UNIT I

NATIONAL INCOME
Syllabus

i. National Income: Meaning, definitions and methods of estimation.

ii. Concepts of National Income
iii. Difficulties in the calculation of national income.

National Income: Meaning and Definitions

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.
National income may be defined as the aggregate factor income (i.e. earnings of the factors of
production) which arises from the current year’s production of goods and services by the nation’s
economy.
Definitions
The definitions of national income can be grouped into two classes: one, the traditional
definitions advanced by Marshall, Pigou and Fisher; and two modern definitions.
The Marshallian Definition. According to Marshall: ‘the labour and capital of a country acting
on its natural resources produce annually a certain net aggregate of commodities, material and
immaterial including services of all kinds…This is the true net annual income or revenue of the
country or national dividend.” In this definition, the word ‘net’ refers to deductions from gross
national income in respect of depreciation and wearing out of machines. And to this must be
added the income from abroad.
Its defects. Though the definition advanced by Marshall is simple and comprehensive, yet it
suffers from a number of limitations.
1. In the present day world, so varied and numerous are the goods and services produced
that it is very difficult to have a correct estimation of them and consequently the national
income cannot be calculated correctly.
2. There always exists the fear of the mistake of double counting and hence NI cannot be
correctly estimated. Double counting means that a particular commodity or service like raw
material or labour etc. might get included in the NI twice or more than twice.
3. It is again not possible to have a correct estimation of NI because many of the commodities
produced are not marketed and the producer either keeps the produce for self-consumption or
exchanges it for other commodities. It generally happens in an agriculture-oriented country like
India. Thus the volume of NI is underestimated.

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 The Pigouvian definition. Marshall’s follower, A.C. Pigou has, in his definition of national
income included that income which can be measured in terms of money. In the words of
Pigou, ‘NI is that part of objective income of the community, including of course income
derived from abroad, which can be measured in terms of money.” This definition is better
than that of Marshall. It has proved to be more practical also. While calculating the NI
nowadays, estimates are prepared in accordance with the two criteria laid down in this
definition. First, avoiding double counting, the goods and services which can be measured in
money are included in NI. Second, income received on account of investment in foreign
countries is included in NI.
Its defects. The Pigouvian definition is precise, simple and practical but it is not free from
criticism.
1. In the light if this definition, we have to unnecessarily differentiate between
commodities which can and which cannot be exchanged for money.
2. When only such commodities which can be exchanged for money are included in the
estimation of national income, the NI cannot be estimated correctly. According to Pigou,
a woman’s services as nurse would be included in NI but excluded when she work at
home looking after the children because she does not get any salary for it. Thus this
definition gives rise to many paradoxes.
3. This definition is only applicable to the developed countries where goods and services are
exchanged for money in the market. In the less developed countries, where a major
portion of the produce is simply bartered, correct estimate of NI will not be possible,
because it will always work out to be less than the actual level.
Fisher’s Definition. Fisher adopted Consumption as the criterion of NI whereas Marshall and
Pigou regarded it to be production. According to Fisher, “the national dividend or income
consists solely of services as received by ultimate consumers, whether from their material or
from their human environments. Thus a piano or an overcoat made to me this year is not an
income but an addition to capital. Only the services rendered to me during this year by these
things are income.” Fisher’s definition is considered to be better than that of Marshall or Pigou,
because Fisher’s definition provides an adequate concept of economic welfare which is
dependent on consumption and consumption represents our standard of living.
Its defects. But from practical point of view, this definition is less useful.
1. It is more difficult to estimate the money value of net consumption than that of net
production. In one country there are several individuals who consume a particular good
and that too at different places and, therefore it is very difficult to estimate their total
consumption in terms of money.
2. Certain consumption goods are durable and last for many years. If we consider the
example of piano or overcoat, as given by Fisher, only the services rendered to use during
one year by them will be included in NI. If an overcoat costs Rs.100 and lasts for10

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 years, Fisher will take into account only Rs.10 as NI during one year whereas Marshall
and Pigou will include Rs.100 in the NI for the year when it is produced. Besides it
cannot be said with certainty that the overcoat will last only for 10 years. It may last
longer or for a shorter period.
3. Durable goods generally keep changing hands leading to a change in their ownership and
value too.
From the modern point of view, Simon Kuznets has defined NI as “the net output of
commodities and services flowing during the year from the country’s productive system in
the hands of ultimate consumers.”
In one of the reports of United Nations, NI has been defined on the basis of the systems of
estimating NI, as net national product, as addition to the shares of different factors and as net
national expenditure in a country in a year’s time. In practice, while estimating NI, any of
these three definitions may be adopted, because the same NI would be derived, if different
items were correctly included in the estimate.

Concepts of National Income

There are various concepts of National Income. The main concepts of NI are: GDP, GNP, NNP,
NI, PI, DI, and PCI. These different concepts explain about the phenomenon of economic
activities of the various sectors of the economy.

1. Gross Domestic Product (GDP)

The most important concept of national income is Gross Domestic Product. Gross
domestic product is the money value of all final goods and services produced within the
domestic territory of a country during a year.

Algebraic expression under product method is,

GDP= (P*Q)

Where,
GDP=Gross Domestic Product

P=Price of goods and service

Q=Quantity of goods and service

*denotes the summation of all values.

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According to expenditure approach, GDP is the sum of consumption, investment, government
expenditure, net foreign exports of a country during a year.

Algebraic expression under expenditure approach is,

GDP=C+I+G+(X-M)
Where,
C=Consumption
I=Investment
G=Government expenditure
(X-M)=Export minus import

GDP includes the following types of final goods and services. They are:

1. Consumer goods and services.

2. Gross private domestic investment in capital goods.

3. Government expenditure.

4. Exports and imports.

2. Gross National Product (GNP)

Gross National Product is the total market value of all final goods and services produced
annually in a country plus net factor income from abroad. Thus, GNP is the total measure of the
flow of goods and services at market value resulting from current production during a year in a
country including net factor income from abroad. The GNP can be expressed as the following
equation:

GNP=GDP+NFIA (Net Factor Income from Abroad)

or, GNP=C+I+G+(X-M)+NFIA

Hence, GNP includes the following:

1. Consumer goods and services.

2. Gross private domestic investment in capital goods.

3. Government expenditure.

4. Net exports (exports-imports).

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 5. Net factor income from abroad.

3. GNP at Factor Cost

GNP at factor cost is the sum of the money value of the income produced by and accruing to the
various factors of production in one year in a country. In order to arrive at GNP at Factor Cost,
we deduct indirect taxes from GNP at Market prices and we add subsidies to it. Thus,

GNP at Factor Cost = GNP at market prices – indirect taxes + subsidy

4. Net National Product (NNP) .

Net National Product is the market value of all final goods and services after allowing for
depreciation. When charges for depreciation are deducted from the gross national product, we
get it. Thus,

NNP at market prices = GNP – Depreciation

or, NNP = C+I+G+(X-M)+NFIA-Depreciation

5. NNP at Market Prices.

NNP at MP is the net value of final goods and services evaluated at market prices in the course
of one year in a country.

NNP at Market Prices = GNP at market prices - depreciation

6. Net National Product (NNP) at Factor cost.

Net National Product at factor cost is also known as National Income. NNP at factor cost means
the sum of all incomes earned by resources suppliers for their contribution of land, labour,
capital and organizational ability which go into the year’s net production. Hence, the sum of the
income received by factors of production in the form of rent, wages, interest and profit is called
National Income. Symbolically,

NNP at Factor Cost = NNP at market prices + Subsidies - Indirect Taxes

or, GNP at market prices - Depreciation + Subsidies - Indirect Taxes

or, NNP at FC = C+G+I+(X-M)+NFIA – Depreciation - Indirect Taxes + Subsidies

7. Private Income.

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Private Income is the income obtained by private individuals from any source, productive or
otherwise, and the retained income of corporations. It can be arrived at from NNP at Factor Cost
by making certain additions and deductions. The additions include transfer payments such as
pensions, unemployment allowances, sickness and other social security benefits etc. and interest
on public debt. The deductions include income from government undertakings, and employees
contributions to social security schemes like provident fund, life insurance, etc. Thus, private
income is’

Private Income = NNP at FC + transfer payments + interest on public debt – social security
contributions – profits and surpluses of public undertakings.

8. Personal Income (PI)

Personal Income is the total money income received by individuals and households of a
country from all possible sources before direct taxes. Therefore, personal income can be
expressed as follows:

PI = NI – Undistributed Corporate Profits – Profit Taxes – Social Security Contributions +

Transfer Payments + Interest on Public Debt.

Or, PI = Private income – Undistributed Corporate Profits – Profit Taxes.

9. Disposable Income (DI)

The income left after the payment of direct taxes from personal income is called Disposable
Income. Disposable income means actual income which can be spent on consumption by
individuals and families. Thus, it can be expressed as:

DI = PI - Direct Taxes

From consumption approach,

DI=Consumption Expenditure + Savings

10. Real Income.

Real Income is national income expressed in terms of a general level of prices of a particular
year taken as a base. To find out the real income of a country, a particular year is taken as base
year when the general price level is neither too high nor too low and the price level for that year

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is assumed to be 100. Now the general level of the prices of the given year for which the real
national income is to be determined is assessed in accordance with the prices of the base year.

Real NNP = NNP for the current year x Base year index (= 100)

Current Year Index

11. Per Capita Income (PCI)

Per Capita Income of a country is derived by dividing the national income of the country by the
total population of a country. Thus,

PCI=Total National Income/Total National Population

Real PCI = Real National Income/ Total National Population.

These are the various concepts of national income.

Methods of estimating National Income

Primarily there are three methods of measuring/estimating national income. Which method is to
be employed depends on the availability of data and purpose. The methods are product method,
income method, expenditure method and value added method. Product method is given by Dr.
Alfred Marshall, income method by A.C. Pigou and expenditure method by Dr. Irving Fisher.

1. Value Added Method

Value added method is also named as Product method. This method is used to measure national
income at the phases of ‘production of each enterprise and each industrial sector during a year. In
fact this method measures the contribution of each enterprise in the flow of goods and services in
the economy.

Under this method, the economy is- generally divided into three industrial classes namely

(a) Primary sector

(b) Industrial sector and

(c) Service sector.

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The main enterprises included in these sectors are agriculture, fishing, forestry, mining,
manufacturing, construction, transport and communication, trade and commerce insurance,
banking etc. For computing national income, the values added by the above three sectors at each
stage is worked out. The value of output at each enterprise is found by multiplying the physical
output with the market prices of the goods produced. For example, firm A produces necessary
raw material and sells it in market for Rs.2000 to firm B. The firm B manufactures raw material,
into finished goods and sells it to firm C for Rs.4000. The firm C sells the finished goods to
household for Rs.5000/=. The value added at each stage is Rs.2000 + 2000 + 1000 = Rs.5000.
The total value added is Rs.5000.

Precautions for this approach

There are certain precautions which are to be taken to avoid miscalculation of national income
using this method. These in brief are:

1 Problem of double counting: When we add up the value of output of various sectors, we
should be careful to avoid double counting. This pitfall can be avoided by either counting the
final value of the output or by including the extra value that each firm adds to an item.

(ii) Value addition in particular year: While calculating national income, the values of goods
added in the particular year in question are added up. The values which had previously been
added to the stocks of raw material and goods have to be ignored. GDP thus includes only those
goods and services that are newly produced within the current period.

(iii) Stock appreciation: Stock appreciation, if any, must be deducted from value added. This is
necessary as there is no real increase in output

(iv) Production for self-consumption. The production of goods for self-consumption should be
counted while measuring national income. In this method, the production of goods for self-
consumption should be valued at the prevailing market prices.

2. The Expenditure Method:

The expenditure approach measures national income as total spending on final goods and
services produced within nation during an year: The expenditure approach to measuring national
income is to add up all expenditures made for final goods and services at current market
prices by households, firms and government during a year. Total aggregate final expenditure on

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final output thus is the sum of four broad categories of expenditures (i) consumption (ii)
Investment (iii) government and (iv) net exports.

(i) Consumption expenditure: Consumption expenditure is the largest component of national

income. It includes expenditure on all goods and services produced and sold to the final
consumer during the year.

(ii) Investment expenditure: Investment is the use of today’s resources to expand tomorrow’s
production or consumption. Investment expenditure is expenditure incurred on by business firms
on(a) new plants, (b) adding to the stock of inventories and (c) on newly constructed houses.

(iii) Government expenditure: (G) it is the second largest component of national income. It
includes all government expenditure on currently produced goods and services but excludes
transfer payments while computing national income.

(iv) Net exports: Net exports are defined as total exports minus total imports.

National income calculated from the expenditure side is the sum of final consumption
expenditure, expenditure by business on plants, government spending and net exports.

NI = C + 1 +G + (X – M)

Precautions

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

(i) The expenditure on second hand goods should not be included as they do not contribute to
the current year’s production of goods.

(ii) Similarly, expenditure on purchase of old shares and bonds is not included as these also do
not represent expenditure on currently produced goods and services.

(iii) Expenditure on transfer payments by government such as unemployment benefit, old age
pensions, interest on public debt should also not be included because no productive service is
rendered in exchange by recipients of these payments.

3. The Income Approach:

Income approach is another alternative way of computing national income. This method seeks to
measure national income at the phase of distribution. In the production process of an economy,
the factors of production are engaged by the enterprises. They are paid money incomes for their
participation in the production. The payments received by the factors and paid by the enterprises
are wages, rent, interest and profit. National income thus may be defined as the sum of wages,

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rent, interest and profit received or accrued to the factors of production in lieu of their services in
the production of goods. Briefly, national income is the sum of all income, wages,
rents, interest and profit paid to the four factors of production. The four categories of payments
are briefly described below:

(i) Wages: It is the largest component of national income. It consists of wages and
salaries along with fringe benefits and unemployment insurance.

(ii) Rents: Rents are the income from property received by households.

(iii) Interest: Interest is the income private businesses pay to households who have lent the
business money.

(iv) Profits: Profits are normally divided into two categories (a) profits of incorporated
businesses and (b) profits of unincorporated businesses (sole proprietorship, partnerships and
producers cooperatives).

Precautions

While estimating national income through income method, the following precautions should be
undertaken.

(i) Transfer payments such as gifts, donations, scholarships, indirect taxes should not be
included in the estimation of national income.

(ii) Illegal money earned through smuggling and gambling should not be included.

(iii) Windfall gains such as -prizes won, lotteries etc. is not be included in the estimation of
national income.

(iv) Receipts from the sale of financial assets such as shares, bonds should not be included in
measuring national income as they are not related to generation of income in the current year
production of goods.

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Difficulties in National Income measurement

To calculate the national income of a country is a complicated problem and is beset with the
following difficulties:

1. First there is the difficulty of defining a nation in national income. Every nation has its
political boundaries, but in the national income is also included the income earned by the
nationals of a country in a foreign country beyond the territorial boundaries of that country.

2. National income is always measured in terms of money, but there are a number of goods and
services which are difficult to be assessed in terms of money, e.g., painting as a hobby of an
individual, the bringing up of her children by a mother.

3. The greatest difficulty in calculating national income is of double counting, which arises from
the failure to distinguish properly between a final and an intermediate product. To solve this
problem, only final goods and services are taken into consideration. But it is not an easy task.

4. Income earned through illegal activities like gambling, illicit extraction of wine etc. are not
included in the calculation of national income. Such goods and services do have value and meet
the needs of the consumers. But by leaving them out, the national income works out to be less
than the actual value.

5. Then there arises the difficulty of including transfer payments in the national income.
Individuals get pension, unemployment allowance and interest on public loans; but whether these
should be included in the national income is a difficult problem. On the one hand, these earnings
are a part of individual income and on the other, they are government expenditure. To avoid this
difficulty, they are deducted from national income.

6. All inventory changes whether negative or positive are included in the GNP. But inventory
evaluation is a very difficult and cumbersome procedure.

7. When we deduct capital depreciation from GNP, the resulting measure is NNP. Depreciation
is a charge on profits which lowers national income. Depreciation valuation is full of statistical
difficulties, such as age-composition of the whole capital stock, and changes in prices of capital
goods every year since the assets were bought.

8. Another difficulty in calculating national income is that of price-changes which fail to keep
stable the measuring rod of money for national income. In order to solve this problem, the
statisticians have brought the concept of real national income, according to which the prices of
the year in question are assessed in terms of prices of the base year.

9. In calculating national income, a good number of public services are also taken which cannot
be estimated correctly. For e.g., police and military.

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In a developing economy certain additional difficulties are to be faced while calculating national
income. Complete and reliable information relating to the various methods of estimating national
income are available due to the following problems:

1. Non-monetised sector. There is a large non-monetised sector in a developing economy.

This is the subsistence sector in rural areas in which a large portion of production is
partly exchanged for the other goods and is partly kept for personal consumption. Such
production and consumption cannot be calculated in national income.

2. Lack of occupational specialisation. There is a lack of occupational specialisation i such

countries which makes calculation of national income by product method difficult. The
crop farmers in such countries, besides crop farming might be also engaged in poultry
farming dairy farming etc.

3. Non-market transactions. People living in rural areas in a developing country are able to
avoid expenses by building their own huts, tools, implements, and other essential
commodities. All such productive activities do not enter the market transactions and
hence are not included in the national income estimates.

4. Illiteracy. The majority of people in such a country are illiterate and they do not keep any
accounts about the production and sales of their products. Under such circumstances, the
estimates of production and earned incomes are mere guesses.

5. Non-availability of data. Adequate and correct production and cost data are not available
in a developing country. Moreover there is no machinery for the collection of data in such
countries.

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