Chapter — 7 National Income 246 _ ATR NATIONAL INCOME ee asia Sa the branch of Economics in which economic activities a re pasis, i.e. employment level, international trade, aggregal agents SubDNy consumption, saving, investment. general pes WiPl pubis finance business cycle etc. Macro economics revolves around ie eee of national Income All the key macro concepts are directly or indirectly related wi ce pt ‘ ational income. In this section, we shall discuss the various concepts of national income measurement of national income, difficulties in the measurement of national income especially with reference to Pakistan and circular flow of national income VARIOUS CONCEPTS OF NATIONAL INCOME () Gross Domestic Product (GDP) (ii) Gross National Product (GNP) (iii) Net National Product (NNP) (iv) National Income / National Product (NI/NP) (v) Personal Income (P1) (vi) Disposable Personal (DPI) FUNDAMENTALS OF THE CONCEPTS —=aeumamcmat tm hE OF THE CONCEPTS All the concepts are based on the following major considerations. i. An Economy / A Country: All the concepts are related with an economy or a country, ii. Time Period: All the basic concepts of national income are discussed for the time period of one year’ It reflects that all the Concepts represent flow variable. Summation of Market Value of All Final Goods and Services: In all the concepts, summation of monetary value of final goods and services produced by an economy during a year will be Considered. It should be noted here that: * (i) Market value is the product of price and output, i.e. MV=P.Q (ii) Only final goods and Services will be considered t i is o Q : counting of national income." —_" 1 it The quantity which changes its value during a specific time period.we National Income iv. Identical Relationship: oe The macro economists are of the view that when goods and services Be prowl ity an economy, the factors of production (which render their services to Prodlie’ Quice * T services) get their rewards. These rewards are their income and they spen ee a on consumption and investment goods. Thus output flow, factors income flow expenditures flow appear which reflect national income. i.e. Output = Factors income = Expenditures. It reveals that we find the same level of national income of an economy under all the approaches. Now we discuss various concepts of national income in the light of these three approaches: fs GROSS DOMESTIC PRODUCT (GDP itis the summation of market value of all final goods and services /rewards of factors of production! expenditures of both private and public sectors in an economy during a year within its national border. It should be noted that contribution of a foreign worker will be considered, while the contribution of a countryman working abroad will not be considered in GDP. For example, if a worker of China renders his services in Pakistan, his contribution will be the part of GDP of Pakistan, and not the part of GDP of China. Symbolic Representation,” i, Total Output Approach: GDP =P; Q; + P2 Q.+ + Pr Qh Where P = Price of output produced within national border Q = Output produced within geographical border. Factors Income Approach: > GDP =r+wtitn Where r, w, i and n are the rewards of land, labour, capital and entrepreneur f respectively for their services within the geographical boundaries (i.e. national border) ; Total Expenditures Approach: : GDP =C+I+G A Where ¢, |, and G shows expenditures on consumer goods, capital Joods ang | government activities respectively within national border.National Income 248 GROSS NATIONAL PRODUCT(GNP) ) Itis ten of market value of all final goods and services/ rewards of factors of os ‘expenditures of both private and public sectors of an economy during a year within and outside of its national border. In the words of W.C.Peterson, ae i pesarist value of all final goods and services produced by the economy le period regardless of where the output is produced. It_should be noted that contribution of a countryman will be considered while the contribution of foreign worker will not be considered in case of GNP. For example, if a worker of China renders his services in Pakistan, his income is the part of china’s GNP, and not of Pakistan's GNP. Symbolic Presentation: GNP = GDP +F Where GDP shows income within the national frontier and F represents income from outside the national border. i. Total Output Approach: GNP = P; Q; +P2Q: + + Pr Qn Where P = Price of output produced by the countrymen within and outside the national border. Q = Output produced by the countrymen within and outside the national border. . Factors Income Approach: GNP =r+wtit 7m where r, w, i and = show the rewards of factors of production associated with countrymen within and outside of the national border. : Total Expenditures Approach: GNP =C +1+G+(X-M) Where right hand side shows the expenditures on consumer goods, capital goods, government activities, and net export respectively by national residents of a country within and outside the geographical border of the country 5 NET NATIONAL PRODUCT (NNP It is the summation of market value of all final goods and services /rewards of factors of production’ expenditures of both private and public sectors of an economy during a year within and outside of its national border, provided that we delete depreciation allowances’. Thus: _Chapter=7 NNP = GNP -D.A. SE A eee rece eee f f Ewy nsonalincome 249 Chapter ~ 7 NATIONAL INCOME (NI) itis the summation of market value of all final goods and services /rewards of factors of i ey Seendtures Of both private and public sectors in an economy during # year ee feed le of its national border provided that depreciation allowance and infec rag Otracted from GNP and subsidies’ are added in GNP. In other words, if we subtract indirect taxes (IT} add si 6 (S P, we find pational income Thus: (IT) from NNP and add subsidies (S) in NNP, we NI=NNP-IT+S, PERSONAL INCOME (PI) itis the summation of rewards of factors of production which is actually received by all ihe individuals of an economy during a year. It is worth mentioning that all the rewards of factors of production (or national income) is not actually received by the individuals Social security contributions like benevolent fund etc are deducted before the individuals receive their income. Joint stock companies do not distribute all the amount of profits; rence these undistributed profits are also not received by individuals. Similarly corporate ‘axes are levied on profits before the distribution of profits to individuals. All these iterns ae not received by individuals. Hence we must subtract these items from national income to arrive at personal income. On the other hand, transfer payments’ are the incomes of individuals and must be added in national income to calculate personal income. Thus P| = NI — Social security contribution corporate taxes — undistributed profits of joint stock companies® + transfer payments. DISPOSABLE PERSONAL INCOME (DPI) income is not at the discretion of the individuals for saving and a peel that part of the personal income is at the disposal of the individuals in a” y during a year which is {eft with the individuals after the payment of personal taxes | direct taxes like income tax, property tax oP canna @ Specific time period. Thus if het are subtracted from personal income during a year, it is called disposable ‘sonal income. Hence: eos. DPI =PI-DT Na an LSEor National Income oe) Chapter ~7 Hypothetical Road Map (from GDP to DPI): * We construct a hypothetical road map to understand the various concepts of national income, Concepts of NI Rs in billion GDP ~--100 + Income of countrymen working abroad=10 — Income of foreigners working within the national border= 5 : GNP (100+10+5) 105 — Depreciation allowanc: NNP -(105-10) 95 — Indirect taxes=20 + Subsides=10 | '95-20+10) 85 ' NI (Factors income approach)- ~ Social security contribution — Corporate taxes=5 ~ Undistributed profits=5 + Transfer payments=15 PL ----—--—=-(85-10-5-5+15), 5 80 DPI =-naenn==na—-(80-20) 60 Nominal National Income: Itis the summation of market value of all final goods and services at current prices in an economy during a year. Thus Nominal NI=P (2031. Qu2011y* Paget), Qay201 )¢-————— +Pr2011).XQry2011) Real National Income: Itis the summation of market value of all final goods and services at base year's prices in an economy during a year. If 2005 is the basic year, Real national income for 2011 will be calculated as under: Real NI(2011)= P4(2005)-*Qyi2011)+ P2(2008)-* Qai2012)+— Real NI is the true reflector of economic performance of an economy. i = *Preaios, XOxao1h)similarly, GDP deflator = Nominal Gop Real Gpp- * 100 For example, if nominal G| 1 2000) 6 RS.68 SNR: 7 2011 is Rs.130 billion and real GNP in 2011 (base year, GNP deflator = 130 | 65 It shows two tims r eS increase or 100% increase in general price level MEASUREMENT OF NATIONAL INCOME Lord Kelvin, a well known English scholar, Says: “Your knowledge is of meager and unsatisfactory kind if your cannot measure what you are speaking about.” The concept of national income is Considered the basic concept of Macro Economics. Alll the macro concepts revolve around this basic Concept. But the question is that whether we can measure national income or not? We must have some measuring rods to measure national income otherwise our knowledge about the concept of national income would be meager and unsatisfactory kind, as pointed out by lord Kelvin. The economists have consensus that we can measure national income by the following three approaches. (i) The total output approach (ii) The factors income approach (iii) The total expenditures approach 100 = 200 eae i * Consumer price index (CPI) and GNP deflator are well known measures of inflation, CP| is calculated as: Price in current year 44 Price in base year : - pies measure because CPI considers only the consumer praadlgeap gS considers not only consumer goods but it also considers caviar neChapter-7 252 — * National Income __ rt Ott = Factors income ‘otal National Income ____—_ 7 Ourout Moreover, the imperial alent aa iat eulatons of national income by all the expenditures. It reveals that We approaches. Now we discuss these ‘approaches in detail THE TOTAL OUTPUT APPROACH . We take the summation of market value of all final goods ad services p inside and outside the national border ‘of an economy dunng 2 ¥ According to W.C. Peterson. th We take the current market value of all final goods and ering cere by the economy during an income period regardless of where the output Is Pr Symbolic representation: Y= P,Q,+P,Q:+ +P, Qe where Y = National income P = Units of output (i.e. goods & services) PQ = Market value PRECAUTIONS To avoid the miscalculation of national income, we should take the following precautions under this approach: 1. Inclusion of income: The income of countrymen working abroad should be included in national. 2. Exclusion of income: The income of foreigners working within the national border of another should ees induced in national income. For example, if a China's resident aries Secon in Pakistan, his income is the part of national income of China, akistan' national income. es \ PE . 3. Risk of double counting: To avoid the risk of double counting of national income, FE ar vale aceon aaa tent ita er oduced both "There are three stages of production of goods. ie . U8. primary stage, secondary / intermediate stage un ssne ara go ay has be sge ney We ae hm ey over-estimation of national income. To avoid this, market value of fina! value at feaiianae, technique in which net addition to the total value: . wd erro es Peans ers TM Sg gE Nyter=7 National Income 253 i Ciaptere 4, Market value of particular year: Market value of goods and services should be taken only for that particular year in which these have been produced 5, Depreciation allowance: Depreciation allowance should be omitted. 6. Free services: Free and unpaid services like self-gardening, house wife's services etc should not be included in national income accounting 7. Indirect taxes: Indirect taxes like sales tax etc. should not be included 8. Subsidies: Subsidies should be included in national income accounting. 9. Second hand goods: The market value of second hand goods like old houses, old automobiles should not be included in national income accounting THE FACTORS INCOME APPROACH Under this approach, national income is calculated by taking the summation of rewards of factors of production for their services to produce output both inside and outside the national border of an economy during a year’. Thus according to this method, national income is obtained by summing up of the income of all individuals in the country Individuals earn income by contributing their own services and the services of their own factors like land, capital etc. in the production national Symbolic representation: Yertwtitn Where Y = National income r= Rent, i.e. reward of the services of land w = Wages, i.e. reward of use of labour = Interest , ie. reward of use of capital m = Profit, i.e. reward of the services of entrepreneur, These rewards are basically income of individuals of a count rewards earned during a year, we find national income, ry. By Summing up all theseNational Income _ 254 Chapter~7 PRECAUTIONS : ne 1. Barter transactions: Barter transactions’ should be avoided 2. Free services: The services without monetary reward like caring of child by mother, Parents by a doctor ete should not be included, 3. Illegal income: Income earned through illegal resources should not be included 4. Net income from abroad: Net factors payment from abroad should be included in national income accounting TOTAL EXPENDITURES APPROACH Under total expenditures approach, national income is computed by taking the summation of expenditures of households, firms and government on final goods and services produced both inside and outside the national border of an economy during a year Symbolic representation: Y=C+l1+G+(X-M) Where Y = National income C = Consumption, i.e. expenditure on final consumer goods and services like automobiles, food, medical care, education etc.” | = Gross private investment, i.e. expenditures on capital goods like machinery, inventories, shares etc. by the private’sector.> G = Gout expenditures on the purchases of goods and services used for productive and non-productive activities, i.e. provision of infrastructure,’ administration, defense etc. X - M = Expenditures on exports by foreigners minus expenditures on imports by countrymen i.e. net foreign expenditure. treatment of ‘if goods are exchanged by goods and money is not involved as medium of exchange, itis called barter transactions. ? it includes both types of consumption expenditures, i.e. explicit and implicit on durable consumers goods i.e. automobiles etc, non-durable consumers goods i.e. food, clothing etc. and services like medical care, education etc. fi Capital goods are the goods which are used to produce more goods. In gross private investment, We consider not only the expenditures on newly purchased capital goods but the expenditures made on wear ind the replacement of the existing capital goods are also considered. Schools, hospitals, dams etc, ree ss =Naererroee sorvreeg PRECAUTIONS ~——~ 4. Expenditures on fi inal only those expend Goods: goods. The expenditures ror ul Be includes in ON intermedigns rational incom mediate 2. Expenditures on The expenditures on seg WY-Produced 3, Transfer Payments.’ On old Shares of The government expendityy UTES On t CONCLUSION Tansfer payments should not be considered. We conclude that when Goods an ic engage in the process of ec id services are Produced, the factors of production (factors rewards) on consun HON, receive their rewards. They spend their income and expenditures flow appear on 2d investment goods. Thus output flow, income flow national income by tales toe a ae reflects national income. Thus we calculate rewards of factofs of prosasiee sation of market value of final goods and services xpenditures of an economy during a year. Moreover, each approach yields the same calculation of national income accounting. DIFFICULTIES IN MEASUREMENT OF NATIONAL INCOME | We observe the following difficulties in the measurement of national income in developing countries like Pakistan 1. Unreliable data: , Reliable data of output, factors income and total expenditure are not available in countries like Pakistan. Thus we cannot get accurate figures of national income. 2. Double counting: There always exists a risk of mr -Mo! ns: Peet, s Non i netary tanec! sek children, laundry and other house hold services are nol Bvalated | Pao thus market value of these services is not included and NI is lui mm . » under estimated. 4. Self - Consumption: i ‘ally in agriculture sector and ynsumption especially in agricul : 'y products are produced 104 Bape Market value of these products is also not these are not brought in —__255 Shp 1 Which are made Goods should not be included, bh goods: 2 company should not be included. ible counting which may lead to false estimation. Bish 3s Dn