National Income is the aggregate money value of all goods and services produced in the economy in a particular financial year, account being taken of the deductions made due to wear and tear and depreciation of plants and machinery used in the production of goods and services. It is distributed among the factors of production in the form of rent, interest, wage and profit. National income is defined by different economist, i.e., Marshall, Pigou and Fisher.
Marshall’s Definition:
“The labour and capital of the economy acting upon its natural resources produced annually a certain net aggregate of the products, material and immaterial including services of all kinds. The term “net” is used in order to provide for using up raw products and half finished products and for the wearing out and depreciation of machinery and plants. Net income due to an account of foreign investment must be added. This is the true net national income of the economy which is known as National Dividend.”
Pigou’s Definition:
“The national dividend is that part of the objective income of the economy including income derived from foreign economy which can be measured in money.”
In this definition we get two components-
(1) Income earned by the residence on capital invested abroad has to be included in the measurement of the national income of the economy.
(2) Only that income can be included in the national income estimation of the economy which can be measured in terms of money. It means if there is any product or service, which has no money value it can’t be included in the national income measurement.
Fisher’s Definition:
While Marshall and Pigou have approached national income measurement from the product end, Fisher has approached the measurement of national income from the consumption end. According to Fisher “The National Dividend or National Income consists of services as received by the consumers in the economy, whether from their material environment or from their human environment.” Thus according to Fisher, the national income of the economy is determined not by its annual production, but by its annual consumption.
Fisher’s definition of national income appears to be better and more scientific definition than that of Marshall’s and Pigou’s, because Fisher has included in the national income measurement only the money value of the actual consumption of goods and services during the particular financial year.
METHODS OF MEASUREMENT OF NATIONAL INCOME
There are 3 methods of measuring national income of the economy and these are –
1. Census of Production Method
2. Census of Expenditure Method
3. Census of Income Method
1. Census of Production Method
According to this method of national income measurement, we find out the monetary value of the entire national output of the economy in a particular financial year. This includes all sources of output, agricultural output, industrial output, mineral output and forest output.
We evaluate the entire national output of the economy in a particular financial year and that constitutes the gross national product of the economy.
From this, we have to deduct the total depreciation undergone by the machinery and plants in the entire economy during that financial year. Since this constitutes an item of cost, the total depreciation has to be deducted from the gross national product in order to arise at the net domestic product at factor cost of the economy.
Into this Net Domestic Product we add net income coming into the economy from abroad, this constitutes The Net National Product or Net National Income at factor cost. Therefore we get –
From this, we have to deduct the total depreciation undergone by the machinery and plants in the entire economy during that financial year. Since this constitutes an item of cost, the total depreciation has to be deducted from the gross national product in order to arise at the net domestic product at factor cost of the economy.
Into this Net Domestic Product we add net income coming into the economy from abroad, this constitutes The Net National Product or Net National Income at factor cost. Therefore we get –
(Gross National Product) – (Depreciation) = (Net Domestic Product at Factor Cost)
(Net Domestic Product at Factor Cost) + (Net Income from Abroad) = (Net National Product or Net National Income at Factor Cost)
While evaluating the national output of the economy, adequate care has to be taken to see that final goods and services are included in the national output in the economy otherwise there is a possibility for double entry which means certain items of output may be counted more than one in the national income measurement. This method is also known as national income by industrialization.
The main advantage of this method is that it indicates clearly the relative importance of the different sectors of the national economy by revealing their respective contribution to national income of the economy. But this method can be used only when correct and updated statistical data relating to the various sector of the economy are available.
The main advantage of this method is that it indicates clearly the relative importance of the different sectors of the national economy by revealing their respective contribution to national income of the economy. But this method can be used only when correct and updated statistical data relating to the various sector of the economy are available.
2. Census of Expenditure Method
The gross national product can be observed as total expenditure of the nation on goods services produced during the year. Each unit of goods and services produced is matched by an expenditure on that unit. Most of the goods and services produced in the economy are purchased by the consumer but the unsold goods and services are regarded as having being purchased by the producers who hold them as stocks and inventories. The monetary value of the total national income is equal to the total national expenditure. The total national expenditure can be divided into the following 4 categories –
(1) Personal Consumption Expenditure – It includes the consumption expenditure made for both durable goods and non-durable goods in the economy during the financial year. This also includes expenditure on services, i.e., transport, education and postal services.
(2) Gross Domestic Private Investment – This item includes private investments in capital goods or producer goods such as buildings, machinery, plants, equipment etc. such goods are primarily purchased by business firms. Houses are also included in this category of expenditure because houses are so durable that they represent the capital goods.
(3) Government Purchases of Goods and Services – Government also purchases from the market different consumer goods, i.e., different types of stationery products as well as investment goods, i.e., machinery and equipment for public sector enterprises. In addition the government also purchases a number of different services in the economy.
(4) Net Foreign Investment – The entire production of the economy is sold within the economy. A part of it is exported to other countries. This part of production should be included in the gross national product of the economy. At the same time the economy imports some finished goods from abroad. The value of imports should be deducted from the value of exports. If the balance is positive, it should be added to the other items of expenditure. If it is negative, it should be subtracted from the aggregate of the other expenditure items. It is therefore clear that if the entire production of the economy is produced at market price, the amount so spent will represent the gross national product of the economy.
Therefore we have to add the above stated four categories of expenditures in order to estimate gross national product of the economy.
3. Census of Income Method
The expenditure incurred on purchasing goods and services produced in the economy during the financial year also becomes income of the various factors of production which are involved in the production of those goods and services. We can identify this factor income in the following categories –
(1) Wages and Salaries of the employees
(2) The Income of the non-company business
(3) Rental Income of the individual
(4) Corporate Profits
(5) Income from Interest
The 1st category includes the wages and salaries received by employees during the financial year plus some supplements. These supplements are the contributions which the employers make to social securities and other provident fund and pension fund of the workers.
The 2nd category includes the income earned by the individual proprietors partners and self employed persons.
The 3rd category comprises rental income earned by the individual on agricultural properties and on non-agricultural properties.
The 4th category include corporate profits earned by the business corporation before the payment of corporate profit taxes or the payment of dividends to the shareholders. Thus the corporate profits used in calculating the gross national product are equal to the aggregate of corporate profit taxes plus dividends paid to the shareholders plus undistributed corporate profits.
The 5th category contains net interest earned by the individual from different sources other than different departments of the governments.
An aggregate of the above stated 5 categories of income will not be equal to the gross national product as measured by the census of expenditure method. The reason is that a part of the total expenditure incurred by the economy does not become available to the factors of production in the form of income. There are 2 such leakages – (i) indirect taxes levied by the government on goods and services, and (ii) depreciation of machinery, plants and buildings. The expenditures incurred by the households or the factors of production on goods and services include the indirect taxes levied by the government. The income from these indirect taxes goes to the government and is not available to the factors of production concerned. The payment on account of depreciation also does not become available to the factors of production in the form of income. Therefore, while estimating the gross national product by income method we have to add indirect taxes and depreciation charges to the factor incomes.
VARIOUS COMPONENTS OR CONCEPTS IN NATIONAL INCOME
1. GROSS NATIONAL INCOME or NET NATIONAL INCOME
The gross national income of gross national product is the fundamental accounting measure. It is known as National Income Aggregate. It is the nation’s total production of goods and services in a particular financial year evaluated in terms of Market Price of goods and services produced. It means the gross national product is the money value of the total national production in a particular financial year.
In estimating the gross national product, adequate care is taken into account in order to improve the money value of only the final goods and services produced in the economy in order to avoid double counting.
On the other hand the net national product is a better concept than gross national product because it gives proper consideration on the depreciation for machinery, equipment and buildings etc during the particular financial year. Therefore we get that Net National Product is equal to Gross National Product minus Depreciation on capital assets.
Net National Product = Gross National Product – Depreciation
It is observed that when we count Gross National Product, we don’t deduct the total depreciation of the fixed assets from the Gross Income, but at the time of calculating Net National Product, depreciation of the fixed assets is being deducted from the Gross Income. Therefore it is observed that the net national product concept gives the idea of the net increase in the total production of the economy and this concept is very effective in the analysis of the long run problem of maintaining an increase in the supply of physical capital of the economy. Therefore the net national product is highly useful concept for the study of development economics.
2. NATIONAL INCOME at MARKET PRICE and NATIONAL INCOME at FACTOR COST
Net national product is the net production of goods and services in the economy in a particular financial year. It is the,
(Net National Product) = (Gross National Product) – (Value of Capital Consumed or Depreciated during the year)
Net national product is known as National Income at Market Price.
National Income is also known as National Income at Factor Cost.
National income is the total of all income payments received by the factors of production in a particular financial year and it can be derived from the net national product in the following way:
(National Income) = (net national product) – (indirect taxes) + (subsidies)
It is observed that net national product or national income at market price is arrived at by subtracting depreciation from the gross national product. But it is also observed that the entire net national product is not available for distribution among the factors of production. The firms have to pay indirect taxes on their goods and services to the government. This aggregate of indirect taxes does not go to the factors of production. Consequently, indirect taxes have to be deducted from the net national product in order to find out National Income at Factor Cost. Sometimes the government also gives subsidies on the production of certain goods and services. The production cost of these goods and services are higher, but on account of subsidies they are sold to the market at prices lower than the actual cost of production. Therefore though these goods and services are sold at lower prices in the market, yet the factors of production are paid higher payment on account of subsidies. If we desire to find out the income of various factors of production, we will have to add the amount of governmental subsidies to the market value of net national product. The concept of national income at factor cost gives idea on the distribution of National Output. This concept indicates how a national output is being distributed among the various factors of production against their services in the economy and therefore this concept of national income is closely related to the concept of economic justice.
3. NET NATIONAL INCOME at FACTOR COST and NET DOMESTIC INCOME at FACTOR COST
When we deduct the total value of depreciation from the gross national product, we get net domestic product at factor cost but if we add net income coming to the economy from abroad to the net domestic product at factor cost, it becomes net national income at factor cost. Therefore we get,
(gross national product) – (total depreciation) = (net domestic product at factor cost)
(net domestic product at factor cost) + (net income coming from abroad) = (net national income at factor cost)
4. PERSONAL INCOME and DISPOSABLE PERSONAL INCOME
Personal income is that income which is actually received by the individuals in the economy in a particular financial year. The entire national income earned by the factors of production in one particular financial year is not available to them. Several deductions are made out of it. The corporate income taxes have to be pay out of corporate profits before they are distributed among the shareholders. Similarly a part of the corporate profit may be written by the corporation that is it may not be distributed among the shareholders. To that extent, the corporate profits available for distribution among the shareholders are reduced. Similarly, the workers have to make certain social security contributions out of their wages and salaries for provident fund and pension fund. To the extent of these deductions, the amount available to the workers is reduced. As against this, the government may give social security benefits like Unemployment Allowance and Pensionery Benefits. Such allowances are known as Transfer Payments. In order to derive personal income from national income we have to deduct from national income those amounts which are not available for the distribution among the different factors of production. At the same time, we have to add to national income the transfer payments made by the government to certain categories of employees. We therefore get,
(Personal Income) = (National Income) – (Corporate Income Taxes) – (Undistributed Corporate Profits) – (Social Security Contributions) + (Transfer Payments)
The concept of personal income helps us in estimating the potential power of the individuals in the economy. It also helps us to measure the welfare of the consumers in the economy. The limitation of this concept is that it does not fairly give us the actual amount of money that is available to the individual for spending and saving. In order to know this, we have to find out the disposable personal income of the individual. The entire amount of the personal income is not available for consumption purpose. A part of the personal income has to be paid by the individuals to the government in form of Personal Direct Tax. This part of the personal income which is left behind after personal direct taxes is known as Disposable Personal Income. In fact, it is the disposable personal income which is spent by the individual on consumption. Therefore we get,
(Disposable Personal Income) = (Personal Income) – (Personal Direct Taxes)
But it is not essential that entire disposable personal income is spend on consumption, because individuals spend a major portion of the disposable personal income on consumption, keeping some portion for saving. Therefore,
(Disposable Personal Income) = (Consumption) + (Saving)
By comparing disposable personal income with personal income, we can find out the money burden of Personal Direct Taxes and therefore we get that disposable personal income is a very useful concept in macroeconomics.
DIFFICULTIES IN THE MEASUREMENT OF NATIONAL INCOME
In measuring national income, we are facing certain difficulties which are as follows:
1. It has been observed that it is not always possible to improve certain categories of services performed by the individual in the national income measurement.
2. There is no authentic method in order to evaluate the raw materials, unfinished products, semi-finished products as well as finished products which are existing as inventories by the firms. Without a correct evaluation of these goods, we can’t arrive at reliable estimate of the national income of the economy.
3. The calculation of the total value of Depreciation and Replacement creates another difficult problem. At what rate depreciation will be calculated for different types of machinery, plants and buildings. There can’t be uniform rate for calculating the depreciation on all these fixed assets.
4. Another problem is related to the income earned by the foreign firms operating in the economy. The problem is whether this income be added to the economies gross national product or it should be treated as the income of the foreign economies to which the firms are belonging.
5. in the underdeveloped or developing country like India we observe that the available statistics are not only inadequate but also unreliable. Statistics pertaining to Indian Agriculture are not complete. We have no reliable estimate of production cost in Indian Agriculture. Similarly there are no reliable statistics for small scale and medium industries.
6. In the developing country like India, we observe that there is the existence of a large non-monetary market system. Therefore it is observed that a quite, substantial part of the agricultural output in the developing countries does not reach the market because either it is consumed in agricultural sector or it is exchanged for other goods and services in the agricultural sector.
7. The other problem in the developing countries is related to the small firms as these firms are not in a position to keep any account of their productive activities and therefore they can’t provide authentic information about the quality as well as the value of the product.
8. It is also observed that in the developing country there is little of operational specialization on the part of the individuals. Many individuals take up more than one activity in order to improve the standards of living. Therefore it becomes difficult to collect information about their income.
FACTORS DETERMINING NATIONAL INCOME
There are a number of factors which determine the size of the national income of the economy. It is on account of these factors that one economy is having a larger national income than the other economy. The main factors which influence volume of national income of the economy are as follows:
1. Quantity and Quality of Factors of Production: This factor is the most important factor which is influencing the national income of the economy. The quantity and quality of the factors of production are determining the volume of the national income. The quantity of labor has significant impact as it is important factor of production as well as it is consumer in the economy. The quality of the labor depends on intelligence, level of education, the adequate training which is given to the workers and these parameters influence the volume of industrial production. Capital is also very important parameter as it has having significant impact on improvement of productivity. The ability of the entrepneurs is another important parameter which is determining the volume of national income.
2. The Size of Technical Knowledge: Another parameter on determination of the national income is the state of technical knowledge in the economy. It is proved that an economy having low level of technical knowledge can’t generate higher national income. This justifies the introduction of new technologies into the existing production process.
3. Political Stability: It has been observed today that political stability is an essential requirement for maintaining production at the highest level. It has been proved that political instability is standing in the way of achieving higher economic development and therefore component is also playing important role in the determination of national income of the economy.
IMPORTANCE/SIGNIFICANCE OF NATIONAL INCOME MEASUREMENT
1.
Since the national income measurement represents the monetary measures of the volume of production in a particular financial year, this measurement gives us the idea of the aggregate production in the economy.
2.
An increasing national income is accepted as an indicator of economic development. Therefore a decreasing national income is an indicator of economic undevelopment.
3.
The national income measurement gives an idea of the rate of national income growth in the economy. Therefore in development economics, national income measurement is important contribution.
4.
The economic welfare is closely connected with the volume of national income. An increase in the national income of economy also implies an increase in the economic welfare.
5.
The national income measurement gives idea on the contribution of the different sectors of the economy to the gross national product of the economy. Therefore national income measurement indicates the comparative importance of the different sectors of the economy.
6.
The national income measurement also indicates how national income of the economy is distributed among the different sectors of the population in the economy. An increase in the share of labor that is increase in wage rate out of the national income is a clear indication that economic inequalities are being reduced.
7.
The national income measurement also gives idea on the volume of consumption, saving and investment in the economy. The level of consumption reflects the level of economic welfare, while level of saving and investment determine the nature of economic growth.
8.
By comparing national income measurement of different countries, we can compare their standard of livings and the level of economic welfare achieved by them.
9.
It is observed that national income estimate is a very important for the formulation of economic policy of the government. No government can formulate a correct, realistic and well balanced economic policy without having authentic national income estimate about the volume and distribution of national income in the economy.
10.
Economic planning is very important in the developed as well as in the developing economy. All countries, whether socialist country or capitalistic or mixed economy must take proper economic plan in order to accelerate the rate of economic growth. The formulation of economic plan is not possible without reliable estimates of national consumption, national saving and national investment. No economic plan can be formulated without adequate national income statistics. Therefore the working of the economic planning can be evaluated with the help of authentic national income estimate.