National Income - Meaning, Methods, Importance and Difficulties, Indian Economy Notes

National Income
Meaning, Methods, Importance and Difficulties
Indian Economy Notes

Meaning and Definition of National Income

National income is an uncertain term which is used interchangeably with national dividend, national output and national expenditure. On this basis, national income has been defined in a number of ways. In common parlance, national income means the total value of goods and services produced annually in a country.

In other words, the total amount of income accruing to a country from economic activities in a year’s time is known as national income. It includes payments made to all resources in the form of wages, interest, rent and profits.

According to Alfred Marshall, National Income is the labour and Capital of a country, acting on its natural resources, produced annually a certain net aggregate of commodities and in materials including services of all kinds. This is the net annual income or revenue of the country or the true national dividend.

According to A. C. Pigou “The national income dividend is that part of the objective income of the community, including, the income derived from aboard which can be measured in Money”.

Different concepts of National Income

1. Gross National Product (GNP): According to W.C. Peterson “GNP may be defined as the current market value of all goods & services produced by the economy during an economic period”. GNP is the aggregate money value or market value of the final goods and services produced by a country in a year before deducting the wear & tear or depreciation charges required to be provided for the replacement of worn out capital assets.

2. Net National Product (NNP): It is the aggregate market value of final goods and services produced in a country in a year after deducting depreciation charges provided for the replacement of worn out capital assets. It should be noted that, in the competitive of the net national product depreciation charges should be deducted from the gross national product. This is necessary, because, in the process of production some capital assets are used up a part of final goods services produced has to be set apart as depreciation charges to the replacement of warm-out capital assets.

3. Gross Domestic Product (GOP): It refers to the monetary value of all the final products & services produced within the country. It can also be defined as the GNP of the country excluding the net export earnings.

4. Net Domestic Product (NOP): It is the net national product of the country excluding net export earnings. In other words, it is the net market value of all final goods & services produced within the country without taking into account the net export earnings.

5. Gross National Product at Factor Cost: It is the sum of the money value of incomes earned by & accruing to various factor of production in a country. It excludes indirect taxes on goods, but includes subsides.

Gross national product at factor cost= Gross national product at market prices – Indirect taxes + Subsidies

6. National Income at Factor Cost: Net National Income at factor cost is the sum total of factors rewards, such as wages, rent, interest and profit earned by the suppliers of various factors of production for their contribution of land, labour, capital & organisation in a year.

To obtain national income at cost, Indirect taxes levied on goods should be deducted from net national product because these taxes do not go to the supplies of factors.  Subsides should be added to the net national product, because they form part of the payment for factors of production. National income at factor cost = Net national product – Indirect taxes + subsidies

7. Gross National Product at Market Prices: Refers to the gross value of final goods and service produced annually in a country + net income from abroad.

8. Net National Product at Market prices: It is the net value of final goods and services valued at market prices.

Net national product at market prices = Gross national product at market prices – depreciation.

9. Net Domestic Product or Factor Cost: It means that national product which is made by the domestic factors of production of the country during the period of a year. It can be obtained by deducting the net Income received from abroad.

NDP at factor or Cost= NN pat factor cost – Net income from abroad.

Method of Measurement of National Income

1. Product Method

This approach is also called output method or inventory method as it measures income from the output side. In this approach, we add up the specific value of the flows of output arising from each sector of the economy. As per this method, the economy is divided into different industrial sectors to show the contribution made by each sector to GDP. Then, the national income is calculated by adding the value of final goods from all the sectors that have taken place during a year. Final goods are those goods which are directly consumed and not used in further production process. In order to avoid the problem of double counting, there are two methods for calculating national income viz; final product method and value-added method. 

a) Final product Method: In this method in estimating GDP, the only final value of goods and services are computed ignoring all intermediate transaction, Intermediate goods are those which are further processed to produce final goods. In this approach, national income is calculated by finding the market value of all final goods and services produced within the country during the time period of one year. Thus, GDP = market value of all final goods and services produced within the country.

b) Value added method: This is also the another method of avoiding double counting in calculating national income in which the country’s income is measured by adding the differences between the values of inputs and output at each stage of production. As per this method, income is the sum of value added by different producing units of a country in their production process. Hence, Value added = Value of output – Cost of production. For the purpose of estimating value added, the following steps are generally applied:

Ø Identifying the production units and classifying them under different industrial activities.

Ø Estimating net value added by each production unit in an industrial sector.

Ø Adding up the total value added of each final product to calculate GDP.

This method is considered very useful as it helps to get some very important information about the contribution made by each of the different production sectors of the economy to the value of GDP. It also gives us an idea about the current structure of national income and changes in the structure over the period of time.

Precautions: The following precautions should be taken while measuring national income of a country through value added method:

1.    Imputed rent values of self-occupied houses should be included in the value of output. Though these payments are not made to others, their values can be easily estimated from prevailing values in the market.

2.    Sale and purchase of second-hand goods should not be included in measuring value of output of a year because their values were counted in the year of output of the year of their production. Of course, commission or brokerage earned in their sale and purchase has to be included because this is a new service rendered in the current year.

3.    Value of services of housewives are not included because it is not easy to find out correctly the value of their services.

4.    Value of intermediate goods must not be counted while measuring value added because this will amount to double counting.

2 Income Method

The income method of calculating national income is also called the factor income method or factor share method. This method measures national income from distribution side i.e. the national income is measured after it has been distributed and appears as income earned by individuals in the country. To estimate the national income by this approach, the total sum of the factor payments received during a given period is estimated. The factors of production are classified as land, labor, capital and organization. Accordingly, the national income is calculated as the sum of various factor payments like rent, wages, interest and profits plus depreciation. Thus, National income = Rent + Wages + Interest + Profits + Depreciation.

This method of estimating national income is of great advantage as it shows the distribution of national income among different income groups such as landlords, capitalists, workers, etc. It is therefore called national income by distributive shares.

Precautions: While estimating national income through income method the following precau­tions should be taken:

1.    Transfer payments are not included in estimating national income through this method.

2.    Imputed rent of self-occupied houses are included in national income as these houses provide services to those who occupy them and its value can be easily estimated from the market value data.

3.    Illegal money such as hawala money, money earned through smuggling etc. are not included as they cannot be easily estimated.

4.    Windfall gains such as prizes won, lotteries are also not included.

3. Expenditure Method of National Income

The expenditure method is also known as the final product method, which measures the national income at the final expenditure stage. In other words, it measures national income as the aggregate of all final expenditure on Gross Domestic Product in an economy within a year. Hence, expenditure method measured the disposal of GDP.  This method calculates national income by adding up all the expenditures made on goods and services during a year. Income can be spent either on consumer goods or investment goods. Hence, the national income is calculated by adding consumption expenditure and investment expenditure made by individuals as well as government during a period of one year. National income is calculated by adding:

(a)  Personal consumption expenditure(C): It is the household sector’s purchases of currently produced goods and services. Consumption can be broken down into consumer goods (automobiles, televisions) , non-durable goods (foods, beverages) and consumer goods (medical services, haircuts).

(b) Gross domestic investment (I): It consists of expenditure of private business on replacement, renewals and new investment.

(c)  Government expenditure (G): It refers to the government purchases of goods and services. Government transfer payments to individuals and government interest payments are examples of government expenditure.

(d) Net export(X): Net export equal total exports minus imports. It represents the contribution of foreign sector in the national economy. 

Hence, GDP = C + I + G + X

Precautions: While calculating National Income by expenditure method, the following precautions are necessary:

1.    We should not include expenditure on the purchase of second hand goods as the expenditure on these goods has been included when they are bought for the first time.

2.    For avoid double counting only including the expenditure of final products.

3.    Expenditure on gifts, donation, taxes, scholarships etc. is not the expenditure on final products. There are transfer payments (or transfer expenditure) and should not be included in final expenditure.

4.    Expenditure on intermediate goods such as fertilisers and seeds by the farmers and wool, cotton and yarn by manufacturers of garments should also be excluded. This is because we have to avoid double counting. Therefore, for estimating Gross Domestic Product we have to include only expenditure on final goods and services.

5.    Expenditure on purchase of old shares and bonds from other people and from business enterprises should not be included while estimating Gross Domestic Product through expenditure method. This is because bonds and shares are mere financial claims and do not represent expenditure on currently produced goods and services.

Importance of National Income Studies

The growing importance of national income studies in recent years is due to the following reasons:

1) Economic Policy: National income figures are an important tool of macroeconomic analysis and policy. National income estimates are the most comprehensive measures of aggregate economic activity in an economy. It is through such estimates that we know the aggregate yield of the economy and can lay down future economic policy for development.

2) Economic Planning: National income statistics are the most important tools for long-term and short-term economic planning. A country cannot possibly frame a plan without having a prior knowledge of the trends in national income. The Planning Commission in India also kept in view the national income estimates before formulating the five-year plans.

3) Economy’s Structure: National income statistics enable us to have clear idea about the structure of the economy. It enables us to know the relative importance of the various sectors of the economy and their contribution towards national income. From these studies we learn how income is produced, how it is distributed, how much is spent, saved or taxed.

4) Inflationary and Deflationary Gaps: National income and national product figures enable us to have an idea of the inflationary and deflationary gaps. For accurate and timely anti-inflationary and deflationary policies, we need regular estimates of national income.

5) Budgetary Policies: Modern governments try to prepare their budgets within the framework of national income data and try to formulate anti-cyclical policies according to the facts revealed by the national income estimates. Even the taxation and borrowing policies are so framed as to avoid fluctuation in national income.

6) National Expenditure: National Income studies show how national expenditure is dividend between consumption expenditure and investment expenditure. It enables us to provide for reasonable depreciation to maintain the capital stock of a community. Too liberal allowance of depreciation may prove harmful as it may unnecessarily lead to a reduction in consumption.

7) Distribution of grants-in-aid: National income estimates help a fair distribution of grants-in-aid by the federal governments to the state governments and other constituent units.

8) Standard of Living Comparison: National income studies help us to compare the standards of living of people in different countries and of people living in the same country at different times.

9) International sphere: National income studies are important even in the international sphere as these estimates not only help us to fix the burden of international payments equitably amongst different nations but also enable us to determine the subscriptions and quotas of different countries to international organisations like U.N.O., I.M.F., I.B.R.D. etc.

10) Defence and Development: National income estimates help us to divide the national product between defence and development purposes. From such figures we can easily know how much can be spared for war by the civilian population.

11) Public Sector: National income figures enable us to know the relative roles of public and private sectors in the economy. If most of the activities are performed by the state, we can easily conclude that public sector is playing a dominant role.

Difficulties in Calculation of National Income

Although all methods are used almost in all countries to calculate national income, yet the calculation is a complex affair and is beset with conceptual and statistical difficulties. The difficulties are as follows:

1. Difficulty of defining the nation: The definition of ‘nation’ is used in the studies of national income. National income doesn’t only include income produced within the country but also income earned in other countries by way of shipping charges, interest, insurance and banking, minus any payments made to foreign countries. Therefore, the definition of nation goes beyond the political boundaries.

2. Non-marketed services: Which kinds of goods and services should be included in national income? Commodities and services having money value are included in the national income but there are goods and services which may have no corresponding flow of money payments, Services performed for love, kindness and mercy and not for money have an economic value but have no money value. The difficulty is whether these services should be included in national income and how to measure their money value.

3. Inapplicability of any one method: Another difficulty is regarding the method to be used in the estimation of national income. It is, however, preferred to use the three methods simultaneously depending upon the availability of statistics.

4. Which stage to choose: Regarding the stage of economic activity at which national income be calculated, it is agreed that any stage – production, consumption and distribution – may be adopted depending upon the function the national income estimate is expected to discharge. If the aim is to show the economic progress and power of the economy, then the production stage would be more suitable; if the aim is to measure the welfare of individuals, then consumption stage would be more useful.

5. Paucity of statistics: Another important difficulty is the non-availability of statistical material. This difficulty is not peculiar to under developed countries, but even in advanced countries reliable and sufficient statistics are lacking. According to the National Income Committee of India, the available statistics, especially for agriculture and small-scale industries, are extremely unreliable and incomplete.

6. How to avoid double counting: Another difficulty is of double counting usually associated with the inventory method. Double counting implies the possibility of a commodity like raw material or labour being included in national income more than once, e.g., a farmer sells maize worth rupees two hundred to a mill-owner, the mill-owner further sells the maize flour to a wholesale dealer, who further sells it to a retailer and who in turn sells it to consumer; if we calculate it at every stage, its money value will come to eight hundred rupees but actually the increase in national income has been to the extent of two hundred rupees only. The best way to avoid this difficulty is to calculate only the value of all goods and services that enter into final consumption.

7. Self-consumed production: Another difficulty mostly peculiar to backward countries is that a substantial part of the output is not exchanged for money in the market, it being either consumed directly by producers or bartered for other goods and services in the unorganised sector. The existence of a vast unorganised and non-monetized sector makes calculation of national income very difficult.

8. Multiple occupations: As a result of little specialisation of functions a precise calculation of income by industrial origin or by distributive shares is rendered almost impossible. The production in agricultural, and industrial, as a matter of fact in all sectors is highly scattered and unorganised rendering the calculation of national income very difficult.

9. Incorrect statistics: Other difficulties pertain to the social backwardness of the people; they are superstitious. People do not disclose their incomes easily and correctly; they are illiterate and do not keep proper accounts or if at all they keep any accounts, these are highly unreliable. All these difficulties exist in India and the calculation of national income has been rendered difficult in the past. Efforts are, however, being made to solve these difficulties so as to find out correct estimates of national income and per capita income in India.

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