National Income

INTRODUCTION

National Income provides a comprehensive measure of the economic activities of a nation. It denotes the country’s purchasing power. The growth of an economy is measured by the rate at which its real national income grows over time. National income thus serves as an instrument of economic planning.

MEANING OF NATIONAL INCOME

• National Income means the total monetary value of all final goods and services produced in a country during a particular period (one year).
• It is also the sum of incomes earned by the residents of the country from the factor services rendered to the production units both within and outside the geographical boundaries of the country.
• The term “residents” here refers to those individuals (and institutions) whose economic interest lies in the country in which they live (or are located). By economic interest, we mean we mean the basic economic activities of production, consumption, and investment.
• For Example: Mr. Zen may or may not be an Indian citizen, but as long as his economic interest lies in India, he is treated as an Indian resident.

SIGNIFICANCE OF NATIONAL INCOME ACCOUNTING

National Income is of great importance for any economy. From formulating national policies to planning and evaluating progress, its data is essential. 

• It provides a comprehensive measure of the economic activities of a nation. It indirectly measures the progress of the nation. The data on national income provides estimates of the country’s purchasing power.
• It helps to know a country’s per capita income that reflects the economic welfare of a country. Thus, it provides a picture of the standard of living in the country.
• Statistical data on national income not only helps in making economic analysis but also helps in policy formulation.
• Moreover, it not only helps in formulating fiscal policy, monetary policy, and foreign trade policy but also helps in making modifications and amendments wherever necessary.
• It thus serves as an instrument of economic planning. It helps business houses/ private players in planning their production activities. It is also helpful in forecasting the effect of economic policies on the level of production & employment.
• It helps us compare the national income and per capita income of our country with those of other countries.
• This may lead us to make suitable changes in our plans and approach to achieve rapid economic development in our country.
• It helps provide knowledge of structural changes occurring in the economy. We come to know about the share of different sectors (agriculture, Industry, Services, etc.) in the economy.
• It enables us to know the importance of various sectors of the economy and their contribution to the economy. It gives an idea of how income is produced, and distributed, and how much is spent, saved, or taxed.
• The performance of the government's economic policies can be evaluated based on the growth in National Income.

PROBLEMS IN CALCULATING NATIONAL INCOME

1. Presence of Formal Sector: India has a large informal sector that employs a large section of population. As per the Economic Survey 2019-20, there are an estimated 38 crore unorganized workers in India. It poses a conceptual problem. Here the proper valuation of output becomes difficult.
2. Payments with no economic activities: The government’s expenditure in the form of scholarships, pensions, unemployment allowances, etc. are not counted in national income. Because there is no production or economic activity done in return for the payment. Domestic transfer payments are also excluded from the national income of a country.
• For example, if an individual receives a cash gift from his father who is also a resident of India, it will not be a part of India’s national income. However, any transfer payment from abroad will be a part of a country’s national income.
3. Unpaid Services: Several services are unpaid in an economy. For Example, domestic work is done by housewives. She is not paid for her service and her service is not directly counted in national income.
4. Subsistence farming: Subsistence farmers who produce food for themselves and their family members consume a major portion of their own output every year. Since this portion is not sold through the market, it is excluded from GDP.
5. Goods given free of Cost: It is very difficult to find the true values of government services (public goods like national defense, law, and order, etc.) since these are not sold through the market. These are provided to people free of cost.
6. Income through illegal activities: Income earned through illegal activities like gambling, smuggling, and illicit extraction of liquor is not counted in national income.
7. Capital assets like houses, land, property, and stocks are sold at a higher price than paid for at the time of purchase. The gain is excluded from the national income.
8. Statistical Problem: There are statistical problems too. Care has to be taken to avoid double counting. There are many sources for compiling the data and reliability becomes the issue. Accurate and reliable data are not adequate as farm output in the subsistence sector is not completely informed.

MEASURES OF NATIONAL INCOME

The following are some of the concepts used in measuring national income.

GROSS DOMESTIC PRODUCT (GDP)

• It is the total market value of final goods and services produced within the country during a year.
• It measures the value of final goods and services produced within the geographic boundary regardless of the nationality of the individual or firm.
• For example, toys manufactured in India by Chinese companies will be included in Indian GDP. Similarly, toys manufactured in America by an Indian company will not be counted in India’s GDP but in America’s GDP.
• GDP at market Price: When GDP is calculated at market prices and is known as GDP at market prices. The word market price signifies that the value of production is calculated by multiplying by the price that buyers paid and not the price that production units actually receive.
• GDP at Factor Cost: GDP is also calculated as factor cost.

Concept of Factor Cost and Market Price

• Factor Cost (FC)
• Several inputs are included in a production process when producing goods and services. These inputs are commonly known as factors of production and include things such as land, labor, capital, and entrepreneurship.
• Producers of goods and services incur a cost for using these factors of production. These costs are ultimately added onto the price of the product
• The factor cost refers to the cost of production that is incurred by a firm when producing goods and services.
• Examples of such production costs include the cost of renting machines, purchasing machinery and land, paying salaries and wages, the cost of obtaining capital, and the profit margins that are added by the entrepreneur.
• It does not include the taxes that are paid to the government since taxes are not directly involved in the production process
• However, subsidies received are included in the factor cost as subsidies are direct inputs into the production.
• Market Price (MP)
• Once goods and services are produced they are sold in a marketplace at a set market price.
• It is the price that consumers will pay for the product when they purchase it from the sellers.
• Taxes charged by the government will be added to the factor price while subsidies provided will be reduced from the factor price to arrive at the market price.
• Taxes are added on because taxes are costs that increase the price, and subsidies are reduced because subsidies are already included in the factor cost, and cannot be double-counted when the market price is calculated
• Thus, MP = FC + Indirect Taxes - Subsidies

Few Elements of GDP Calculations

1. Final goods and services: These are those goods that are purchased for the purpose of consumption or final use. For example, if a burger is treated as a final product for GDP calculation, then buns used in burgers will not be counted as a final product as buns are intermediate goods in this case.
2. Domestic Territory: Domestic territory is the geographical territory administered by the government within which persons, goods, services, and capital freely flow. It includes:
• Political frontiers including territorial water and air space;
• Indian Embassies and Consulates;
• Military bases located abroad,
• Ships and aircraft owned and operated by residents between 2 or more nations, fishing vessels, oil and natural gas rigs, etc. operated by the residents of a country in the international waters where they have exclusive rights of operation.
3. Residents: For National Income Accounting, a resident is defined as a person or an institution who normally resides (at least one year or more in India) in a country and whose center of economic activity lies in that country.
• Residents also include Indians working in the Indian embassies abroad and foreign citizens living in India for more than one year. However, foreigners who come to India for medical treatment or study purposes are not considered normal residents even if they stay for more than one year.
• The residents do not include- Foreigners working in the Indian embassies abroad; foreigners working in the office of WHO, IMF, etc. located in India; foreign technical experts working in India for less than one year and foreign visitors or travelers.
4. Transfer Payment: Transfer payments are those payments that are earned without any economic activity or income for which no goods and services are produced. While measuring the national income of a country, it must be kept in mind that not every income is a factor in income.
• Key Points to note about Transfer Payments
• Transfer payments are payments made, typically by government or governmental agencies, to individuals who need such assistance.
• Transfer payments are also excluded from the national income of a country.
• Transfer payments are earned without any economic activity. Examples of transfer payments include social security benefits, state pension, unemployment benefits, public health services, etc.

TYPES OF GDP

Nominal GDP or GDP at current prices 

The total monetary value of all the goods and services produced in the domestic territory of a country during a given financial year and counted based on market prices prevailing in that year is known as Nominal GDP or GDP at current prices.

• In short, it is calculated at the current market price.
• It does not require any adjustments for inflation

Real GDP or GDP at a constant price

It refers to the total monetary value of all the final goods and services produced in the domestic territory of a country during a given financial year valued at a constant price.

• In short, Real GDP is the GDP calculated at constant prices(or base year price).
• It is adjusted for inflation to reflect changes in real output.
• While discussing economic growth, real GDP is considered

APPROACHING GDP BY VARIOUS METHODS

All goods and services produced in the country must be counted and converted against money value during a year. Thus, whatever is produced is either used for consumption or for saving. Thus, national output can be computed at any of three levels, viz., production, income and expenditure. Accordingly, there are three methods that are used to measure national income.

1. Production or value-added method
2. Income method or factor earning method
3. Expenditure method

If these methods are done correctly, the following equation must hold.

Output = Income = Expenditure

This is because the three methods are circular in nature. It begins as production, through recruitments of factors of production, generating income and going as incomes to factors of production.

GDP - By Sum of Spending, Factor Incomes or Output

1. GDP (Value of Output):  Value added from each of the main economic sectors
1. Primary
2. Secondary
3. Manufacturing
4. Quaternary
2. GDP (Factor Incomes):  Sum of all factor income (e.g. wages, rent, interest, etc)
1. Profits of private sector business
2. Rent income from the ownership of land
3. GDP (Expenditure): Sum of all item of final expenditure is measured like Consumption, Government spending, etc

Production or value-added method

In this method, national Income is estimated by calculating the value addition done by the firms at each stage of production in all the sectors of the economy i.e. agriculture, manufacturing, industries, Services, trade and commerce, etc. The value of the final product is derived by the summation of all the values added in the productive process.

Meaning of Value addition
Value-added refers to the addition in the value of a raw material or intermediate good by an organization during the production process.

Value Added = Value of Output – Intermediate Consumption

GDP calculation in the value-added Method

GDP at Current Market Price (MP) = (Summation of Gross value added of all goods and Services) + Taxes- Subsidies

GDP @ current MP Adjusted with the base year  GDP at Constant Market Price (official GDP)

List of goods and services included and not included in the value-added method:

Goods and Services	Included/Not included
Goods and Services sold in the market.	Included
Services provided by the agents.	Included
Buying and selling of second-hand goods.	Not Included.
Transfer payments such as scholarships, and pensions.	Not Included (as income is received but no goods and services are created).
Imputed rent or Imputed Interest. When a property is owned and used by the same person, then rent is not actually paid by him to himself. That rent is termed as imputed rent and is part of National Income.	Included

Income method or factor earning method
This method approaches national income from the distribution side. Under this method, GDP is calculated by adding up all the incomes generated in the course of producing the national product. The value that is derived is GDP at Factor Cost.

• In this method, we measure the factor incomes given to the owners of factors of production
• There are basically 4 Factors of Production namely – Land, Labour, Capital, Entrepreneurship which get income in the form of Factor Payments
• The first factor of production is Land. This not only includes land but also other natural resources like water, coal, Petroleum etc. The income or return that the owners of land get is called rent.
• The second factor of production is Labour. This is basically the hard work and effort put by people to produce any good or service. The income or return that labour resources earn is called wages.
• The third factor of Production is Capital. This includes machinery, tools etc. which are used to produce other goods. The income or return that owners of capital earn is called interest.
• The fourth factor of production is Entrepreneurship. An entrepreneur is an innovator who combines all the other factors of production. The income or return that entrepreneurs earn is called profit.
• Under this method, factor incomes are calculated under the following three major components.They are:
• Compensation to Employees: This includes wages, salaries n employer’s contribution to social security schemes, dearness allowances etc.
• Operating Surplus: This includes rent, profit, royalty and interest, Profit includes corporate tax, dividend and undistributed profit.
• Mixed income of Self Employed: It refers to income of self-employed people like farmers, doctors, Lawyers etc.