Concepts and measurement of

National Income
 Definition of National Income
• Inventor of National Income: Nobel laureate Simon
Kuznets is considered as the inventor of national income.
• Definition of National Income: National income can be
defined as the aggregate money value of the annual flow
of final goods and services in the national economy.
• The definition of national income links income with
production or economic activity in the economy. Thus,
from the national point of view what is important is the
income earned by the nationals of a country by
undertaking productive services.
 Contd..
• In other words, corresponding to the factor incomes there
is the counterpart production of goods and services which
represents the manifold economic activities undertaken
on part of input owners or factors of production
• However, if an individual has received income in form of
gifts or transfer receipts from other individuals, business
firms and government no doubt is regarded as income of
that individual, but will not form a part of national income
because there has been no corresponding economic
activity reflected in the production of goods and services
against such money receipts in economy.
 Contd..
• Unless the transfer of money also involves the
exchange of the productive services, it will not
be counted as income from the
macroeconomic point of view.
• National income is actually the aggregate of
individuals’ income excluding the transfer
receipts or payments.
 Contd..
• Why transfer payments and capital gains are
excluded in the national income? - The logic
behind not including the transfer payments in
the national income is that these receipts do
not involve any economic activities embodying
the production of goods and services in the
economy although these are a part of the
income of the personal or household sector.
 Contd..
• Also excluded from the national income are
the capital gains (or losses) made by the
individual or institutional asset-holders
because such capital gains (or losses) do not
represent any productive activity in the
economy.
 Contd..
• So national income is the aggregate of the i)
wages and salaries (without deducting taxes)
ii) net income received from rents and
royalties iii) income received from interest iv)
profits whether earned by corporate or non-
corporate sector before deducting income tax.
 Importance of National Income
• How important is the knowledge about
national income? – Knowledge of national
income and its movements over the time is of
significance to an economy as its serves the
purpose of economic planning
• The sales of any business organisation depends
on the national income as it provides a
measure of nation’s ability to buy goods and
services
 National Income concepts
• GNP – Gross National Product
• NNP – Net National Product
• GDP – Gross Domestic Product
• NDP – Net Domestic Product
• Private Income
• Personal Income
• Personal Disposable Income
Of these it is NNP at factor cost or NNP F that is
globally referred to as the national income
 Contd…
• Gross National Product: The GNP stands for the
monetary value of all goods and services that are
a) currently produced
b) sold through official market
c) not resold
d) produced by nationally owned resources
(factors of production)
 Contd..
• GNP is expressed in terms of money (rupees
in India) because the goods and services differ
in the units of measurement (tonnes of wheat,
metres of cloth, number of haircuts). The
quantities of various goods are multiplied by
their respective prices and then the various
money magnitudes are added to give GNP.
 Contd..
• GNP accounts only for goods and services that
are traded through the official market. For
e.g., any household work including
babysitting, whitewashing of own house,
tutoring of own children, and such activities
are excluded, while payments to maid-
servants, washerman, paid babysitters, private
tutions and so are included in the GNP.
 Contd…
• Moreover, unreported transactions triggered
by the desire to avoid excise duties are not
included in GNP (giving rise to
parallel/underground economy)
 Contd..
• Raw materials and intermediate goods and
services (i.e., goods and services resold or used
for further production during measurement
period) are not included in the GNP so as to
avoid double counting of production. Thus,
wheat used in making bread, leather used in
making shoes and tyres used in making cars are
excluded because these are contained in the
values of bread, shoes and cars respectively.
 Contd..
• To avoid double counting, the value added at
each stage of production can be taken into
account.
• Value added equals market value of the
product minus the cost of inputs purchased
from other firms and used in the production of
the said product.
 Contd..
• For e.g., if wheat used in the production of a
loaf of bread is valued at Rs. 2, wheat flour
produced by the miller is valued at Rs. 2.25,
bread sold by the baker to the vendour is
valued at Rs. 3 and that purchased by the
household costs Rs. 3.50, then the GNP due to
this production is Rs. 3.50 and not the sum
total of values of wheat, flour and bread.
 Contd..
• If this value added concept is used, then the
farmer produces Rs. 2 worth of GNP, the miller
25 paise, the baker 75 paise and the vendor 50
paise worth of GNP. Therefore only the value
of the final goods (goods that are produced
and sold for consumption) are included in the
GNP.
 Contd..
• The GNP belongs to the nation and thus it
must be produced by its owned factors of
production only.
• GNP = Market value of domestically produced
goods and services + incomes earned by the
residents of a country in foreign countries –
minus incomes earned by the foreigners in the
country
 Contd..
• Gross Domestic Product: The GDP refers to the
value of the goods and services produced
within the nation’s geographical territory,
irrespective of the ownership of the resources.
• While GNP consists of income produced by the
nation’s owned resources irrespective of the
place of production, GDP refers to income
produced within the nation’s territory,
irrespective of the ownership of the resources
 Contd..
• GDP = Market value of goods and services
produced by the residents in the country +
incomes earned in the country by foreigners –
incomes received by the residents of a country
from abroad.
 Contd..
• Net National Product: Net National Product
(NNP) is also referred to as national income.
NNP is obtained by subtracting depreciation
(consumed part of fixed capital or capital
consumption) from GNP.
• NNP = GNP - Depreciation
• If NNP (or national income) is divided by the
population of the country then we get the per
capita income.
 Contd..
• Personal Income: Personal income (PI) can be
defined as the sum of all kinds of incomes received
by the individuals from all sources of incomes.
• Personal incomes includes wages and salaries, fees
and commission, bonus, fringe benefits, dividends,
interest earnings and earnings from self-
employment. It also includes transfer payments like
pensions, family allowances, unemployment
allowances, sickness allowances, old age benefits
and social security benefits.
 Contd..
• Disposable income: Disposable income is
derived from personal income by deducing
from personal income tax. The residue left is
the disposable income because it represents
the total amount of income which is available
for disposal by the person concerned.
 Market Prices and Factor Costs
• The valuation of national income at market
prices indicates the total amount paid by the
final buyers.
• The valuation of national income at factor
cost is a measure of the total amount earned
by the factors of production for their
contribution to the final output.
 Contd..
• GDP (FC) = GDP (MP) – Indirect cost+Subsidies
(or)
GDP (FC) = GDP (MP) – taxes on products +
subsidies on products
 Contd..
• If the economic survey says that economy has
grown by 8.6% in this year, what does it
indicate? Is it GDP at market price or GDP at
factor cost?
 Contd..
• The answer is GDP at factor cost.
 Contd..
• Approaches to measurement of National
Income:
Basically there are three ways of looking at
the circular flow of income. It arises out of
process of activity-chain in which production
creates income, income generates spending
and spending in turn induces production.
 Contd..
• There are three different ways in which we
can measure size of circular flow. We can
measure it either at the production stage by
measuring the value of output; or at the
income accrual stage by measuring the
amount of factor income earned; or at the
expenditure stage by measuring the size of
total expenditure incurred in the economy.
 Contd..
• These alternative ways of looking at the flow
of income are known as the Product
Approach, the Income Approach and the
Expenditure Approach to the measurement o
national income.
 Contd..
• The final output in a modern economy
consists of a large number of goods such as
apples, bread, shirts, pens, chairs, etc., and
services such as medical, legal, educational,
etc. Let us denote the amounts of each of the
different types of final outputs in a given year
as Q1, Q2, Q3……….Qn and their respective
market prices as P1, P2, P3……….Pn, where n
stands for the total number of final goods and
services produced in the economy. Then
according to the product approach the size of
national income (NI) will be equal to the sum
of annual flow of final goods and services at
their respective market prices,
NI = P1Q1 + P2Q2+……..PNQN
 Contd..
• Income Approach: National income can be
measured by aggregating the annual flows of
factor earnings generated by the production
of final output. For instance, the value of the
output of say, good I (PiQi) is also reflected in
the sum of corresponding factor incomes
generated,
PiQi = Ri + Wi, Ii + Pi
 Contd…
where Ri, Wi, Ii and Pi denote respectively the
flow of rent, wages, interest and profits
generated by production of good i. Therefore
NI = Ri + Wi + Ii + Pi
 Contd..
• Expenditure Approach:
National income can be measured by
aggregating the flow of total expenditures on the
final goods and services in the economy.
NI = Eh + Eb +Eg
where Eh, Eb, and Eg denote the annual flow of
expenditure on final goods and services
incurred by the household sector, business sector
and government sector respectively.
 Contd..
• These three approaches to the measurement
of national income yield identical results. If
we follow income approach we are actually
trying to measure the flow in lower half of the
circle. However, the size of the flow of upper
half will be exactly the same as that in the
lower half on account of the way profit is
defined while computing total factor incomes.
 Contd…
• Profit which is treated as a separate category
of factor incomes in income approach is
defined as amount that is left from total sales
after paying the other factor incomes, viz.,
rent, wages and interest. According to this
definition, total profit for the economy as a
whole will be equal to national income minus
sum of total rent, wages and interest.
 Contd..
• Some problems in national income accounting
On a number of points, the national income
accountant is faced with ambiguous,
borderline areas, where he has to take
decisions regarding inclusion, exclusion, or
valuation as the case may be.
 Major issues involved in national income
accounting
• Demarcation of productive activity
The distinction between productive and non-
productive activities is crucial to the basic
concepts of national income accounting. A
productive activity in its broadest sense, can
be defined as one which involves use of scarce
resources in provision of goods and services to
satisfy human wants.
 Contd..
The most obvious and controversial e.g. that can be
cited in this connection is that of services by
housewives.
ii) Distinction between final and intermediate
products:
Only final goods and services should be included
in the national income accounting.
 Contd..
• The Underground Economy

The underground economy consists of illegal and

uncleared transactions where the goods and
services are themselves illegal such as drugs,
gambling, smuggling, and prostitution. Since, these
incomes are not included in the national income,
the national income seems to be less than the
actual amount as they are not included in the
accounting.
 Contd…
• Petty Production

There are large numbers of petty producers

and it is difficult to include their production
in national income because they do not
maintain any account.
 Contd..
• Public Services 

Another problem is whether the public

services like general administration, police,
army services, should be included in national
income or not. It is very difficult to evaluate
such services.
 Contd..
• Transfer Payments 

Individual get pension, unemployment

allowance and interest on public loans, but
these payments creates difficulty in
the measurement of national income.
These earnings are a part of individual income
and they are also a part of government
expenditures.
 Contd..
• Capital Gains or Loss

When the market prices of capital assets

change the owners make capital gains or loss
such gains or losses are not included
in national income.
 Contd..
• Price Changes

National income is the money value of goods and

services. Money value depends on market price,
which often changes. The problem of changing
prices is one of the major problems of national
income accounting. Due to price rises the value
of national income for particular year appends to
increase even when the production is decreasing.
 Contd..
• Wages and Salaries paid in Kind 

Additional payments made in kind may not be

included in national income. But, the facilities
given in kind are calculated as the
supplements of wages and salaries on the
income side.
 Contd..
• The main problem is whether to include the
income generated within the country or even
generated abroad in national income and
which method should be used in
the measurement of national income.
 Contd..
• Environmental damage
• When second hand goods are sold the value
of the product is double counted.
• When it comes to expenditure method,
defense expenses could lead to higher
government expenditure if there is a war in
the country misleading user by giving a high
national income figure.
 Double counting
• Double counting is an error caused as a result of
illogical calculation. This term is used in economics
to refer to the faulty practice of counting the value
of a nation's goods more than once. Since goods
are produced in stages, through specialized
channels of production, many intermediate goods
are used to produce a final good
 Cont..
• If the values of each of these intermediate
goods is added together, without subtracting
expenditures incurred during the production
process, the error of double counting will be
committed.
 Contd..
• By figuring in "value added," economists can
reasonably assess the final value of goods
produced by a nation. Value added figures the
value of a nation's final products, subtracting
costs that were incurred to produce these
products. Ultimately, value added can serve to
correct the mistake of double counting.
 Contd..
• The final sales for a single firm is not a good
measure of its output. Total sales is a better
measure of output for a single firm but even
the total sales of a firm may not accurately
reflect its contribution to the economy.
 Contd..
• For example, two calculator firms may have
the same sales but one might merely
assemble components purchased from other
firms or as imports.
• The other firm might manufacture all of the
components for its calculators. Clearly, the
second firm is contributing more production
to the economy. 
 Contd..
• The concept of VALUE ADDED provides a
better way of quantifying a firm's
contribution to the production of an
economy.
• VALUE ADDED is defined as the total sales of
a firm less its purchases from other firms or
imports. 
 Contd..
Industry Total sales Purchases from Value added
industries &
imports
Steel 150 30 120
Vehicles 160 60 100
Agriulture 100 50 50
 Contd..
• The TOTAL VALUE ADDED by all industries is
120+100+50=270, which is the same figure as
GROSS DOMESTIC PRODUCT. Again this is not
a coincidence. The total sales of an industry
is the same as its total payments.
 Methodology of estimation
• For the purpose of estimating national income
in India, the various economic activities are
classified into the following broad sectors:
i) Agriculture including animal husbandry
ii) Forestry and logging
iii) Fishing
iv) Mining and quarrying
 Contd..
v) Manufacturing:
Registered manufacturing
Unregistered manufacturing
vi) Construction
vii) Electricity, gas and water supply
viii) Tranport, storage and communication
ix) Trade, hotels and restaurants
 Contd..
x) Banking and insurance
xi) Real estate and business services
xii) Public administration and defence
xiii) Other services
 Contd…
• Depending upon the nature and extent of data
available for each of these sectors, various
estimation procedures are adopted for
different sectors. On the basis of the nature of
basic statistical data and the related source
material available for the estimation of
national income, these sectors are classified
into three broad categories.
 Contd..
• The first category will consist of six sectors which
include first six items (except unregistered
manufacturing. For each of these sectors the
basic data on output, input and prices are
available on a more or less regular basis.
• The second category consists of railways,
electricity generation and transmission,
communication, organised banking and insurance
 Contd…
real estate and public administration and
defence. Fairly comprehensive data on all
types of factor incomes are readily available
from the published annual accounts of the
undertakings in each of these sectors.
 Contd..
• The third category includes the remaining
sectors for which no satisfactory data is
available either on output and input or on
different types of factor incomes.
Unregistered manufacturing, trade, hotels,
and restaurants and other services are the
major sectors that fall under this category.
 Contd..
• Generally for measuring national income, the
product approach can be directly followed
only in the case of commodity-producing
sectors while the income approach is the only
available alternative that can be followed in
case of various types of services for which
output cannot be directly measured.
 Contd..
• Thus it is obvious that in the case of the Indian
economy, the product approach can be
followed only for the six sectors falling under
the first category while the income approach
has to be followed for deriving estimates for
the sectors falling under the remaining two
categories.