= GDP + NFIA

Where,

GDP= Gross Domestic Product

GNP= Gross National Product

NFIA= Net Factor Income from Abroad

3. Net National Product (NNP):

Gross National Product minus depreciation is called Net National Product. Net National Product is the market value of all final goods and services after allowing for depreciation. Depreciation is the wear and tear of physical capital goods such as machinery. It is calculated as;

NNP= GNP – Depreciation

or, NNP= C + I + G + (X-M)+NFIA-Depreciation

Where,

C= Capital Expenditure

I= Investment Expenditure

G= Government Expenditure

X= Export

M= Import

4. National Income (NI):

The sum of the income received by all factors of production in the form of rent, wages, interest, and profit of a nation is called national income. Indirect taxes are not available to factors of production, so they are deducted from NNP to find out the national income. Subsidy causes the market price to be lower than the factor cost, it should be added to NNP. It is calculated as;

National Income= NNP – Indirect Taxes + Subsidies

5. Personal Income (PI):

Personal Income is the total money income received by individuals and households of a country from all possible sources before direct taxes. The factors of production do not get the whole amount of national income. It is calculated as;

PI= National income – Corporate income taxes – Undistributed corporate profits – social security contribution + transfer payments

6. Per-capita Income (PCI):

The average income of the individuals of a country is called per capita income. The per capita income of a country is calculated by dividing the national income of the country by its total population in a year. Mathematically, it is calculated as;

Per-capita income= National Income/Total number of population of a country

 

Calculation of National Income:

• Income Method:

The income method measures the national income by adding all the incomes received by the owners of the factors of production in the form of wage, interest, normally in one year. The calculation of national income by income method is presented in the hypothetical table;

Income Headings	Amount of Income (In $ millions)
Wages and salaries	5,000
Rent (Interest)	2,000
Interest (Capital)	3,000
Corporate profit	5,000
Indirect taxes	1,000
Gross Domestic Product (GDP)	16,000
Net factor income from abroad (NFIA)	(1,000)
Gross National Income (GNI)	15,000
Depreciation	(500)
Net National Income (NNI)	14,500
Indirect taxes	(500)
Subsidies	1,000
National Income	15,000

The income approach shows the distribution of national income among different classes of people. Hence, this method is called national income by distributive share.

• Expenditure Method:

The expenditure method measures the national income as the aggregate of all expenditures made by different sectors of the economy on the purpose of final goods and services during a period of one year. It includes household consumption expenditure (C), business investment expenditure (I) on capital goods, government expenditure on goods and services (G), and net foreign export (Export{E} – Import{M}).

Symbolically, it is expressed as;

GDP= C+I+G+(X-M)

And, GNP=C+I+G+(X-M) + NFIA

Here,

GDP= Gross Domestic Product

GNP= Gross National Product

C= Consumption Expenditure

I= Investment Expenditure

G= Government Expenditure

X= Export

M= Import

NFIA= Net Factor Income from Abroad

Expenditure Headings	Amount (In $)
Consumption Expenditure (C)	10,000
Investment Expenditure (I)	8,000
Government Expenditure (G)	12,000
Net Exports (X-M)	(2,000)
Gross Domestic Product (GDP)	28,000
Net Factor Income from Abroad (NFIA)	3,000
Gross National Expenditure (GNP)	31,000
Depreciation	(1,000)
Net National Expenditure (NNP)	30,000
Indirect Tax	(4,000)
Subsidy	6,000
National Income	32,000

 

• Product Approach:

According to this approach, national income is measured in the form of the total product obtained from each economic sector such as primary sector (agriculture), secondary sector(industry), and tertiary sector. This method involves the following two methods;

(I) Final Product Method:

To measure national income from the final product method, an economy is divided into different productive sectors like primary, secondary, and tertiary sectors. The components of the final product method are as follows;

• Primary sector:

Agricultural sectors like food crops, cash crops, vegetables, fruits, bee-keeping, etc. are called primary sectors.

• Secondary sector:

Industrial sectors like manufacturing and construction, food processing, electricity, water supply, etc. are called secondary sectors.

• Tertiary sector:

Service sectors like banking, insurance, defense, education and health, administration, etc. are called a tertiary sectors.

The calculation of national income by final product method is presented in the below table;

Production Sectors	Value of Products (In $million)
Primary sector	10,000
Secondary sector	7,000
Tertiary sector	8,000
Gross Domestic Product (GDP)	25,000
Net factor income from abroad (NFIA)	(5,000)
Gross National Product (GNP)	20,000
Depreciation	(1,000)
Net National Income (NNP)	19,000
Indirect taxes	(1,000)
Subsidies	2,000
National Income	20,000

 

(II) Value Added Method:

This method calculates the national income by considering the values of both intermediate goods and final output simultaneously. In this approach, the value-added at different stages of production is calculated and then added for estimating national income. This method is considered to be more realistic than the final product method to solve the problem of double counting. It is calculated as;

Value added= Sales value- cost of intermediate goods

The calculation of national income by the value-added method is presented in the below table;

Production stage	Sales value of output	Cost of intermediate goods	Value-added
Wheat (Farmer)	100		100
Flour (Flour mill)	150	100	50
Bread (Baker)	200	150	50
Total	450	250	200

Let us suppose that there are three stages in bread production till the product produces wheat equal to the value of Rs.100. The flour mill grinds the wheat and sells flour to the baker at Rs.150. Hence, the value-added to the economy by the flour mill is Rs.50 (150-100). Similarly, the baker sells bread at Rs.50 (200-150). The sum of value-added in each stage of production is 100+50+50=200. Therefore, Rs.200 is the final value added to the economy.

 

Difficulties in the Measurement of National Income:

1. Problem of Double Counting:

Only final goods and services are included in the national income accounting. But it is very difficult to distinguish between final goods and intermediate goods.

2. Underground Economy or Black Economy:

Black economy themselves are illegal such as drugs, gambling, smuggling, and prostitution. Since these incomes are ignored while calculating the income, the NI seems to be less than the actual amount.

3. Petty Production:

There are large numbers of petty producers and it is very difficult to include their products in national income because they do not maintain an account.

4. Illiteracy and Ignorance:

If the majority of people are illiterate and ignorant, they cannot keep the records of production activities accurately. Hence, it is difficult to get the correct information about production.

5. Transfer Payments:

Individuals get the pension, unemployment allowance, and interest on public loans but these payments create difficulty in the measurement of national income.

6. Calculation of Depreciation:

Capital depreciation should be deducted to find the net national income or product. But it is difficult to calculate the present depreciation rate of capital goods having a long life.