National Income

National income is the aggregate money value of all incomes earned by individuals and
enterprises.

National income may also be defined as the money measure of the net aggregates of all
commodities and services accruing to the inhabitants of an economy during a year.

Thus, the concept national income has different meanings. It may be described as the
‘national product’ or ‘national income’ or ‘national dividend’.

Different Views on National Income by Different Economists:

Here we present different views on national income suggested by different economists at

different times:

1. Marshall’s Definition:

Marshall defines national income or national dividend in the following way: “The labour and
capital of a country, acting on its natural resources, produce annually a certain net
aggregate of commodities, material and immaterial including services of all kinds… This is
the true net annual income or revenue of the country or national dividend.”

The term net refers to deductions from total gross produce in respect of depreciation and
wearing out of the plant and equipments plus additions of net income from abroad. This
may be construed as national dividend as a flow of goods and services but not a fund. In
Marshall’s words, “the national dividend is at once the aggregate net product of and the
sole source of payment for all agents of production within the country.” Thus, what is
produced in an economy is distributed among the various factors of production.

2. Pigou’s Definition:

According to A.C. Pigou; “National income is that part of the objective income of the
community, including, of course, income derived from abroad which can be measured in
money.” This definition is rather narrow as it does not include unmarketed goods and
services for which no money payment is involved. This definition involves certain paradoxes.
He argues that if a man marries his maid-servant the national income is reduced since he is
not supposed to pay any remuneration or wages to his housewife who was paid before
marriage. Anyway, Pigou’s definition is narrow.

Prof. Cairncross says; “The national income is, in fact, simply the output upside down. What
we produce flows into a reservoir; what are consumed is drawn from the same reservoir,
from the joint output of the community.”

What is clear from the above discussion is that Marshall’s definition seems to be more
comprehensive.

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3. Modern Definition:

National income is a money measure of the value of all goods and services produced in a year by a
nation. The National Sample Survey defines national income as “money measures of the net
aggregates of all commodities and services accruing to the inhabitants of a community during a
specific period.” According to the National Income Committee of India” A national income estimate
measures the volume of commodities and services turned out- during a given period, counted with
duplication.”

The important concepts of national income are:

1. Gross Domestic Product (GDP)

2. Gross National Product (GNP)

3. Net National Product (NNP) at Market Prices

4. Net National Product (NNP) at Factor Cost or National Income

5. Personal Income

6. Disposable Income

Let us explain these concepts of National Income in detail.

1. Gross Domestic Product (GDP): Gross Domestic Product (GDP) is the total market value of all final goods and
services currently produced within the domestic territory of a country in a year.

Four things must be noted regarding this definition.

First, it measures the market value of annual output of goods and services currently produced. This implies
that GDP is a monetary measure.

Secondly, for calculating GDP accurately, all goods and services produced in any given year must be counted
only once so as to avoid double counting. So, GDP should include the value of only final goods and services and
ignores the transactions involving intermediate goods.

Thirdly, GDP includes only currently produced goods and services in a year. Market transactions involving
goods produced in the previous periods such as old houses, old cars, factories built earlier are not included in
GDP of the current year.

Lastly, GDP refers to the value of goods and services produced within the domestic territory of a country by
nationals or non-nationals.

2. Gross National Product (GNP): Gross National Product is the total market value of all final goods and
services produced in a year. GNP includes net factor income from abroad whereas GDP does not. Therefore,

GNP = GDP + Net factor income from abroad.

Net factor income from abroad = factor income received by Indian nationals from abroad – factor income paid
to foreign nationals working in India.

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3. Net National Product (NNP) at Market Price: NNP is the market value of all final goods and services after
providing for depreciation. That is, when charges for depreciation are deducted from the GNP we get NNP at
market price. Therefore’

NNP = GNP – Depreciation

Depreciation is the consumption of fixed capital or fall in the value of fixed capital due to wear and tear.

4.Net National Product (NNP) at Factor Cost (National Income): NNP at factor cost or National Income is the
sum of wages, rent, interest and profits paid to factors for their contribution to the production of goods and
services in a year. It may be noted that:

NNP at Factor Cost = NNP at Market Price – Indirect Taxes + Subsidies.

5. Personal Income: Personal income is the sum of all incomes actually received by all individuals or
households during a given year. In National Income there are some income, which is earned but not actually
received by households such as Social Security contributions, corporate income taxes and undistributed
profits. On the other hand there are income (transfer payment), which is received but not currently earned
such as old age pensions, unemployment doles, relief payments, etc. Thus, in moving from national income to
personal income we must subtract the incomes earned but not received and add incomes received but not
currently earned. Therefore,

Personal Income = National Income – Social Security contributions – corporate income taxes – undistributed
corporate profits + transfer payments.

Disposable Income: From personal income if we deduct personal taxes like income taxes, personal property
taxes etc. what remains is called disposable income. Thus,

Disposable Income = Personal income – personal taxes.

Disposable Income can either be consumed or saved. Therefore,

Disposable Income = consumption + saving.

MEASUREMENT OF NATIONAL INCOME

Production generate incomes which are again spent on goods and services produced. Therefore, national
income can be measured by three methods:

1. Output or Production method or value added method

2. Income method, and

3. Expenditure method.

Let us discuss these methods in detail.

1. Value Added Method:

This is also called output method or production method. In this method the value added by
each enterprise in the production goods and services is measured. Value added by an
enterprise is obtained by deducting expenditure incurred on intermediate goods such as

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raw materials, unfinished goods (purchased from other firms from the value of output
produced by an enterprise.

Value of output produced by an enterprise is equal to physical output (Q) produced

multiplied by the market price (P), that is, P.Q. From the value added by each enterprise we
subtract consumption of fixed capital (i.e., depreciation) to obtain net value added at
market prices (NVAMP).

However, for estimating national income (that is, Net National Product at factor cost (NNPFC)
we require to estimate net value added at factor cost (NVAFC ) by each enterprise in the
economy. NVAFC can be found out by deducting net indirect taxes (i. e. indirect taxes less
subsidies provided by the Government).

Under this method, the economy is divided into different industrial sectors such as
agriculture, fishing, mining, construction, manufacturing, trade and commerce, transport,
communication and other services. Then, the net value added at factor cost (NVAFC) by each
productive enterprise as well as by each industry or sector is estimated.

It follows from above that in order to arrive at the net value added at factor cost by an
enterprise we have to subtract the following from the value of output of an enterprise:

1. Intermediate consumption which is the value of goods such as raw materials, fuels
purchased from other firms

2. Consumption of fixed capital (i.e., depreciation)

3. Net indirect taxes.

Summing up the net values added at factor cost (NVAFC) by all productive enterprises of an
industry or sector gives us the net value added at factor cost of each industry or sector. We
then add up net values added at factor cost by all industries or sectors to get net domestic
product at factor cost (NDPFC ). Lastly, to the net domestic product we add the net factor
income from abroad to get net national product at factor cost (NNPFC) which is also called
national income. Thus,

NI or NNPFC = NDPFC + Net factor income from abroad

This method of calculating national income can be used where there exists a census of
production for the year. In many countries, the data of production of only important
industries are known. Hence this method is employed along with other methods to arrive at
the national income. The one great advantage of this method is that it reveals the relative
importance of the different sectors of the economy by showing their respective
contributions to the national income.

Precautions:

The following precautions should be taken while measuring national income of a country
through value added method:

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1. Imputed rent values of self-occupied houses should be included in the value of output.
Though these payments are not made to others, their values can be easily estimated
from prevailing values in the market.

2. Sale and purchase of second-hand goods should not be included in measuring value of
output of a year because their values were counted in the year of output of the year of
their production. Of course, commission or brokerage earned in their sale and purchase
has to be included because this is a new service rendered in the current year.

3. Value of production for self-consumption are be counted while measuring national

income. In this method, the production for self-consumption should be valued at the
prevailing market prices.

4. Value of services of housewives are not included because it is not easy to find out
correctly the value of their services.

5. Value of intermediate goods must not be counted while measuring value added because
this will amount to double counting.

2. Income Method:

This method approaches national income from distribution side. In other words, this
method measures national income at the phase of distribution and appears as income paid
and or received by individuals of the country. Thus, under this method, national income is
obtained by summing up of the incomes of all individuals of a country. Individuals earn
incomes by contributing their own services and the services of their property such as land
and capital to the national production.

Therefore, national income is calculated by adding up the rent of land, wages and salaries of
employees, interest on capital, profits of entrepreneurs (including undistributed corporate
profits) and incomes of self-employed people. This method of estimating national income
has the great advantage of indicating the distribution of national income among different
income groups such as landlords, owners of capital, workers, entrepreneurs.

Measurement of national income through income method involves the following main
steps:

1. Like the value added method, the first step in income method is also to identify the
productive enterprises and then classify them into various industrial sectors such as
agriculture, fishing, forestry, manufacturing, transport, trade and commerce, banking,
etc.

2. The second step is to classify the factor payments. The factor payments are classified
into the following groups:

i. Compensation of employees which includes wages and salaries, both in cash and
kind, as well as employers’ contribution to social security schemes.

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 ii. Rent and also royalty, if any.

iii. Interest.

iv. Profits:

Profits are divided into three sub-groups:

i. Dividends

ii. Undistributed profits

iii. Corporate income tax

iv. Mixed income of the self-employed:

In India as in other developing countries there is fifth category of factor income which is
termed as mixed income of self-employed. In India a good number of people are
engaged in household industries, in family farms and other unorganised enterprises.
Because of self-employment nature of the business it is difficult to separate wages for
the work done by the self-employed from the surplus or profits made by them.
Therefore, the incomes earned by them are mix of wages, rent, interest and profit and
are, therefore, called mixed income of the self-employed.

3. The third step is to measure factor payments. Income paid out by each enterprise can be
estimated by gathering information about the number of units of each factor employed
and the income paid out to each unit of every factor. Price paid out to each factor
multiplied by the number of units of each factor employed would give us the factor’s
income.

4. The adding up of factor payments by all enterprises belonging to an industrial sector

would give us the incomes paid out to various factors by a particular industrial sector.

5. By summing up the incomes paid out by all industrial sectors we will obtain domestic
factor income which is also called net domestic product at factor cost (NDPFC).

6. Finally, by adding net factor income earned from abroad to domestic factor income or
NDPFC we get net national product at factor cost (NNPFC) which is also called national
income.

Income approach to measurement of national income is shown through bar diagrams in

Figure 2.7.

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Precautions:

While estimating national income through income method the following precautions
should be taken:

1. Transfer payments are not included in estimating national income through this method.

2. Imputed rent of self-occupied houses are included in national income as these houses
provide services to those who occupy them and its value can be easily estimated from
the market value data.

3. Illegal money such as hawala money, money earned through smuggling etc. are not
included as they cannot be easily estimated.

4. Windfall gains such as prizes won, lotteries are also not included.

5. Corporate profit tax (that is, tax on income of the companies) should not be separately
included as it has already been included as a part of profits.

6. Death duties, gift tax, wealth tax, tax on lotteries, etc., are paid from past savings or
wealth and not from current income. Therefore, they should not be treated as a part of
national income of a year.

7. The receipts from the sale of second-hand goods should not be treated as a part of
national income. This is because the sale of second-hand goods does not create new
flows goods and services in the current year.

8. Income equal to the value of production used for self-consumption should be estimated
and included in the measure of national income.

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3. Expenditure Method:

Expenditure method arrives at national income by adding up all expenditures made on

goods and services during a year. Income can be spent either on consumer goods or capital
goods. Again, expenditure can be made by private individuals and households or by
government and business enterprises.

Further, people of foreign countries spend on the goods and services which a country
exports to them. Similarly, people of a country spend on imports of goods and services from
other countries. We add up the following types of expenditure by households, government
and by productive enterprises to obtain national income.

1. Expenditure on consumer goods and services by individuals and households. This is

called final private consumption expenditure, and is denoted by C.

2. Government’s expenditure on goods and services to satisfy collective wants. This is

called government’s final consumption expenditure, and is denoted by G.

3. The expenditure by productive enterprises on capital goods and inventories or stocks.

This is called gross domestic-capital formation, or gross domestic investment and is
denoted by I or GDCF.

Gross domestic capital formation is divided into two parts:

(i) Gross fixed capital formation

(ii) Addition to the stocks or inventories of goods

4. The expenditure made by foreigners on goods and services of a country exported to

other countries which arc called exports and are denoted by X We deduct from exports
(X) the expenditure by people, enterprises and government of a country on imports (M)
of goods and services from other countries. That is, we have to estimate net exports
(that is, exports -imports) or (X—M) which is also denoted by NX.

Thus, we add up the above four types of expenditure to get final expenditure on gross
domestic product at market prices (GDPMP). Thus,

GDPMP = Private final consumption expenditure + Government’s final consumption

expenditure + Gross domestic capital formation + Exports — Imports or

GDPMP = C+G + I+ (X — M)

= C + G + I + NX

On deducting consumption of fixed capital (i.e., depreciation) from gross domestic

product at market prices (GDPMP) we get net domestic product at market prices (NDPMP).

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 In this method, we then subtract net indirect taxes (that is, indirect taxes – subsidies) to
arrive at net domestic product at factor cost (NDPFC),

Lastly, we add ‘net factor income from abroad’ to obtain net national product at factor
cost (NNPFC), which is called national income. Thus,

NNPFC = GDPMP – Consumption of Fixed capital – Net Indirect taxes + Net Factor Income
from Abroad.

Expenditure approach to national income is shown through bar diagram in Table 2.2.

Precautions:

While estimating Gross Domestic Product through expenditure method or measuring final
expenditure on Gross National Product, the following precautions should be taken:

1. Second-hand goods: The expenditure made on second-hand goods should not be

included because this does not contribute to the current year production of goods and
services.

2. Purchase of shares and bonds: Expenditure on purchase of old shares and bonds from
other people and from business enterprises should not be included while estimating Gross
Domestic Product through expenditure method. This is because bonds and shares are mere
financial claims and do not represent expenditure on currently produced goods and
services.

3. Expenditure on transfer payments by government such as unemployment benefits, old-

age pension should also not be included because no goods or productive services are
produced in exchange by the recipients of these payments.

4. Expenditure on intermediate goods such as fertilisers and seeds by the farmers and wool,
cotton and yarn by manufacturers of garments should also be excluded. This is because we

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have to avoid double counting. Therefore, for estimating Gross Domestic Product we have
to include only expenditure on final goods and services.

Difficulties in the Measurement of National Income

There are many difficulties in measuring national income of a country accurately. A greatest
difficulty in the measurement of national income in the developing countries is general lack
of adequate statistical data. Inadequacy, non-availability and unreliability of statistics is a
great handicap in measuring national income in these countries.

Statistical information regarding agriculture and allied occupations, and household

enterprises is not available. Even the statistical information regarding the enterprises in the
organised sector is sketchy and unreliable. There is no accurate information available
regarding consumption, investment expenditure and savings of either rural or urban
population. The difficulties involved are both conceptual and statistical in nature. Some of
these difficulties or problems are discuss below:

1. The first problem relates to the treatment of non-monetary transactions such as the
services of housewives and farm output consumed at home. On this point, the general
agreement seems to be to exclude the services of housewives while including the value
of farm output consumed at home in the estimates of national income.

2. The second difficulty arises with regard to the treatment of the government in national
income accounts. On this point the general viewpoint is that as regards the
administrative functions of the government like justice, administrative and defense are
concerned they should be treated as giving rise to final consumption of such services by
the community as a whole so that contribution of general government activities will be
equal to the amount of wages and salaries paid by the government. Capital formation by
the government is treated as the same as capital formation by any other enterprise.

3. The third major problem arises with regard to the treatment of income arising out of the
foreign firm in a country. On this point, the IMF viewpoint is that production and income
arising from an enterprise should be ascribed to the territory in which production takes
place. However, profits earned by foreign companies are credited to the parent
company.

Special Difficulties of Measuring National Income in Under-developed Countries

In under-developed countries like India, we face some special difficulties in estimating

national income. Some of these difficulties are:

1. The first difficulty arises because of the prevalence of non-monetised transactions in such
countries so that a considerable part of the output does not come into the market at all. Agriculture
still being in the nature of subsistence farming in these countries, a major part of output is
consumed at the farm itself.

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2. Because of illiteracy, most producers have no idea of the quantity and value of their
output and do not keep regular accounts. This makes the task of getting reliable
information very difficult.

3. Because of under-development, occupational specialization is still incomplete, so that

there is lack of differentiation in economic functioning. An individual may receive
income partly from farm ownership, partly from manual work in industry in the slack
season, etc. This makes the task of estimating national income very difficult.

4. Another difficulty in measuring national income in under-developed countries arises

because production, both agriculture and industrial, is unorganized and scattered in
these countries. In India, agriculture, household craft, and indigenous banking are the
unorganized and scattered sectors. An assessment of output produced by self-employed
agriculturist, small producers and owners of household enterprises in the unorganized
sectors requires an element of guesswork, which makes the figure of national income
unreliable.

5. In under-developed countries there is a general lack of adequate statistical data.

Inadequacy, non-availability and unreliability of statistics is a great handicap in
measuring national income in these countries.

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