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National Income is generally defined as income of the nation. It reveals the nature of economic activities in a country, and also gives us an idea of a country’s aggregate economic activity.

According to Alfred Marshall, “the labour and capital of a country acting on its natural resources, reduces annually a certain net aggregate of commodity and material including services of all kinds.” Hence, Net means from the gross value of output, the depreciation must be deducted.

According to National Income Committee of India, “a national income estimates and measures the volume of commodity and services produced during a given period.”

Disposition of Income

What people do with their income? Here is how they relate:

  1. Income - This is the total flow of earnings received by individuals and businesses in exchange for factors of production (land, labor, capital, and entrepreneurship). Every rupee spent by a consumer is a rupee of income for a producer. National Income is the sum of all wages, rents, interest, and profits.
  2. Consumption - This represents the portion of National Income spent by households on final goods and services (like food, clothes, or haircuts) to satisfy immediate wants. In a simple economy, consumption is the primary driver of demand.
  3. Saving - Saving is essentially deferred consumption. It is the portion of National Income that is not spent on current goods and services.Saving must equal Investment (S = I). When people save money in banks, those funds are (ideally) loaned out to businesses to buy machinery or build factories, which grows the National Income in the future.

Features of National Income

Features of national income are as follows:

  1. It is Calculated Every Year - National Income is a flow concept, meaning it measures the value of goods and services produced over a specific period. In most economies, this is calculated for a single fiscal year (e.g., April 1 to March 31). This allows governments to track growth trends, compare performance against previous years, and adjust economic policies accordingly.
  2. Inclusion of Diverse Services - It isn't just about physical products like cars or bread. National Income accounts for the tertiary sector, which includes services provided by professionals such as teachers, doctors, engineers, and IT specialists. As long as these services are paid for, their value contributes to the total economic output.
  3. Monetary Valuation - To have a common denominator, everything must be expressed in a monetary unit (like Rupees, Dollars, Euros). Items or activities that cannot be assigned a market price, such as unpaid housework or volunteer charity work, are generally excluded because they lack a reliable financial metric.
  4. Avoidance of Double Counting - To get an accurate figure, we only count the value added at each stage or the value of the final product. For example, if we counted the value of wheat, then the value of flour, and then the value of bread, we would be counting the wheat three times. To avoid this, we only record the final price of the bread.
  5. Focus on Final Consumption - National Income considers only final goods and services, those purchased by the ultimate consumer for use. It excludes intermediate goods (materials used to produce something else) to ensure the data reflects the actual standard of living and the total utility provided to the society during that year.

Basic Concepts Related to National Income

One must know about the following basic concepts before calculating National Income: 

  1. National Income (NNPfc) – NNP at factor cost is the net value of all goods and services produced by a country's residents, adjusted for depreciation, and calculated at the cost of the factors of production (labour, capital, etc.). It is also known as National Income and is calculated by subtracting depreciation from Gross National Product (GNP). [NNP = GNP – Depreciation]
  2. Domestic Income (NDPfc) – Domestic income is the total income earned within a country's geographical borders during a specific period, including income generated by both residents and non-residents, such as wages, profits, rents, and interest. Unlike national income, domestic income excludes any income earned by a country's residents from outside its borders. 
  3. Net Factor Income from Abroad (NFIA) – It is the excess of factor incomes (rent, wages, interest, profit) earned from abroad over factor incomes paid to abroad. [NFIA = Factor Income from Abroad – Factor Income to Abroad]
  4. Depreciation (or Consumption of fixed capital) – It is the continuous fall in the value of fixed assets due to normal wear and tear, passage of time, expected obsolescence or change in technology over a period of time.
  5. Indirect Tax – It is a tax imposed by government on production and sale of goods and services. E.g.: Goods and services tax (GST). Indirect taxes increase market prices of goods and services.
  6. Subsidy – It is a form of financial/economic assistance given by the government to the firms and households, with a motive of general welfare e.g. Subsidy on price of cooking gas to the households, Interest-free loan to the firms, etc. Subsidies reduce the market prices of goods and services. [Net Indirect Taxes = Indirect Taxes – Subsidy]

Estimation of National Income

There are 3 methods for estimating National Income:

1. Product Method or Value Added Method –

  • Value Added = Value of Output – Intermediate Consumption
  • Value of Output = sales + change in stock
  • Sales = Quantity x Price
  • Change in Stock = closing stock – opening stock

GVAmp = GDPmp

  • GVAmp of Primary Sector + GVAmp of Secondary Sector + GVAmp of Tertiary Sector = GDPmp
  • NDPfc (domestic income) = GDPmp – Depreciation – Net indirect taxes

National income (NNPfc) = NDPfc + NFIA

Precautions –

Precautions to take while using product method: -

  1. Avoid double counting - Value of intermediate goods is not included in the estimation of National Income to avoid problem of double counting. Problem of double counting refers to the counting of the value of a good or service, more than once in the estimation of national income.

Two approaches to correct problem of double counting:

  1. Final output Method: Value of only the final goods and services should be added to determine national income.
  2. Value Added Method: Sum total of the value added by all firms should only be taken in consideration. Value of intermediate consumption should not be taken.
  1. Do not include sale of second hand goods - However, any brokerage or commission paid to sell the second hand goods is a fresh production activity, so brokerage or commission is included.
  2. Imputed Value of self-consumed output must be included in national income.

 

2. Income Distribution Method –

Domestic Income (NDPfc) = Compensation of employees + Operating surplus + Mixed income

  • Compensation of employees includes: Wages and salaries in cash and kind, Social security contributions by the employers.
  • Operating surplus/Income from property and entrepreneurship/ Non-wage income includes: Rent, Royalty, Interest, Profit.
  • Mixed income of self-employed – It is the combined income earned by self-employed people rendering their productive services.

National income (NNPfc) = NDPfc + NFIA

Precautions - 

Precautions to take while using income distribution method: -

  1. Avoid Transfers - National income includes only factor payments/income. Transfers are not a production activity; it should not be included.
  2. Avoid Capital Gain - Income from sale of old cars, old house, etc. is not included since these are not production transactions. Income from sale of financial assets, e.g., shares, bonds, debentures, etc. are not included as such transactions are mere paper claims and do not lead to value addition.
  3. Include income from self-consumed output - For e.g.: imputed rent of own factory should be included in national income since the house provides housing services.

3. Expenditure Method –

Components of GDPmp by Expenditure Method: -

  1. Private Final Consumption Expenditure (PFCE)
  2. Government Final Consumption Expenditure
  3. Gross Domestic Capital Formation (GDCF) = Gross domestic fixed capital formation + Net change or addition in stock OR, GDCF = Net domestic fixed capital formation + Depreciation + Closing stock – Opening Stock
  4. Net exports: Exports – Imports

GDPmp = Private final consumption expenditure + Government final consumption expenditure + Gross domestic capital formation + Net exports (or – Net imports)

National income (NNPfc) = GDPmp – Depreciation – Net indirect taxes + NFIA

Precautions - 

Precautions to take while using Expenditure Method: -

  1. Avoid intermediate expenditure - Expenditure on ‘intermediate goods’ like that on raw materials, etc. should not be included.
  2. Do not include expenditure on second hand goods and financial assets.
  3. Avoid transfer expenditures - Expenditure on transfer payments (e.g. Charities, donations, gifts, scholarships, etc.) should not be included.

Real and Nominal GNP

Nominal Income:

When national income is expressed in terms of money, it is called Nominal Income. It measures the value of output during a given year using the price prevailing that year. Therefore, when a country’s income of a particular year is measured at current price, it is called nominal income.

Value of Product x Current Price = Nominal Income

Real National Income:

When national income is expressed in terms of constant price or price prevailing in the base year, it is called real national income. It is measured in terms of constant prices and the base year is one which is free from fluctuations or there is a little possibility of fluctuation.