National Income

National income is the sum total of wages, rent, interest, and profit
earned by the factors of production of a country in a year. Thus it is
the aggregate values of goods and services rendered during a given
period counted without duplication.

National income or national product is defined as the total market

value of all the final goods and services produced in an economy in a
given period of time.
This suggests that the labour and capital of a country, working on the
natural resources produces certain net amount of goods and services,
the aggregates of which as known as national income or national
products.
ADDING VALUE

National output, income and expenditure, are generated when there is an exchange
involving a monetary transaction. However, for an individual economic transaction to be
included in aggregate national income it must involve the purchase of newly produced goods
or services. In other words, it must create a genuine addition to the ‘value’ of the scarce
resources. For example, a transaction that involves selling a second-hand good, and which
was new two years ago does not add to national income, though the original production and
purchase does. Transactions which do not add value are called transfers, and include second-
hand sales, gifts and welfare transfers paid by the government, such as disability allowance
and state pensions.

THE CREATION OF NATIONAL INCOME

The simplest way to think about national income is to consider what happens when one
product is manufactured and sold. Typically, goods are produced in a number of 'stages',
where raw materials are converted by firms at one stage, then sold to firms at the next
stage. Value is added at each, intermediate, stage, and, at the final stage, the product is
given a retail selling price. The retail price reflects the value added in terms of all the
resources used in all the previous stages of production.
FINAL OUTPUT

In accounting terms, only the value of final output is recorded. To avoid the problem of double
counting, only the value of the final stage, the retail price, is included, and not the value added
in all the intermediate stages - the costs of production, plus profits. In short, national income
is the value of all the final output of goods and services produced in one year.

Example
For example, consider the production of a motor car which has a retail price of £25,000. This
price includes £21,000 for all the costs of production (£6,000 for components, £10,000 for
assembly and £5,000 for marketing) plus £4,000 for profit. To avoid double-counting, the
national income accounts only record the value of the final stage, which in this case is the
selling price of £25,000.

When goods are bought second-hand, the transaction does not add new value and will not be
included in national output. If second-hand goods are included, double-counting will occur,
and this would falsely inflate the value of national income.

For example, if the car in question is sold in two year’s time for £15,000 it would provide the
owner with money, but the sale will not add to national income. If it were included in national
income, it would make the value of the car £35,000 - the initial £25,000 plus the second hand
value of £15,000. This is clearly not the case, so any future second-hand sales are not included
when valuing national income. Such second-hand transactions are called transfers.
 Definitions For GDP
at market price

GDP is equal to the total expenditures for all final goods and services produced
within the country in a year.

GDP is equal to the sum of the value added at every stage of production (the
intermediate stages) by all the industries within a country, plus taxes less
subsidies on products, in the period.
GDP is equal to the sum of the income generated by production in
the country in the period—that is, compensation of employees,
taxes on production and imports less subsidies, and gross operating
surplus (or profits).
 Calculating GDP
Commonly the Expenditure Method is used for measuring and
quantifying GDP

Formula:
GDP = C + I + G+(X-M)
OR
GDP = consumption + gross investment
+ government spending
+ (exports – imports)
 Components of GDP
 C : consumption Includes :: Personal expenditures mainly
consists of food, households, medical expenses, rent, etc. For example,
if you live in rental home then renovation spending would be measured
as Consumption.
I : investments by business or households in capital. Example, If you spend
money to renovate your hotel so that occupancy rates increase, that is private
investment. Includes: Construction of a new mine, Purchase of machinery or
equipment for factory, Purchase of software, Expenditure on new houses,
Buying goods and services.
Total government expenditures on final goods and services
Includes: Investment expenditure by the government. Purchase of weapons
for the military, Salaries of public servants. Example: if a government
agency is converting the hotel into an office for civil servants the renovation
spending would be measured as part of public sector spending (G).  
X:Gross Exports Includes :: All goods and services produced for overseas
consumption. Example, If a domestic producer is paid to make the software for a
foreign hotel, the payment would be counted in gross export. 
 

M:Gross imports Includes :: Any goods or services imported for

consumption Example, If the renovation of hotel involves the purchase of a
electronics from abroad, that spending would be counted in gross imports.  
Definition Gross National
at market price
Product
GNP is the total value of all final goods and services produced within a nation
in a particular year, plus income earned by its citizens (including income of
those located abroad), minus income of non-residents located in that country.

Basically, GNP measures the value of goods and services that the country's
citizens produced regardless of their location. GNP is one measure of the
economic condition of a country, under the assumption that a higher GNP
leads to a higher quality of living, all other things being equal.

GNP = GDP + NR (Net income inflow from assets abroad or Net Income
Receipts) - NP (Net payment outflow to foreign assets).
Net National Product
at market price

Net National product measures the net money value of final goods and
services at current prices produced in a year in a country. It is the gross
national product at market price less depreciation. In production of output
capital assets are constantly used up. This fixed capital consumption is
called depreciation. Depreciation constitutes loss of value of fixed
capital. Thus net national product is the net money value of final goods
and services produced in the course of a year. Net money value can be
arrived at by excluding depreciation allowance from total output.

[NNP = GNP - Depreciation + net balance from international

trade]
Net Domestic Product
at market price

Net domestic product accounts for capital that has been consumed over
the year in the form of housing, vehicle, or machinery deterioration. The
depreciation accounted for is often referred to as capital consumption
allowance and represents the amount needed in order to replace those
depreciated assets.

[NDP = GDP - Depreciation]

at factor cost
GDP @ FACTOR COST – GDP @mp – indirect taxes + subsidies

GNP @ FACTOR COST – GNP @mp – indirect taxes + subsidies

NDP @ FACTOR COST – NDP @mp – indirect taxes + subsidies

 National Income
National income is the sum total of wages, rent, interest, and profit
earned by the factors of production of a country in a year. Thus it is
the aggregate values of goods and services rendered during a given
period counted without duplication.

National income or national product is defined as the total market

value of all the final goods and services produced in an economy in a
given period of time.
This suggests that the labour and capital of a country, working on the
natural resources produces certain net amount of goods and services,
the aggregates of which as known as national income or national
products.
Net National Product at Factor Cost (NNP fc) or National Income:

NNP fc or national income is equal to the sum total of factor incomes

received by the factors of production during the year. It is equal to the
sum of rent, wages, interests and profits in a given year. The sum total
of incomes of the factors of production is known as national income or
net national product at factor cost. Thus, the national income is equal
to the NNP at mp minus revenue of the government by way of indirect
taxes plus subsidies provided by the government to the business
sector.

NNP fc = NNP mp – Indirect taxes + Subsidies

= GNP mp – depreciation – indirect taxes + subsidies
 In billions of dollars

Consumption 3600
Investment 800
Transfer payments 750
Government 1000
expenditures
Exports 650
Imports 450
Net foreign factor income -30

Calculate the GDP and GNP.

 In trillions of dollars

GDP 5.0
Government 1.0
purchases
Transfer payments 0.2
Exports 0.4
Imports 0.5
Net foreign factor 0.4
income
Investment 1.0

What is consumption in this economy?

Calculating national income
Any transaction which adds value involves three elements – expenditure by
purchasers, income received by sellers, and the value of the goods traded. For
example, if a student purchases a textbook for £30, spending = £30, income to the
bookseller = £30, and the value of the book = £30. All of the transactions in an
economy can be looked at in this way, giving us three ways to measure national
income.
There are three methods of calculating national income:
1.The income method, which adds up all incomes received by the factors of
production generated in the economy during a year. This includes wages from
employment and self-employment, profits to firms, interest to lenders of capital and
rents to owners of land.
2.The output method, which is the combined value of the new and final output
produced in all sectors of the economy, including manufacturing, financial services,
transport, leisure and agriculture.
3.The expenditure method, which adds up all spending in the economy by
households and firms on new and final goods and services by households and firms.
GNP – 525,725
Allowance - 563000
Depreciation - 45,305
Indirect business tax - 46,305
Subsidies – 3,218

Q. Calculate NNP and NI.

 Nominal GDP

Nominal GDP, is the value of all final output

produced in an economy during a given year,
calculated using the prices current in the year
which the output is produced.
 Keeping it Real

Comparing output over time is best done

with real output which is nominal output
adjusted for inflation.
Real GDP is the value of the final goods and
services produced calculated using the prices
of some base year.
 Nominal Vs. Real

Nominal GDP is GDP calculated at existing

prices.
Real GDP is nominal GDP adjusted for
inflation.
Real GDP is important to society because it
measures what is really produced.
Real vs. Nominal GDP
 Shortcomings of GDP as a Measure
of National Economic Well-being
Production that is excluded
Household production
Illegal production
The underground economy
Treatment of leisure time
Human cost and benefits
GDP gives us a ballpark idea of how much we produce, not
necessarily how well off we are.
 Why GDP is Important?
The gross domestic product (GDP) is one the primary
indicators used to gauge the health of a country's economy.
It represents the total dollar value of all goods and services
produced over a specific time period - you can think of it
as the size of the economy. Usually, GDP is expressed as a
comparison to the previous quarter or year. For example, if
the year-to-year GDP is up 3%, this is thought to mean that
the economy has grown by 3% over the last year.
Why GDP is Important?
As one can imagine, economic production and growth,
what GDP represents, has a large impact on nearly
everyone within that economy. For example, when the
economy is healthy, you will typically see low
unemployment and wage increases as businesses demand
labor to meet the growing economy.
 CONVERSIONS

+ Depreciation
NET GROSS
- Depreciation

+ Net Factor Income from Abroad

DOMESTIC NATIONAL
- Net Factor Income from Abroad

+ Net Indirect Taxes

FACTOR COST MARKET PRICE
- Net Indirect Taxes

Net Indirect Taxes = Indirect Taxes – Subsidies

Net Factor Income from Abroad = Factor Income from abroad – Factor Income To abroad
1. Value Added Method
Value added method is also named as Production method. This method is used to measure national
income at the phases of ‘production of each enterprise and each industrial sector during a year. In fact
this method measures the contribution of each enterprise in the flow of goods and services in the
economy.
We calculate money value of all final goods and services produced in an economy during a year. Final
goods here refer to those goods which are directly consumed and not used in further production process.
oods which are further used in production process are called intermediate goods. In the value of final
goods, value of intermediate goods is already included therefore we do not count value of intermediate
goods in national income otherwise there will be double counting of value of goods.
To avoid the problem of double counting we can use the value-addition method in which not the whole
value of a commodity but value-addition (i.e. value of final good value of intermediate good) at each
stage of production is calculated and these are summed up to arrive at GDP.
The value of output at each enterprise is found by multiplying the physical output with the market prices
of the goods produced. For example, firm A produces necessary raw material and sells it in market for
Rs. 2000 to firm B. The firm B manufactures raw material, into finished goods and sells it to firm C for
Rs. 4000. The firm C sells the finished goods to household for Rs. 5000/=. The value added at each
stage is Rs. 2000 + 2000 + 1000 = Rs. 5000. The total value added is Rs.5000.
Precautions for this approach 
There are certain precautions which are to be taken to avoid miscalculation of national
income using this method. These in brief are:
1 Problem of double counting: When we add up the value of output of various sectors,
we should be careful to avoid double counting. This pitfall can be avoided by either
counting the final value of the output or by including the extra value that each firm adds
to an item.
(ii)  Value addition in particular year: While calculating national income, the values
of goods added in the particular year in question are added up. The values which had
previously been added to the stocks of raw material and goods have to be ignored. GDP
thus includes only those goods and services that are newly produced within the current
period.
(iii)     Stock appreciation: Stock appreciation, if any, must be deducted from value
added. This is necessary as there is no real increase in output
(iv) Production for self consumption. The production of goods for self consumption
should be counted While measuring national income. In this method, the production of
goods for self consumption should be valued at the prevailing market prices.
ACCORDING TO VALUE ADDED METHOD

GDP@MP/ GVA @ MP = Value of Output – intermediate consumption

Net Value added (NVA) @ MP = GVA @MP – Depreciation

VALUE OF OUTPUT = SALES + CHANGE IN STOCK

CHANGE IN STOCK = ( CLOSING STOCK – OPENING STOCK)

+ Depreciation
NET GROSS
- Depreciation

+ Net Factor Income from Abroad

DOMESTIC NATIONAL
- Net Factor Income from Abroad

+ Indirect Taxes
FACTOR COST MARKET PRICE
- Indirect Taxes
Calculate Gross Value added at factor cost from the following data :

Sr. No. Items Rs. In Crore

1 Purchase of machinery 100
2 Sales 200
3 Intermediate Cost 90
4 Indirect taxes 12
5 Change in stock 10
6 Excise Duty 6
7 Stock of raw material 5

Sol: GVA FC = Sales + Change in Stock – Intermediate Cost – Indirect Taxes

= 200 + 10 – 90 – 12
= 108 Crore
Q. An Economy has two firms A & B on the basis of following information find
out
a) Value added by firm A & B
b) GDP at Market Price

Rs. In Lakh
1 Exports by firm A 20
2 Imports by firm A 50
3 Sales to house holds by firm A 90
4 Sales to firm B by firm A 40
5 Sales to firm A by firm B 30
6 Sale to house hold by firm B 60

Sol: a) Value added by firm A

= Sale to households +Sales to firm B + Exports – Imports – Purchase from firm B
= 90 +40+20-50-30 = 70 Lakh
Value added by firm B
= Sales to Firm A + Sales to households – purchase from firm A
= 30+60-40
= 50 Lakh

b) GDP@MP = Value added by firm A + value added by Firm B

= 70+50
= 120 Lakh
I. The Expenditure Method:
The expenditure approach measures national income as total spending on final goods and
services produced within nation during an year: The expenditure approach to measuring
national income is to add up all expenditures made for final goods and services at current
market prices by households, firms and government during a year. Total aggregate final
expenditure on final output thus is the sum of four broad categories of expenditures (i)
consumption (ii) Investment (iii) government and (iv) Net exports.
(i)    Consumption expenditure: Consumption expenditure is the largest component of
national income. It includes expenditure on all goods and services produced and sold to the
final consumer during the year.
(ii)  Investment expenditure: Investment is the use of today’s resources to expand
tomorrow’s production or consumption. Investment expenditure is expenditure incurred on
by business firms on(a) new plants, (b) adding to the stock of inventories and (c) on newly
constructed houses.
(iii)      Governnnent expenditure: (G) it is the second largest component of national income.
It includes all government expenditure on currently produced goods and services but
excludes transfer payments while computing national income.
(iv)     Net exports: Net exports are defined as total exports minus total imports.
National income calculated from the expenditure side is the sum of final consumption
expenditure, expenditure by business on plants, government spending and net exports.
NI = C + 1 +G + (X – M)
Precautions

While estimating national income through expenditure method, the following -

precautions should be taken.
(i) The expenditure on second hand goods should not be included as they do not
contribute to the current year’s production of goods.

(ii)  Similarly, expenditure on purchase of old shares and bonds is not included as these
also do not represent expenditure on currently produced goods and
services.

(iii) Expenditure on transfer payments by government such as unemployment benefit,

old age pensions, interest on public debt should also not be included because no
productive service is rendered in exchange by recipients of these
payments.
ACCORDING TO EXPENDITURE METHOD

Gross Domestic Product At Market Price = Private Final Consumption Expenditure +

Govt. Final Consumption Expenditure + Gross Domestic Capital Formation + Net Exports

Gross Domestic Capital Formation = Gross Domestic Fixed Formation + Change in Stock

Gross Domestic Capital Formation = Net domestic capital formation + Consumption of

fixed capital

Net Exports = Exports – Imports

NOTE - Consumption of fixed capital is same as depreciation.*

From the following data calculate GNP at factor cost by
Expenditure Method

Sr. No. Items Rs. in Crore

1 Net Domestic capital formation 500
2 Compensation of employees 1850
3 Consumption of fixed capital 100
4 Govt. Final consumption Expenditure 1100
5 Private Final consumption Expenditure 2600
6 Rent 400
7 Dividend 200
8 Interest 500
9 Net Exports (-) 100
10 Profits 1100
11 Net Factor Income From Abroad (-) 50
12 Net Indirect Taxes 250

GNP FC = Private Final consumption Expenditure + Govt. Final consumption Expenditure

+ ( Net Domestic capital formation + consumption of fixed capital) + Net Exports + Net
Factor Income From Abroad - Net Indirect Taxes

= 1100 +2600 + (500 +100) + (-) 100 + (-)50 – 250

= 3900 CRORE
From the following data calculate National Income by Expenditure methods:

(Rs crore)
(i) Government final consumption expenditure 100
(ii) Subsidies 10
(iii) Rent 200
(iv) Wages and salaries 600
(v) Indirect taxes 60
(vi) Private final consumption expenditure 800
(vii) Gross domestic capital formation 120
(viii) Social security contributions by employers 55
(ix) Royalty 25
(x) Net factor income from abroad -30
(xi) Interest 20
(xii) Consumption of fixed capital 10
(xiii) Profit 130
(xiv) Net exports 70
(xv) Change in stock 50
Expenditure Method
National Income = vi + i + vii + xiv – v + ii – xii – x
= (Private final consumption expenditure + Government final consumption expenditure +
Gross domestic capital formation + Net exports - Indirect taxes + Subsidies )+ Net factor
income from abroad - Consumption of fixed capital

= 800 + 100 + 120 + 70 – 60 + 10 – 10 – 30

= Rs 1,000 crore
3. INCOME METHOD :

Under this method, national income is measured as a flow of factor incomes. There are
generally four factors of production labour, capital, land and entrepreneurship. Labour
gets wages and salaries, capital gets interest, land gets rent and entrepreneurship gets
profit as their remuneration.

Besides, there are some self-employed persons who employ their own labour and capital
such as doctors, advocates, CAs, etc. Their income is called mixed income. The sum-total
of all these factor incomes is called NDP at factor costs.
Net Domestic Product At Factor Cost = Compensation Of Employees + Operating Surplus +

Mixed Income of Self Employed

1. WAGES & SALARIES CASH AS WELL AS KIND

+
• COMPENSATION OF EMPLOYEES 2. SOCIAL SECURITY CONTRIBUTION BY THE
EMPLOYER
+
3. RETIREMENT PENSION

1. RENT
+
* OPERATING SURPLUS 2. INTEREST

+
Dividend
3. PROFIT Corporate Profit Taxes
Undistributed Profit
From the following data calculate GNP at factor cost by INCOME
Method

Sr. No. Items Rs. in Crore

1 Net Domestic capital formation 500
2 Compensation of employees 1850
3 Consumption of fixed capital 100
4 Govt. Final consumption Expenditure 1100
5 Private Final consumption Expenditure 2600
6 Rent 400
7 Dividend 200
8 Interest 500
9 Net Exports (-) 100
10 Profits 1100
11 Net Factor Income From Abroad (-) 50
12 Net Indirect Taxes 250

Income Method
GNP@FC = Compensation of employees + ( Rent + Interest + Profits ) + Consumption of
fixed capital + Net Factor Income From Abroad

= 1850 + (400 +500 +1100) + 100+ (-)50

= Rs 3900 crore
From the following data calculate National Income by Income methods:

(Rs crore)
(i) Government final consumption expenditure 100
(ii) Subsidies 10
(iii) Rent 200
(iv) Wages and salaries 600
(v) Indirect taxes 60
(vi) Private final consumption expenditure 800
(vii) Gross domestic capital formation 120
(viii) Social security contributions by employers 55
(ix) Royalty 25
(x) Net factor income paid to abroad 30
(xi) Interest 20
(xii) Consumption of fixed capital 10
(xiii) Profit 130
(xiv) Net exports 70
(xv) Change in stock 50

National Income = iv + viii + (iii + ix ) + xi + xiii – x

= 600 + 55 + (200 +25) + 20 +130 -30
= Rs 1,000 crore