National Income Concepts


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theories and function of national income

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National Income Concepts

  1. 1. National Income and Related Aggregates National income or national product is defined as the total market value of all the final goods and services produced in an economy in a given period of time. This suggests that the labor and capital of a country, working on the natural resources produces certain net amount of goods and services, the aggregates of which as known as national income or national products. There are many concepts of national income which are used by different economists and all of which are inter-related. These concepts are: 1
  2. 2. 1. Gross National Product at Market Price (GNP mp) GNP mp refers to the total value of all the final goods and services produced during the period of one year plus the net factor incomes earned from abroad during the year. The word “gross” is used to indicate that the total national  product includes in it that part of product which represents depreciation. Depreciation means the wear and tear of the machinery and  other fixed capital during the process of production. GNP includes the economic activities of all the residents of a  nation whether operating within the country or outside it. 2
  3. 3.  It takes into account the incomes which the residents get from rest of the world and at the same time it excludes those incomes which arise from the economic activities within the country but have to paid out to the non-residents operating in the country.  GNP being the monetary measure of all final goods and services produced, is widely used as an index for judging the performance of an economy. 2. Net National Product at Marker Price (NNP mp):  NNP at market price is equal to GNP minus the charges of depreciation and replacements, where depreciation represents the values of fixed capital consumed during the process of production.  NNP mp = GNP mp – Depreciation  The concept of NNP is important because it gives an estimate of the net increase in the output of final goods and services. 3
  4. 4. 3. Net National Product at Factor Cost (NNP fc) or National Income: NNP fc or national income is equal to the sum total of factor incomes received by the factors of production during the year. It is equal to the sum of rent, wages, interests and profits in a given year. The sum total of incomes of the factors of production is known as national income or net national product at factor cost. Thus, the national income is equal to the NNP at mp minus revenue of the government by way of indirect taxes plus subsidies provided by the government to the business sector. NNP fc = NNP mp – Indirect taxes + Subsidies (or) NNP fc = NNP mp – net Indirect taxes. taxes 4
  5. 5.  The importance of estimating national income lies in the fact that it throws light on the distribution of income in a society.  It helps to see how equitably income is distributed in the societies.  Which tells us whether there are inequalities of income distribution , and if so, how vast is the inequalities.  It is regarded as the fair measure of over all economic activity of the nation and is therefore, commonly accepted as an index of economic conditions prevailing in the country. 5
  6. 6. 4. National Income at Current Price and Constant Price: when the value of goods and services is found out by multiplying the quantity produced during one year by the prices prevailing in that year, we call it National income at Current Prices. on the other hand, when the value of goods and services is calculated by multiplying the quantity during one year with prices of the base year, we call it National Income at Constant Prices. Example: (1) q1 is the quantity of final product I in year 1980 and p1 is the price of that year. Then, the value of the final product I = q1p1 Similarly, q2 is the quantity of final product II in year 1980 and p2 is the price of that year. Then, the value of the final product II = q2p2 If we add up the value of all final goods and services produced, we get National Income at Current Prices. So, National Income at Current Price will be: q1p1+q2p2+ …………….qnpn = NI at Current Prices. Prices 6
  7. 7. (2) Suppose we want to compare the national income figures of 1980 and 1990, we may find that the national income in 1990 is higher than that of 1980. This increase in income may be due to (a) increase in output (b) increase in prices which may be higher in 1990 than 1980. To get the exact increase in real income, we need to multiply the quantity of goods produced in 1990 with the 1980 prices. This shows: National Income at Constant Prices: Quantity of Current period x Prices of Base period. period Formula for Real National Income: Income Money National Income (Current year) x Price Index of Base year ____________________________________________________ Price Index of Current year 7
  8. 8. Measurement of National Income  The methods of estimating national income of a country depends upon the availability of proper statistics.  This can be viewed from three interrelated angles, such as, in terms of production, income and expenditure.  These three terms are broadly related to GNP, GNI and GNE respectively.  The ideal national income equation shows that National Income or NI =GNP=GNI=GNE 8
  9. 9.  To measure the national income of a country, we use three different methods, such as: (b) The product method (c) The income method (d) The expenditure method The Product Method The production method measures national income as the  sum of net products produced by the production units in the given period.  Therefore, the production method involves the following steps: (h) Identifying the production unit (i) Estimating their net products (j) Valuing the goods and services (k) Estimation of net income from abroad 9
  10. 10.  The next step in the production method is the estimation of net product of each sector.  This comes from the Gross products minus the intermediate products minus the depreciation during the process of production. NNP = GNP – Intermediate products – Depreciation  The total estimates would give us Net Domestic Product at factor cost.  The addition of net income from abroad to this total would give us net national income at factor cost or National Income. 10
  11. 11. The Income Method  The income method measures national income as the sum total of factor income shares accruing to the factor owners.  Factors of Production: Land, Labour, Capital and Organization.  Factor Incomes: Rent, Wage, Interest and Profit.  One can easily aggregate all the factor incomes over a period of time and this aggregate figure is known as national income at factor cost.  There are major additions and deductions to the national income accounting.  Additions: Income from foreign sectors in the form of rent, profits etc.  Deductions: Incomes from all illegal activities: theft, rubbery, smuggling, child labor, prostitutions etc.  Incomes to the foreign sector acting in domestic sectors. 11
  12. 12. Comparison between Product method and Income method:  NI fc = NI mp – Indirect tax + Subsidies. Subsidies For the sake of convenience, economists suggests that the  Product method is for Primary sector and the Income method is for tertiary sectors. The Expenditure Method  Because of identical relation the GNP=GNI=GNE, the GNP=GNI=GNE expenditure of one becomes the income of other. Hence, the GNE is calculated which will be identical with GNI.  The Expenditure in the Economy can be broadly divided into three types, such as, (g) Consumption Expenditure (h) Investment Expenditure, and (i) The pure Govt. Expenditure 12
  13. 13. Consumption expenditure provides direct satisfaction where  as the investment expenditure is necessary to increase the productivity of the nation.  Pure Govt. expenditure is necessary for maintenance of law and order situation and providing the infrastructural facilities to the nation. In details, all expenses are again divide into five different  categories: (v) Private Consumption Expenditure (vi) Public Consumption Expenditure (vii) Private Investment Expenditure (viii) Public Investment Expenditure (ix) Pure Government Expenditure 13
  14. 14. Comparison f three Methods:  The product method is very suitable for the primary sector such as agriculture, industries etc.  The income method is appropriate for the tertiary and service sectors.  The Expenditure method is only for the calculation of identical relationship between three method. It is because we may not get the details of all expenditure correctly. Neither it is possible nor it is desirable to reveal all types of expenditure.  In fact, the expenditure method is only to complete the identical relationship i.e. GNP=GNI=GNE=NI 14
  15. 15. Reconciling the three methods of Measuring National Income:  The three methods of measuring national income represents three aspects of the national income of the country, such as: (d) National income as an aggregate of net products (e) National income as an aggregate of factor shares (f) National income as an aggregate of final expenditure  These represents three ways of looking the national income as: (x) National income as viewed from the point of view of the production enterprise (xi) As viewed from the point of view from owners of the primary factors of production, and (xii) As viewed by the purchasers of the final goods and services available in the country during a period of time. 15
  16. 16. Three Aspects of National Income Production Method Income Method Expenditure Method 1. Total Product from 1. Rent…………….1,000 1.Household Household and 2. Wage……………3,200 Consumption………5,000 Government………..8000 3. Interest…………1,000 2. Govt. Consumption……… 2. Inventory 4. Profits…………..3,200 1,000 Investment…………..500 5. Surplus of 3. Private Fixed 3. Net Export…………..500 Govt………………200 Investment…………1,100 4. Minus 6. Minus: 4. Public Fixed (e) Depreciation………...500 Interest paid by Govt. Investment……………900 (f) Net Indirect …………………………200 5. Inventory Taxes………………..500 Investment……………500 7. Plus: Net Income from 6. Minus: abroad………………400 (a) Depreciation…....500 (b) Net Indirect Taxes…………....500 7.Plus: Net Foreign Investment…………...900 Total: NNP fc. Total: National Income = Total: Net expenditure: =…………………..8,400 …………………………..8,400 ……….8,400 16
  17. 17. Difficulties in Estimating National Income (2)The first difficulty regarding the concept of national income relates to the treatment of non-monetary transactions. Example: Services of Housewife, Services of house- maid. The services of house-maid are part of national income, but if suppose the master marries the hose- maid, although she still performs the same services, her contribution to the national income becomes zero. This is because now these services do not contribute to the economic activity. 17
  18. 18. (2) Second conceptual difficulty arises with regard to the treatment of output produced by the foreign firms in the country. Should their income form a part of national income of the country in which they are located? Or, should this income be treated as a part of national income of the country to which the ownership of the firms belongs? It is generally agreed that the income of such firm should be taken into account in the national income of the country in which the firm is located. However, the profit earned by such firms will be sent to their own country, and hence, would form apart of that country’s income. 18
  19. 19. (3) The national income accounts involves inventory adjustments. The unused stock of the previous year may be sold in the current year, but the income will be included in the previous years account. This adjustment is not at all logical and creates problem in the calculation of national income of the current year. (4) Another difficulty in national income arises with regard to the Govt. sector. How should we treat govt. functions like civil administration of maintenance of law and those regarding the defense of the country? It is difficult to account the wages and salaries paid the workers who are in service to that. 19
  20. 20. (5) There are some difficulties which are particular to underdeveloped country: Barter System. In the underdeveloped countries there is large non- monetized sector. A non-monetized sector refers to that part of economy where output is not bought or sold with the help of money. Money does not enter into exchange, and hence the value of commodities is not expressed in terms of money. The problem therefore arises that what value should be imputed to this art of output which does not enter into monetary transactions. 20
  21. 21. (6) In underdeveloped countries, agriculture is the predominant form of economic activity. But the farming being still of subsistence in nature, a considerable amount of production is consumed by the farmers themselves. This is that part of output which has been produced in the country, but does not come to the market. How should we estimate such production? Obviously, again this involves the guess work or imagination of the satisfaction who is estimating the national income of the country. 21
  22. 22. (7) Illiteracy: A large majority of people in the underdeveloped countries being illiterate , do not keep any accounts of the actual quantity of goods they have produced.  No record of such transactions is available and the majority of the people do not have any idea about their income and expenditure.  Which again leads the inaccurate estimation of national income. (8) More than one Jobs: in the underdeveloped countries, there is no clear-cut demarcation of the occupations from which people derive their income.  Many people are simultaneously engaged in more than one occupation and thus derive their income from many source of livelihood.  Example: A “farmer” in “Slack season”, take up jobs in industries in some casual jobs like washing and painting etc.  Therefore, it becomes difficult to place a worker under particular occupation. 22
  23. 23. (9) Inadequate Information: information regarding small agriculturists, household industries, and other unorganized enterprises is generally not available. Whatever little information is available is not adequate and reliable to estimate the national income. (10) Biasness in statistical process: the national income accounting is a statistical process and it involves huge time, energy and money costs. Because of these inherent difficulties, an individual investigator may cheat in the process of accounting. He/she may give fake information/figures only to complete the process of accounting which is very subjective and can not be checked. 23