NATIONAL INCOME

Concepts & Meaning of National Income

National income is a measure of the total flow of earnings of the factor-owners through the
production of goods & services. In a simple way, it is the total amount of income earned by
the citizens of a nation.
All incomes are based on production. In this sense, national income reflects the level of
aggregate output.
The term national income carries at least meaning in economics.
The total value of the level of aggregate output is called !ross National "roduct or !.N.".
!.N.". is a measure of the total mar#et value of all final goods & services currently produced
by all the citizens of a nation within a period, usually a year.
There are a few points important here$
% It measures how much people produce.
% It counts current production only.
% It counts the level of output with a mar#et value.
% It relies on the mar#et prices of goods & services as a measure.
Measurement of National Income
There are mainly & approaches to measure !N".
The relationship of the & approaches is shown by the diagram below.
The Circular Flow of Economic Activities
'(penditures )*+ Prouct
Mar!et
"
,utput
#ousehol
s
Firms
Income by
production
" -actor
.osts
The & arrows in the diagram show the overall level of economic activities.
/ased on these & directions of flows, i.e. a flow of income, a flow of output, & a flow of
e(penditures, economists develop & approaches to measure !N".
0. ,utput or 1alue-Added Approach
The total value of all final goods & services ) i.e. outputs + can be found by adding up the total
values of outputs produced at different stages of production.
This method is to avoid the so-called double-counting or an over-estimation of !N".
2owever, there are difficulties in the collection and calculation of data obtained. It is from
0345 that the 2.6. government started to collect data by this approach.
In 0337, the government started to release !N" data.
. '(penditure Approach
The amount of e(penditures refers to all those spending on currently-produced final goods &
services only.
In an economy, there are & main agencies which buy goods & services. They are the
households, firms and the government.
In economics, we have the following terms$
. 8 "rivate .onsumption '(penditure ) of all households +
I 8 Investment '(penditure ) of all firms+
! 8 !overnment .onsumption '(penditure ) of the local government +
The e(penditure approach is to measure the !N". 9e could not buy all our outputs because
some are e(ported to overseas. :imilarly, our consumption e(penditures may include the
purchases of some imports. In order to find the !N", the value of e(ports must be added to .,
I & ! whereas the value of imports must be deducted from the above amount.
-inally, we have $
$ N P at mar!et prices % C & I & $ & ' ( M
!ross ;omestic "roduct ) !;" +
In 26, the government is difficult to #now about the amount of income earned through
production by 2 6 citizens outside 2 6 and the income earned by foreign citizens within 26
because of free trade policy. :o we can only find the amount of outputs produced within our
domestic boundary.
!;" is an aggregate measure of the total value of net output produced within the domestic
boundary of an economy in a specific period, say a year.
Income from abroad 8 Income earned by local citizens ) 2 6 + from the provision of
factor services abroad
Income to abroad 8 Income earned by foreign citizens from the provision of
factor services locally ) in 2 6 +
Net income from abroad 8 Income earned from abroad - Income sent to abroad
$ N P % $ ) P & Net Income from a*roa
&. Income Approach
The income approach tries to measure the total flows of income earned by the factor-owners
in the provision of final goods & services in a current period.
There are < types of factors of production and < types of factor incomes accordingly.
National Income % +ages & Interest Income & ,ental Income & Profit
The term profit can be further sub-divided into $ "rofit Ta( = ;ividend to all those shareholders =
& >etained "rofit ) or retained earnings +.
,elevant Concepts of National Income
Net National "roduct ) N N " +
The investment e(penditure of the firms is made up of parts. ,ne part is to buy new capital
goods & machinery for production. It is called net investment because the production capacity
of the firms can be e(panded.
Another part - consumption allowance or depreciation - is spent on replacing the used-up
capital goods or the maintenance of e(isting capital goods because capital goods will wear
and tear out over time..
;epreciation refers to all those e(penses to replace physical capital due to wear and tear,
obsolscence, destruction and accidential loss etc.
The sum of these amounts is called !ross Investment in economics.
$ross Investment % Net Investment & )epreciation
Net investment will increase the production capacity and output of a nation, but not by
depreciation e(penditure. :o we have,
N N P % $ N P ( )epreciation
! N " at factor cost
The amount of national income found by the income approach will not be the same as the
amount of ! N " at mar#et prices found by the e(penditure approach.
In the e(penditure approach, the value of ! N " includes some types of e(penses which are
N,T factor incomes earned by the citizens. They include depreciation, indirect business
ta(es, and government subsidies.
$ N P at factor cost % $NP at mar!et prices ( Inirect -usiness Ta.es & /u*siies
% $NP at mar!et prices ( Inirect -usiness Ta.es less su*siies
!N" at factor cost carries the meaning that we are measuring the total output by their costs of
production. As output generates income to the factor-owners, it is also related with the value
of national income.
$ N P at factor cost % National Income & )epreciation
;epreciation is also a type of costs of production but will not become a source of income
directly. :o, it is included in the factor cost but e(cluded in the value of national income.
Nominal ! N " ) ! N " at .urrent ?ar#et "rices +
!N" is a measure based on mar#et prices which are e(pressed in terms of money. In reality,
mar#et prices change all the time. The same amount of outputs may have different total
mar#et values provided that prices change.
In order to isolate the effect of price changes on the value of !N", economists have
developed the
concept and techni@ue of constant mar#et prices.
E.ample 0
Nation A with a population of 1 million
2334 2331 5444
Price 6uantit7
8million9
Price 6uantit7
8million9
Price 6uantit7
8million9
T(shirt 0 A 0 A A
+atch < A 7
/oft(rin! & < < 7
! N " at the base year ) 0335 + 8 0 ( A B ( < B ( m. 8 04 million
! N " at current mar#et prices in 0337 8 0 ( A B ( A B & ( < m. 8 &5 million
! N " at current mar#et prices in 555 8
The values of !N" at current mar#et prices in 0337 & 555 are calculated by using the
money prices in that year. They are also called nominal $NP.
Nominal growth rate of !N" refers to the change in the value of nominal !N" between any
years, e.g. the nominal growth rate is AA.AC D between 0335 to 555.
! N " at constant mar#et prices of 0337 8 0 ( A B ( A B ( < m. 8 A million
The real output changes from 04 to A million from 0335 to 0337. !N" at constant mar#et
prices
is called real $NP.
The growth rate of real !N" is called real growth rate of !N".
! N " at constant mar#et prices in 555 8
>eal ! N "
The value of real !N" is based on the prices of the base year. 2owever, there are too many
different values of prices on goods & services. To ma#e the calculation of !N" easier,
economists use a price inde( to find the real !N".
A price inde( is a number showing the changes in the overall level of prices. It shows a
change in the general price level of an economy.
9ith the value of the price inde(, the real !N" of anyone year can by found$
,eal $NP % Nominal $NP ' 8Price ine. at *ase 7ear : Price ine. at current 7ear9
Factors Affecting National Income
0. -actors of "roduction
Normally the more efficient and richer the resources, the higher the level of national income
or !N" will be.
Eand
>esources li#e coal, iron & timber are essential for heavy industries so that they must be
available and accessible. In other words, the geographical location of these natural resources
affect the level of !N".
.apital
.apital is greatly determined by investment. Investment in turn depends on other factors li#e
profitability, political stability etc.
Eabour & 'ntrepreneur
The @uality or productivity of human resources is more important than @uantity.
?anpower planning and education affect the productivity and production capacity of an
economy.
. Technology
This factor is more important for nations with little natural resources. The development in
technology is affected by the level of invention and innovation on production.
&. !overnment
!overnment can help to provide a favourable business environment for investment. It
provides laws and order, regulations that affect e(changes. In 26, the government promotes
free trade and competition which encourage economic activities.
<. "olitical :tability
A stable economic and political system helps the allocation of resources. 9ars, stri#es and
social unrests will discourage investment and business activities.
;ses of National Income /tatistics
:tandard of Eiving
The per capita !N" allows us to compare the standard of living of different nations. In
general, a nation has a higher standard of living if its per capita !N" is greater than that of
another nation.
"olicy -ormulation
In the compilation of !N" statistics, the government had already gathered a lot of information
of the economy. The government can base on these figures to plan and decide its policies.
International .omparison
/y converting the local !N" figures into a common unit ) usually in F:* +, we can compare
the standard of living of different nations. It helps to show the rate of growth or development
of different nations.
/usiness ;ecision
The !N" figures can show the level of development of different industries and sectors of an
economy. It helps the businessmen to plan for production.
Limitations of National Income /tatistics
!N" is a measure of the overall flow of goods & services, as well as to show the general
welfare of the people.
It aims not only at the level of cost of living but also the standard of living. It is @uite correct to
show the cost of living but there are some limitations on the !N" statistics to indicate the
standard of living of an economy.
0. "rice .hanges
A higher nominal !N" of a nation may not mean that the standard of living is better. If the
prices increase at a high rate, the real !N" may even fall.
. ,mittion or Fnder-estimation
1oluntary :ervices
!N" figures do not include the contribution of the voluntary agencies which raise the general
welfare, e.g. the Tung 9ah group of hospitals.
In this respect, the !N" figures under-estimate the level of welfare.
The voluntary wor# of housewives is also neglected by the !N" figures. It again under-
estimates our welfare or standard of living.
Eeisure
It is also a source of welfare and raises our standard of living, e.g. the welfare enGoyed with a
.hinese New Hear 2oliday. 2owever, the monetary value is difficult to calculate.
Illegal Activities
;rug traffic#ing and illegal gambling are activities omitted in the value of !N". It is difficult to
determine its effect on the welfare of an economy.
Fndesirable 'ffects of "roduction
!N" figures had not considered the effects of pollution, traffic congestion on the economy.
They have lowered our standard of living.
&. "roblem of .omparison
,utput .omposition
Nations with the same !N" may have different living standard because their output
composition may be different. In general, a higher level of consumer goods & services in the
!N" indicates a higher current level of living standard.
;istribution of Income & 9ealth
If income is obtained by a small rate of people in a nation, the general living standard is still
low compared with a nation having a more evenly distributed income or !N".
<. ,ther Eimitations
"opulation :ize
A large population has a lower living standard even if its !N" is the same as that of a small
population. The per capita !N" is more useful to compare the nations.
National ;efense
If a nation has spent a lot of resources in the production of weapons and so on, its living
standard
may not be improved.
Time
Technology will be improved over time. This may not be shown in !N" figures because there
may be small changes in cost and price only.
/esides, durable goods provide welfare to us over a period of time ) usually more than 0
year +. This cannot be shown by !N" figures within a year.