NATIONAL INCOME

METHODS OF MEASURING NATIONAL INCOME:

National income of the country can be measure by the following three methods:

INCOME METHOD OR FACTOR INCOME METHOD:

National income, according to this method is the sum total of income earned by
various factors of production. Factors of production are engaged in the production
process and remunerated for their contribution. Following incomes are added in the
calculation of national income:
 Wages and salaries;
 Other compensation of employees;
 Employer’s contribution towards social security;
 Income of the self-employed;
 Rent;
 Interest;
 Dividend;
 Profit;
 Surplus of public enterprises;
 Net flow of factor income from abroad.
Total of the above income is known as gross national income at factor cost.

PRODUCT METHOD OR VALUE ADDED METHOD:

According to this method, productive enterprises produce certain goods and services in
the economy. The value of these goods and services is known as national income. Goods
include both consumer and capital goods. Consumer goods include bread, butter apples,
furniture and refrigerator etc. capital goods include pant, machines, equipments, tools,

Page 1 of 9
 NATIONAL INCOME

and etc. services include the services rendered by employees in government

departments and private enterprises. It also includes the services of doctors, teachers,
advocates, charted accountants, musicians and other artists. The money value of these
goods and services produced in the economy during the year is termed as gross
domestic product.
Product method is also known a census of output method, or value added method. It will
not be out of place to mention here that we have discussed the estimation of national
income according to value added method. The process of estimating national income
according to this method may be summarized as:
 Estimating the gross value of output in the various sectors of the economy;
 Determining the cost of material used and services rendered;
 Determining depreciation on capital goods and equipments;
 Calculating net value of domestic product by deducting depreciation from gross
domestic product.

EXPENDITURE METHOD:
Income generated in the economy is either spent in satisfying various wants or saved.
Savings are further invested in the productive activities. In other words,
Y=C+I+G+E
Y= yield (national income); C= private investment expenditure; I=private investment
expenditure; G=government expenditure on consumption and investment; E=net
income earned from abroad.

Page 2 of 9
 NATIONAL INCOME

DIFFICULTIES IN ESTIMATION OF NATIONAL INCOME IN INDIA:

Estimation of national income is very difficult and complicated. National income
statistics are not adequate and reliable even in advanced economies like America and
Japan. Under-developed economies like India face various problems in the estimation of
national income. These difficulties may be as follows:
1. Conceptual difficulties: the concept of national income used by socialist and
capitalist differs. Socialist countries do not include income from service sector in
the national income. Further, difficulty is faced as regards new products like
synthetic yarn, synthetic rubbers and chemical fertilizers etc. as these
commodities have come to existence recently, and i.e. they did not exist during
the base year.
2. Lack of reliable and sufficient data: complete and reliable data regarding national
income is not available in India. Estimates regarding costs are generally absent in
primary and subsidiary occupations. Data regarding consumption and savings of
rural sector is not available. In industrial sector data regarding small unit is not
available.
3. Unreliable data collecting agencies: there are still inadequate and incompetent
data collecting agencies at local and regional level. Enumerators and
investigators in many cases do not possess requisites qualification and ability of
collecting, classifying and analyzing data. These statistics are also not free from
personal prejudice and bias.
4. Presence of non-monetized sectors: majority of our population resides in
villages, where barter system is still prevailing. There is no record of these
transactions. Large quantity of goods is consumed by the producers themselves.
These goods do not reach even market. Data regarding self-consumed goods is
not available. It is simply a quess work and cannot be taken as accurate.
5. Lack of differentiation of occupations: considerable numbers of people engage
themselves in many occupations. Income from their main occupations may be
available but not from subsidiary occupations. In rural areas farmers engage
themselves in other economic activities other than cultivation. In urban areas
also people are engaged in various part time works. Lack of information from
subsidiary occupations makes the estimations of national income defective.
6. Inadequate information regarding income: proper accounts regarding income is
not maintained by marginal farmers, small producers, petty shopkeepers and
other production units due to ignorance, illiteracy and indifferent attitude
towards statistical enquiry. Even data collected suffers from false information
and distortion of statements.
7. Difficult demarcation between economic and non-economic activities: income is
generated through economic activities. Services of house-wives and children are
categorized as non-economic activities and are not included in the national
income. Income from these services can be imputed but practically ignored.
8. Scattered and unorganized production: production in India is scattered and
unorganized. It makes the collection of income statistics very difficult. Income
from these units is merely guess work.
9. Escaping from financial burden: in order to avoid and evade income tax, people
deliberately conceal their income. The under estimation of income and output by
business men, professionals and other producers makes the estimation of
national income false.

Page 3 of 9
 NATIONAL INCOME

10. Problem of double counting: in case of estimating national income, value of final
goods is added. It is not easy to identify intermediate and final goods. The same
commodity may be intermediate or final goods depending on its use. For
example, wheat may be final goods, if consumed domestically; it will be an
intermediate good if sold to flour mill. In the same way flour will be final goods, if
consumed domestically and intermediate goods if sold to bakery. It is very
difficult to avoid double counting and thus measurement of national income
becomes unreliable.

CIRCULAR FLOW OF INCOME:

Production of goods and services is a continuing process in every economy to
satisfy unlimited innumerable wants of all the individuals. Households render their
factor services as owners of land, labour, capital and enterprise to firms.
Real flow-The firm produces goods and services to meet the demand of the
household. Such flow of goods, services and factor services is known as real flow. In an
economy, the flow of factor services from households to firms and flow of goods and
services from firms to households is known as real flow.

Money flow- All payments by the firms to the households for their factor
services and by the households to the firms against goods and services supplied by them
are made in money form. Thus, the cycle of monetary payment from firms to the
households for their factor-services and in turn the monetary payments from
households to the firms against their gods and services, is known as money flow.

Page 4 of 9
 NATIONAL INCOME

Circular flow of income in two sector economy:

Income is generated during production process and flow of income between households
and firms in a two sector economy takes place. Firms produce goods and services by
obtaining factor services from households and pay rent, wages, salaries, interest and
profit to them. These payments are the income of households, who use it in purchasing
goods and services from production units. In this way, money reaches firms again who
invest it I production process again, generate income, make factor payments to
households, who purchases goods and services and in this way money is sent back t
firms again and flow of income continues. During the production process of an economy
due to transactions between different sectors of the economy, income and expenditure
more from one sector to the other in a circular form.

Circular flow of income in two sector economy:

The circular flow of income is flow of income in an economy which has four sectors.
Firms make the payment to households for their factor services. These payments
become the income of the households. Households spend a part of their income to
purchase goods and services. Their expenditure becomes the income of the firms. Here
it is presumed that both household sector as well as firm sector do not spend their
whole of income, rather part of it, they save. They deposit their savings in the capital
market. From this capital market, this savings returns back to the firms as investment.
Government gets its revenue by imposing taxes on households and o firms. Government
pays back this revenue to the firm’s households by purchasing from them goods and
services. Besides this government also gives subsides to the households and firms.
Country makes payments for the imports from the rest of the world and receives
payments for the exports to the rest of the world. Thus, we see that there is a
continuous flow of income among different sectors of the economy and from this flow;
income is generate at different levels.

Page 5 of 9
 NATIONAL INCOME

NATIONAL INCOME AND ITS RELATED AGGREGATES:

Gross domestic product: Gross domestic product at market price is the total value of all
final goods as services produced with in the country during an accounting year. It
should be noted that goods and services must be produced within the country. GDP is
always the money value of goods and services produced within a year. Goods and
services produced include all types of agricultural, industrial and commercial goods. It
includes the value of all economic activities producing both goods and services. GDP is
calculated as under:

GDP at market price= market price of goods produced + market price of services
produced.

GDP = P(Q)+P(S)
Where P=market price; Q=quantity of goods produced
during the year; S-services. While calculating GDP according to the formula, the quantity
of every individual goods and services is multiplied by their price per unit. The total
value of all the individual goods and services is Gross Domestic Product. GDP doesn’t
include transfer payments, capital gains, and income earned through illegal means.

Gross national product:

GNP is the total value of goods and services produced by the nationals of India with in
the country or outside the country. Here it is very important to understand the term
national. It means the citizens of India living within the country or outside the country.
The nationals must be resident one who ordinarily resides in the country and whose
economic interest lies in the same country. A normal resident means persons normally
residing in the Indian citizenship and non-nationals will be having foreign citizenship
but residing within the country. It is also possible that Indian nationals may be living in
foreign countries producing goods and services there. The value of these goods’ and
Page 6 of 9
 NATIONAL INCOME

services produced by Indian nationals abroad will be added to GNP. In the same way the
value of goods and services produced by non-nationals in India will not be included in
GNP.
GNP=GDP+FY
FY stands for net foreign yield i.e., net income from abroad. It may be both positive and
negative. Positive value of FY is added and the negative value of FY is deducted from
GDP.
Gross national product may thus be defined as the value of final goods and services
produced during the year plus net earnings from abroad.

Concept of net earnings from abroad:

In order to calculate GNP, we should add or subtract net earnings from abroad. Net
earnings from abroad are the difference between the value of goods and services
produced by foreign nationals in India and Indian nationals abroad. It may be positive
of negative. If the value of output produced by Indian nationals abroad exceeds the
value of the odds and services produced by foreign nationals in India, net earnings will
be positive.

Gross Domestic Product and Gross National Product at factor cost and market prices:
Factor cost: Factor here means factors of production. We know that the production of
goods is the result of effective combination of land, labour, capital and enterprises, as
factors of production. These factors are remunerated for their contribution in the
production. Income received by these factors of production is known as factor income.
The sum total of wages, salaries, rent, interest and profit is known to be factor cost.

Taxes: taxes are classified as direct and indirect. The taxes, whose incidence cannot be
shifted to other person is known as direct taxes. In other words, direct taxes are to be
borne by the tax payer himself. Income tax, wealth-tax, estate duty etc., are the example
of direct taxes. Indirect taxes, on the other hand are those taxes whose burden is shifted
by the tax payer to some other persons. Excise sales tax, entertainment tax etc, are the
examples of indirect taxes.

Subsidies: subsidies mean economic assistance given by the government to firms, in

certain cases, the government to firms. In certain cases, the government asks the firms
to produce certain specified articles such as controlled cloth, sugar etc. and also
instructs to supply them to consumers at specified rate. In these cases, if cost of
production of the firm is more than the rate of specified by the government, the
difference is subsidized by the government. In case of international trade commodity, in
order to earn foreign exchange, the government may encourage the export of certain
commodity. If the international competitive price of the commodity is lesser than the
cost of production of Indian firm or provided subsidy to the firm.

Calculation of GNP at market price and factor cost:

Gross national product at market price is calculated on the basis of the following
formula:
GNP at mp=GNP at fc +IT - S
Where GNP=Gross National Product; Mp=market price; Fc=factor cost; It= indirect taxes
S= subsidies.
Page 7 of 9
 NATIONAL INCOME

GNP at FC= compensation of employees

+operating surplus
+mixed income
+consumption of fixed capital(depreciation)
(Or)
GNP at fc =GNP at mp - IT + S

Gross domestic product at market price and factor cost:

GDP at market price differs from GDP at factor cost as regard indirect taxes and
subsidies. In other words,
GDP at factor cost includes indirect taxes and excludes subsidies.

GDP at fc =GNP at fc - Net factor income from abroad

Net factor income from abroad means the difference between the factor income of
Indian nationals in foreign countries and the factor income of foreigners in India. In case
the difference is positive it will be deducted.
GDP at market price will also differ from GNP at market price as regards net factor
income from abroad, so-

GDP at mp = GNP at mp - Net factor income from abroad

Difference between GDP and GNP

SL Points of
GDP GNP
NO. difference
It is the value of goods and It is the value of goods and
1 Meaning services produced within the services produced both within
domestic territory. and outside the country.
Net earnings It excludes net factor income It includes net factor income
2
from abroad from abroad from abroad
It is concerned with goods and
GNP can take place in any part of
3 Territory services produced within
the world.
domestic territory

Net domestic product:

Gross domestic product is the sum total of goods and services produce during the year
in the economy. It does not reveal the true national income, because it includes the full
value of all the goods and even capital goods such as machines, equipments, tools and
furniture etc. these capital goods are subject to wear and tear. There is loss in their
value due to their constant use. This loss in the use is termed as ‘depreciation’, In order
to calculate net product depreciation should be deducted from gross domestic product.
Net domestic product or domestic income as such may be defined as the value of goods
and services produced in the economy in an accounting year less consumption of fixed
capital (depreciation).

Page 8 of 9
 NATIONAL INCOME

NDP =GDP-Depreciation

Relationship and difference between net domestic product (NDP) and net national
product (NNP):
It has already been discussed that GDP and GNP differ from each other as regards net
income from abroad (fy). Net income received from abroad means the difference
between the factor income of foreigners in India and the factor income of Indian
nationals in the foreign countries. In the same way, NDP and NNP also differ from each
other as regards net receipts from abroad. Net receipts from abroad are the difference
between exports and imports expressed as (X-M). NNP can be calculated on the basis of
the formula:

NNP =NDP+(X-M)
Net national product may be equal to national domestic product or more than that. The
change may be effected by value of exports and imports. NNP will be equal to NDP if
exports are equal to imports. In case exports exceed imports NNP will be more than
NDP. In certain case, where imports exceed exports, NNP will be lesser than NDP.

Net domestic product at market price

Market price means prevailing current price in the market. In this way NDP at market
price means the value of goods and services produced during the year at market price
i.e., at prevailing current price. NDP and NNP are different from each other as regards
net factor income from abroad. NDP may be equal to NNP. It may be more than NNP or
lesser than that. Net factor income from abroad may be positive or negative. If it is
positive.NDP will be lesser than NNP. In case of negative net factor income from abroad
NDP will be more than NNP.
Net domestic product at factor cost
Factor, here means factor of production, and factor cost means earnings received by
various factors of production. In other words, it is sum total of earnings received by
factors of production as wages, rent, interest and profit. Net domestic product at factor
cost differs from bet national product as regards, net factor income from abroad. NDP at
factor cost is equal to NNP at factor cost less net factor income from abroad

NDP at fc = NNP at fc – Net factor income from abroad

NNP at fc= GNP at fc – Depreciation

GNP at fc = GNP at mp - Indirect taxes less subsidies

GNP at mp=GNP at fc +IT - S

GNP at FC= compensation of employees+ operating surplus

+mixed income
+consumption of fixed capital (depreciation)

Page 9 of 9