National Income

The National Dividend is that part of the objective income of the community, including of course income derived from abroad which can be measured in money – Prof. Pigou

Teaching Points
8.1     Introduction
8.2     Meaning and Definitions
8.3     Features of National Income
8.4     Circular Flow of National Income
8.5     Different Concepts of National Income
8.6     Methods of Measuring National Income
8.7     Difficulties in the measurement of National Income

Teaching Objectives
To make the students aware of national income and the various methods of measuring national and its difficulties.

One of the most outstanding features of all modern economies is the influential and active role undertaken by government.

8.1     Introduction
The Concept of national income occupies an important place in economic theory. National income is one of the important subject matters of Macro Economics. National income is an uncertain term, which is used interchangeably with national dividend, national output and national expenditure.
National income .is the flow of goods and services, which become available to a nation during the year. To be more precise, national income is the aggregate money value of all final goods and services produced in a country during one year. As an indicator of economic health and as an instrument of economic analysis, national income computation is of great importance to the economists.
The total economic performance of a nation is evaluated with the help of national income data. The basic purpose of national income accounting is to measure the aggregate output and income, and provide a basis for the government to formulate their policy programmes, to maximize the national welfare of the people. In India, since 1955, the responsibility for the calculation of national income rests with the Central Statistical Organization (C.S.O.).

         Meaning :
In common, national income means the total value of goods and services produced annually in a country. In other words, the total amount of income accruing to a country from economic activities, in a year's time is known as national income. It includes payments made to all resources in the form of rent, wages, interest and profits.
Thus, national income is the aggregate monetary -value of all final goods and services produced-in the, economy in a year.
Definitions of National Income:
Dr. Marshall's Definition                  
Marshall's definition represents a total value of production - it is from production end.
According to Marshall, "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."
Prof. Pigou's Definition
Pigou's definition of national income represents a receipts total production end.
According to Pigou, the national dividend is that part of the objective income of the community, including of course income derived from abroad, which can be measured in money:



Fisher's Definition
Fisher's approach is consumption end. "The national dividend or income consists solely of services as received by ultimate consumers, whether from their material or from their human environments".
Thus, according to Fisher, the national income of a country is determined not by its annual production, but by its annual consumption. Fisher's definition provides an adequate concept of economic welfare, which is dependent on consumption and consumption represents our standard of living.
         National Income Committee's Definition (1948)
"A national estimate measures the volume 11 of commodities and services turned out during a given period counted without duplication."
        
8.3     Features of National Income
1)      National income is a macro economic concept : Macro economics deals with aggregate or the economy as a whole. National income data present the picture of the performance of the country's economy as a whole in course of a given period of time.
2)      National income is a flow concept: National income is the flow of goods and services produced in the country during a year. It includes only those goods or services which are actually produced.
         3)      National income is the money valuation of goods : National income is always expressed in monetary terms. It represents only those goods and services which are exchanged for money.
         4)      National income includes value of only final goods and services : In order to avoid double counting, while estimating national income, we include only value of final goods and services, and not the value of intermediate goods or raw material. For example, while estimating the production of sugar, there is no need to take the value of sugarcane, as it is already included in the price of sugar.   
         5)      National income is the net aggregate value: National income includes net value of goods and services produced and does not include depreciation cost i.e. wear and tear of capital goods, due to their use in the process of production.
         6)      Net income from abroad is included in national income: While estimating national income, net income received from international trade that is the net export value (X-M) as well as net receipts (R-P).
         7)      Financial Year: It is always expressed with reference to time period, that is, generally a financial year, which in India is from 1st April to April to 31st March of every year.

8.4     Circular Flow of National Income
         The Circular Flow of National Income and expenditure refers to the process, whereby the national income and expenditure of an economy flow in a circular manner continuously through time.
         Circular flow in a simple economy :
We begin with a simple hypothetical economy, where there are only two sectors, the household and business.
         •        Households are the owners of factors of production and consumers of goods and services.
         •        Business sector produce goods and services and sell them to the household sector.
         •        The household sector receives income by selling the services of theses factors to the business sector.
         •        The business sector consists of producers who produce goods and services and sell them to the household sector of consumers.
         •        Thus, the household sector buys the goods and services from the business sector.
         •        Thus, one man's income is another man's expenditure.
The circular flow can be understood with the help of diagram.
The outer circle of diagram shows the real flow i.e. flow of factor services from household sector to business sector and corresponding flow of goods and -services, from business sector to household sector.
The inner circle shows the money flow, that is, flow of factor payments from business sector to household sector and corresponding flow of consumption expenditure from household sector to business sector.
It must be noted that entire amount of money, which is paid by business sector as factor payments, is paid back by the factor owners to the business sector. So, here is a circular and continuous flow of money income. In the circular flow of income, production generates factor income, which is converted into expenditure. This flow of income continues as production is a continuous activity due to never ending human wants. It makes the flow of income circular.
8.5     Different Concepts of National Income
         National income is an important concept of Macro Economics. There are number of concepts pertaining to national income.
1)      Gross National Product (GNP)
Gross national product is the total measure of the flow of goods and services, at market value resulting from current production, during a year in a country, including net income from abroad.
GNP =C+I+G+(X-M)+(R-P)
2)      Gross National Product at Market Price (GNP (MP))
It means the gross value of final goods and services produced annually in a country, which is estimated according to the price prevailing in the market. Market price including cost of production + indirect taxes.
GNP (MP) = C + I + G + (X-M) + (R-P)
C = Private Consumption Expenditure
I = Domestic Private Investment
G = Government's Consumption & Investment Expenditure.
(X-M) = Net Export Value. (Value of exports Value of imports)
(R-P) = Receipts from Property abroad - Payments to abroad.
MP = Production at Market Price.
3)      Gross National Product at Factor Cost: (GNP (FC))
Gross national product at factor cost is the sum of the money value of the income, produced by and accruing to the various factors of production in one year in a country.
In order to arrive at GNP at factor cost, we deduct indirect taxes from GNP at market prices and add subsidies to GNP at Market. Prices.
GNP(FC) = GNP(MP) - Indirect Taxes + Subsidies
4)      Gross Domestic Product at Market Price (GDP (MP))
Gross domestic product at market price is the gross market value of all final goods and services produced within the domestic territory of a country, during a period of one year.
         •        The term gross implies that it includes depreciation.
         •        GDP at market price includes amount of indirect taxes paid and excludes amount of subsidy received, that is, net indirect taxes are included. GDP(MP) = GNP - Net Income from abroad.
\GDP(MP) = C + I + G + (X-M)
5)      Gross Domestic Product at Factor Cost (GDP (FC) )
Gross domestic product at factor cost is the gross money value of all final goods and services produced within the domestic territory of a country, during a period of one year.
GDP at factor cost includes amount of subsidy, but excludes amount of indirect taxes paid.
GDP (FC) = GDP (MP) - Indirect Taxes + Subsidies
\ GDP(FC)=C+I+G+(X-M)-IT+S
6)      Net Domestic Product at Market Price (NDP (MP)):
Net domestic product at market price is the net market value of all final goods and services produced, within the territorial boundaries of a country, during a period of one year.
NDP (MP) = GDP (MP) - Depreciation
7)      Net Domestic Product at Factor Cost (NDP (FC)):
Net domestic product at factor cost is the net money value of all final goods and services produced, within the territorial boundaries of a country, during a period of one year.
NDP (FC) is also known as domestic income or domestic factor income.
         NDP (FC) = GDP (MP) - Net Indirect Taxes - Depreciation        
8)      Net National Product at Market Price (NNP (MP)):
Net national product at market price is the net market value of all final goods and services produced, by the residents of a country, during a period of one year. If we deduct depreciation from GNP at market prices we get NNP at market prices.
NNP (MP) – GNP (MP) = Depreciation
9)      Net National Product at Factor Cost (NNP (FC)):
Net national product at factor cost is the net money, value of all final goods and services produced by the residents of a country, during a period of year.
It includes income earned by factors of production.
NNP (FC) - NNP (MP) - Indirect Taxes + Subsidies
10)    National Income at Factor Cost (NI (FC)): National income at factor cost means the sum of all incomes, earned by resource suppliers for their contribution of land, labour, capital and entrepreneurial ability, which go into the year's net production.
NI (FC) = NNP (MP) - Indirect Taxes + Subsidies.
Personal Income (PI):
Personal income is the sum of all incomes, actually received by all individuals or households from all the sources during a given year. It may be earned or unearned.
Personal Disposable Income:
Personal disposable income is that part of personal income which is left behind after payment of personal direct taxes like income tax, personal property taxes, etc.

8.6     Methods of Measuring National Income
There are three methods of measuring national income.
1)       The output method/Product method
2)       The income method
         3)       The expenditure method.
1)      Output Method:
This method of measuring national income is also known as product method or inventory method. This method approaches national income from the output side. According to this method, the economy is divided into different. sectors, such as agriculture, mining, manufacturing, small enterprises, commerce, transport; communication and other services. The, output or product method is followed either by valuing all the final goods and services, produced during a year, at their market price or by adding up all the values at each higher stage of production, until these products are turned into final products.
While using this method utmost care must be taken to avoid multiple or double counting. To avoid double counting this method suggests two alternative approaches for the measurement of GNP
i)       The Final Goods Approach / The Final Product Approach:
Final goods are those goods which are ready for final consumption. According to this approach value of all final goods and services produced in primary, secondary and tertiary sector are included and the value of all intermediate transactions are ignored. Intermediate goods are involved in the process of producing final goods, that is, the final flow of output purchased by consumers. Hence, the value of final output includes the value of intermediate products.
For example, the price of bread includes, the cost of wheat, making of flour, etc., wheat and flour are both intermediate goods. Their values are paid up during the process of production. In the value of the final product, bread, the values of intermediate goods are already included.
Thus, a separate accounting of the values of intermediate goods, along with the accounting of the value of final product, would mean double counting. To avoid this, the value of only the final product must be computed.
ii)      The Value Added Approach / The value Added Method:
In order to avoid double counting value added approach is used. According to this approach, the value added at each stage of the production process is included. The difference between the value of final outputs and inputs, at each stage of production is called the value added. Thus, GNP is obtained as the sum total of the values added by all the different, stages of the production process, till the final output is reached in the hands of consumers, to meet the final demand. This can be illustrated with the help of the following table.

Table No. 8.1 – Value Added Method
Production Stages
Value of Output (`)
Value of Input (`)
Value Added (`)
Wheat (Farmer)
700
0
700
Flour (Flour mill)
1000
1000
300
Bread (Baker)
1300
1000
300
Retailer (Merchant)
1400
1300
100
Total Value


1400

Here, we have assumed a much simplified model of an economy, producing only a single final product, bread. It is assumed, that there are four productive stages in production of bread.
         In the given example farmer produces and sells wheat for ` 700/- to the miller. Miller sells flour for ` 1000/- to the baker. Baker sells bread for ` 1300/- to the retailer/merchant. Retailer sells bread for ` 1400/- to the consumers. So the value added by farmer (` 700), miller (` 300), baker (` 300) and retailer (` 100) that is, total of ` 1400 should be included in the national income.
To avoid double counting, either the value of final output or the sum of value added should be taken in the estimate of GNP.
Precautions:
While estimating national income by output method, the following precautions should be taken:
1)       To avoid double counting, only the value of final goods and services must be taken into account.
2)       Goods used for self consumption by farmers should be estimated by a guess work that, is imputed value of goods produced for self consumption, is included in national income.
3)       Indirect taxes included in the market prices are to be deducted and subsidies given by the government to certain products should be added for accurate estimation of national income.
4)       While evaluating output, changes in the price level between different years must be taken into account.
5 )      Value of exports should be added. and value of imports should be deducted.
6)       Depreciation of capital-assets should be deducted.     
7)       Sale and purchase of secondhand goods should be ignored as it is not a part of current production. The output method is widely used in the underdeveloped countries. However, it is less reliable because of the margin of error. In India, this method is applied to agriculture, mining and manufacturers, including handicrafts. But it is not applied for transport, commerce and communication sectors in India.
2)      Income Method:
This method of measuring national income is also known as factor cost method. This method approaches national income from the distribution side.
According to this method, the income payments received by all citizens of a country, in a particular year, are added up, that is, incomes that accrue to all factors of production by way of rents, wages, interest and profits are all added together, but income received in the form of transfer payments are ignored. The data pertaining to income are obtained from different sources, for instance, from income tax returns, reports, books of accounts, as well as estimates for small income.
The GNP can be treated as the sum of factor incomes, earned as a result of undertaking economic activity, on the part of resource owners and reflected in the production of the total output of goods. and services during any given time period.
Thus, GNP, according to income method, is calculated as follows:
NI = Rent + Wages + Interest + Profit + Mixed Income + Net income from abroad.
Precautions:
         While estimating national income by income method, the following precautions should be taken.
         1)       Transfer incomes or transfer payments like scholarships, gifts, donations, charity, old age, pensions, unemployment allowance etc., should be ignored.
         2)       All unpaid services like services of housewife, teacher teaching her/his child, should be ignored.
         3)       Any income from sale of second hand goods like car, house etc., should be ignored.
         4)       Income from sale of shares and bonds should be ignored as they do not add anything to the real national income.
         5)       Revenue received by the government through direct taxes, should be ignored, as it is only a transfer of income.
         6)       Undistributed profits of companies, income from government property and profits from public enterprise, such as water supply, should be included.
         7)       Imputed value of production kept far self consumption and imputed rent of owner occupied houses should be included.
In India, the national income committee of the Central Statistical Organization, uses the income method for adding up the income arising from trade, transport, professional and liberal arts, public administration and domestic services.
3)      Expenditure Method
This method of measuring national income is also known as Outlay Method.
According to this method, the total expenditure incurred by the society, in a particular year, is added together. Income can be spent either on consumer goods or on capital goods. Thus, we can get national income by summing up all consumption expenditure and investment expenditure made by all individuals, firms as well as the government of a country during a year.
Thus, gross national product is found by adding up­
NI = C + I + G (X-M) + (R-P)
         1)      Private Final Consumption Expenditure Private Final Consumption Expenditure (C) by households on non-durable goods, such as food, which are used immediately, expenditure on durable goods such as car, computer, television set, washing machine etc., which are generally used for a longer period of time, and expenditure on services like transport services, medical services, etc.
         2)      Gross domestic private investment expenditure (I)­
                  It refers to expenditure made by private businesses on replacement, renewals and new investment (I).
         3)      Government final consumption and investment expenditure (G)­
                  i)        Government's final consumption expenditure refers to the expenditure incurred by government on various administrative services like, law and order, defence, education etc.
                  ii)       Government's investment expenditure refers to the expenditure incurred by government, on creating infrastructural facilities like construction of roads, railways, bridges, dams, canals, which are used by the business sector for production of goods and services in any economy (G).
         4)      Net Foreign Investment/Net Exports = (X-M): It refers to the difference between exports and imports of a country during a period of one year.
         5)      Net Receipts (R-P):
                  The difference between expenditure incurred by foreigners in the country (R) and expenditures incurred abroad by residents (P) : (R-P).
         Precautions:
While estimating national income by Expenditure Method, the following precautions should be taken.
1)       Expenditure on all intermediate goods and services should be ignored, in order to avoid double counting.
2)       Expenditure on the purchase of second hand goods, should be ignored, as it is not incurred on currently produced goods.
3)       Expenditure on transfer payments like scholarships, old age pensions, unemployment allowance etc., should be ignored.
4)       Expenditure on purchase of financial assets such as shares, bonds, debentures etc., should not be included, as such transactions do not add to the flow of goods and services.
5)       Indirect taxes should be deducted.
6)       Expenditure on final goods and services should be included.
7)       Subsidies should be included.
Out of these methods, the Output Method and Income Method are extensively used. In advanced countries like U.S.A. and U.K. the Income Method is popular. Expenditure Method is rarely used by any country because of practical difficulties. In India, the Central Statistical Organization (CSO) adopts a combination of output method and income method to estimate national income of India.

8.7     Difficulties in the measurement of National Income :
The calculation of the national income of a country is a task full of difficulties and complexities. The following difficulties generally arise while estimating national income.
i)        Theoretical difficulties
ii)       Practical difficulties.
i)       Theoretical difficulties :
         This is also known as conceptual difficulties.
1)      Transfer payments:
Individuals get pension, unemployment allowance, but whether these should be included in national income is difficult problem. On one hand, these earnings are a part of individual income and, on the other, they are government expenditure. Therefore, these transfer payments are ignored from national income.


2)      Income of foreign firms:    
         According to IMF view-point, income of a foreign firm, should be included in the national income of the country, where the firm actually undertakes production work. However, profits earned by foreign firms are credited to the parent concern.
3)      Unpaid services:
National income is always measured in money, but there are a number of goods and services which are difficult to be assessed in terms of money. For example, painting as ahobby. by an individual, the bringing up of children by the mother, these services are not included in national income as remuneration is not given to them.
Also services of housewives and the services provided out of love, affection; mercy, sympathy and charity are not included in national income, as they are not paid for. By excluding all such services from it, the national income will work out to be less than what it actually is.
4)      Incomes from illegal activities:
Income earned through illegal activities such as gambling, black marketing, theft, smuggling etc., is not included in national income. Such goods and services do have value and meet the needs of the consumers. Thus to that extent national income is underestimated.
5)      Treatment of government sector: Government provides a number of public services like defence, public administration, law and order etc. Measuring the market value of such government services is difficult; as the real value of these services is not known, therefore it has become a convention to treat all such services as final consumption. Hence, it is included in national income.
6)      Production for self consumption:
Goods produced for self consumption such as food grains, vegetables and other farm products do not enter in the market. But the value of such goods should be estimated at the rate of market price that have been marketed and should be included in national income.
7)      Changing price levels:
The difficulty of price changes arise in the national income estimate, when the price level in the country rises, the national income also shows an increase even though the production might have fallen and when price level falls., National Income may show a decrease even though production may have increased.
ii)      Practical difficulties / statistical:
In practice, a number of difficulties arise in the collection of required statistics in estimating national income, some of these are.
1)      Problem of double counting:
The greatest difficulty in calculating the national income is of double counting. It arises from the failure to distinguish properly, between a final and an intermediate product. It so happens, the national income would work out to be many times the actual. For example, flour used by a bakery is an intermediate product and that by a household the final product.
2)      Existence of non-monetized sector:
There is a large non-monetized sector, in-the developing economy like India. Agriculture, still being in the nature of subsistence farming in the developing countries, a major part of the output is consumed at the farm itself and a part of production is partly exchanged for other goods and services. Such production and consumption cannot be calculated in national income.
3)      Lack of occupational specialization:
There is the lack of occupational specialization, which makes the calculation of national income by product method difficult. For instance, besides the crop, farmers in a developing country are engaged in supplementary occupations like dairy farming, poultry farming, cloth making etc. But income from such productive activities may not be revealed and thus is not included in the national income estimates.
4)      Inadequate and unreliable data:
Adequate and correct production and cost data are not available in a developing country, such data relate to crops, fisheries, animal husbandry, forestry, the activities of petty shopkeepers, construction workers, small enterprises etc. That is why, national income of a country will not show at its actual.
For estimating national income by income method, data on unearned incomes and on persons employed in the service sector are not available. Data on consumption and investment expenditures of the rural and urban population are also not available for the estimation of national income. Moreover, there is no machinery for the collection of data in such countries.

5)      Capital gains or losses:
Capital gains or losses, which accrue to the property owners by increases or decreases in the market value of their capital assets or changes in demand, are not included in the gross national product, because these changes do not result from current economic activities.
6)      Depreciation:
The calculation of depreciation on capital consumption is one more difficulty. Depreciation refers to wear and tear of capital assets, due to their use in the process of production. Depreciation of capital assets will depend on technical life of the asset, the intensity of its use, nature of the asset, regular and careful maintenance etc. There are no uniform, common or accepted standard rates of depreciation applicable to the various capital assets. In case of depreciation, one has to make many reasonable assumptions, which involve an element of subjectivity. So it is difficult to make correct deductions for depreciation.
7)      Valuation of inventories:
Raw materials, intermediate goods, semi­finished and finished products in the stock of the producers are known as inventory. All inventory changes, whether negative or positive, are included in the gross national product. Any mistake in measuring the value of inventory, will distort the value of the final production of the producer. Therefore, valuation of inventories requires careful assessment.
8)      Illiteracy and Ignorance:
Majority of the small producers in developing countries are illiterate and ignorant; and are not in a position to keep any account of their productive activities. So they cannot give information about the quantity or value of their output. Hence, the estimates of production and earned income are simply guesses.

Q.1.A) Fill in the blanks with appropriate alternatives given in the brackets.
1)       National income is the subject matter of ............... Economics.
         (Micro/Macro/ Managerial/Business).
2)       GDP (FC) = GDP (MP) ...............
         (factor cost/indirect taxes/depreciation/subsidy)
3)       In India, the responsibility for the calculation of national income rests with ...............
         (World Bank / International Monetary Fund /Central Statistical Organization / International Labour Organization)
4)       National income is ............... concept. (stock/final/intermediate/flow)
5)       Paper purchased by a publisher is ...............
         (intermediate good/final good/consumer good/service)
Q.B)   Match the following groups
         `A' Group                                `B' Group
         1)    Income method                   a)    Personal income - direct taxes
         2)    Unemployment allowance     b)    Money value of goods and services
         3)    Disposable income               c)     Factor cost method
         4)    National Income                  d)    Personal income - subsidy
         5)    NNP (MP)                             e)    Transfer payment
                                                         f)     GNP (MP) - Depreciation
                                                         g)    Output method
                                                         h)    Transfer income
Q. C)  State whether the following statements are true or false
         1)       National income is computed every year.
         2)       Inclusion of value of intermediate goods leads to double counting.
         3)       GDP includes net income from abroad.
         4)       Financial year in India is leap year.
         5)       Services of housewives are included in national income.

Q.2. A) Define or explain the following concepts :
         1)       Final goods
         2)       National income
         3)       Personal income
         4)       Depreciation

Q.2 B) Give reason or explain the following statements:
         1)       Income from second hand sale of goods is excluded from national income.
         2)       National income at factor cost includes subsidy.
         3)       National income estimates are accurate in India.
         4)       Old age pension is transfer income.
         5)       Paid services are included in national income.

Q.3 A) Distinguish between
         1)       Gross national product and Gross domestic product.
         2)       Net national product and Net domestic product.
         3)       Output method of measuring national income and Income method of measuring national income.
         4)       Gross National Product and Net National Product
         5)       National income at market prices and national income at factor cost.

Q.3 B) Write short notes on:
         1)       Value added approach
         2)       Expenditure method of measuring national income
         3)       Circular flow of national income
         4)       Personal disposable income
         5)       Net national product at factor cost.

Q.4    Answer the following questions:
         1)       What is double counting of national income?
         2)       What are the features of national income?
         3)       Explain the concept of Gross domestic product at market prices.
         4)       State the precautions while using expenditure method to measure national income.
         5)       Explain the income method of measuring national income.

Q.5    State with reasons whether you agree or disagree with the following statements:
         1)       There are many conceptual or theoretical difficulties in the measurement of national income.
         2)       Many precautions are to be taken while estimating national income by income method.
         3)       Gross National product and Gross Domestic product are same concepts.
         4)       The money value of intermediate goods is not included in the estimation of national income.
Q.6    Answer in detail:
         1)       Explain the practical or Statistical difficulties involved in the estimation of national income.
         2)       Explain the Output method of measuring National income.
         3)       Explain the `Final Good Approach' to avoid double counting of goods and services in the estimation of National income.

Project :
Find out the changes in the size and pattern of contribution of primary sector to National income of India.

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ECONOMICS TEXT BOOK

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Demand Analysis

Producer's Behaviour

Elasticity of Demand

Introduction to MacroEconomics

Introduction to MicroEconomics

Money