Domestic Income of Production and Its 7 Components | Micro Economics

Seven Components of domestic income of production are:

1. Compensation of employees (traditionally called Wages) 2. Rent and Royalty 3. Interest 4. Corporate (Profit) tax 5. Dividend 6. Undistributed Profit 7. Mixed Income!

(a) Meaning:

Domestic income is the sum total of factor incomes generated by all the production units located within the domestic territory of a country during a period of account.

It does not matter whether the producer is the normal resident or foreigner. What is essential is that production is done within the domestic territory of the country. Again, domestic Income does not include ‘net factor Income earned from abroad’. Now, we discuss components of domestic income. In detail which facilitate solution of numerical sums.

(b) Components of Domestic Income:

Broadly speaking, components of domestic income (NDP_FC) are Compensation of employees. Operating surplus (Rent + Interest + profit) and Mixed Income (see Section 6.6, part 19) but they are further sub-divided into following Individual actor incomes so as to facilitate solution of numerical sums and understanding of other aggregates.

Each component is explained below:

1. Compensation of employees (traditionally called Wages):

This is the reward or compensation paid to employees (labour) for rendering productive services. It Includes (i) Wages and salaries paid both in cash and kind and (ii) Employer’s contribution to social security schemes.

Remuneration in cash includes wages and salaries, dearness allowance, bonus, city compensatory allowance, house rent allowance, leave travelling allowance, etc., whereas in kind (i.e., in the form of goods and services) it includes rent-free quarter, free water and electricity, free uniform, free services of vehicles (car, scooter), amount of Interest on interest-free loans, etc.

Employer’s contribution to social security schemes consists of contribution to life Insurance, casualty Insurance, provident fund, pension schemes, etc. Mind, old-age pension is a transfer payment but retirement pension is a part of compensation of employees.

Note:

Compensation to injured worker, employee’s contribution to social security schemes, TA relating to business promotion, amount of loan, etc. are not included in compensation of employees.

2. Rent and Royalty:

Rent is a factor income earned from lending the services of land, building whereas royalty is income received by the landlord from granting leasing rights of sub-soil assets. It may be noted that domestic income includes not only rent but imputed rent also. The rent of owner-occupied houses is called imputed rent. When the owner of a house, instead of renting out to a tenant, himself stays in it, he is assumed to have paid rent to himself.

Thus, market rent of self-occupied house is labelled as imputed rent which is Included in
national income. Similarly, royalty, which is the amount receivable by a landlord for granting leasing rights of sub-soil assets (deposits of coal, iron, natural gas, etc.) and for use of patents, copyrights, etc., is treated as a part of rent If not mentioned separately.

3. Interest:

Interest is the price for the funds borrowed. A production unit borrows money for making investment in business and pays interest in return. In other words, interest is the reward or payment which the borrower makes to the lender of the money capital for using his capital for a certain period of time.

So interest is a factor payment of the capitalist who lends money Interest is included in national income since it is a compensation for the productive service rendered by the factor of production called capital (money capital). With borrowed money a firm purchases capital goods like machinery and thereby increases its productive capacity and income.

It is important to note that interest paid by the government on public debt (loan taken from public) is not included in domestic (or national) income because loans taken by the government are conventionally treated as consumption borrowing (i.e., loan for consumption purposes and not for production). Similarly interest paid by consumers is not included in national income for the same reason. However, such interests are included in personal Income of the lenders of money capital.

Profit:

Profit is the residual factor payment to owners of production units. Thus, profit is the income of the factor input called entrepreneurship for organising production and undertaking attendant risks. It is reward that owners of firms get for being in business and taking risk involved therein. Reward of other factors of production (land, labour, capital) is of contractual nature but of entrepreneur is of residual nature.

It should be kept in mind that profit of a corporation (Joint stock company) is used mainly for three purposes, viz., corporate (or profit) tax, dividend and undistributed profit—items which frequently appear in numerical questions.

Thus, profit can be taken as sum of corporate profit, dividends and undistributed profit. Therefore, instead of mentioning profit, its three parts are shown as components. Once profit is included in the estimation of national/domestic income, none of its three parts should then be included separately.

4. Corporate (Profit) tax:

The net profit of a corporate enterprise is used mainly for three purposes:

(i) Corporate tax, (ii) dividend and (iii) reserve fund (undistributed profit). Profit tax is the direct tax levied by the government on the profit of a company. The company pays it out of its total profit. Profit tax, thus, is a part of domestic income since it is actually earned by the company Profit tax is also called corporate tax.

5. Dividend:

It is that part of profit of a corporate enterprise which it pays to its shareholders in accordance with the number of shares held by the latter. By virtue of owning shares, the shareholders become owners of the company. The returns on these shares are called dividend. It is another matter that the dividend income depends upon the profitability of the company.

Dividend is also a part of domestic income since it is paid by the company out of its total profit. Mind, dividend paid by one firm to another firm is not included since it is already included in the profit of the firm which pays. Similarly, money received from sale of shares is not included because tills has changed only ownership of shares and not contributed to the flow of goods and services.

6. Undistributed Profit:

A company (or a firm), after paying profit tax and distributing dividend out of its total profit, keeps the balance as reserve fund which is known as undistributed profit (or corporate savings). The reserve fund is maintained and augmented to meet unexpected contingencies, to expand the size of production and to provide social security benefits to its employees. Undistributed profit is also known as savings of private corporate sector. ‘Income of public (govt.) sector’ (explained in last paragraph), If not shown separately, is treated as a part of undistributed profit.

7. Mixed Income:

Income of own account workers (like farmers, doctors, barbers, etc.) and unincorporated enterprises (like small shopkeepers, repair shops, small hotels, retail traders, etc.) is known as mixed income. They do not maintain proper accounts. They do not generally hire factor services from the market; rather they use their own resources like land, labour, funds, etc.

As a result, it becomes difficult to classify their income distinctly among rent, wages, interest and profit. Even self-employed people do not distinguish labour income from property income. Hence, such incomes are treated as mixed income because they are mixture of rent, wages, interest and profit. In India this is known as unorganised sector. When some producers consume a large part of their own produce, imputed value of production for self-consumption should also be included.