National Income of a Country (Study Notes)

National Income of a Country (Study Notes)!

Meaning of National Income:

The labour and capital of a country acting on its natural resources produce annually a certain amount of goods and services.

This is called national income of the country. National income of a country can be defined as the total market value of all final goods and services produced in the economy in a year. Two things must be noted in regard to this meaning of national income. First, it measures the market value of annual output. In other words, national income is a monetary measure.

This is because there is no other way of adding up the different sorts of goods and services except with their money prices. But in order to know accurately the changes in physical output, the figure for national income is adjusted for price changes. Secondly, for calculating national income accurately all goods and services produced in any given year must be counted only once, and not more than once.

Most of the goods go through a series of production stages before reaching a market. As a result, parts or components of many goods are bought and sold many times. Hence, in order to avoid counting several times the parts of goods that are sold and resold, national income only includes the market value of all final goods and ignores the transactions involving intermediate goods.

The above way of explaining national income is only one way of interpreting it. In fact, the concept of national income has three interpretations. It represents a total value of production, it represents a receipts total, and it represents an expenditure total.

It is an obvious fact that every expenditure is at the same time a receipt. In other words, amount spent is equal to amount received. But if goods and services are valued at their market prices, we have three­fold identity, namely, that the value received equals the value paid equals the value of goods and services produced and sold.

To explain the above idea, let us take an economy where there are only two agents: households and firms. Firms are required to produce goods. To produce them, they require services of factors of production. Factors of production are paid the rewards for their contribution to the production of goods. Thus incomes of these factors arise in the course of production. The sales value of net production must equal the sum total of payments made by the firms to the factors of production in the course of production.

The sales value of net production must equal the sum total of payments made by the firms to the factors of production in the form of wages, rents, interest and profits. These incomes in turn become the sources of expenditure. Thus income flows from the firms to the households in exchange for productive services. This income again returns to the firms when expenditure is made by the households on the goods produced by the firms.

From above it follows that:

National Income = National Product = National Expenditure. In other words, there are three measures of national income of a country.

(a) The sum of values of all final goods and services produced.

(b) The sum of all incomes, in cash and kind, accruing to factors of production in a year; and

(c) The sum of consumers’ expenditure, net investment expenditure and government expenditure on goods and services.

Sum of all income, sum of values of all final production, and sum of all expenditures will be the same, but the significance of each arises from the fact that they reflect the three basic activities of the nation’s economy, viz., production, distribution and expenditure.

Concepts of National Income:

There are various concepts of national income which we study below one by one:

1. Gross National Product (GNP)

This is the basic national accounting measure of the total output or aggregate supply of goods and services. Gross National Product is defined as the total market value of all final goods and services produced in a year in a country. Two things must be noted in regard to gross national product. First, it measures the market value of annual output. In other words, GNP is a monetary measure.

There is no other way of adding up the different sorts of goods and services produced in a year except in terms of their money prices. But in order to know accurately the changes in physical output, the figure for gross national product is adjusted for price changes.

Secondly, for calculating gross national product accurately, all goods and services produced in any given year must be counted once, and not more than once. Most of the goods go through a series of production stages before reaching a market.

As a result, parts or components of many goods are bought and sold many times. Hence to avoid counting several times the parts of goods that are sold and resold, gross national product includes the market value of only final goods and ignores transac­tions involving intermediate goods.

Final Goods and Intermediate Goods:

What do we mean by final goods’? Final goods are those goods which are purchased for final use and not for resale or further processing. Intermediate goods, on the other hand, are those goods which are purchased for further processing or for resale.

The sale of intermediate goods is excluded from gross national product. Why? Because the value of final goods includes the value of all intermediate goods used in their production. The inclusion of intermediate goods would involve double counting and will therefore give an exaggerated estimate of gross national product.

An example will clarify this point. Suppose in our economy only two things are being produced, raw cotton worth Rs. 1000 and cotton cloth worth Rs. 2000. Now what will be the measure of gross national product? For finding it, if we add up the sales value of cloth and cotton, there is clearly an element of double counting in the sense that we have added the value of cotton twice—one as the sales value of cotton and secondly when we added to it the value of cloth. Actually, the value of cloth includes also the value of cotton which having been accounted for already should not be added second time.

Further, it is worth noting that Gross National Product (GNP) includes only currently produced goods and services in a year. It is a flow measure of output of goods and services per time period, say in a year. In it are only goods and services produced in a particular year are included.

Market transac­tions involving goods produced in previous periods such as old houses, cars, factories built earlier are not included in GNP of the current year. Similarly, purchase and sale of assets such as stock and bonds do not involve current production of goods and are therefore excluded from GNP of the year.

Lastly, Gross National Product (GNP) refers to the value of goods and services currently produced by normal residents of a country. These residents may be national or non-national compa­nies. Thus, many foreign companies have set up plants in India. They are owned by non-nationals but work to produce goods and services within the domestic territory of India and generate incomes for the Indian people employed in them. These foreign companies can only send back to their own countries profits earned by them.

Gross national product has the following components:

1. Value of final consumer goods and services produced in a year and consumed by two house­holds which is denoted by to consumption (C) by households.

2. Value of new capital goods produced and addition to the inventories of goods such as raw materials, unfinished goods and consumer goods produced but not sold during a year. This is called Gross Private Investment (I).

3. Value of output of General Government which is taken to be equal to the value of purchases of goods and services by the Government which we denote by G.

4. Net Exports (X_n) which is equal to value of goods exported minus the value of goods im­ported (M).

5. Net Factor Income from Abroad

Net Factor Income from Abroad:

Now, what does net factor income from abroad stand for? The sum of factor incomes such as wages and salaries (i.e., compensation of employees), rent, interest and profits generated within the domestic territory of a country in a year is called domestic factor income. It includes factor incomes generated both by residents and non-residents working in the domestic territory of a country. For example, non-residents (i.e., foreigners) work in the domestic territory of India and earn wages and salary.

Thus, foreign individuals and companies from the USA, Great Britain and other countries have acquired property such as factories, offices, buildings, places and have also acquired financial assets such as bonds and shares of Indian companies. This generates incomes in the form of rent and interest to them. In addition to this, foreign residents—individuals and companies—have set up industrial plants and factories producing goods and services from which they earn profits.

On the other hand, Indians go abroad and work in the territories of other countries and earn wages and salaries. Likewise, some Indian individuals and corporate companies have acquired assets such as buildings, factories, commercial space, and have also invested in bonds, bank deposits of foreign countries and thus receive rent and interest. Some Indian companies have set up factories abroad and earn profits.

Now, the net factor income from abroad is the difference between factor income received from abroad by normal residents of India for rendering factor services in other countries on the one hand and the factor incomes paid to the foreign residents for factor services rendered by them in the domestic territory of India on the other.

Net factor income earned from abroad have therefore the following three components:

1. Net compensation of employees.

2. Net income from property i.e., rent, interest and income from entrepreneurship (that is, profits and dividends).

3. Net retained earnings of the resident companies working in foreign countries.

(Note that’ Net in the above means the difference between the relevant income of normal residents earned from abroad and the same type of incomes paid to non-residents working in the domestic territory of a country)

2. Gross Domestic Product (GDP):

Another important concept of national income is gross domestic product (GDP). Gross domestic product is the money value of all final goods and services produced by normal residents as well as non-residents working in the domestic territory of a country but do not include net factor income earned from abroad.

Thus difference between gross domestic product (GDP) and gross national product (GNP) at market prices arises due to the existence of ”net factor income from abroad’. Gross domestic product does not include net factor income from abroad, whereas gross national product Includes it. Therefore,

Gross Domestic Product (at market prices) or

GDP_Mp = GNP_Mp – net factor income from abroad

or GNP_MP = GCP_MP + net factor income from abroad

It should however be noted that net factor income from abroad should not be confused with income from net exports which are a part of both gross national product (GNP) and gross domestic product (GDP). Net exports equal total exports minus imports.

Gross exports are the total value of domestically produced goods and services sold to foreign buyers in a year and are therefore a part of Gross Domestic Product (GDP) and not a factor income from abroad. On the other hand, imports are the value of imported goods and services purchased by the domestic buyers.

Therefore, imports do not form a part of GDP or GNP. In national income accounting, we subtract the value of imports from the value of exports to arrive at net exports which are a part of GDP and therefore also of GNP. Thus, earnings from net exports are quite distinct from net factor income from abroad.

Thus, we can obtain Gross Domestic Product (GDP) by adding up the first four items of Gross National Product listed above. Thus

GDP = C + I + G +X_n

where X_n = (X- M)

We have graphically depicted GDP by second bar in Figure 2.

GNP GDP NDP_Mp NDP_FC

(Note: By adding Net Factor Income from Abroad to NDP_Mp and NDP_fC we get NNP_Mp and NNP_pc respectively).

3. Net National Product (NNP) or National Income at Market Prices:

The second important concept of national income is that of net national product (NNP). In the production of gross national product of a year, we consume or use up some fixed capital i.e., equip­ment, machinery, etc. The capital goods, like machinery, wear out or fall in value as a result of its consumption or use in the production process.

This consumption of fixed capital or fall in the value of fixed capital due to wear and tear is called depreciation. When charges for depreciation are deducted from the gross national product we get net national product. Clearly, it means the market value of all final goods and services after providing for depreciation. Therefore, it is also called ‘national income at market prices’. Therefore,

4. National Income (NI) or National Income at Factor Cost (NNP_FC):

National Income at factor cost which is also simply called national income means the sum of all incomes earned by resource suppliers for their contribution of land, labour, capital and entrepre­neurial ability which go into the year’s net production. In other words, national income (or national income at factor cost) shows how much it costs society in terms of economic resources to produce net output.

It is really the national income at factor cost for which we use the term National Income. The difference between national income (or national income at factor cost) and net national product (national income at market prices) arises from the fact that indirect taxes and subsidies cause market prices of output to be different from the factor incomes resulting from it.

Suppose for instance, a metre of mill cloth sold for Rs.200 includes Rs. 25 on account of the excise and the sales tax. In this case while the market price of the cloth is Rs. 200 a metre, the factors engaged in its production and distribution would receive Rs. 175 a metre. The value of cloth at factor cost would thus be equal to its value at market price less the indirect taxes on it.

On the other hand, a subsidy causes the market price to be less than the factor cost. Suppose handloom cloth is subsidised at the rate of Rs. 10 per metre and it sells at Rs. 90 per metre. Then while the consumer pays Rs. 90 per metre, the factors engaged in the production and distribution of such cloth will receivers. 100 per metre (Rs. 90 + 10 = Rs.100).

The value of handloom cloth at factor cost would thus be equal to its market price plus the subsidies paid on it. It follows, therefore, that the national income (or national income at factor cost) is equal to net national product minus indirect taxes plus subsidies.

Net of indirect taxes and subsidies is called Net Indirect Taxes. Therefore,

National Income = Net National Product – Net Indirect Taxes

5. Personal Income (PI):

Personal Income is the sum of all incomes actually received by all individuals or households during a given year. National income, that is, total incomes earned and personal income, that is, total incomes received must be different because some incomes which are earned such as social security contributions, corporate income taxes and undistributed corporate profits are not actually received by households, and conversely, some incomes which are received like transfer payments are not currently earned (examples of transfer payments are old-age pensions, unemployment compensation, relief payments, interest payments on the public debt, etc.).

Obviously, in moving from national income as an indicator of income earned to personal income as an indicator of income actually received, we must subtract from national income those three types of income which are earned but not received and add those incomes which are received but currently not earned. Therefore,

Personal Income = National Income — Social Security Contributions — Corporate Income Taxes —Undistributed Corporate Profits + Transfer Payments.

6. Personal Disposable Income (PDI):

Even whole of the incomes which are actually received by the people are not available to them for consumption. This is because governments levy some personal taxes such as income tax, per­sonal property taxes. Therefore, after a part of personal income is paid to government in the form of personal taxes like income tax, personal property taxes, etc., what remains of personal income is called disposable income. Therefore,

Personal Disposable Income = Personal Income – Personal Taxes.

Personal Disposable Income can either be either consumed or saved. Hence,

Personal Disposable Income = Consumption + Saving.

How do we get personal income and disposable income from national income is illustrated in Figure 6.6.