NATIONAL INCOME

Prabin Khanal
prabin.piscnepal@gmail.com

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Course Outline
Unit 1: Measuring a Nation’s Income
Unit 2:Consumption, Saving and
Investment functions
Unit 3: Equilibrium in product and money
market
Unit 4: Fiscal policy
Unit 5: Business Cycle
Unit 6: Growth Models
Unit 7: Migration
Y=C+I+G+X-M

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TEACHING METHODS

Lectures
Assignments
Presentation by students
 Paper Writing
Case study
Group Discussion and participation

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A modern economy consists of a four-sector
economy. The sectors are
1. Household
2. Private Sectors
3. Government Sectors
4. Foreign Sectors

Every sector is interconnected through

goods and services by the payment of other
sectors.
Money is medium of exchange.

Four Sector Economy

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The Household Sector
 This sector includes all the individuals in the economy.
 The primary function of this sector is toprovide the factors of production. The factors
of production include land, labour, capital and enterprise.
 The household sectors are the consumers who consume the goods and services
produced by the firms and in return make payments for the same.

The Firms Sector

 This sector includes all the business entities, corporations and partnerships. The
primary function
 of this sector is to produce goods and services for sale in the market and make
factor payments to the household sector.

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
The Government Sector
This sector includes the center, state, and local governments. The prime
function of this sector is to regulate the functioning of the economy. The
government sector incurs both revenue as well as
expenditure. The government earns revenue from tax and non-tax sources
and incurs expenditure for provide essential public services to the people.

The Foreign Sector

This sector includes transactions with the rest of the world. Foreign trade
implies net exports(exports minus imports).

Exports include goods and services produced domestically and sold to the rest
of the world and imports include goods and services produced abroad and sold
domestically

Circular flow of income in four sector economy

The circular flow of income describes the movement of goods or services and
income among the different sectors of the economy. It illustrates the
interdependence of the sectors and the markets to facilitate both real and
monetary flow

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Circular flow of income in four sector
economy
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Inequilibrium
Y=C+I+G+X-M

Leakages are that part of the income which the household withdraw from
the circular flow and is not used to purchase goods and services.This part
of the income does not go to the goods market. There are three main
leakages and these are:

1. Saving: It is that part of the income that is not used by the household
to purchase of goods and services or pay taxes. It is kept with the
financial institutions like banks that can be lend further by the banks to
the firms for investment or capital expansion purposes.
2. Taxes: Tax revenue is the income paid by the household and firms to
the government. It flows to the government rather that the goods market.
3.Imports: Import payments are made to the foreign sector for the good
and services bought from them. This is an outflow of income from the
economy.

Leakages = S + T + M Where, S = Saving; T = Taxes; and M = Imports

Leakages
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Injections: An injection is an inflow of income to the circular flow. The volume of
income increases due to an injection of income in the circular flow. There are three
main injections and these are:

1. Investment: It is the total expenditure by the firms on capital expansion. It

flows to the goods market.

2.Government Expenditure: It is the total expenditure of the government on

goods and services, subsidies to the firms and transfer payments to the household
sector. Transfer payments are government payments like social security schemes,
pensions, retirement benefits, and temporary aid to needy families etc.

 3. Exports: Export receipts are the payment made by the foreign sector for the
purchase of domestic goods. It is an inflow of income from the foreign sector to
the financial market.
 Injections = I + G + X Where, I = Investment; G = Government Expenditure;
and X = Exports
Balance of leakages and Injections in an open economy is; S + T + M = I + G + X

Leakages and Injections

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Macro economics: Study of aggregate
variables of economy.

Y= C+I+G+X-M, Unemployment, Poverty,

Inflation, General Price Level

Ragnar Frisch coined the term in 1933.

National Income
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National Income:
NI is the total value of all final goods and
services produced in a country within one
year period of time.
It counts the level of output with a market
value.
National income is the flow variable.
National income considers only final
goods.

Measuring National Income

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Various Concepts
GDP, GNP, NNP, NI, PI and DI
GDP
The market value of the output of final
goods and services produced in the
domestic territory of a country during an
accounting year, generally a year.

Concepts of National Income

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GDP may be defined as the total market value of all
currently produced final goods and services within
the geographical border during a given period of
time, generally for a year.
GDP includes only currently produced goods and
services. That is to say it includes goods and services
produced in that particular year
GDP includes only final products. It excludes
intermediate goods. The goods which are used in the
process of production are called intermediate goods.
GDP includes production made by foreigners in
country X as well as the production made be the
resident of country X.

GDP=Gross Domestic Product

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Letx1, x2, x3……………..xn be the final
goods and services produced in the
country Y where the corresponding
market price be p1,p2,p3………pn, then the
GDP is given as

GDP=p1 x1+p2 x2+…………… pnx2

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Market price is the last price of goods and
services paid by consumers at the time of
consumption. Final buyer’s price.
Price actually received by producer is
called factor cost.
Market price=Factor Cost+ Indirect tax-
Subsidies
GDP at market price
GDP at factor cost

Base Price and Factor Cost (Basic

Price)
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 Million Dollar
 World[20] 84,740,322
1  United States 20,494,050
2  China[n 2] 13,407,398
3  Japan 4,971,929
4  Germany 4,000,386
 
5 2,828,644
United Kingdo
m
6  France 2,775,252
7  India 2,716,746
8  Italy 2,072,201
9  Brazil 1,868,184
10  Canada 1,711,387
Nepal 2040
Source: World Economic Outlook Database,
International Monetary Fund, 2019
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Net Domestic Product NDP
NDP=GDP-Depreciation
The wear and tear of physical capital is
called depreciation.
Gross National Product: GNP is defined as
the current market value of all final goods
and services produced by the economy
during an income period regardless of
where the output is produced.
GNP=GDP+NFIA, where NFIA is net factor
income from abroad.
Gross National Product
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NFIA= Total inflow-Total outflow
NFIA= Factor income received from the rest of
world –factor payments to the rest of the world
There are three different ways to measure
National Income:
Product Method, Income Method and
Expenditure Method.
These three methods of calculating GDP yield
the same result because National Product =
National Income = National Expenditure.

Measurement of GDP
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1. The Product Method:
 In this method, the value of all goods and services produced in
different industries during the year is added up. This is also
known as the value added method to GDP or GDP at factor cost.
 According to this method, GDP is measured in the form of total
product. The total product may be obtained from each economic
sector, namely, agricultural, industrial and tertiary sector.

 Agricultaral sector: It includes agro-products, fishery and forest

product.
 Industrial sector: It includes manufacturing, electricity, water
supply etc.
 Tertiary sector: It includes service sector such as banking,
insurance, transportation, communication etc.
 GDP= Total production from each sector
(Agriculture+Industry+service)
 GNP=GDP+NFIA

Product Method 19
 Under Product Method, there are two approaches for
measuring national income.
 A. Final Product Method
 B. Value Added Method
 A. Final Product Method: In this method the market
value of goods and services produced by all sectors are
added. Basically, there are three sectors
 1) Primary sector: Economic activities focused with the
agricultural sector……
 2)Secondary sector: Manufacturing sector, and this
sector uses raw materials and intermediate goods and
produces final goods. Eg: construction, electricity, gas
and water supply; transport, …….
 3) Tertiary sector: Service sector eg: Banking,
communication, insurance, medical and teaching
profession, public administration……………..

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B. Value Added Method:
 Value added means the addition to the value of raw materials
and other inputs during the process of production.
 Value added of any producer is the value of its output minus
the value of inputs it purchases from other producers.
 Value added =Value of output-cost of intermediate goods

Producer Stages of Sales Cost of Gross

Production intermediate value
good added

Farmer Wheat 1000 - 1000

Miller Flour 1900 1000 900
Baker Bread 2700 1900 800
Total 5600 2900 2700

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2. The Income Method:
According to this method, national income is obtained by adding all
incomes received by individuals of a country.

Thus GDP is the sum total of the following items:

(i) Wages and salaries:
Under this head are included all forms of wages and salaries earned
through productive activities by workers and entrepreneurs. It includes
all sums received or deposited during a year by way of all types of
contributions like overtime, commission, provident fund, insurance, etc.
(ii) Rents:
Total rent includes the rents of land, shop, house, factory, etc. and the
estimated rents of all such assets as are used by the owners themselves.
(iii) Interest:
Under interest comes the income by way of interest received by the
individual of a country from different sources. To this is added, the
estimated interest on that private capital which is invested and not
borrowed by the businessman in his personal business..

Income Method 22
(iv) Dividends:
Dividends earned by the shareholders from companies are included in the
GNP.
(v) Undistributed corporate profits:
Profits which are not distributed by companies and are retained by them are
included in the GNP.
(vi) Mixed incomes:
These include profits of business, self-employed persons and partnerships.
They form part of GNP.
(vii) Direct taxes:
Taxes levied on individuals, corporations and other businesses are included
in the GNP.
viii) Indirect taxes:
The government levies a number of indirect taxes, like excise duties and
sales tax.
These taxes are included in the price of commodities.

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 ( (ix) Depreciation:
 Every corporation makes allowance for expenditure on wearing out
and depreciation of machines, plants and other capital equipment.
Since this sum also is not a part of the income received by the factors
of production, it is, therefore, also included in the GNP.
 (x) Net income earned from abroad:
 This is the difference between the value of exports of goods and
services and the value of imports of goods and services. If this
difference is positive, it is added to the GNP and if it is negative, it is
deducted from the GNP.

 GDP by income method,

 GDP=Wages and salaries+Interest+Rent+Dividends+Undistributed
corporate profits+corporate profit tax+social security
contribution+income from self employment+Depreciation

 GNP=GDP+NFIA

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GDP by expenditure method includes:
(1) Consumer expenditure on services and durable and non-
durable goods (C),
(2) Investment in fixed capital such as residential and non-
residential building, machinery, and inventories (I),
(3) Government expenditure on final goods and services (G),
(4) Export of goods and services produced by the people of
country (X),
(5) Less imports (M). That part of consumption, investment
and government expenditure which is spent on imports is
subtracted from GDP. Similarly, any imported component,
such as raw materials, which is used in the manufacture of
export goods, is also excluded.
Thus GDP by expenditure method at market prices = C+ I +
G + (X – M), where (X-M) is net export which can be positive
or negative.

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Personal Income:
Personal income is the total income received
by the individuals of a country from all
sources before payment of direct taxes in one
year. Personal income is never equal to the
national income, because the former includes
the transfer payments whereas they are not
included in national income.

Personal Income = National Income –

Undistributed Corporate Profits – Profit Taxes
– Social Security Contribution + Transfer
Payments + Interest on Public Debt.

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Disposable Income
In order to obtain disposable income, direct
taxes are deducted from personal income.
Thus Disposable Income=Personal Income –
Direct Taxes.
Per Capita Income:
The average income of the people of a
country in a particular year is called Per
Capita Income for that year. This concept
also refers to the measurement of income at
current prices and at constant prices.

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 GDP (PPP) per capita (Int. $)
Rank Country
times to
2019 diff 2023 Rank
world

1 Qatar 133,254 7.03 - 158,296 1

2 Macao SAR 126,584 6.68 6670 156,622 2

3 Luxembourg 112,623 5.94 13961 124,410 3

4 Singapore 102,027 5.38 10596 118,202 4

5 Brunei Darussalam 86,480 4.56 15547 109,767 5

6 Ireland 81,686 4.31 4793 95,211 6

7 Norway 76,621 4.04 5066 85,034 7

8 United Arab Emirates 72,182 3.81 4438 78,123 9

9 Kuwait 69,257 3.65 2925 77,294 10

10 Hong Kong SAR 67,558 3.56 1700 80,065 8 28

 GDP per capita (Nominal) ($)
Growth
Rank Country/Economy
(%)
2019 diff 2023 Rank

131,95
1 Luxembourg 115,203 - 1 3.51
6
102,75
2 Macao SAR 86,339 28864 2 6.28
7
3 Switzerland 85,157 1182 97,020 4 1.82

4 Norway 82,773 2384 88,956 6 2.06

5 Iceland 79,271 3502 97,659 3 2.94

6 Ireland 77,160 2110 91,750 5 4.01

7 Qatar 72,677 4484 84,874 7 2.82

8 United States 65,062 7615 72,861 10 2.54

9 Singapore 62,984 2078 73,619

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 Nominal and Real GDP:

 GDP measured on the basis of current market price is

called nominal GDP.

On the other hand, when GDP is calculated on the basis of

fixed prices in some year, it is called GDP at constant
prices or real GDP.

Nominal GDP adjusted for inflation is called real GDP.

Nominal and Real GDP

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YEAR OUTPUT MARKET NOMINAL REAL GDP
PRICE GDP
2000 2000 10 20000 20000
2001 2100 12 25200 21000

2002 2200 13 28600 22000

2003 2300 14 32200 23000
2004 2400 17 40800 24000
2005 2500 18 45000 25000

Calculation
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DIFFICULTIES IN MEASURING NATIONAL INCOME
1. Insufficient data
2. Underground economy: illegal transaction, such as drugs, smuggling,
prostitution etc
3. Depreciation value
4. Government transfer payment
5. Non market activities: Household chores, consumption of own agricultural
products
6. Problem of Double Counting

Only final goods and services is included in the national income accounting. But,
sometimes it is very difficult to distinguish between final and intermediate goods.
So, there is highly likely chances of double counting.
7. Illiteracy and Ignorance
8. Environmental damage
9. Petty Production

There are large numbers of petty producers and it is difficult to include their
production in national income because they do not maintain any account.

DIFFICULTIES IN MEASURING NI
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GDP Deflator:
GDP deflator is an index of price changes
of goods and services included in GDP. It
is a price index which is calculated by
dividing the nominal GDP in a given year
by the real GDP for the same year and
multiplying it by 100.
GDP Deflator=Nominal GDP/Real
GDP*100

GDP DEFLATOR
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NATIONAL INCOME CALCULATION
FORMULA
 Market Price (MP)=Factor Cost (FC)+Indirect Tax-
Subsidies
 Gross National Product (GNP)= Gross Domestic
Product (GDP)+Net Factor Income from Abroad (NFIA)
 NFIA=Total Inflow to Country A from rest of the world
– Total outflow from Country A to the rest of the world.
 

Key Takeaways
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INCOME METHOD
 
GDPFC = Compensation of Employees (COE)+ Operating Surplus (OS)+
Mixed Income (MI)+ Depreciation
where, COE=Wages and Salaries+ Employer’s contribution to social
security+ Bonus+ Commission+ Insurance+----
OS= Rent+ Interest+ Profit, Profit= Corporate profit which includes
dividend, corporate income tax and undistributed profit (retained earning).
Depreciation=Gross Capital Formation – Net Capital formation.
Depreciation is also called as consumption of fixed capital or capital
consumption allowance.
GNPFC = GDPFC +NFIA
NDP=GDP-Depreciation
NNP=GNP-Depreciation
Personal Income (PI)=National Income-Undistributed Profit-Social Security
Contribution-Corporate Income Tax+ Transfer payment
Disposable Income=PI-Personal Taxes

Key Takeaways
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EXPENDITURE METHOD
 GDPMP = C+I+G+X-M
 GDPMP = GDPFC +Indirect tax-Subsidy
 GNPMP = GDPMP +NFIA

Product Method
GDP=Total products of all sectors of the
economy, namely: primary, secondary and
tertiary

Key Takeaways
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What is not included in National Income ?
 National income does not include transfer payments.
Transfer payments are not connected with any
production.
 National income does not include capital gain.
 NI does not include money receive from sale of existing
assets.
 NI does not include windfall gain. Eg lottery
it does not add to the flow of goods and services in the
economy.
 Interest on public debt is not included in NI
 Intermediate goods that are used to produce other final
goods are not included in NI.
 Purchase of financial assets. These do not show flow of
income and expenditures in the economy.

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Non-market transactions
Intermediate consumption expenditure
Sale of purchase of second had goods
Capital loss like destruction of building,
machinery etc by earthquake
Capital gains
eg: Rs 100 house is sold for Rs 150. The
difference is capital gain.
National debt interest or interest paid by
household to the commercial banks.

What is not included in National

Income ?
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 MP=FC+Indirect tax-Subsidy
 GDPMP = GDPFC +Indirect tax-Subsidy
Calculation of GDP
1. Product Method, GDPMP
 GDPMP =Value added in Primary Sector+ Value added in
secondary sector+value added in tertiary
2. Income Method, GDPFC
A. Compensation of Employees- Wages and Salaries,
Payments (cash/kinds), social security, pension (retirement)
+B. Operating surplus-Rent+Interest+Profit
(Dividends+Corporate tax+Undistributed tax)+c. Mixed
Income+Depreciation

3. Expenditure Method GDPMP =C+I+G+X-M

Computation of National Income

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 Q.1 Information of an economy A is given as below
 Gross Investment=10
 Net export=5
 Indirect tax=2
 Depreciation=2
 NFIA=5
 Private Expenditure=10
 Government Expenditure=10
 Find GDPFC
GDPMP =C+I+G+X-M=10+10+10+5=35
As MP=Factor cost+Indirect tax-Subsidy
MP=FC+2-0
FC=MP-2
Therefore, GDPFC = GDPMP - 2=35-2=33

Question no. 1
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 Q.2 Information of an economy A is given as below
1. Compensation of Employees=5
2. Operating surplus=5
3. Mixed income=5
4. Depreciation=2
5. NFIA=3
6. Susidies+2
7. Indirect tax=3

Find GDPMP
GDPFC = 10+5+5+2=22
GDPMP= GDPFC+Subsidy-Indirect tax
=22+2-3=23 billion doallar

Question no. 2
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 1. From the following data calculate Gross Domestic
Product at Market Price by using Income method.

i) Gross national product at factor cost       6,150

ii) Net exports                  (-)50
iii) Compensation of employees           3,000
iv) Rent                   800
v) Interest                   900
vi) Undistributed Profit                     1,300
vii) Net indirect taxes               300
viii) Net domestic capital formation        800
ix) Gross fixed capital formation           850
x)   Change in stock               50
xi) Dividend                 300
xii) Factor income to abroad           80

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Solution
Gross Domestic Product at Market Price
=Compensation of employees+ Rent+ Interest+ Undistributed
Profit +Mixed income+ Net
Indirect taxes+ Consumption of fixed capital (depreciation)
=Rs 3,000+ Rs 800 + Rs 900 + Rs 1,300 + Rs 0crore+ Rs
300 + (Rs 850 + Rs 50 - Rs 800 )
= Rs 3,000+ Rs 800 + Rs 900 + Rs 1,300 + Rs 300 + Rs
300 + Rs 100
= Rs 6,700 crore
Note: Consumption of fixed capital (depreciation) = Gross fixed
capital formation+ Change
in stock – Net domestic capital formation

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