National Income Concept, Importance, Approaches, Limitations

National Income

National income is the aggregate money value of all incomes earned by individuals and enterprises.

National income is the total income earned in a nation. Gross domestic product (GDP) measures the value of all final goods produced within a nation’s borders. Gross national product (GNP), the other common measure, counts all income accruing to factors of production owned by a nation’s citizens. The value of all final output equals the sum of all factor payments. For example, wages paid to a U.S. citizen working for a domestic firm is counted in both U.S. GDP and GNP. Wages earned by a U.S. citizen working in Spain is counted in the U.S. GNP but in the Spanish GDP. Economists often analyze national income as the sum of household consumption (C), business investment (I), government consumption (G), and exports (X) minus imports (M).

The important concepts of national income are:

  1. Gross Domestic Product (GDP)

  2. Gross National Product (GNP)

  3. Net National Product (NNP) at Market Prices

  4. Net National Product (NNP) at Factor Cost or National Income

  5. Personal Income

  6. Disposable Income

Let us explain these concepts of National Income in detail.

1. Gross Domestic Product (GDP): Gross Domestic Product (GDP) is the total market value of all final goods and services currently produced within the domestic territory of a country in a year.

Four things must be noted regarding this definition.

First, it measures the market value of annual output of goods and services currently produced. This implies that GDP is a monetary measure.

Secondly, for calculating GDP accurately, all goods and services produced in any given year must be counted only once so as to avoid double counting. So, GDP should include the value of only final goods and services and ignores the transactions involving intermediate goods.

Thirdly, GDP includes only currently produced goods and services in a year. Market transactions involving goods produced in the previous periods such as old houses, old cars, factories built earlier are not included in GDP of the current year.

Lastly, GDP refers to the value of goods and services produced within the domestic territory of a country by nationals or non-nationals.

2. Gross National Product (GNP): Gross National Product is the total market value of all final goods and services produced in a year. GNP includes net factor income from abroad whereas GDP does not. Therefore,

GNP = GDP + Net factor income from abroad.

Net factor income from abroad = factor income received by Indian nationals from abroad – factor income paid to foreign nationals working in India.

3. Net National Product (NNP) at Market Price: NNP is the market value of all final goods and services after providing for depreciation. That is, when charges for depreciation are deducted from the GNP we get NNP at market price. Therefore’

NNP = GNP – Depreciation

Depreciation is the consumption of fixed capital or fall in the value of fixed capital due to wear and tear.

4.Net National Product (NNP) at Factor Cost (National Income)NNP at factor cost or National Income is the sum of wages, rent, interest and profits paid to factors for their contribution to the production of goods and services in a year. It may be noted that:

NNP at Factor Cost = NNP at Market Price – Indirect Taxes + Subsidies.

5. Personal Income: Personal income is the sum of all incomes actually received by all individuals or households during a given year. In National Income there are some income, which is earned but not actually received by households such as Social Security contributions, corporate income taxes and undistributed profits. On the other hand there are income (transfer payment), which is received but not currently earned such as old age pensions, unemployment doles, relief payments, etc. Thus, in moving from national income to personal income we must subtract the incomes earned but not received and add incomes received but not currently earned. Therefore,

Personal Income = National Income – Social Security contributions – corporate income taxes – undistributed corporate profits + transfer payments.

Disposable Income: From personal income if we deduct personal taxes like income taxes, personal property taxes etc. what remains is called disposable income. Thus,

Disposable Income = Personal income – personal taxes.

Disposable Income can either be consumed or saved. Therefore,

Disposable Income = consumption + saving.

The Importance of National Income

Measuring national income is crucial for various purposes:

  1. The measurement of the size of the economy and level of country’s economic performance;
  2. To trace the trend or the speed of the economic growth in relation to previous year(s) also in other countries;
  3. To know the composition and structure of the national income in terms of various sectors and the periodical variations in them.
  4. To make projections about the future development trend of the economy.
  5. To help government formulate suitable development plans and policies to increase growth rates.
  6. To fix various development targets for different sectors of the economy on the basis of the earlier performance.
  7. To help businesses to forecast future demand for their products.
  8. To make international comparison of people’s living standards.

Approaches Of measuring National Income

The national income of a country can be measured by three alternative methods: (i) Product Method (ii) Income Method, and (iii) Expenditure Method.

1. Product Method:

In this method, national income is measured as a flow of goods and services. We calculate money value of all final goods and services produced in an economy during a year. Final goods here refer to those goods which are directly consumed and not used in further production process.

Goods which are further used in production process are called intermediate goods. In the value of final goods, value of intermediate goods is already included therefore we do not count value of intermediate goods in national income otherwise there will be double counting of value of goods.

To avoid the problem of double counting we can use the value-addition method in which not the whole value of a commodity but value-addition (i.e. value of final good value of intermediate good) at each stage of production is calculated and these are summed up to arrive at GDP.

2. Income Method:

Under this method, national income is measured as a flow of factor incomes. There are generally four factors of production labour, capital, land and entrepreneurship. Labour gets wages and salaries, capital gets interest, land gets rent and entrepreneurship gets profit as their remuneration.

Besides, there are some self-employed persons who employ their own labour and capital such as doctors, advocates, CAs, etc. Their income is called mixed income. The sum-total of all these factor incomes is called NDP at factor costs.

3. Expenditure Method:

In this method, national income is measured as a flow of expenditure. GDP is sum-total of private consumption expenditure. Government consumption expenditure, gross capital formation (Government and private) and net exports (Export-Import).

Difficulties and Limitations of National Income Account

  • There are some kinds of economic activities that are not counted in national income.  One example of such omissions is the omission of the black market.  These are economic activities that are not conducted legally and in which proper records are not kept.  This can include illegal activities such as drug dealing.  It can also include legal activities such as child care which are paid for “off the books,” with the payments not being reported to the government.  Another example is unpaid work.  When a person cooks a meal for their own family, that activity is not counted even though it would be counted if the same meal were prepared by someone who was being paid to prepare it.
  • National income ignores quality of life.  National income accounting measures how much money is made in the economy, but it does not measure how happy people are.  Thus, national accounting purports to be a measure of well-off people are, but it ignores their actual welfare.
  • Externalities.  National income does not account for economic activities that have negative (or positive) consequences that cannot be measured monetarily.  For example, if a mine pollutes a waterway and destroys the quality of life for those downstream, national income only shows the money made by mining, not the devastation caused by that mining.

These are the main limitations to national income accounting.






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