National Income and Its

determination
National Income:

National income is the aggregate money value of all incomes earned by

individuals and enterprises.
 National income may also be defined as the money measure of the net
aggregates of all commodities and services accruing to the inhabitants of an
economy during a year
The concept national income has different meanings. It may be described as the
‘national product’ or ‘national income’ or ‘national dividend’.
National Income Accounts:
National income accounting is a bookkeeping method used by governments to track
the level of economic activity in their country through time.
Economic growth of any country is measured by its growth of national and per capita
incomes.
 In other words, national income is the yardstick of measuring the growth performance of any
economy.
The method through which national income statistics is prepared and compiled is
called national income accounting.
In national income accounts, all types of transactions conducted, say, in a year, are
recorded.
National income data help in measuring changes in the standard of living over time.
Level of development is also measured by using national income figures. Such figures
are also of importance for making international comparisons.
National Income Aggregates: Gross National Product
 Gross national product (GNP) is defined as the total value of all the final goods
and services produced in a country in a particular year, plus the income which is
earned by its citizens who are located abroad minus the income of nonresidents
located within that country.
GNP is a measure of the value of goods and services that the nationals or
residents of the country produce regardless of where they are located.
 It is, thus, the total income of a nation as earned by the citizens of a nation.
Contd.

Gross National Product:

GDP, GNP are both metrics used to measure country’s economic
output.
GNP unlike GDP measures the value of goods and services
produced by a country’s citizens domestically and abroad.
GNP is not territory specific but citizen specific.
US abandoned the use of GNP in 1991, adopting GDP as its
measure to compare itself with other economies.
Source: Investopedia.
Contd.

Examples:
Indian Reporter placed in Iraq sends his income back to India to be included
in India’s GNP
German investor who transfers her profits earned in India back to Germany –
Excluded from India’s GNP.
Indian based airline ‘Vistara’ generates revenue from its overseas operations
should be included in India’s GNP.
Gross Domestic Product (GDP)
Gross domestic product (GDP) is defined as the total value of all the final
goods and services produced by all the enterprises (both resident and non-
resident) within the domestic territory of a country in a particular year.
 The GDP, one of the most essential macroeconomic variables, can be said to
measure both a nation’ total income and its total output of goods and services.
 It is believed to be one of the best indicators of judging an economy’
performance.
In calculating the GDP,
(1) only market prices are used as they reveal the willingness of the public to pay
for a good or a service;
(2) only the value of currently produced goods and services are included.
Contd.

Measuring the Size of the Economy: Gross Domestic Product (GDP).

What is the size of Indian Economy?
 The size of a nation’s overall economy is typically measured by its
gross domestic product (GDP)
The measurement of GDP involves counting up the production of
millions of different goods and services and summing them into a
total rupee value.
Contd.

 For the gross domestic product:

“gross” means Total value of final goods and services produced. (GDP measures
production regardless of the various uses to which the product can be put).
“Domestic” means that the measurement of GDP contains only products from
within its borders.
Contd.
Treatment of Inventories in the GDP:
 In general when a firm adds to its inventories of goods, it involves expenditure by the firms.
 Hence like production for the final sale of the product, the accumulation of inventories also
increases the GDP.
 Treatment of Intermediate Goods in the GDP:
Production involves many stages: raw materials, intermediate goods and then the
finished goods.
It is important to note that only the values of the final goods are included in the GDP.
The values of the intermediate goods are already a part of the market price of the final
goods in the production of which they are used.
This avoids duplication/double counting.
Contd.

 Imputations in the GDP:

Imputed values have to be used in the GDP calculations for goods, which are not sold in the
market.
For example, for people living on their own for durable goods which are owned by
households, meals which are cooked at home, etc.
Nominal and Real GDP:
Nominal GDP is the total of the value of the goods and services calculated at
current prices. (Not adjusted for inflation).
 It is calculated by using the prices that are current in the year in which the
output is produced.
 A nominal value is expressed in monetary terms.
 For example, a nominal value can change due to shifts in quantity and price.
Contd.

 Real GDP is the total value of the final goods and services calculated at
constant prices.(adjusted for inflation)
 It is calculated using the prices of a selected base year.
 Real value is not influenced by changes in price, it is only impacted by
changes in quantity.
Base year in India: 2011-12
Contd.
Measurement of Real GDP:
Real GDP can be calculated in following two ways:
(1) by using base year prices;
(2) by using chain weighted measures
 GDP and the Other Measures of Income:
From the GDP, we can arrive at the other measures of income in the national income accounts.
 Gross National Product (GNP):

GNP =GDP +factor payments from abroad - factor payments to abroad

Contd.

Net National Product (NNP):

NNP = GNP – depreciation
 National Income (NI)
NI = NNP - Indirect business taxes
 Depreciation = quantity of the economy’ stock of plants and equipment that
wears out during the period of a year.
 Indirect business taxes= like sales tax and value added taxes account for the
difference between the price received by the firms and the price paid by the
consumers for a good.
Contd.

Personal income is the income received by the households and the non-
corporate businesses.
It includes income from all sources.
 Personal Income = National Income (NI) - (Corporate Profits + Social Security
Contributions+Net Interest) + (Dividends +Transfers from Government to
individuals + Personal Interest Income)
Contd.
We can arrive at the personal income from the national income by making some
adjustments in the following sectors:
(1) Corporate sector:
(a) Deduction to be made from the national income of undistributed corporate
profits (or retained earnings) and the corporate taxes paid to the state.
(b) Addition to be made to the national income of dividends.
(2 ) Government sector:
(a) Deduction of the contributions to social insurance.
(b) Addition to be made of the net amount the government pays as transfer
payments to the individuals.
Contd.

(3) Household sector:

(a) Deduction of net interest payable on loans
(b) Addition to be made of the personal interest income.
Contd.

 Disposable Personal Income:

Disposable personal income or personal disposable income is the amount,
which is actually available to the households and to the non-corporate businesses
after they have fulfilled their tax obligations to the government.
It is the income available to the households for saving and consumption.
Disposable Personal Income= Personal Income - Personal Tax and Non-tax
Payments
Contd.
What is counted in GDP?
Final goods and services
Raw materials that have been produced, but not yet been used in the
production of intermediate or final goods.
 What is not included in GDP?
Intermediate goods that have been turned into final goods and services
(e.g. tires on a new truck)
Sales of second hand goods
Transfer payments
Illegal goods
GDP Deflator:
The GDP deflator or the implicit price deflator is the ratio of the nominal GDP to the real GDP.
GDP Deflator= nominal GDP/real GDP*100.
This deflator deflates (or in other words takes out inflation from) the nominal GDP to give the
real GDP.
Hence, it reflects as to what is really happening to the general price level in an economy.
Contd.

The GDP price deflator measures the changes in prices for all of the
goods and services produced in an economy.
The GDP price deflator is a more comprehensive inflation measure
than the CPI index because it isn't based on a fixed basket of goods.
 The GDP deflator is a measure of inflation.
It is the ratio of the value of goods and services an economy produces in a
particular year at current prices to that of prices that prevailed during the base
year.
This ratio helps show the extent to which the increase in gross domestic
product has happened on account of higher prices rather than increase in
output.
GDP at Market Price and Factor Cost
GDP at Market Price:
GDPMP = GDPFC + Indirect Taxes- Subsidies
 GDP at Factor Cost:
GDPFC = GDPMP -Indirect Taxes+ Subsidies
Gross Value Added (GVA):
GVA at basic prices =GVA at factor cost + (Production taxes less production
subsidies)
GDP at market prices = GVA at basic prices + Product taxes – Product subsidies
Basic price = Factor cost + Production taxes – Production subsidy
Contd.

GVA at market prices =GVA at basic prices + Net product taxes

Net product taxes=Product taxes-product subsidies
GVA at Market prices=GDP at market prices
Market Price=Basic Price + Product Taxes –Product Subsidy
Production Taxes and subsidies: Production taxes and subsidies are paid or
received in relation to production and are independent of the volume of
production such as land revenues, stamp and registration fee.
 Product taxes and subsidies: Product taxes and subsidies are paid or received
per unit or product, e.g., excise tax, service tax, export and import duties etc.
Contd.

Most of the international agencies including IMF report GDP at Market Prices.
This led to confusion between calculations made by India (done at FC) and
International agencies(done at MP)
India started the calculations at MP from 2015
Source:
https://www.wsj.com/articles/india-changes-gdp-calculation-method-142262
2762
IMPUTATIONS IN GDP
Imputed value is an assumed value given to an item when the actual value is
not known or available.
Gross domestic product (GDP) is a comprehensive measure of the nation’s
production.
In order to be comprehensive, it must include some goods and services that
are not traded in the market place.
Those components of the GDP are called imputations.
Examples include the services of owner-occupied housing, financial services
provided without charge, and the treatment of employer-provided health
insurance.
Treatment of certain transactions in
GDP

1)Sale of second hand goods –

should not be included
2)Changes in inventory-
should be included. Increase in inventories involves expenditures by firms.
Accumulation of inventories increases the GDP.
3)Owner occupied dwellings-
should be Included. The largest imputation in the GDP accounts. Done so that the
treatment of owner-occupied housing in the GDP is comparable to that of
tenant-occupied housing.
Contd.

4)Services of homemaker/housewives-
should ideally be included. But is not accounted for.
“If you hire a caretaker and pay her salary, the GDP will go up. But if the same
work is done by woman in the family without any payment then the GDP will
go down.”
5)Services of consumer durables-
should be included. Imputed values are used for the durable goods which are
owned by households.
National Income Accounting Identity:

 Y=C +I+ G +NX

Y= Agggerate(total)demand for domestic output.
C=consumption spending by households
I=Investment spending by businesses and households
G=government (federal, state, and local) purchases of goods and services
NX=foreign demand for our net exports (NX).
 A simple economy without government and foreign trade
Y=C+I
Relationship between Consumption (C), Saving(S) and GDP (Output)
Y=S+C where S=Private sector savings
Contd.

 The whole of income (Y) is allocated to either consumption or saving.

 C + I =Y= C + S
The left-hand side of identity shows the components of demand, and the right-
hand side shows the allocation of income.
The identity emphasizes that output produced is equal to output sold.
 The value of output produced is equal to income received, and income
received, in turn, is spent on goods or saved.
Subtracting consumption from each part of identity , we have
I =Y-C =S where investment is identically equal to saving.
Measurement of National Income:
Many measures are used to estimate the aggregate economic activity in a
country, mainly GDP, GNP and NNP.
 Among these, GDP is perhaps one of the most important macroeconomic
variables and one of the best measures to judge an economy’ performance.
 Three approaches to calculating the GDP are:
The output approach (product method or the value added method)
The income approach and
The expenditure approach
Contd.

Theoretically, the three approaches must yield the same result because the
total expenditures on goods and services (GNE) must be equal to the total
income paid out to the producers (GNI), and that in turn must also be equal to
the total value of the output of goods and services (GNP).
Contd.

1. Output Approach:
It is also called the product method or the value added method.
To estimate the GDP by this approach, the total value of all the final goods and
services produced in an economy during a given time period are estimated.
 Value Added or Value Addition = Value of Output - Intermediate Consumption
What is Intermediate Consumption?
All inputs other than factor inputs of land, labor, capital and entrepreneurship. Basically
all raw materials.
 What is a Value of output?
It refers to the market value of goods and services produced by a firm during an
accounting year (Price*quantity).
Contd.
If the entire output of the year is sold during the year, value of output = Sales
If some output remains unsold during the year then,
Value of Output = Sales + Change in Stock

 Gross Value Added by all the producing enterprises within the domestic territory of the
country (Primary sector + Secondary sector + Tertiary sector).
= Gross Domestic Product at market price (GDPmp)
(-) Depreciation
= Net Domestic Product at market price (NDPmp)
(-) Net Indirect Taxes
= Net Domestic Product at factor cost (NDPfc)
(+) Net Factor Income from Abroad
= National Income (NNPfc)
Contd.

Why is National income at factor cost and not market price?

Indirect Taxes and Subsidies are kind of transfer payments and not factor
payments, and these are made by the govt and not by the factors of production.
So Market Price does not show the actual contribution of the factors of
production in the value of goods and services produced.
But when income is determined as sum of factor payments made, it exactly
shows the actual contribution by different factors in production of goods and
services, and hence presents a more fair picture of actual productive activities in
the economy.
Contd.

Example:
Country A and B produced goods of factor cost $100.
Suppose Net Indirect Taxes (tax-subsidies) in country A is $20 and in country B
is $5.
NNP mp of A is $120 and of B is $105.
But actual production was same $100.
Hence it is not fair to compare National Income at MP because the difference is
just caused by taxes and subsidies, and not actual production.
Contd.

The output approach: It is also called the product method or the value added
method.
 To estimate the GDP by this approach, the total value of all the final goods and
services produced in an economy during a given time period are estimated.
 The stages involved are: (a) Estimation of gross value of the domestic product:
Firstly, this involves a classification of the production enterprises according to
their activities.
The three sectors here are the primary sector that relates to agriculture and
allied activities, secondary sector(manufacturing sector) that includes all units
engaged in producing material goods and tertiary sector (services sector) that
includes all the units engaged in producing services like banking and transport.
Contd.

 Secondly, the gross value or the value of the output is estimated from all the sectors
in two ways:
(i) By multiplying the output of each sector with the respective price and then summing
them up.
(ii) By adding up the sales and change in stocks.
b. Estimation of the intermediate cost of production and depreciation: While
intermediate costs are estimated by including expenditure on non-factor inputs like raw
materials, electricity and fuel used in the production process, depreciation may be
estimated as a percentage of output or as a percentage of capital.
Deduction of the intermediate cost of production and depreciation from the gross
value to arrive at the net value of the domestic product.
Contd.

2. The income approach: It is also called the factor income method or factor share
method.
 To estimate the GDP by this approach, the total sum of the factor payments
received during a given period is estimated.
 National income is measured in terms of factor payment (wages. rent, interest and
profit) to the owners of factors of production during an accounting year.
However, in the estimation of national income, only those household are
considered who are residents of the country.
National income is estimated as the sum total of the factor income earned by the
residents of the country during an accounting year.
Net factor income from abroad is added to domestic to final national income.
Contd.
Depending on the way the income is earned, it can be classified into five
components:
 (a) Employee’ compensation: the wages, salaries, and the fringe benefits
received by the workers. (Fringe benefits are benefits in addition to an employee's
wages: pension plans, profit-sharing programs, vacation pay, and company-paid life,
health, and unemployment insurance programs)
 (b) Proprietor’ income: includes the incomes of non-corporate businesses
including small firms.
 (c) Rental income: which includes all the rental income earned by the owners
of properties including the imputed rent on the houses which are self owned.
 (d) Corporate profits: which include the incomes of corporations after having
made payments to the workers, creditors and others.
Contd.

(e) Net interest: which includes the interest paid by the domestic business to
households after deducting the interest received and also interest earned from
abroad.
All the different categories of income are added together to obtain the GDP
from the income method.
Contd.
It must be noted that factor incomes are only 'earned' incomes.
 It does not include any income which is not earned or for which a factoring
service has not been rendered.
To illustrate, old age pension received by the senior citizens is not their
earned income. It is just a help by the government without anything in return.
Such receipts or payments are called transfer receipts or transfer payments.
These are not included in the estimation of national income.
Measurement of National Income using Income
Method
(+) Compensation of Employees
(+) Proprietor’s income
(+) Rental income
(+) Corporate profits
(+) Net interest
= Net Domestic Income
(+) Net Factor Income from Abroad
= National Income (NNPfc)
 Contd.

The expenditure approach:

The GDP can be classified into following four components of expenditure:
 Private Consumption Expenditure (C): It includes goods and services, which are
purchased by households.
These can be further grouped into three categories:
 (i) Non-durable goods: goods, which last only for a short period like food and clothing.
 (ii) Durable goods: goods, which last for a long period like cars and electronic goods.
(iii) Services: include the work performed or services provided by firms, individuals and
others for the benefit of the consumers like banking, accounting and auditing services.
Contd.

Investment Expenditure: It consists of goods and services bought for use in the
future.
It can be further grouped into three categories:
(i) Business fixed investment: the purchase of new plant and equipment by
firms.
(ii) Residential investment: the purchase of new housing by households and
others.
(iii) Inventory investment: the change in the inventory of goods of the firm.
This change can be positive or negative depending on whether the inventories
increase or decrease.
Contd.

Government Purchases:
They include the goods and services bought by the different governments like
defense equipment.
 It is to be noted that transfer payments to the individuals like social security
payments are not included in the GDP as they are not the payments for any
goods and services.
Net Exports: They are the values of goods and services exported to other
countries minus the value of goods and services imported into the country.
(X-M).
A sum of all these different expenditures will give the GDP by the expenditure
method.
Measurement of National Income using Expenditure Method.
(+) Private Final Consumption Expenditure (C)
(+) Government Final Consumption Expenditure (G)
(+) Gross Fixed Capital Formation (I)
(+) Change in stock or Inventory Investment
(+) Net Exports (exports-imports) (X-M)
= Gross Domestic Product at market price (GDP mp)
(-) Depreciation
= Net Domestic Product at market price
(-) Net Indirect Taxes
= Net Domestic Product at factor cost (NDPfc)
(+) Net Factor Income from Abroad
= National Income (NNP fc)
Contd.

It is important to understand that all the three methods discussed above yield
the GDP at market price or the GDP for a closed economy.
To arrive at the GDP for an open economy, we need to add to it the net factor
incomes earned from abroad.
Hence we will now obtain what is called the Gross National Income, GNI.
 As already mentioned, theoretically, the three approaches must yield the
same result. However, in practice there exist minor differences in results
obtained from the various methods for several reasons; some of them are:
Contd.

1) Changes in inventory levels and errors in the statistics. This occurs because
the goods, which are in inventory have been produced (and are therefore
included in GNP), but they are not yet sold (and are therefore not yet included in
GNE).
 (2) Issues relating to timing can cause a slight difference between the value of
goods produced (GNP) and the payments to the factors involved in the
production of the goods.
This is particularly so if the inputs are bought on credit, and also because the
wages are often collected after the production period.
National Income Identities:
Gross Domestic Product at Market Prices(GDPMP):
GDPmp=C + I +G+ (X-M)
 GDP at Factor Cost(GDPfc):
GDPfc=GDPmp-Net Indirect Taxes
 Net Domestic Product at Market Prices(NDPmp)
NDPmp=GDPmp-Depreciation
 NDP at Factor Cost(NDPfc):
NDPfc = NDPmp- Net Product Taxes - Net Production Taxes
 Gross National Product at Market Prices (GNPmp):
GNPmp = GDPmp + NFIA (Net factor income from abroad)
Contd.

GNP at Factor Cost (GNPfc):

GNPfc =GNPmp- Net Product Taxes - Net Production Taxes
 Net National Product at Market Prices (NNPmp):
NNPmp = GNPmp-Depreciation
NNPmp=NDPmp+NFIA
 NNP at Factor Cost(NNPfc) OR National Income (NI):

NI=NNPmp-Net Product Taxes - Net ProductionTaxes

=NDPfc+NFIA= NNPfc
Contd.

GVA at Market Prices= GDP at market prices

GVA at basic prices= GVAmp - Net Product Taxes
GVA at factor cost= GVA at basic prices - Net Production Taxes