Chapter 3.

2 National Income: Measurement

1. Learning Outcomes
After studying this module, you would
 Know the meaning of National Income.
 Know the different factors affecting National Income.
 Analyze the methodology to calculate National Income.
 Know the uses and limitations of national income statistics.
 Evaluate the relationship between GNP and the standard of living of a nation.
2. National Income: Meaning
National income is the sum of a country’s final output of all new final goods and services produced
in one year by the productive system of an economy.
3. Factors Affecting National Income
I. Resource Allocation: This is based on the physical capacity of factors of production and the given
technology. The more efficient and effective factors of production lead to better National Income as
the total productivity of the nation increases. Hence, every nation strives to get better factors of
production.
i. Land Resources: The geographical location of the natural resources also affects the level of
National income. That is, the areas rich in coal, iron, and other such essential items affect the
nation's level of GNP.
ii. Labour: The quality of human resources today affects the standard of a nation. The
productivity of labour is more important than the quantity.
iii. Capital: Capital is generally determined by investment, which in turn depends on other
factors like profitability, political stability, etc.
iv. Technology: In addition to natural resources and labour, the level of invention and
innovation in production affects the productivity of the production factors. Thus, the per
capita output grows with the help of technology.
II. Government: The government is the key resource to providing a favourable business
environment, and hence, it affects the productivity of the nation and, in turn, affects the National
Income of an economy. Although, classicalists believe that the government impedes growth in
output.
III. Political Stability: The political system of a nation affects the stability of an economy. A stable
economy, in turn, increases the productivity and the national income of a country. An unfavourable
business environment encourages problems like wars, strikes and other social unrests, which
discourage economic development.
4. National Income Accounting:
a) Gross Domestic Product(GDP): GDP is the total value of goods and services produced within
the country during a year. This is calculated at market price and is known as GDP at market prices.
There are 3 methods to calculate GDP at market price:
i. The income method under this method, all incomes received by the factors of production
generated in the economy during a year are added together. It includes payment for wages on
both employment and self-employment, profits, interest to lenders on capital or rents to
owners of land.
ii. The output method/product method, under this method, takes into account the combined
amount of the new and final output produced in different sectors of the economy, including
manufacturing, financial services, transport, leisure, and agriculture.
iii. The expenditure method, under this method, all spending of the economy by households and
firms on new and final goods and services by households and firms are added together to
calculate the national income of an economy.
National Income Aggregates:
Value of Gross output = Price * Quantity of all goods and services produced in the country (not
adjusted for bought-out inputs)
If GNP is adjusted for income earned from abroad:
GNP – Net income earned from abroad = Gross domestic Product (measured at market prices =
𝐺𝐷𝑃𝑚𝑝
b) Gross Domestic Product at Factor Cost (GDPfc)
GDP at factor cost is the net value added by all producers within the country.
GDP at Factor Cost = 𝐺𝐷𝑃𝑚𝑝 - Indirect taxes + subsidies = 𝐺𝐷𝑃𝑓𝑐
c) Net Domestic Product (NDP)
NDP is the nation's net output during the year. Capital asset wears out or becomes obsolete each year
during the production process. Thus
Net Domestic Product = GDP at Factor cost – Depreciation = 𝑁𝐷𝑃𝑓𝑐
d) Nominal and Real GDP: When GDP is calculated based on the current price, it is called GDP at
current prices or nominal GDP. When GDP is calculated on the basis of fixed prices in some
previous year, it is called GDP at constant prices or real GDP. It measures the value of goods and
services by ignoring the changes in the price level.
To find out the real GDP, a base year is chosen when the general price level is normal, i.e., it is
neither too high nor too low. The prices are adjusted on 100 (or 1) in the base year.

Real GDP (at base year prices) = GDP for the current year
Suppose 2000-01 is the base year, and GDP for 2014-15 is Rs. 6 00,000 crores, and the price index
for this year is 300 (2014-15 index).
Thus, Real GDP for 2000-01 = Rs. 6, 00,000 x 100/300 = Rs. 2, 00,000 crores. Thus, real GDP (at
constant prices) = GDP (at current prices)/GDP Deflator
e) GDP Deflator:
The GDP deflator is a measure to figure out if the prices of goods and services produced in a country
are going up or down. It shows how much of the GDP's growth is because things actually got more
expensive (inflation) or cheaper (deflation) rather than just producing more stuff. Imagine you're
checking how much your shopping bill has changed over time. If the GDP deflator goes up, it means
the economy's prices have increased overall, like your bill getting bigger without buying extra things.
If it goes down, it means prices have dropped. It basically helps people understand if the economy is
growing because of more production or just because prices are changing.
If the GDP deflator > 100, it means prices have risen (inflation) compared to the base year.
If the GDP deflator = 100, prices are the same as in the base year.
If the GDP deflator < 100, prices have fallen (deflation) compared to the base year.

GDP Deflator=
f) Gross National Product (GNP):
GNP is the total value in the flow of goods and services at market value resulting from the current
year’s production of a country. It also includes the net income from abroad.
4.1 GNP includes the following final goods and services:
i. Consumers’ goods and services which satisfy the wants and demands of people;
ii. Gross investment in capital goods consisting of total capital formation, household
construction and inventories of finished and unfinished goods;
iii. Goods and services manufactured by the government and its organizations;
iv. Net exports of goods and services, i.e., the difference between the value of exports and the
value of imports of goods and services, known as Net Income from abroad (NIA).
5. National Income Estimation:
There is a difference between National Income Accounting and National Income Estimation.
Accounting tells us how to derive one NI aggregate from the other. National Income Estimation tells
us how to calculate NI. However, we do not use the term calculation because, very often, the
enumerators who calculate national income have to use methods of estimation (or even guess
estimates) to assess the production or income generated during one year.
Precautions in National Income Estimation:
The factors to be taken into consideration while estimating National Income:
 i. Money value considered: GNP is the sum of money, in which all kinds of goods and
services manufactured in a country during one year are measured in terms of money at
current prices and then added together. However, due to fluctuations in prices, the GNP may
increase or decline, which may not be real. To guard against erring on this account, a
particular year (base year) when prices are normal is taken, and the GNP is adjusted in
accordance with the index number for that year.
ii. Avoid double counting: In estimating GNP, only the market price of the final products
should be considered. Many of the products pass through a different number of stages before
consumers ultimately purchase them. If these products are counted and calculated at every
stage, they will be included many times in the national product list. Consequently, the GNP
would increase too much. To avoid double counting, only the final products and not the
intermediary goods should be taken into account.
iii. Avoid non-market value: Goods and services given free of cost are not included in the GNP
because it is not difficult to have a correct estimation of their market value or price. For
example, the bringing up of a child by the mother, giving instructions to his son by a teacher,
recitals to his friends by a musician, etc.
iv. The transactions that do not arise in the current year or that do not contribute in any way to
production are not included in the GNP. The sale and purchase of second-hand goods, as well
as shares, bonds, and assets of existing companies, are not included in GNP because these do
not add to the national product, and the goods are transferred.
v. The payments received under social security, e.g., unemployment insurance allowance, old
age pension, and interest on public loans, are also not included in GNP because the recipients
do not provide any service in lieu of them. However, the depreciation of machinery and other
capital goods has not been deducted from GNP.
vi. The profits earned, or losses incurred due to fluctuations in market prices in the value of
capital assets are not included in the GNP if they are not responsible for current production or
economic activity. For example, if the price of a building or bare land increases due to
inflation, the profit earned by selling it will not be a part of GNP. But if, during the current
year, a portion of a house is constructed anew, the increase in the value of the house (after
subtracting the cost of the newly constructed portion) will be adjusted in the GNP. Similarly,
variations in the value of assets that can be ascertained beforehand and are insured against
flood or fire are not included in the GNP.
vii. The income earned in restricted activities is not to be included in the GNP. Though the goods
sold on the black market are priced and fulfil the needs of the people, as they are not useful
 from a social point of view, the income received from their sale and purchase is always
excluded from the GNP.
g) GNP at Market Prices: To convert the gross domestic product into national product, we must
add the total income from abroad into a nation. GNP at Market Prices = GDP at Market Prices + Net
Income from Abroad.
h) 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. GNP at Factor Cost = GNP at Market Prices –
Indirect Taxes + Subsidies.
i) Net National Product (NNP): NNP is the total output of consumption goods and investment
goods. However, this process of production uses a certain amount of fixed capital, and the fixed
equipment wears out with time, or other components are damaged or destroyed, and still others are
rendered obsolete through technological changes.
NNP = GNP—Depreciation.
j) NNP at Market Prices:
Net National Product at market prices is the total of final goods and services evaluated at market
price in a country. Value of final goods and services evaluated at market prices in a country. NNP at
Market Prices = GNP at Market Prices—Depreciation.
k) NNP at Factor Cost:
Net National Product at factor cost is the total output evaluated at factor prices. It includes income
earned by factors of production through participation in the production process, such as wages and
salaries, rents, profits, etc. It is also called National Income.
NNP at Factor Cost/ National Income = NNP at Market Prices – Indirect taxes+ Subsidies
6. Uses of National Income Statistics
i. Standard of living: One can easily compare the standard of living of different nations with the
help of GNP. Hence, national income statistics can be used to analyze a nation's standard of
living.
ii. Policy Formulation: The national income statistics are used to compile GNP statistics of the
economy. The government then uses this data to formulate policy.
iii. International comparison: The standard of living of different nations can be compared with
national income statistics, which, in turn, helps show the rate of growth or development of
various countries.
iv. Business Decisions: The level of development of different industries and sectors of an
economy is analyzed with national income statistics. It, in turn, helps the business plan for
production and planning.
7. Limitations of National Income Statistics:
GNP is used to measure the overall flow of goods and services and to show the general welfare of
the people. It aims to get the standard of living of a nation. There are certain limitations of GNP
statistics, which are as follows:
i. Price Changes: A high GNP may not necessarily mean that the standard of living of the
nation is also good. With a high rate of increase in GNP, real GNP may even fall.
ii. Omission or wrong estimation: The national income statistics can be affected by wrong
estimations, such as double counting, etc. Due to this, the other supplementary statistics may
be misled, too.
iii. Voluntary services: Some voluntary services also influence the national income. However,
the statistics may or may not accommodate them.
iv. Illegal Activities: Some illegal activities are always prevalent in an economy, but national
income statistics ignore the income and productivity generated from such activities. Illegal
activities may affect the actual standard of living of an economy.
v. Undesirable effects of production: Factors like pollution and traffic congestion do influence
the standard of living of the economy. This is again not taken into account for national
income statistics.
vi. Problem of Comparison: National Income statistics are a bit difficult to compare as the
methods adopted by different nations are different. To bring in complete similarity in the
methodology is a difficult task.
vii. Output Composition: Nations having the same GNP may even have different living
standards because their output composition may be different.
viii. Distribution of National Income and Wealth: The GNP of a nation may be generated by a
small group or rate of people in a country. So, in that case, even with a high National Income,
the standard of living of the nation will be low, as it is not evenly distributed income or GNP.
ix. Population Size: The population level of a nation does not hold any significance with the
standard of living. So, the per capita income is a better measure for comparing the growth of
the two countries.
x. National Defense: If a nation has spent a lot of resources in the production of national
defence, such as weapons and so on, its living standards may not be improved.
xi. Time: Technology is improved and improvised with time, but these statistics do not depict
these parameters and, hence, are not the true indicators of the standard of living of a nation.