NATIONAL INCOME

It is defined as the aggregate factor income (earning of labor and land)

which arises from the current production of goods and services by the
nation’s economy. There is a circular flow of income as given in the
following figure:

CIRCULAR FLOW OF MACROECONOMIC ACTIVITY

CONSUMPTION / PURCHASES

FINAL GOODS AND SERVICES

HOUSE HOLD BUSINESS

FACTORS OF PRODUCTION

WAGES, RENT, PROFIT

IMPORTANCE OF NATIONAL INCOME:

National Income is considered an important indicator of

economic development of a country. There is no doubt that if national
income increases over a long period of time, the economic conditions of the
people improve. It is, therefore, suggested that while estimating the
economic growth in a country, the level of income and the rate of increase in
national income should both be taken into consideration.

TYPES OF MEASURE OF NATIONAL INCOME:

Following are the measures of national income:

1. As the sum of all incomes, in cash and kind, according to

factor of production, in a given time period.
2. As the sum of net output arising in several sectors of nation’s
production.

3. As the sum of consumer’s, government expenditure on goods

and services and net expenditure on capital goods.

CONCEPTS OF NATIONAL INCOME:

The various concepts of national income are given below:

1. Gross National Product (G.N.P): This is the basic social

accounting measure of total output or aggregate supply of goods
and services. Gross National Product is defined as the total market
value of all final goods and services produced in a year.

2. Gross Domestic Product (G.D.P): Gross Domestic Product is the

most comprehensive measure of economic activity and a broad
measure of people’s income and well-being. The growth in real
GDP is hence a measure of the growth of people’s real incomes
and therefore the pace of improvement in living standards.

3. Net National Product (N.N.P): In the production of gross national

product of a year, we consume or use up some capital (equipment,
machinery). It is generally known as depreciation, when charges
for depreciation are deducted. When charges for depreciation are
deducted from the gross national product, we get net national
product.

Net National Product or National Income at Market Prices = Gross

national Product – Depreciation

4. National Income (N.I) at Factor Cost: National Income at factor

cost means the sum of all incomes earned by resources suppliers
for their contribution of land, labor, capital and entrepreneurial
ability which go into the year’s net production. In other words, it
shows how much it costs society in terms of economic resources to
produce net product.
National Income or National Income at Factor Cost = Net National
Product – Indirect Taxes + Subsidies

5. Personal Income (P.I): Personal Income is the sum of all incomes

actually received by all individuals or households during a given
year.

Personal Income = National Income - Social Security Contribution

-Corporate Income Taxes - Undistributed Corporate Profits + Transfer
Payments

6. Disposal Income (D.I): After a good part of personal income is

paid to government in the form of personal taxes like income tax,
personal property tax, etc., what remains of personal income is
called disposable income.
Disposable Income = Personal Income – Personal Taxes

MEASUREMENT OF NATIONAL INCOME:

There are three possible measures of national income:

1. The Income Method: This method approaches national income

from the distribution side. According to this method, national
income is obtained by summing up of the incomes of all
individuals in the country.

2. The Production or Output Method: This method approaches

national Income from the output side. According to this method,
the economy is divided into different sectors such as agriculture,
mining, manufacturing, small enterprises, commerce, transport,
communication and other services. Then the gross product is found
out by adding up net values of all the production that has taken
place in these sectors during a given year.

3. The Expenditure Method: We can get national income by

summing up all the consumption expenditure and investment
expenditure made by all individuals as well as the government of a
country during a year.
DIFFICULTIES OR PROBLEMS IN CORRECT MEASUREMENT:

There are some problems which crop up when measuring national

income of a country. Some are as below:

1. Problems of Definition: Ideally we should include all goods and

services produced in the course of the year; but there are some parts of
the total which defy measurement. The services of housewives, for
example, are not included on the ground that there is no means of
assessing their market value.

2. Calculation of Depreciation: The question of calculation of

depreciation on capital consumption presents another formidable
difficulty. Unless from the gross national income correct deductions
are made for depreciation, the estimate of net national income is
bound to go wrong. The main problem is that both the amount and the
composition of capital are changing all the time.

3. Value of Inventories: It is not easy to calculate the value of

inventories, i.e., raw materials, semi-finished and finished goods in
the custody of the producers.

4. The Treatment of Government: Another difficulty arises with regard

to the treatment of Government in national income accounts. On this
point, the general viewpoint is that as regards the administrative
functions of the government like justice, administration and defense,
they should be treated as giving rise to final consumption of such
services by the community as a whole, so that the contribution of
general government activities will be equal to the amount of wages
and salaries paid by the government.

5. Income by Foreign Firms: Another major problem arises with regard

to the treatment of income arising out of activities of the foreign firms
in a country. On this point, The IMF viewpoint is that production and
income arising from an enterprise should be ascribed to the territory in
which production takes place. However, profits earned by foreign
branches and subsidiaries are credited to the parent concern.
THE EQUILIBRIUM LEVEL OF INCOME:

When the income earned in a given period is totally spent on the

goods and services produced in that specific period, national income is said
to be at equilibrium level in such a case, aggregate expenditure equals
aggregate income.

Let C = Consumption Expenditure

I = Investment
X = Value of Exports
G = Government of Expenditure
Aggregate Expenditure (Y) = C + I + X + G

The income earned is spent on:

1. consumption goods (C)
2. imports (M)
3. the payment of taxes levied by the government (T)
4. savings (S)
Y=C+S+T+M
Thus for the income flow to continue at equilibrium level when:
C+I+X+G=C+S+T+M
Since the consumption expenditure item (C) appears on both sides of the
equation, it can be cancelled out
I+X+G=S+T+M

Aggregate demand is the amount domestic and foreign residents

wish to spend on the national product of a country and aggregate supply is
the amount of national output domestic firms wishes to produce. When
national income equals aggregate demand, there is equilibrium in the
economy. That is, planned expenditure by economic agents (individuals,
firms and government) is equal to national income. If aggregate demand
were less than national income then firms would be left with unsold goods
on their hands and so would cut back production. National income would be
falling over time and so would not be in equilibrium and the economy will
tend to decrease and output, employment, imports and prices will decrease.
In the opposite situation of aggregate demand in excess of output, firms
would respond by increasing production provided that they had
underutilized productive capacity. Excess aggregate demand at full
employment would lead to rising prices and the economy will tend to grow
and output, employment, import and prices will rise.