National Income & its

Different Concepts
Unit-3 : 2nd portion
Meaning & Definition:
“National income is the flow of goods and services
which becomes available to a nation during a year”
“National income is the aggregate money value of
all goods and services produced in a country
during one year, account being taken of the
deductions made due to wear and tear, and
depreciation of plants and machinery used in the
production of goods and services”
“The money value of the goods and services produced in a
country during a year is called national income.”
A country is high national income is said to be a
prosperous country.
What is National Income?
National income measures the total value of goods
and services produced within the economy over a
period of time
It is the final outcome of all economic activities of
a nation. In another words, it is the value of the
final goods and service produced in the country in
a year.

Production of goods and service generates income

and income give rise to demand for goods and
service, demand give rise to expenditure, and
expenditure give further rise to production of
goods and service. Hence, there is a circular flow of
production, income and expenditure.
According to Alfred Marshall -:The labor and
capital a country acting upon natural resources
produce annually a certain net aggregate of
commodities, material and immaterial including
service of all kinds. This is the net annual income
or revenue of country or the national dividend.
In the word of A.C. Pigou -"The national
dividend is that part of the objective income of the
community including of course, income dividend
from aboard, which can be measured in money.
According to Irving fisher -"The true national
income is that part of annual net produce which is
directly consumed during that year".
Circular Flow of Economic Activities and Income
The simple model of the circular flow assumes two players
Business
 Produce and supply the goods and services.
 Require various factors of production to produce these
goods and services.
Households
 Include a set of individuals living in the same house
 Take joint decision about the consumption of goods and
services.
 Provide services in terms of factor inputs to the firms
 Get paid for these services by firms which households
spend on consumption.
 Money flows from firms to households as factor
payments and from households to firms as expenditure
on goods and services.
 It is a circular flow of money or income
 Circular Flow of Economic Activities and
Income

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The Circular Flow of income
Wages, rents,
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Basic concepts in National Income:-
Gross Domestic Product (GDP).
GDP at Constant Prices and Current Prices.
GDP at Factor Cost and GDP at Market Price.
Net Domestic Product (NDP).
Gross National Product (GNP).
Net National Product (NNP).
NNP at Factor cost or National Income
Personal Income (PI).
Gross Domestic Product (GDP):-
Gross Domestic Product is the money value of all final
goods and services produced within the domestic territory of
a country during a year inclusive of depreciation.
Domestic territory is defined to include:
(i) Territory lying within the political frontiers, incl. territorial
water of the country.
(ii) Ships and aircrafts operated by the residents of the country
between two or countries.
(iii)Fishing vessels, oil and natural gas rigs, and floating
platform operated by the residents of the country in the
international waters,
(iv)Embassies consulates and military establishments of the
country located abroad.
GDP at Constant Prices and Current Prices
If the domestic product is estimated on the basis of the
prevailing(current) prices, it is called GDP at current
prices.
If the GDP is measured on the basis of some fixed prices,
that is prices prevailing at a point of time or in some base
year, it is known as GDP at constant or real gross
domestic product.
Net Domestic Product
Net Domestic Product is the market value of
final goods and services produced by all the
producers in the domestic territory of a
country during an accounting year exclusive
of consumption of fixed capital. It is equal to
the net value added at market price.

When depreciation allowance is subtracted

from GDP, we get net domestic product.
Thus, NDP = GDP – depreciation.
Gross National Product
GNP is sum total of all the goods and
services produced in a country during a year
and net income from abroad.
GNP is the sum of Gross Domestic Product
at Market Price and Net Factor Income from
abroad.
Thus, GNP = GDP + NIFA
Net National Product
In the process of production of goods and
services, there will be some depreciation of
fixed capital also called as consumption of
fixed capital, if the value of depreciation is
deducted from the value of gross national
product in a year, we obtain the value of net
national product.
Thus, NNP = GNP - depreciation
Net National Product at Factor Cost
Net National Product at factor cost is also called as
national income.
Net National Product at factor cost is equal to sum
total of value added at factor cost or net domestic
product at factor cost and net factor income from
abroad.
Thus, NI = NNP – Indirect Taxes + subsidies -
Profits accruing to the govt.
 Personal Income
Personal income is that income which is actually received by
the individuals or households in a country during the year
from all sources.
In order to derive PI from NI, we have to deduct from NI
those amounts which are not available for distribution
among the factors of production.
Thus, PI = NI – corporate income taxes – undistributed
corporate profits – social security contribution + transfer
payments.
Note: One-way payment of money for which no money, good, or service is received in
exchange. Governments use such payments as means of income redistribution by
giving out money under social welfare programs such as social security, old age or
disability pensions, student grants, unemployment compensation
Disposable Personal Income
It is the disposable income which is spent
by the individual or the household on
consumption.
DPI = Personal Income- Personal Direct
taxes
DPI = Consumption + savings.
 Methods to avoid Double Counting:-
Final product method:- adding up the value of final
products only. i.e., taking total value of the final consumer
goods produced in the country during the year and adding
total value of durable producer goods. Again to this
collective and govt. services are also added then we will
arrive at total product of the country.
Value added method:- under this method we do not take
the value of the final goods and services produced in the
country. But, we go on adding the values created at each
stage in the manufacture of a commodity.
The difference between the value of output and input at
each stage of production is called value added. By summing
such value added for all industries in the economy, GNP
can be found out.
Some Concepts (Definitions)
Good: In economics a good is defined as any physical
object ,natural or man-made, that could goods which help
in production. These goods are used for generating income.

Intermediate Goods: refers to those goods which are used

either for final consumption or for resale. These goods do
not command a price in the market.

Consumption Goods: Those goods which satisfy human

wants directly.

Capital Goods: Those final fulfil needs of mankind

directly.
Investment: Addition made to the stock of capital during
a period is called investment. It is also called capital
formation.
Definitions:
Depreciation: is expected fall in value of fixed
capital goods due to normal wear and tear and
obsolescence.

Gross Investment: Total addition of capital goods to

the existing stock of capital during a time period at
market price.

Net Investment: is a measure of net availability of

new capital or new addition to capital stock in an
economy.
Net Investment =Gross investment- Depreciation

Stocks: Variables whose magnitude is measured at a

particular point of time are called stock variables.
Definitions:
Flows: Variables whose magnitude is measured
over a period of time are called flow variable.

Economic Territory: Economic (or domestic)

Territory is the geographical territory
administrated by a government within which
persons, goods, and capital circulate freely.

Normal Resident of a country: is a person or an

institution who ordinarily resides in a country and
whose centre of economic interest lies in that
country.
 Measurement of National Income
Interpretations of the National Income:-
It represents the monetary value of aggregate
annual production in the economy.
It represents aggregate income of the country.
It represents aggregate expenditure of the country.

Methods of measuring National Income:-

Census of Production Method.
Census of Income Method.
Census of Expenditure Method.
i. Census of Production Method:-
It is also referred to as the Inventory Method.
The aggregate production of the final goods and services
in an economy in any one year is evaluated in terms of
money.
The entire output of final goods and services is multiplied
by their respective market prices to find out gross national
product or GNP may be arrived at by adding up the values
imparted(imposed) to the intermediate goods and
services during the different process of production.
From the GNP estimated gross depreciation on
machinery involved in the process of production should
be deducted.
 Census of Production Method:-
It is defined as that method, which measure the
national income by estimating the contribution of
each producing enterprise to production in the
domestic territory of the country in an accounting
year.

Value of Output = Quantity x Price

= sales + Change in stock
Value added = value of output – value of intermediate
consumption.

National income = sum total of net value added at factor

cost across all producing units of an economy.
 Estimation of national income
1.Gross value added in primary sector
+
2.Gross value added in secondary sector
+
3.Gross value added in tertiary sector

= Gross Value Added (1+2+3)

Subtract(-)
4. Depreciation
= Net Value Added (1+2+3-4)
Subtract(-)
5.Net Indirect Taxes
= Net Domestic Income (1+2+3-4-5)
Add(+)
6.Net Factor Income From Abroad
=National Income (1+2+3-4-5+6)
Limitations of Product Method
Problem of Double Counting:
 unclear distinction between a final and an
intermediate product.
Not Applicable to Tertiary Sector:
 This method is useful only when output can be
measured in physical terms
Exclusion of Non Marketed Products
 E.g. outcome of hobby or self consumption
Self Consumption of Output
 Producer may consume a part of his production.
Other limitations:
Large areas of production activities are
excluded for varying reasons.
It is difficult to ascertain actual amount of
depreciation.
Lack of adequate and reliable data is the
major problem particularly in under-
developed countries.
ii. Census of Income Method:-
Acc. to this method, the incomes accruing to
all the factors of production during the
process of production are aggregated together
to arrive at national income of the country.
This is known as National Income at factor
cost.
Thus, under this method national product is
obtained by adding up the factor-incomes
accruing to the concerned factors during the
process of production.
ii. Census of Income Method:-
According to this method, NI is measured in terms of
payments made to primary factors of production. So
it is also called Factor payment method or distributed
share method. The components of NI are given by the
formula:
NI = 1.Compensation of employees

2. Operating surplus
(rent+royality+interest+profit)
+
3. Mixed income of self-employed
(OR Domestic Factor Income = 1+2+3)
+
 Limitations of Income Method
Exclusion of non monetary income: Ignores the
non-monetized section of economic activities.
Economic activities that contribute to national
income, but due to their non monetary nature, they
go unrecorded. For e.g. a farmer and family
working in their own field.
Exclusion of Non Marketed Services: People
undertake a particular activity that are difficult to
ascertain in money value. E.g. mother’s services to the
family.
iii. Census of Expenditure Method:-
Prof. Samuelson calls this method as “flow of
product approach”.
It is known as Outlay method.
GNP is the sum of expenditure incurred on
goods and services during one year in a
country.
Under this method we sum up the flow of
expenditure in an to arrive at national income
estimates.
 “The total expenditure incurred by the society
in a particular year is added together to get
that year’s national income.”
 Components of Expenditure:
 personal consumption expenditure
 net domestic investment
 government expenditure on goods and services, and
 net foreign investment

Limitations
 Ignores Barter System
 Ignores Own Consumption
 Affected by Inflation
The expenditure method of measuring National Income
is also called Income disposal Method or consumption
and Investment method. Expenditure method is a
method which measures the final expenditure on
gross domestic product at market price during an
accounting year.
According to expenditure method, GDP is the aggregate
of all the final expenditure in an economy during a
year, i.e.,
Y= C+ I + G + (X-M)
Where,
Y=National income
C=Private Final Consumption Expenditure
I =Final Investment expenditure or Capital formation
G=Government Final Consumption Expenditure
X-M=Net exports
Factors Determining National Income:-
Quantity and Quality of Factors of
Production.

The State of Technical Know-how.

Political Stability.
Note:
Intermediate consumption consists of the value of
the goods and services consumed as inputs by a
process of production, excluding fixed assets whose
consumption is recorded as consumption of fixed
capital; the goods or services may be either
transformed or used up by the production process.
Definition of 'Tertiary Industry'
The segment of the economy that provides services to its
consumers. This includes a wide range of businesses
including financial institutions, schools, transports and
restaurants.

Also known as "tertiary sector of industry," or "service

industry/sector".
Difficulties in the calculation of National
Income:-
1. Problem of Definition:-
One of the greatest difficulties while calculating national
income is that what should be included and what excluded
with respect to the goods and services produced. As a general
rule only those goods and services which are bought and sold
i.e. enter into exchange must be only considered.
2. Calculation of Depreciation:-
Another problem is the calculation of depreciation. The main
reason behind it is that both the amount and the composition
of capital change from time to time. There are no standard or
concept rules of depreciation that can be applied.
3. Treatment of the Government:-
Government expenditures: Administration expenditure,
social welfare expenditure, payment of interest on national
debts, miscellaneous development expenditure.
The real problem that is faced relates to which of the above
should be included in the national income.
4. Income from Foreign Firms:-
One of the major problem relates to the fact that weather
the income arising from the activities of the foreign firms
operating in a country should be included in the countries
national income or not .With the growing trend of doing
business globally has increased this problem to a great
extant.
5. Danger of Double Counting:-
Proper care is required for calculating national
income so that double counting may not take
place. This problem usually arises in those
countries where proper documentation or
statistics are not available.
6. Value of Inventories
Since it is not easy to calculate the value of raw
materials, semi finished and finished goods in
the custody of producers there fore it creates
problems.
Uses of National Income Data
National income is the most dependable indicator of a
country’s economic health.
Difference between GDP and GNP indicates the
contribution of net income earned abroad
Necessary for Economic planning: useful aid in judging
which sectors should be given more emphasis
A measure of economic welfare.
 higher aggregate production implies more and more goods and
services being available to people
Helps in determining the regional disparities, income
inequality and level of poverty in a country.
Helps in comparing the situations of economic growth in
two different countries.