National IncomeMeaning, Methods, Importance and DifficultiesIndian Economy Notes
Meaning and Definition of National Income
National income is an uncertain term which is used
interchangeably with national dividend, national output and national
expenditure. On this basis, national income has been defined in a number of
ways. In common parlance, national income means the total value of goods and
services produced annually in a country.
In other words, the total amount of income accruing to
a country from economic activities in a year’s time is known as national
income. It includes payments made to all resources in the form of wages,
interest, rent and profits.
According to Alfred Marshall, National Income is the
labour and Capital of a country, acting on its natural resources, produced
annually a certain net aggregate of commodities and in materials including
services of all kinds. This is the net annual income or revenue of the country
or the true national dividend.
According to A. C. Pigou “The national income dividend is that part of the objective income of the community, including, the income derived from aboard which can be measured in Money”.
Different concepts of National Income
1. Gross National Product (GNP): According to W.C.
Peterson “GNP may be defined as the current market value of all goods &
services produced by the economy during an economic period”. GNP is the
aggregate money value or market value of the final goods and services produced
by a country in a year before deducting the wear & tear or depreciation
charges required to be provided for the replacement of worn out capital assets.
2. Net National Product (NNP): It is the aggregate
market value of final goods and services produced in a country in a year after
deducting depreciation charges provided for the replacement of worn out capital
assets. It should be noted that, in the competitive of the net national product
depreciation charges should be deducted from the gross national product. This
is necessary, because, in the process of production some capital assets are
used up a part of final goods services produced has to be set apart as
depreciation charges to the replacement of warm-out capital assets.
3. Gross Domestic Product (GOP): It refers to the
monetary value of all the final products & services produced within the
country. It can also be defined as the GNP of the country excluding the net
export earnings.
4. Net Domestic Product (NOP): It is the net national
product of the country excluding net export earnings. In other words, it is the
net market value of all final goods & services produced within the country
without taking into account the net export earnings.
5. Gross National Product at Factor Cost: It is the sum
of the money value of incomes earned by & accruing to various factor of
production in a country. It excludes indirect taxes on goods, but includes subsides.
Gross national product at factor cost= Gross national
product at market prices – Indirect taxes + Subsidies
6. National Income at Factor Cost: Net National Income
at factor cost is the sum total of factors rewards, such as wages, rent,
interest and profit earned by the suppliers of various factors of production
for their contribution of land, labour, capital & organisation in a year.
To obtain national income at cost, Indirect taxes
levied on goods should be deducted from net national product because these
taxes do not go to the supplies of factors.
Subsides should be added to the net national product, because they form
part of the payment for factors of production. National income at factor cost =
Net national product – Indirect taxes + subsidies
7. Gross National Product at Market Prices: Refers to
the gross value of final goods and service produced annually in a country + net
income from abroad.
8. Net National Product at Market prices: It is the net
value of final goods and services valued at market prices.
Net national product at market prices = Gross national
product at market prices – depreciation.
9. Net Domestic Product or Factor Cost: It means that
national product which is made by the domestic factors of production of the
country during the period of a year. It can be obtained by deducting the net
Income received from abroad.
NDP at factor or Cost= NN pat factor cost – Net income
from abroad.
Method of Measurement of National Income
1. Product Method
This approach is also called
output method or inventory method as it measures income from the output side.
In this approach, we add up the specific value of the flows of output arising
from each sector of the economy. As per this method, the economy is divided
into different industrial sectors to show the contribution made by each sector
to GDP. Then, the national income is calculated by adding the value of final
goods from all the sectors that have taken place during a year. Final goods are
those goods which are directly consumed and not used in further production
process. In order to avoid the problem of double counting, there are two
methods for calculating national income viz; final product method and
value-added method.
a) Final product Method:
In this method in estimating GDP, the only final value of goods and services
are computed ignoring all intermediate transaction, Intermediate goods are
those which are further processed to produce final goods. In this approach,
national income is calculated by finding the market value of all final goods
and services produced within the country during the time period of one year.
Thus, GDP = market value of all final goods and services produced within the
country.
b) Value added method:
This is also the another method of avoiding double counting in calculating
national income in which the country’s income is measured by adding the
differences between the values of inputs and output at each stage of
production. As per this method, income is the sum of value added by different
producing units of a country in their production process. Hence, Value added =
Value of output – Cost of production. For the purpose of estimating value
added, the following steps are generally applied:
Ø Identifying the
production units and classifying them under different industrial activities.
Ø Estimating net
value added by each production unit in an industrial sector.
Ø Adding up the
total value added of each final product to calculate GDP.
This
method is considered very useful as it helps to get some very important
information about the contribution made by each of the different production
sectors of the economy to the value of GDP. It also gives us an idea about the
current structure of national income and changes in the structure over the
period of time.
Precautions: The following precautions should be
taken while measuring national income of a country through value added method:
1.
Imputed rent values of
self-occupied houses should be included in the value of output. Though these
payments are not made to others, their values can be easily estimated from
prevailing values in the market.
2.
Sale and purchase of
second-hand goods should not be included in measuring value of output of a year
because their values were counted in the year of output of the year of their
production. Of course, commission or brokerage earned in their sale and
purchase has to be included because this is a new service rendered in the
current year.
3.
Value of services of housewives
are not included because it is not easy to find out correctly the value of
their services.
4.
Value of intermediate goods
must not be counted while measuring value added because this will amount to
double counting.
2 Income Method
The income method of
calculating national income is also called the factor income method or factor
share method. This method measures national income from distribution side i.e.
the national income is measured after it has been distributed and appears as
income earned by individuals in the country. To estimate the national income by
this approach, the total sum of the factor payments received during a given
period is estimated. The factors of production are classified as land, labor,
capital and organization. Accordingly, the national income is calculated as the
sum of various factor payments like rent, wages, interest and profits plus
depreciation. Thus, National income = Rent + Wages + Interest + Profits +
Depreciation.
This method of estimating
national income is of great advantage as it shows the distribution of national
income among different income groups such as landlords, capitalists, workers,
etc. It is therefore called national income by distributive shares.
Precautions: While
estimating national income through income method the following precautions
should be taken:
1.
Transfer payments are not
included in estimating national income through this method.
2.
Imputed rent of self-occupied
houses are included in national income as these houses provide services to
those who occupy them and its value can be easily estimated from the market
value data.
3.
Illegal money such as hawala
money, money earned through smuggling etc. are not included as they cannot be
easily estimated.
4.
Windfall gains such as prizes
won, lotteries are also not included.
3. Expenditure Method of National Income
The expenditure method is
also known as the final product method, which measures the national income at
the final expenditure stage. In other words, it measures national income as the
aggregate of all final expenditure on Gross Domestic Product in an economy
within a year. Hence, expenditure method measured the disposal of GDP.
This method calculates national income by adding up all the expenditures made
on goods and services during a year. Income can be spent either on consumer
goods or investment goods. Hence, the national income is calculated by adding
consumption expenditure and investment expenditure made by individuals as well
as government during a period of one year. National income is calculated by
adding:
(a) Personal
consumption expenditure(C): It is the household sector’s purchases of currently
produced goods and services. Consumption can be broken down into consumer goods
(automobiles, televisions) , non-durable goods (foods, beverages) and consumer
goods (medical services, haircuts).
(b) Gross domestic
investment (I):
It consists of expenditure of private business on replacement, renewals and new
investment.
(c) Government
expenditure (G):
It refers to the government purchases of goods and services. Government
transfer payments to individuals and government interest payments are examples
of government expenditure.
(d) Net export(X): Net export equal
total exports minus imports. It represents the contribution of foreign sector
in the national economy.
Hence, GDP = C + I
+ G + X
Precautions: While calculating
National Income by expenditure method, the following precautions are necessary:
1.
We should not include expenditure on
the purchase of second hand goods as the expenditure on these goods has been
included when they are bought for the first time.
2.
For avoid double counting only
including the expenditure of final products.
3.
Expenditure on gifts, donation, taxes,
scholarships etc. is not the expenditure on final products. There are transfer
payments (or transfer expenditure) and should not be included in final
expenditure.
4.
Expenditure on intermediate goods such
as fertilisers and seeds by the farmers and wool, cotton and yarn by
manufacturers of garments should also be excluded. This is because we have to
avoid double counting. Therefore, for estimating Gross Domestic Product we have
to include only expenditure on final goods and services.
5.
Expenditure on purchase of old shares
and bonds from other people and from business enterprises should not be
included while estimating Gross Domestic Product through expenditure method.
This is because bonds and shares are mere financial claims and do not represent
expenditure on currently produced goods and services.
Importance of National Income Studies
The growing importance of national income studies in
recent years is due to the following reasons:
1) Economic
Policy: National income figures are an important
tool of macroeconomic analysis and policy. National income estimates are the
most comprehensive measures of aggregate economic activity in an economy. It is
through such estimates that we know the aggregate yield of the economy and can
lay down future economic policy for development.
2) Economic
Planning: National income statistics are the most
important tools for long-term and short-term economic planning. A country
cannot possibly frame a plan without having a prior knowledge of the trends in
national income. The Planning Commission in India also kept in view the
national income estimates before formulating the five-year plans.
3) Economy’s
Structure: National income statistics enable us to
have clear idea about the structure of the economy. It enables us to know the
relative importance of the various sectors of the economy and their
contribution towards national income. From these studies we learn how income is
produced, how it is distributed, how much is spent, saved or taxed.
4) Inflationary
and Deflationary Gaps: National income and national
product figures enable us to have an idea of the inflationary and deflationary
gaps. For accurate and timely anti-inflationary and deflationary policies, we
need regular estimates of national income.
5) Budgetary
Policies: Modern governments try to prepare their
budgets within the framework of national income data and try to formulate
anti-cyclical policies according to the facts revealed by the national income
estimates. Even the taxation and borrowing policies are so framed as to avoid
fluctuation in national income.
6) National
Expenditure: National Income studies show how
national expenditure is dividend between consumption expenditure and investment
expenditure. It enables us to provide for reasonable depreciation to maintain
the capital stock of a community. Too liberal allowance of depreciation may
prove harmful as it may unnecessarily lead to a reduction in consumption.
7) Distribution
of grants-in-aid: National income estimates help a
fair distribution of grants-in-aid by the federal governments to the state
governments and other constituent units.
8) Standard of
Living Comparison: National income studies help us
to compare the standards of living of people in different countries and of
people living in the same country at different times.
9) International
sphere: National income studies are important even
in the international sphere as these estimates not only help us to fix the
burden of international payments equitably amongst different nations but also
enable us to determine the subscriptions and quotas of different countries to
international organisations like U.N.O., I.M.F., I.B.R.D. etc.
10) Defence and
Development: National income estimates help us to
divide the national product between defence and development purposes. From such
figures we can easily know how much can be spared for war by the civilian
population.
11) Public
Sector: National income figures enable us to know
the relative roles of public and private sectors in the economy. If most of the
activities are performed by the state, we can easily conclude that public
sector is playing a dominant role.
Difficulties in Calculation of National Income
Although all methods are used almost in all countries
to calculate national income, yet the calculation is a complex affair and is
beset with conceptual and statistical difficulties. The difficulties are as
follows:
1. Difficulty of
defining the nation: The definition of ‘nation’ is
used in the studies of national income. National income doesn’t only include
income produced within the country but also income earned in other countries by
way of shipping charges, interest, insurance and banking, minus any payments
made to foreign countries. Therefore, the definition of nation goes beyond the
political boundaries.
2. Non-marketed
services: Which kinds of goods and services should
be included in national income? Commodities and services having money value are
included in the national income but there are goods and services which may have
no corresponding flow of money payments, Services performed for love, kindness
and mercy and not for money have an economic value but have no money value. The
difficulty is whether these services should be included in national income and
how to measure their money value.
3.
Inapplicability of any one method: Another
difficulty is regarding the method to be used in the estimation of national
income. It is, however, preferred to use the three methods simultaneously
depending upon the availability of statistics.
4. Which stage
to choose: Regarding the stage of economic activity
at which national income be calculated, it is agreed that any stage –
production, consumption and distribution – may be adopted depending upon the
function the national income estimate is expected to discharge. If the aim is
to show the economic progress and power of the economy, then the production
stage would be more suitable; if the aim is to measure the welfare of
individuals, then consumption stage would be more useful.
5. Paucity of
statistics: Another important difficulty is the
non-availability of statistical material. This difficulty is not peculiar to
under developed countries, but even in advanced countries reliable and sufficient
statistics are lacking. According to the National Income Committee of India,
the available statistics, especially for agriculture and small-scale
industries, are extremely unreliable and incomplete.
6. How to avoid
double counting: Another difficulty is of double
counting usually associated with the inventory method. Double counting implies
the possibility of a commodity like raw material or labour being included in
national income more than once, e.g., a farmer sells maize worth rupees two
hundred to a mill-owner, the mill-owner further sells the maize flour to a
wholesale dealer, who further sells it to a retailer and who in turn sells it
to consumer; if we calculate it at every stage, its money value will come to
eight hundred rupees but actually the increase in national income has been to
the extent of two hundred rupees only. The best way to avoid this difficulty is
to calculate only the value of all goods and services that enter into final
consumption.
7. Self-consumed
production: Another difficulty mostly peculiar to
backward countries is that a substantial part of the output is not exchanged
for money in the market, it being either consumed directly by producers or
bartered for other goods and services in the unorganised sector. The existence
of a vast unorganised and non-monetized sector makes calculation of national
income very difficult.
8. Multiple
occupations: As a result of little specialisation
of functions a precise calculation of income by industrial origin or by distributive
shares is rendered almost impossible. The production in agricultural, and
industrial, as a matter of fact in all sectors is highly scattered and
unorganised rendering the calculation of national income very difficult.
9. Incorrect statistics: Other difficulties pertain to the social backwardness of the people; they are superstitious. People do not disclose their incomes easily and correctly; they are illiterate and do not keep proper accounts or if at all they keep any accounts, these are highly unreliable. All these difficulties exist in India and the calculation of national income has been rendered difficult in the past. Efforts are, however, being made to solve these difficulties so as to find out correct estimates of national income and per capita income in India.
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