National Income Concept/Calculation of National Income

Calculation of National Income Other Concepts Associated with National Income

National Income Concept

National Income is the total value of all final goods and services produced by the country in certain year. The growth of National Income helps to know the progress of the 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.
• From the modern point of view, national income is defined as “the net output of commodities and services flowing during the year from the country’s productive system in the hands of the ultimate consumers.”

National Income Accounting (NIA)
National Income Accounting is a method or technique used to measure the economic activity in the national economy as a whole.

NIA is mainly done for:
Policy Formulation: It helps in comparing the estimates of the past from the future and also forecast the growth rates in future. For example, if a country has a GDP of Rs. 103 Lakh which is 3 Lakh rupees higher than the last year, it has a growth rate of 3 per cent.

Effective Decision Making: To estimate the contribution of each of the sectors of the economy. It helps the business to plan for production.

International Economic Comparison: It helps in comparing the level of development of countries and provides useful insight into how well an economy is functioning, and where money is being generated and spent. One can compare the standard of living of different nations and its growth rate.
There are various terms associated with measuring of National Income.

• Here the catch word is ‘Domestic’ which refers to ‘Geographical Area’
• The total value of all final goods and services produced within the boundary of the country during a given period of time (generally one year) is called as GDP.
• In this case, the final produce of resident citizens as well as foreign nationals who reside within that geographical boundary is considered.

Types of GDP: Real GDP and Nominal GDP
Real GDP: Refers to the current year production of goods and services valued at base year prices. Such base year prices are Constant Prices.

Nominal GDP: Refers to current year production of final goods and services valued at current year prices.

Which one is a better measure?
• Real GDP is a better measure to calculate the GDP because in a particular year GDP may be inflated because of high rate of inflation in the economy.
• Real GDP therefore allows us to determine if production increased or decreased, regardless of changes in the inflation and purchasing power of the currency.

• Here the catch word is ‘National’ which refers to all the citizens of a country.
• GNP is the total value of the total production or final goods and services produced by the nationals of a country during a given period of time (generally one year).
• In this case, the income of all the resident and non-resident citizens (who resides in abroad) of a country in included whereas, the income of foreigners who reside within India is excluded.
• The GNP contains the income earned by Indian Nationals (both in Indian Territory and Abroad) only.

GDP and GNP are measured on the basis of Market Price and Factor Cost.
a) Market Price
It refers to the actual transacted price which includes indirect taxes such as custom duty, excise duty, sales tax, service tax etc. (impending Goods and Services Tax). These taxes tend to raise the prices of the goods in an economy.

b) Factor Cost
It is the cost of factors of production i.e. rent for land interest for capital, wages for labour and profit for entrepreneurship. This is equal to revenue price of the final goods and services sold by the producers.
Revenue Price (or Factor Cost) = Market Price – Net Indirect Taxes
Net Indirect Taxes = Indirect Taxes – Subsidies
Hence, Factor Cost = Market Price – Indirect Taxes + Subsidies

C. Net National Product (NNP): NNP = GNP – Depreciation
• It is calculated by subtracting Depreciation from Gross National Product.
• Depreciation – Wear and Tear of goods produced.
• This deduction is done because a part of current produce goes to replace the depreciated parts of the products already produced. This part does not add value to current year’s total produce. It is used to keep the products already produced intact and hence it is deducted.

D. Net Domestic Product (NDP): NDP = GDP – Depreciation
• It is the calculated GDP after adjusting the value of depreciation. This is basically, Net form of GDP, i.e. GDP – total value of wear and tear.
• NDP of an economy is always lower than its GDP, since their depreciation can never be reduced to zero. The concept of NDP and NNP are not used to compare different economies because the method of calculating depreciation varies from country to country.

E. National Income at Factor Cost (NIFC):
• It is the sum of all factors of income earned by the residents of a country (Indian) both from within the country as well as abroad.
National Income at Factor Cost = NNP at Market Price – Indirect Taxes + Subsidies
• In India, and many developing countries across the world, National Income is measured at factor cost instead of market prices. Some of the reasons for the same are lack of uniformity in taxes, goods not being printed with their prices, etc.

F. Transfer Payments
• A payment made by the government to individuals for whom there is no economic activity is produced in return. For example: Old Age Pensions, Scholarship etc.

G. Personal Income
• It refers to all of the income collectively received by all of the individuals or households in a country.
• It includes compensation from a number of sources including salaries, wages and bonuses received from employment or self employment; dividends and distributions received from investments; rental receipt from real estate investments and profit sharing from businesses.
• In National Income Accounting, some income is attributed to individuals, which they do not actually receive. For Example: Undistributed Profits, Employees’ contribution for social security, corporate income taxes etc. which needs to be deducted from National Income to estimate the Personal Income.
PI = NI + Transfer Payments – Corporate Retained Earnings, Income Taxes, Social Security Taxes.

H. Disposable Personal Income
• It is the amount left with the individuals after paying Personal Taxes such as Income Tax, Property Tax, and Professional Tax etc. to spend as they like.
• DPI = PI – Taxes (Income Tax i.e. Personal Taxes)
• DPI results into Savings and Expenditure i.e. (Spend and Save). This concept is very useful for studying and understanding the consumption and saving behaviour of the individuals.

Several factors affect the national income of a country. Some of them have been listed below:
1. Factors of Production
Normally, the more efficient and richer the resources, higher will be the level of National Income or GNP

(a) Land
Resources like coal, iron and timber are essential for heavy industries so that they must be available and accessible. In other words, the geographical location of these natural resources affects the level of GNP.

(b) Capital
Capital is generally determined by investment. Investment in turn depends on other factors like profitability, political stability etc.

(c) Labour
The quality or productivity of human resources is more important than quantity. Manpower planning and education affect the productivity and production capacity of an economy.

(d) Entrepreneur

(e) Technology
This factor is more important for Nations with fewer natural resources. The development in technology is affected by the level of invention and innovation in production.

(f) Government
Government can help to provide a favourable business environment for investment. It provides law and order, regulations.

(g) Political Stability
A stable economy and political system helps in appropriate allocation of resources. Wars, strikes and social unrests will discourage investment and business activities.

Methods of National Income Calculation
There are three approaches and methods of measuring National Income:

A. Income Method
• By this National Income is calculated compiling income of factors of production viz., land, labour, capital and entrepreneur.
National Income = Total Wage + Total Rent + Total Interest + Total Profit
• In Indian context, since 1993 as per the System of National Accounts (SNA), National Income is total of the following:
GDP = Compensation of Employees + Consumption of Fixed Capital + (Other Taxes on Production – Subsidies of Production) + Gross Operating Surplus
• Compensation of employees: (Wage) salaries paid in cash and kind and other benefits provided to employees.
• Consumption of Fixed Capital: wear and tear of machinery which are replaced by new parts.
• Other Taxes on Production minus Subsidies: Net tax on production.
• There is a difference between tax on products and tax on production. Tax on products includes taxes like sales tax and excise duty. Tax on production is tax imposed irrespective of production like license fees and land tax.
• Gross Operating Surplus: balance of value added after deducting the above three components. It goes to pay rent of land and interest of capital.

B. Product Method (or Value Added Method, Output Method)
• It is used by economists to calculate GDP at market prices, which are the total values of outputs produced at different stages of production.

Some of the goods and services included in production are:
• Goods and services actually sold in the market.
• Goods and services not sold but supplied free of cost. (No Charge/Complementary)

Some of the goods and services not included in production are:
• Second hand items and purchase and sale of the same. Sale and purchase of second cars, for example, are not a part of GDP calculation as no new production takes place in the economy.
• Production due to unwarranted/ illegal activities.
• Non-economic goods or natural goods such as air and water.
• Transfer Payments such as scholarships, pensions etc. are excluded as there is income received, but no good or service is produced in return.
• Imputed rental for owner-occupied housing is also excluded.
• Here the Gross Value of final goods and services produced in a country in certain year is calculated.
• GDP is a concept of value added; it is the sum of gross value added of all resident producer units (institutional sectors, or industries) plus that part of taxes (total) less subsidies, on products which is not included in the valuation of output.
Gross Value Added = Output of Final Goods and Services – Intermediate Consumption
National Income = Gross Value Added + Indirect Taxes – Subsidies

C. Expenditure Method
• It measures all spending on currently-produced final goods and services only in an economy.
• In an economy, there are three main agencies which buy goods and services: Households, Firms and the Government.

This final expenditure is made up of the sum of 4 expenditure items, namely;
Consumption (C): Personal Consumption made by households, the payment of which is paid by households directly to the firms which produced the goods and services desired by the households.

Investment Expenditure (I): Investment is an addition to capital stock of an economy in a given time period. This includes investments by firms as well as governments sectors.

Government Expenditure (G): This category includes the value of goods and service purchased by Government. Government expenditure on pension schemes, scholarships, unemployment allowances etc. are not included in this as all of them come under transfer payments.

Net Exports (X-IM): Expenditures on foreign made products (Imports) are expenditure that escapes the system, and must be subtracted from total expenditures. In turn, goods produced by domestic firms which are demanded by foreign economies involve expenditure by other economies on our production (Exports), and are included in total expenditure. The combination of the two gives us Net Exports.

National Income = Consumption (C) + Investment Expenditure (I) + Government Expenditure (G) + Net Exports (X-IM)

Calculating GDP (National Income) is extremely important as the performance of the economy is fixed by means of this method. The results would help the country to forecast the economic progress, determine the demand and supply, understand the buying power of the people, the per capita income, the position of the economy in the global arena. The Indian GDP is calculated by the expenditure method.

Calculation of National Income

A. Per Capita Income
• Per Capita Income is obtained by dividing the total number of population from the National Income i.e. the GDP of a country.
PCI = National Income / Population of country
• Earlier Human Development (HDI) was measured on the basis of Per Capita Income (PCI) as PCI helps to fulfill all basic needs of human. In this context, if the PCI is high the HDI is also high and vice versa.
• The above context treats rich and poor on the same ground which brings faulty measurement in HDI.

B. Human Development Index (HDI)
• The Human Development Index (HDI) is a summary measure of average achievement in key dimensions of human development: a long and healthy life, being knowledgeable and have a decent standard of living. The HDI is the geometric mean of normalized indices for each of the three dimensions.
• It measures the average achievements in a country in three basic dimensions of human development:
1. A long and healthy life
2. Access to knowledge
3. Decent standard of living
• The index was developed by Mahbub-ul-Haque along with Amartya Sen which is used by the United Nations Development Programme (UNDP) in their annual report since 1990. This method was followed till 2009 and by 2010 new method (20th anniversary edition) is adopted with a slight change in it by introducing three new indices viz, Gender Inequality Index, Multi-dimensional Poverty Index and Inequality adjusted HDI.
• Its goal was to place people at the centre of the development process in terms of economic debate, policy and advocacy. “People are the real wealth of a nation,” was the opening line of the first report in 1990. This report ranks the countries on the basis of the Human Development Index.

C. Green GDP
• An index of economic growth with the environmental consequences of that growth factored in. From the final value of goods and services produced, the cost of ecological degradation is deducted to arrive at Green GDP.
• Green GDP calculations have been developed for countries as diverse as Australia, Canada, China, Costa Rica, Indonesia, Mexico, Papua New Guinea, and the US, although none of these efforts have resulted in regular reporting of the results.

D. Gross National Happiness: ‘Happiness matters, not Money’
• With many of the world’s countries about as unhappy as they can get because of their dwindling GDP figures, the tiny nation of Bhutan has gone in the opposite direction. Officials in Bhutan came up with a different indicator, called gross national happiness (GNH).
• The country’s beloved former king, Jigme Singye Wangchuck, envisaged the concept of gross national happiness since 1972, and the country adopted it as a formal economic indicator in 2008.
• Beginning in November 2008, all the economic factors started measuring gross domestic product analyzed for their impact on Bhutan’s residents’ happiness.
• The factors of production are still there such as unemployment, agriculture, retail sales but GNH represents a paradigm shift in what’s most valued by Bhutanese society compared to the rest of the world.

Following parameters are used in the GNH:
1. Higher real per capita income
2. Good Governance
3. Environmental Protection
4. Cultural Promotion

E. Human Poverty Index (HPI)
• It is developed by UN which focuses solely on amount of poverty in a country.
• Deprivations in longevity are measured by the probability at birth of not surviving to age 40;
• Deprivations in knowledge are measured by the percentage of adults who are illiterate;
• Deprivations in a decent standard of living are measured by two variables:
– The percentage of people not having sustainable access to an improved water source and
– The percentage of children below the age of five who are underweight.
• HPI focuses attention on the most deprived people and deprivations in basic human capabilities in a country, not on average national achievement.
• The human poverty indices focus directly on the number of people living in deprivation presenting a very different picture from average national achievement. It also moves the focus of poverty debates away from concern about income poverty alone.

F. Genuine Progress Indicator (GPI)
• While GDP is a measure of current income, GPI is designed to measure the sustainability of that income.
• GPI uses the same personal consumption data as GDP but makes deduction to account for income inequality and costs of crime, environmental degradation, and loss of leisure and additions to account for the services from consumer durables and public infrastructure as well as the benefits of volunteering and housework.
• By differentiating between economic activity that diminishes both natural and social capital and activity that enhances such capital, the GPI and its variants are designed to measure sustainable economic welfare rather than economic activity alone.
• Proponents of the GPI see it as a better measure of the sustainability of an economy when compared to the GDP measure. Since 1995 the GPI indicator has grown in stature and is used in Canada and the United States.

G. GDP Deflator – (Implicit price deflator for GDP)
• It is a measure of the level of prices of all domestically produced final goods and services in an economy in a year. This is calculated to find the overall rise in the level of price.
GDP Deflator = Nominal GDP/Real GDP × 100
• GDP deflator is published on a quarterly basis since 1996 with a lag of two months. It is because of this very reason that economists prefer the use of WPI or CPI for deflating nominal price estimates to derive real price estimates
• Unlike the WPI and the CPI, GDP deflator is not based on a fixed basket of goods and services, it covers the whole economy. One of the other advantages of GDP deflator is that changes in consumption patterns or the introduction of new goods and services are automatically reflected in the deflator, such a feature is missing in WPI/CPI.

H. Universal Basic Income (UBI)
• Also referred to as Guaranteed Income or the Basic Income Guarantee: “A simpler way to ensure that everyone made enough to survive.”
• In order to ensure that all citizens can afford to meet their basic needs, the government provides every citizen with a set amount of money on a regular basis, enough to lift them above the poverty line.
• This cash income would be universal and unconditional, meaning that every citizen would receive it no matter what – no work requirements, no means-testing and no restrictions on how the money is used.

I. Purchasing Power Parity (PPP)
• Purchasing Power Parity (PPP) is an economic theory that compares different countries’ currencies through a market “basket of goods” approach. According to this concept, two currencies are in equilibrium or at par when a market basket of goods (taking into account the exchange rate) is priced the same in both countries.
• This is how the relative version of PPP is calculated:

• “S” represents exchange rate of currency 1 to currency 2
• “P1” represents the cost of good “x” in currency 1
• “P2” represents the cost of good “x” in currency 2

J. Lorenz Curve
• It is the graphical representation of wealth distribution developed by American economist Max Lorenz in 1905. On the graph, a straight diagonal line represents perfect equality of wealth distribution; the Lorenz curve lies beneath it, showing the reality of wealth distribution.
• The difference between the straight line and the curved line is the amount of inequality of wealth distribution, a figure described by the Gini coefficient.

K. Gini Coefficient
• The Gini index is a measurement of the income distribution of a country’s residents. This number, which ranges between 0 and 1 and is based on residents’ net income, helps define the gap between the rich and the poor, with 0 representing perfect equality and 1 representing perfect inequality.
• It is typically expressed as a percentage, referred to as the Gini coefficient.

L. Phillips Curve
• It is an economic concept developed by A. W. Phillips showing that inflation and unemployment have a stable and inverse relationship.
• The theory states that with economic growth comes inflation, which in turn should lead to more jobs and less unemployment.
• However, the original concept has been somewhat disproven empirically due to the occurrence of stagflation in the 1970s, when there were high levels of both inflation and unemployment.