CH 2.
NATIONAL INCOME AND MATHODS OF CALCULATING
NATIONAL INCOME
NATIONAL INCOME:-
National income is the sum total of factor incomes earned by
normal residents of a country,whether within its border or
abroad during the period of an accounting year.
OR
National income refers to the total money value all final
goods and services produced by normal resident of a country,
whether within its border or abroad during the period of an
accounting year.
NATIONAL INCOME=
FACTOR INCOME GENERATED BY NORMAL RESIDENT WITH IN
DOMESTIC TERRITORY +
FACTOR INCOME GENERATED BY NORMAL RESIDENT
OUTSIDE DOMESTIC TERRITORY
Factor income/Earned income :- Factor incomes are the
payments made by the producing units to the households
(owners of the factors of production) for the use of their
factor sevices. Ex.- (compensation, Rent, interest and
profit).
Transfer income/unearned income(unilateral) :-
Transfer income are those incomes which are received by a
person as a help, donation or charity etc.
These are not included in the estimation of national
income because these are not as reward for rending service,
Ex: - Pocket money, unemployment allowance, old age
pension etc.
Normal Resident :- A person is said to be normal resident of
that country if :-
i)He ordinarily resides in that country.
ii)His centre of economic interest lies in that country that is
he perform all economic activity like consumption,
production and investment in that country on large scale.
Domestic and National concepts of Income
Domestic income:- Domestic income is the sum total of
factor income generated within domestic territory of a
country during the period of an accounting year.
OR,
Domestic income is money value of all final goods and
services produced within domestic territory of a country
during period of an accounting year.
Domestic territory :
Such geographical area within which person,goods and
services and capital can circulate freely.
It refers to political boundary of a country.
CONVERSION OF NATIONAL INCOME INTO DOMETIC INCOME
AND VICE- VERSA
DOMESTIC INCOME=
FACTOR INCOME GENERATED BY NORMAL RESIDENT WITHIN
DOMESTIC TERRITORY (A)+
FACTOR INCOME GENERATED BY NON RESIDENT WITHIN
DOMESTIC TERRITORY(B)
NATIONAL INCOME=
FACTOR INCOME GENERATED BY NORMAL RESIDENT WITH IN
DOMESTIC TERRITORY(A) +
FACTOR INCOME GENERATED BY NORMAL RESIDENT
OUTSIDE DOMESTIC TERRITORY (C)
CONVERSION
(i)DOMESTIC INCOME +NFIA= NATIONAL INCOME
A+B+(C-B) = A+C
Here,
NFIA(NET FACTOR INCOME FROM ABROAD)=
FACTOR INCOME RECEIVED FROM ABROAD(C) – FACTOR
INCOME PAID TO ABROAD (B)
AND ALSO
NATIONAL INCOME – NFIA= DOMESTIC INCOME
• If NFIA = 0, Domestic income = National income
• If NFIA = +ve, National income > Domestic Income
• If NFIA = -ve, National income < Domestic income
Equipment
Domestic Income = Domestic product
National Income = National Product
CONCEPTS OF GROSS PRODUCT AND NET PRODUCT VALUE
GROSS PRODUCT =NET PRODUCT +DEPRECIATION
NET PRODUCT +DEPRECIATION= GROSS PRODUCT
CONCEPTS OF FACTOR COST AND MARKET PRICE
Domestic product at factor cost will be equals to domestic
product at market price so long as we consider only two
sector of an economy.
Once the government sector is introduced, taxes and
subsidies start playing their role.
• Taxes in goods tend to raise the market price of goods.
• Subsidies tend to lower the market price of goods.
To restore the parity between domestic product at market
price and factor cost :
(i) We deduct the value of indirect taxes from domestic
product at market price.
ii) We add the value of subsidies to domestic product at
price.
FORUMLA
Domestic product (gross/net) at Market price – Net indirect
taxes = Domestic product (gross/net) at factor cost
Net Indirect taxes = Indirect taxes - Subsidies
National product (gross/net) at MP – Net indirect taxes =
National product (gross/net) at factor cost
Methods of Calculating National Income
❖ Circular flow model reveals that national income can be viewed from
three different angles :
i. As the sum total of value addition in the economy. (Value added
method)
ii. As the sum total of income generated in the economy (income method)
iii. As the sum total of expenditure on the final goods and services
produced in the economy. (expenditure method)
1. Value added Method/Product Method
▪ Value added method measure national income in terms of value addition
by each producing enterprise (primary/secondary/tertiary) in the
economy during an accounting year.
▪ Also known as industrial origin method or Net output method.
▪ Estimation of the contribution of all producing enterprises to production
in the domestic territory of all country during the year is equal to the
GDPMP. It is then adjusted to find out NNPFC on national income.
❖ Gross value added – value added by primary sector
(GDPMP) +
Value added by secondary sector
+
Value added by tertiary sector
OR,
❖ Value added = value of output – Intermediates consumption
(GDPMP)
Domestic Import
Value of output :
It refers to the market value of goods produced by a firm during an
accounting year.
value of output = sales, if entire output of the year is sold during
the year
If some output remains unsold then,
Value of output = sales + Δ Stock
DOMESTIC SALES EXPORT
Intermediate consumption
It refers to value of non-factor inputs (all inputs other than factor inputs
of land, labour capital and entrepreneurship). Primarily includes raw
material used in the process of production, domestic purchase &
import.
Converting estimated GDPMP into NNPFC
GDPMP - Depreciation = NDPMP
NDPMP - Net indirect tax = NDPFC
NDPFC + Net factor income from abroad = NNPFC (National income)
2. Income Method
▪ Also known as distributed share method or factor payment
method.
▪ According to this method, national income is estimated in terms of
factor payments to the owners of factors of production during an
accounting year.
▪ Sum total of factor incomes generated within the domestic territory
of a country is called domestic income (NDPFC)
❖ Classification of factor incomes :-
(i) Compensation of employees :
▪ Wages and salaries in cash
Refers to cash paid by the employees as a reward for the work
done by employees during the period of an accounting year.
▪ Payments in Kind
refers to benefits in kind (like rent -free accommodation) given to
the employees by the employers.
▪ Employers Contribution to social security
Refers to such payments as provides fund contribution by the
employers on behalf of the employees.
▪ Pension of Retirement
Refers to pension payments as a part of ‘service contact’ between
the employer and the employees.
(ii) Operating Surplus :
Refers to income from property and entrepreneurship
(a) Rent
(b) Interest
(c) Profit
Profit is further split into three components :
(a) Dividends /Distributed Profit
That part of the profit which is distributed among the
shareholders.
(b) Corporate /Corporate Traffic tax
That part of the profit which is paid to the government by way of “Profit
tax”
(c) Undistributed Profit
That part of profit which is retained by the firms for future use,
particularly to meet some contingent expenses. It is also called corporate
saving’ or ‘undistributed profits’
(iii) Mixed income
Mixed income refers to the income of the self Employed person using
their own labor, and capital and entrepreneurship in their household
enterprises. These incomes are mix fare of wages, rent, interest and
profit. So they are called mixed income.
Step 1 : NDPFC = Compensation of employees
+
Operating surplus
+
Mixed Income
Step 2 : NNPFC = NDPFC + Net factor income from abroad
EXPENDITURE METHOD
Estimation expenditure on the final goods produced during the year
(within a domestic territory of a country) is equal to the market value of
GDP called GDPMP. It is adjusted to find NNPFC or national income
Classification of final expenditure :-
(i) Private final consumption expenditure (C)
refers to expenditure on final goods and services by the individuals,
household and non-profit private institutions serving society (like help
age) it includes
a) Consumer Services
b) Consumer non-durable goods, that is goods which are not repeatedly
used like milk or butter.
c) Consumer durable goods which are repeatedly used for several years,
like furniture and washing machines.
(ii) Government final Consumption Expenditure (G)
• It refers to expenditure on final goods and services by the government,
like expenditure on the purchase of goods for consumption by the
defense personnel
(iiI) Investment Expenditure (I)
• Refers to expenditure on the purchase of final goods by the
producers. These goods are to be further used in the process of
production. Ex. Expenditure by the farmers on the purchase of
tractors.
• Fixed Investment :
Fixed investment refers to expenditure by the producers on the
purchase of fixed assets like plant and machinery.
Economists often classify fixed
(a) Business fixed investment
(b) Fixed investment by the household in terms of construction of
residential houses.
(c) Public fixed investment or fixed investment by the government like
expenditure by the government on the construction of roads, dams
and bridges.
▪ Inventory Investment
It refers to change in stock during the year. (closing stock –
opening stock)
(iv) Net exports (x-H)
• Refers to the difference between exports and imports during an
accounting year.
• Exports are an expenditure by the foreigners on the domestically
produced final goods and services, while imports are an
expenditure on the goods and services produced abroad.
• Exports are added to the total expenditure in the economy during
an accounting year, expenditure on import is deducted.
• This adjustment is essential for a precise estimation of the
expenditure on the domestically produced goods services.
Private final consumption expenditure
+Government final consumption expenditure
+ Business fixed investment GROSS
Step : 1
DOMESTIC
+ Government fixed investment CAPITAL
+ investment on residential construction by house hold
+ Inventory investment = Δ Stock = closing stock - opening stock FORMATION
+ Net exports X − M
= GDPMP
Step : 2 GDPMP – Depreciation=NDPMP
= NDPMP – (Net Indirect taxes)=NDPFC
= NDPFC (Domestic Income) + NFIA
=NNPFC (National Income)
Q. What cause increase in inventory stock?
Ans. Unexpected fall in demand in the current year.
# Precautions while calculating National Income.
1. Value added method:-
i. Sale and purchase of second hand goods is not included in the
National Income because it is already accounted in the year in
which they are produced however commission earned on sale and
purchase of second hand goods is included as they are reward for
rendering services.
ii. Production of self consumption is included in National Income as
these goods have some market value, e.g.;- farmer produced wheat
for self consumption.
iii. Own account production of goods and services are included in
National Income as these goods have some market value and
produced for to be sold in market like other goods.
They are simply not sold owing to their need by the producer
themselves.
Ex- Car used by the car producers for transportation of their
employees.
iv. Value of intermediate goods is not included while counting
National Income because value of intermediate goods is already
included in market price.
If they are included then it would lead to problem of double
counting.
v. Imputed rent on owner occupied house is included in National
Income because all houses have some rental value, no matter these
are self occupied or rented out.
vi. Services for self consumption are not included in National Income
because it is difficult to estimate their market value. Ex- Services of
Housewives.
2. Income method:-
i. Transfer earning like old-age pensions, unemployment, allowances,
scholarship, pocket money etc are not included in National Income
as these incomes are not like reward for rendering services.
ii. Income from illegal activities like theft, kidnapping, gambling etc
are not included in National Income because these incomes are not
like reward for rendering services.
As regards, income generated in terms of black money, it is not
included simply because no estimates are available of such
incomes.
iii. Commissions earned on sale and purchase of second hand goods is
included in National Income as they are reward for rendering
services.
iv. Brokerage earned on sale and purchase of shares and bonds is to
be included in National Income because they are reward for
rendering factor services.
v. Income in terms of windfall gains (like from lotteries) should not
be included as there is no value addition corresponding to windfall
gains, or such income.
vi. Imputed rent on owner occupied house is included in National
Income as these houses have some rental value.
vii. Corporate tax, dividend and undistributed profit are not be
included separately if profit is included while estimating National
Income.
viii. Income tax is paid out of compensation of employees, so it is not
included in National Income.
3. Expenditure method:-
i. Since the production value of final goods is included, the expenses
for any intermediate goods are not considered. Otherwise, a single
expense will be counted twice, causing the National income to
inflate inaccurately.
ii. The transfer payments do not ass value to the economy of a nation;
hence, they should not be included.
iii. The purchase of second-hand goods is not
included since they do not affect the total
value of goods and services. However, if
the purchase of second-hand goods
involve brokerage, the brokerage paid is
included in the expense calculation.
iv. When assets such as bonds and shares are
procured, it signifies a change in
ownership and does not affect the value
of goods and services; hence, the
transactions are not involved in expense
calculation. However, the brokerage paid
for the transfer of shares is considered
while using the expenditure method.
v. Services provided by the government and
non-profit organizations and the
expenses incurred for the production of
any good that is used for self-
consumption are considered in the
National Income Calculation.