National Income Concepts and Its Measurement | National Income

Let us make an in-depth study of National Income Concepts and Its Measurement:-

1. Meaning and Definition of National Income or National Dividend 2. Different Concepts of National Income 3. Importance of National Income Analysis.

Meaning and Definition of National Income or National Dividend:

The total income of the nation is called national income. In real terms, national income is the flow of goods and services produced in the economy in a particular period—a year.

Modern economy is a money economy. Thus, national income of the country is expressed in money terms.

A National Sample Survey has therefore defined national income as “The money measures of the net aggregate of all commodities and services accruing to the inhabitants of community during a specific period.”

In other words we can say that national income is a money measure or value of net aggregate of goods and services becoming available annually to the nation as a result of the economic activities of the community at large consisting of households or individuals, business firms and social and political institutions. The time is accepted as one year all over the world as it is concerned with the natural and seasonal factors. In one year all the seasons repeat itself. Thus, all the definitions and National Income consider one year.

Definitions:

The definitions of national income can be grouped into two classes:

1. The traditional definitions advanced by Marshall, Pigou and Fisher.

2. Modern definition given by Prof. Simon Kuznet.

The Marshallian Definition:

According to Marshall—”The labour and capital of a country acting on its natural resources produce annually a certain net aggregate of com­modities, material and immaterial including services of all kinds. This is the true net annual income or revenue of the country or national dividend.” In this definition, the word “net” refers to deductions from the gross national income in respect of depreciation of capital equipment used in the creation of productive activity. And to this must be added income from abroad.

Other features of this definition are:

(i) It is measured on one year basis,

(ii) It includes the values of goods and services,

(iii) It includes only those things which are produced by labour and capital of a country with the help of the natural resources,

(iv) It excludes the depreciation and debasement of capital goods,

(v) It includes the net foreign investment in the country,

(vi) It excludes all those goods and services which are produced by friends, relatives or organisations free of costs.

No doubt Prof. Marshall’s definition is theoretically sound, simple and comprehensive but it has got some serious practical limitations:

(i) It is not easy to ascertain or make
statistically correct estimate of the total production of goods and services in an economy,

(ii) The problem of double counting has been ignored,

(iii) How to make allowance for the portion of the produce kept for self-consumption,

(iv) The problem of current and base year prices is also ignored.

The Pigovian Definition:

Marshall’s follower, A. C. Pigou has in his definition of national income included that income which can be measured in terms of money. In the words of Pigou—”National income or National Dividend is that part of objective income of the community including of course income derived from abroad which can be measured in money.”

This definition is better than the Marshallian definition. It has proved to be more practical also. The above definition of Prof. Pigou is classificatory; it takes into account of those goods and services which can be measured by the measuring rod of money.

All those goods which are given as gifts, bounties etc. are not included in the national income, Prof. Pigou’s definition is used in exchange economy where goods and services are exchanged for money only, The definition takes into account the net value of goods and services which are exported and imported.

Criticism:

Although the definition of Prof. Pigou is precise, simple and practical but it is not free from criticisms.

The important criticisms advanced by economists are:

(i) National income estimate account for only those goods and services which are exchanged for money. It is not appropriate for an underdeveloped country where there is barter system is prevalent.

(ii) The measuring rod of money is also defective. This makes the calculation of national income very faulty. Pigou himself has said that the services rendered by women enter into the national dividend when they are rendered in exchange of money whether in the factory or home, but do not enter into it when they are rendered by the members and wives gratuitously to their own families.

(iii) Thus, if a man pays to his maid servant for her service, the money payment will be included in the national income. But if that man marries the maid-servant then her service will not be included in the national dividend. Though the services rendered are the same or rather better. Thus, these services are included in one case and are excluded in the other.

Fisher’s Definition:

Fisher picked up in his study ‘Consumption’ as the criterion of national income whereas Marshall and Pigou regarded it to be ‘production’. According to Fisher—”The national dividend or income consists solely of services as received by ultimate consumers, whether from their material or from the human environments. Thus, a piano, or an overcoat made for me this year is not a part of this year’s income, but an addition to the capital, only the services rendered to me during this year by these things are income.”

Fisher’s definition has been considered as better than that of Marshall or Pigou because Fisher’s definition provides an adequate concept of economic welfare which is dependent on consumption and consumption represents our standard of living.

Criticism:

But various economists are of other view that from the practical point this definition is less useful and improper because there are certain difficulties in measuring the goods and services in terms of money:

(i) It is very difficult to estimate the money value of net consumption than that of net production,

(ii) Certain consumption goods are durable and last for many years. If we consider the example of piano or overcoat, as given by Fisher, only the services rendered to us during one year by them will be included in income,

(iii) Third and the important aspect are regarding the durable goods generally keep changing hands leading to a change in their ownership and value. If therefore, becomes difficult to measure in money the service value of these goods from the point of view of consumption.

Prof. Simon Kuznet’s Definition:

Prof. Simon Kuznets was an expert advisor to the National Income Estimate Committee of India in 1949. He has the practical experience of estimating National Income in India and U.S.A. His view was that the concept of national income may be simple from theoretical point of view whereas most difficult from the practical point of view.

He has defined national income in practical prospective as:

“The Net Output of Commodities and Services flowing in a year from the country’s productive system in the hands of ultimate consumers or into net addition to the country’s capital goods. In practical life, while estimating national income any of these four definitions may be adopted, because the same national income would be derived, if different it’s were correctly included in the estimate.

Which Definition is the Best?

From the above definitions written, the definition of Prof. Simon Kuznets is more comprehensive and can be considered as the best definition. Because it is fully equipped with theoretical and practical significance.

The salient features of its being best as given as under:

(i) It is the net aggregate of goods and services,

(ii) Only those goods and services are taken into consideration which are produced by the productive system of an economy,

(iii) The period of production is taken as one year,

(iv) In order to avoid the problem of double counting only those goods are considered as product which either go into the hands of ultimate consumers or used by the productive system as capital goods,

(v) National income is considered as flow of goods and services. The flow is a continuous one.

But this definition takes into consideration only domestic income and ignores the concept of net income earned from abroad. Further, in the estimation of national income the concept of ultimate consumer is ignored. We normally undertake that value of goods which we get in exchange for commodity.

Different Concepts of National Income:

In the measurement of national income there are various situations which we will have to study and they are known as concepts of national income. These concepts have their significance in national income accounting.

Important concepts have been discussed here under:

1. Gross National Income or Product (GNP):

Gross National Product has been defined as the total market value of all final goods and services produced in a year. It is the money value of all the final goods and services which the labour and capital of a country working on its natural resources have produced in a year. It includes not only the part of the production which is brought to the market for sale but also that part of the produce which is kept for self consumption.

While estimating Gross National Product a care is taken that no commodity is counted more than once. For this, only the value of the final goods and services produced or value added by each producer is included in the Gross National Product.

Factors to be taken into consideration while studying Gross National Product:

(i) As GNP is the measure of money, so all kinds of goods and services produced in a country during one year are measured in terms of money at current prices and then added together.

(ii) In estimating GNP of the economy, the market price of only the final products should be taken into account. Many of the products pass through a number of stages before they are ultimately purchased by consumers.

(iii) Goods and services rendered free of charge are not included in the GNP, because it is not possible to have a correct estimate of their market prices.

(iv) The transactions which do not arise from the produce of current year or which do not contribute in any way to production are not included in the GNP. The sale and purchase of old goods and of shares, bonds are assets of existing companies are not included in GNP because they do not make any addition to the national product and the goods are simply transferred.

(v) The profits earned or losses incurred on account of changes in capital assets as a result of fluctuations in market prices are not included in the GNP if they are not responsible for current production or economic activity.

(vi) The income earned through illegal activities is not included in the GNP. Although the goods sold in the black-market are priced and fulfill the needs of the people, but as they are not useful from the social point of view, the income received from their sale and purchase is always excluded from the GNP.

2. Net National Product or (NNP):

Net National Product (NNP) refers to the value of the net output of the economy during the year. It is obtained by deducting the value of depreciation or replacement allowance of the capital assets from the GNP.

To put it symbolically:

NNP = GNP – D

where D = depreciation allowances.

This value is measured at current prices, while GNP is expressed at the current market price. Net National Product, in-fact, is the value of total consumption plus the value of net investment of the community. It is the sum total of net values added by each producer in the productive process of an economy during one year period.

3. Gross Domestic Product (GDP):

Gross Domestic Product is the money value of all goods and services produced annually within the territorial limits of the country.

Gross Domestic Income includes:

(i) Wages and salaries,

(ii) Rents, including imputed house rents,

(iii) Interest,

(iv) Dividends,

(v) Undistributed corporate profits, including surpluses of public undertakings,

(vi) Mixed incomes consisting of profits of unincorporated firms, self-employed persons, partnership etc., and

(vii) Direct taxes.

In the estimation of Gross Domestic Product, no consideration is given to the fact as to whether the gross value of produce is with the combined efforts of only the people of the country with the co-operation of the foreigners. But the product must be produced in the country alone as the net earnings from abroad are excluded.

Therefore, Domestic Income = National Income – Net Income earned from abroad.

Thus, the difference between domestic income and national income is the net income earned from abroad. If we add net income from abroad to domestic income, we get national income.

i.e., National Income = Domestic Income + Net Income earned from abroad.

But the net national income earned from abroad may be positive or negative.

4. Per Capita Income:

Per capita income refers to the average income of an individual in a particular year. It denotes the income received by an individual during a certain year in a country. In order to find per capita income of a country in a certain year, we divide the national income of that country by the population of that country in that year e.g.,

Per-Capita Income = National Income of India in 2002/Population of India in 2002

It is clear that a country having high national income and less population will have higher per capita income. The concept of per capita income helps us in estimating the standard of living of different nations and it also serves as an index of economic development.

5. Personal Income:

Personal income is the aggregate income received by the individuals of a country from all sources before payment of direct taxes in one year. It is derived from national income by deducting undistributed corporate profits, profit taxes and employee’s contributions to social security schemes.

These three components are excluded from national income because they do reach individuals. It can never be equal to the national income, because the former includes the transfer payments whereas they are not included in national income.

Business and Government transfer payments and transfer payments from abroad in the form of gifts and remittances, wind-full gains and interest on public debts are a source of income for individuals are added to national income. Thus,

Personal Income = National Income + Transfer Payment + Interest on Public Debt – Undistributed Corporate Profits – Profit Taxes — Social Security Contribution.

Personal Income differs from Private Income in that it is less than the latter because it excludes undistributed corporate profits. Thus

Personal Income = Private Income – Undistributed corporate profits – Profit taxes.

6. Disposable Income or Personal Disposable Income:

Disposable income or personal disposable income is the actual income which can be spend on consumption because it is the income that accrues before direct taxes have actually been paid. Therefore, in order to obtain the disposable income, direct taxes are deducted from personal income. Thus,

Disposable Income = Personal Income — Direct Taxes.

But it should be remembered while calculating this income that the whole of the disposable income is not spend on consumption and a part of it is saved. Therefore, the disposable income is divided into consumption expenditure and saving. Thus,

Disposable Income = Consumption Expenditure + Savings

The concept of Disposable Income is very useful in computing the real purchasing power of the country. It also gives us an information regarding the personal consumption pattern. It refers to that part of the personal income which is actually available to the consumers. It can be obtained by deducting the amount of personal taxes, fines etc., from personal income. It is at the disposal of the consumers to save or consume or to use it in any way they like.

Importance of National Income Analysis:

The following are the main uses and importance of the national income analysis:

National income analyses are of great importance for the economy of a country. These days it has been regarded as the accounts of the economy which are known as social accounts. Social accounts tell us how the aggregates of a nation’s income, output and product result from the income of different individuals, products of industries and transactions of international trade. This helps us to assess the pace of economic development of a country. If they are not in a position to measure the progress of the country precisely, at least they show us the trends and they give us at-least an idea as to standard of living of community or the people of the country.

Further, they are helpful in the assessment of the saving and investment potential of the community. Because the rate of saving and investment is finally dependent on the national income. We can draw and make inter-country comparisons by taking the national income analysis of two countries which will help us to know where we stand among the world economies. This helps us to assess inter-sectoral growth of an economy. This information is useful in planning the development of the various sectors.

Another importance of national income analysis is that they throw light on inter-class distribution of national income. One can ascertain and judge the standard of welfare of the various sections of the community. All modern societies aim at reducing inequalities of incomes and this is not possible without the help of national income analysis.

This analysis helps us to know about the distribution of income in the country. From the analysis pertaining to wages, rent, interest and profits we learn of the disparities in the incomes of different sections of society.

Further, the regional distribution of income is revealed. It is only on the basis of these that the government can adopt measures to remove the inequalities in income distribution and to restore ‘regional equilibrium’.

In this connection Samuelson has said:

“By means of statistics of national income we can chart the movements of a country from depression to prosperity, its steady long-term rate of economic growth and development and finally, its material standard of living in comparison with other nations.”