National Income: National income estimates, GNP vs GDP, Economics, Best Formula & Pdf

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INTRODUCTION

The performance of an economy depends on the output of goods and services produced by it. Just as there are accounting conventions that measure the performance of the business, there are conventions for measuring and analyzing the economic performance of a nation. 

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National Income Accounting, pioneered by the Nobel prize-winning economists Simon Kuznets and Richard Stone, is one such measure. National income is an important macroeconomic aggregate forming the basis of modern macroeconomic analysis and provides detailed measures of the value and composition of national output and incomes generated in the production of that output.

National Income is defined as the net value of all economic goods and services produced within the domestic territory of a country in an accounting year plus the net factor income from abroad. According to the Central Statistical Organisation (CSO), ‘National income is the sum total of factor incomes generated by the normal residents of a country in the form of wages, rent, interest, and profit in an accounting year’.

usefulness and significance of national income estimates

National income accounts are fundamental aggregate statistics in macroeconomic analysis and are extremely useful, especially for emerging and transition economies.

1. National income accounts provide a comprehensive, conceptual, and accounting framework for analyzing and evaluating the short-run performance of an economy. The level of national income indicates the level of economic activity and economic development as well as the aggregate demand for goods and services of a country.

2. The distribution pattern of national income determines the pattern of demand for goods and services and enables businesses to forecast the future demand for their products.

3. Economic welfare depends to a considerable extent on the magnitude and distribution of national income, the size of per capita income, and the growth of these over time.

4. The estimates of national income show the composition and structure of national income in terms of different sectors of the economy, the periodical variations in them, and the broad sectoral shifts in an economy over time. 

It is also possible to make temporal and spatial comparisons of the trend and speed of economic progress and development. Using this information, the government can fix various sector-specific development targets for different sectors of the economy and formulate suitable development plans and policies to increase growth rates.

5. National income statistics also provide a quantitative basis for macroeconomic modeling and analysis, for assessing and choosing economic policies, and for objective statements as well as evaluation of governments’ economic policies. These figures often influence popular and political judgments about the relative success of economic programs.

6. National income estimates throw light on income distribution and the possible inequality in the distribution among different categories of income earners. It is also possible to make comparisons of structural statistics, such as ratios of investment, taxes, or government expenditures to GDP.

7. International comparisons in respect of incomes and living standards assist in determining eligibility for loans, and/or other funds or conditions under which such loans, and/ or funds are made available. The national income data are also useful to determine the share of the nation’s contributions to various international bodies.

8. Combined with financial and monetary data, national income data provides a guide to making policies for growth and inflation.

9. National income or a relevant component of it is an indispensable variable considered in economic forecasting and to make projections about the future development trends of the economy.

different concepts of national income

The basic concepts and definitions of the terms used in national accounts largely follow those given in the UN System of National Accounts (SNA) developed by the United Nations to provide a comprehensive, conceptual, and accounting framework for compiling and reporting macroeconomic statistics for analyzing and evaluating the performance of an economy. Each of these concepts has a specific meaning, use, and method of measurement.

National income accounts have three sides: a product side, an expenditure side, and an income side. The product side measures production based on the concept of value added. The expenditure side looks at the final sales of goods and services, whereas the income side measures the distribution of the proceeds from sales to different factors of production. 

Accordingly, national income is a measure of the total flow of ‘earnings of the factor owners which they receive through the production of goods and services. Thus, national income is the sum total of all the incomes accruing over a specified period to the residents of a country and consists of wages, salaries, profits, rent, and interest.

On the product side, there are two widely reported measures of overall production namely, Gross Domestic Product (GDP) and Gross National Product (GNP).

Gross Domestic Product (GNP)

Gross domestic product (GDP) is a measure of the market value of all final economic goods and services, gross of depreciation, produced within the domestic territory of a country during a given time period. It is the sum total of ‘value added’ by all producing units in the domestic territory and includes value added by current production by foreign residents or foreign-owned firms. 

The term ‘gross’ implies that GDP is measured as the ‘gross’ of depreciation. Domestic refers to the geographic confines of a country. For example, if a Chinese citizen works temporarily in India, her production is part of the Indian GDP. If an Indian citizen owns a factory in another country, for e.g. Germany, the production at her factory is not part of India’s GDP. However, GDP excludes transfer payments,

financial transactions and non-reported output generated through illegal transactions such as narcotics and gambling.

Gross Domestic Product (GDP) is in fact Gross Domestic Product at market prices (GDP MP) because the value of goods and services is determined by the common measuring unit of money or it is evaluated at market prices. 

Money enables us to measure and find the aggregate of different types of products expressed in different units of measurement by converting them in terms of Rupees, say tonnes of wheat may, thus, be added with millions of apples and with the value of services such as airplane journeys.

While learning about national income, there are a few important points that one needs to bear in mind:

(1) The value of only final goods and services or only the value added by the production process would be included in GDP. Final goods refer to those goods which are used either for consumption or for investment. They are neither resold nor undergo further transformation in the process of production. 

The distinction between intermediate goods and final goods is made on the basis of end use: if the good is for consumption or investment, then it is a final good. By ‘value added’ we mean the difference between the value of output and the purchase of intermediate goods. Value added represents the contribution of labor and capital to the production process.

(ii) Intermediate goods refer to those goods which are used either for resale or for further production in the same year. They do not end up in final consumption and are not capital goods either. The intermediate goods or services may be either transformed or used up by the production process. 

They have derived demand. Intermediate goods are used up in the same year; if they remain for more than one year, then they are treated as final goods. Intermediate consumption consists of the value of the goods and services consumed as inputs by a process of production, excluding fixed assets whose consumption is recorded as the consumption of fixed capital. Intermediate goods used to produce other goods rather than being sold to final purchasers are not counted as it would involve double counting. The intermediate goods or services may be either transformed or used up by the

production process. For example, the value of flour used in making bread would not be counted as it will be included while bread is counted. This is because flour is an intermediate good in bread making process. Similarly, if we include the value of an automobile in GDP, we should not be including the value of the tires separately.

(iii) Gross Domestic Product (GDP) is a measure of production activity. GDP covers all production activities recognized by SNA called the ‘production boundary’. The production boundary covers the production of almost all goods and services classified in the National Industrial Classification (NIC). 

Production of agriculture, forestry, and fishing which are used for the own consumption of producers is also included in the production boundary. Thus, the Gross Domestic Product (GDP) of any nation represents the sum total of gross value added (GVA) (ie, without discounting for capital consumption or depreciation) in all the sectors of that economy during the said year.

(iv) Economic activities, as distinguished from non-economic activities, include all human activities which create goods and services that are exchanged in a market and valued at market price. Non-economic activities are those which produce goods and services, but since these are not exchanged in a market transaction they do not command any market value; for e.g. hobbies, housekeeping, and child-rearing services of homemakers, and services of family members that are done out of love and affection.

(v) National income is a ‘flow’ measure of output per time period-for example, per year, and includes only those goods and services produced in the current period i.e. produced during the time interval under consideration. 

The value of market transactions such as the exchange of goods that already exist or are previously produced, do not enter into the calculation of national income. Therefore, the value of assets such as stocks and bonds which are exchanged during the pertinent period are not included in national income as these do not directly involve the current production of goods and services. 

However, the value of services that accompany the sale and purchase (e.g. fees paid to real estate agents and lawyers) represent current production and, therefore, is included in national income.

(vi) An important point to remember is that two types of goods used in the production process are counted in GDP namely, capital goods (business plant and equipment purchases) and inventory investment-the net change

in inventories of final goods awaiting sale or of materials used in the production which may be positive or negative. Inventories are treated as capital. Additions to inventory stocks of final goods and materials belong to

GDP because they are currently produced output. The national income in real terms when available by industry of origin, gives a measure of the structural changes in the pattern of production in the country which is vital for economic analysis. 

Nominal GDP versus Real GDP: GDP at Current and Constant Prices

When GDP is estimated on the basis of the current year’s market prices, it is called ‘nominal GDP’ or ‘GDP at current prices’. 

For example, the GDP of the year 2020-21 may be measured using prices of 2020-21. Nominal GDP changes from year to year for two reasons. First, the amount of goods and services produced changes, and second, market prices change. Changes in GDP due to changes in prices fail to correctly explain the performance of the economy in producing goods and services.

Therefore, for making comparisons of GDP at different points in time, we need to compute real GDP. Real GDP is calculated in such a way that the goods and services produced in a particular year are evaluated at some constant set of prices or constant prices. In other words, it is calculated using the prices of a selected ‘base year’. 

For example, if 2011-12 is selected as the base year, then real GDP for 2020-21 will be calculated by taking the quantities of all goods and services produced in 2020-21 and multiplying them by their 2011-12 prices. 

Thus, real GDP or GDP at constant prices refers to the total money value of the final goods and services produced within the domestic territory of a country during an accounting year, estimated using base year prices. 

Real GDP is an inflation-adjusted measure and is not affected by changes in prices; it changes only when there is a change in the amount of output produced in the economy. Real GDP is a better measure of economic well-being as it shows the true picture of the change in production of an economy.

The calculation of real GDP gives us a useful measure of inflation known as the GDP deflator. The GDP deflator is the ratio of nominal GDP in a given year to the real GDP of that year.

GDP Deflator = Nominal GDP / Real GDP X100

The GDP deflator, as the name implies, can be used to ‘deflate’ or take inflation out of GDP. In other words, the GDP deflator is a price index used to convert nominal GDP to real GDP

The deflator measures the change in prices that has occurred between the base year and the current year. In other words, it measures the current level of prices relative to the level of prices in the base year. For example, in 2019 if the nominal GDP is 6,000 billion and the real GDP is 3,500 billion, the GDP deflator is 171.43. Since nominal GDP and real GDP must be the same in the base year, the deflator for the base year is always 100.

As you know, inflation is a closely monitored aspect of macroeconomic performance and a significant variable guiding macroeconomic policy. Using the GDP deflator, the inflation rate between two consecutive years can be computed using the following procedure:

Gross National Product (GNP)

Gross National Product (GNP) is a measure of the market value of all final economic goods and services, gross of depreciation, produced within the domestic territory of a country by normal residents during an accounting year including net factor incomes from abroad. 

It is the total income earned by a nation’s permanent residents (called nationals). It differs from GDP by including income that our citizens earn abroad and excluding income that foreigners earn here. In the example given in 1.3.1 above, the Chinese citizen’s production is part of the Indian GDP, but it is not part of the Indian GNP. (It is part of China’s GNP).

Gross National Product (GNP) is evaluated at market prices and therefore it is in fact Gross National Product at market prices (GNP MP). GNP MP GDP MP +Factor income earned by the domestic factors of production employed in the rest of the world – Factor income earned by the factors of production of the rest of the world employed in the domestic territory.

GNP = GDP + Net Factor Income from Abroad

GDP = GNP - Net Factor Income from Abroad (NFIA)

NFIA is the difference between the aggregate amount that a country’s citizens and companies earn abroad and the aggregate amount that foreign citizens and overseas companies earn in that country.

NFIA =Net compensation of employees + Net income from property and entrepreneurship + Net retained earnings

If Net Factor Income from Abroad is positive, then GNPMP would be greater than GDP. You might have noticed that the distinction between ‘national’ and ‘domestic’ is net factor income from abroad.

National = Domestic + Net Factor Income from Abroad

The two concepts GDP and GNP differ in their treatment of international transactions. The term ‘national’ refers to normal residents of a country who may be within or outside the domestic territory of a country and is a broader concept compared to the term ‘domestic’. 

For example, GNP includes earnings of Indian corporations overseas and Indian residents working overseas; but GDP does not include these. In other words, GDP excludes net factor income from abroad. Conversely, GDP includes earnings from current production in India that accrue to foreign residents or foreign-owned firms; GNP excludes those items. 

For instance, profits earned in India by X Company, a foreign-owned firm, would be included in GDP but not in GNP. Similarly, profits earned by Company Y, an Indian company in the UK would be excluded from GDP but included in GNP.

Net Domestic Product at market prices (NDP)

Net domestic product at market prices(NDP) is a measure of the market value of all final economic goods and services, produced within the domestic territory of a country by its normal residents and non-residents during an accounting year less depreciation. 

The portion of the capital stock used up in the process of production or depreciation must be subtracted from final sales because depreciation represents capital consumption and therefore a cost of production.

NDP = DP - Depreciation

As you are aware, the basis of the distinction between ‘gross’ and ‘net’ is the depreciation or consumption of fixed capital. 

Gross = Net + Depreciation or Net = Gross - Depreciation

Net National Product at Market Prices (NNP)

Net National Product at Market Prices(NNP) is a measure of the market value of all final economic goods and services, produced by normal residents within the

domestic territory of a country including Net Factor Income from Abroad during an accounting year excluding depreciation.

NNP = GNP - Depreciation
NNP = NDP + Net Factor Income from Abroad 
NNP = GDP + Net Factor Income from Abroad - Depreciation

Gross Domestic Product at Factor Cost (GDPFc)

The production and income approach (which we will discuss later in this unit) measures the domestic product as the cost paid to the factors of production. Therefore, it is known as ‘domestic product at factor cost. GDP at factor cost is called so because it represents the total cost of factors viz. labor capital, land, and entrepreneurship.

At this stage, we need to clearly understand the difference between the concepts: ‘market price’ and ‘factor cost. In addition to factor cost, the market value of the goods and services will include indirect taxes and subsidies such as:

Production taxes or subsidies are paid or received in relation to production and are independent of the volume of actual production. Examples of production taxes are land revenues, stamps, and registration

fees and tax on profession, factory license fees, taxes to be paid to the local authorities, pollution tax, etc. Examples of production subsidies are subsidies to railways and subsidies to villages and small industries.

Product taxes or subsidies that are paid or received per unit of product. Examples of product taxes are excise duties, sales tax, service tax, and import-export duties. Examples of product subsidies are food, petroleum, and fertilizer subsidies.

The market price will be lower by the amount of subsidies on products and production that the government pays to the producer. Hence, the market value of final expenditure would exceed the total obtained at factor cost by the amount of product and production taxes reduced by the value of similar kinds of subsidies. 

Direct taxes do not have the same effect since they do not impinge directly on transactions but are levied directly on the incomes. For example, if the factor cost of a unit of good X is .50/, indirect taxes amount to 15/per unit and the government gives a subsidy of *.10/per unit, then the market price will be 755/-

Thus, we find that the basis of the distinction between market price and factor cost is net indirect taxes (i.e., Indirect taxes – Subsidies).

Market Price = Factor Cost + Net Indirect Taxes 
                        = Factor Cost + Indirect Taxes - Subsidies

Factor Cost = Market Price - Net Indirect Taxes 
                      = Market Price - Indirect Taxes + Subsidies

Gross Domestic Product at Factor Cost (GDPFC)
= GDP - Indirect Taxes + Subsidies
= Compensation of employees + Operating Surplus (rent + interest+ profit)
+ Mixed Income of Self-employed
+ Depreciation

Net Domestic Product at Factor Cost (NDP)

Net Domestic Product at Factor Cost (NDPro)is defined as the total factor incomes earned by the factors of production. In other words, it is the sum of domestic factor incomes or domestic income net of depreciation.

As mentioned above, the market price includes indirect taxes imposed by the government. We have to deduct indirect taxes and add the subsidies in order to calculate that part of the domestic product which actually accrues to the factors of production. The measure that we obtain so is called Net Domestic Product at factor cost.

NDPIC = NDP-Net Indirect Taxes
            = Compensation of employees
            + Operating Surplus (rent + interest+ profit) 
            + Mixed Income of Self-employed

Net National Product at Factor Cost (NNPFC) or National Income

National Income is defined as the factor income accruing to the normal residents of the country during a year. It is the sum of domestic factor income and net factor income from abroad. In other words, national income is the value of factor income generated within the country plus factor income from abroad in an accounting year.

NNPC = National Income = FID (factor income earned in the domestic territory) + NFIA

If NFIA is positive, then national income will be greater than domestic factor incomes.

Per Capita Income

The GDP per capita is a measure of a country’s economic output per person. It is obtained by dividing the country’s gross domestic product, adjusted by inflation, by the total population. It serves as an indicator of the standard of living of a country.

Personal Income

While national income is income earned by factors of production, Personal Income is the income received by the household sector including Non-Profit Institutions Serving Households. 

Thus, national income is a measure of income earned and personal income is a measure of actual current income receipts of persons from all sources which may or may not be earned from productive activities during a given period of time. In other words, it is the income ‘actually paid out’ to the household sector, but not necessarily earned. 

Examples of this include transfer payments such as social security benefits, unemployment compensation, welfare payments, etc. Individuals also contribute income that they do not actually receive; for example, undistributed corporate profits and the contribution of employers to social security. Personal income excludes retained earnings, indirect business taxes, corporate income taxes, and contributions toward social security. 

Households receive interest payments from firms and governments; they also make interest payments to firms and governments. As such, the net interest paid by households to firms and the government is also deducted from national income. Personal income forms the basis for consumption expenditures and is derived from national income as follows:

PI = NI+ income received but not earned-income earned but not received.
PI = NI Undistributed profits - Net interest payments made by households - Corporate Tax +Transfer Payments to the households from firms and government.

An important point to remember is that national income is not the sum of personal income because personal income includes transfer payments (eg. pension) which are excluded from national income. Further, not all national income accrues to individuals as their personal income.

Disposable Personal Income (DI)

Disposable personal income is a measure of amount of the money in the hands of the individuals that is available for their consumption or savings. Disposable personal income is derived from personal income by subtracting the direct taxes paid by individuals and other compulsory payments made to the government.

DI = PI - Personal Income Taxes - Non tax payments

Apart from the above aggregates, a few other aggregates are reported in India. These reflect the amount of goods and services the domestic economy has at its disposal. Two more concepts need to be understood, namely:

1. Net National Disposable Income

Net National Disposable Income (NNDI) = Net National Income + other net current transfers from the rest of the world (Receipts less payments) Net National Disposable Income (NNDI) = NNI + net taxes on income and wealth receivable from abroad net social contributions and benefits receivable from abroad.

2. Gross National Disposable Income (GNDI) = NNDI+ CFC = GNI + other net current transfers from the rest of the world (Receipts less payments)

(Other Current Transfers refer to current transfers other than the primary incomes) (For a detailed explanation of concepts please refer to ‘Glossary of Main Terms’ Apr 1, 2020 – National Accounts Statistics-Sources & Methods, 2007, MOSPI)

Domestic Income may be categorized into:

1. Income from domestic product accruing to the public sector which includes income from property and entrepreneurship accruing to government administrative departments and savings of non-departmental enterprises. 

2. Income from domestic product accruing to private sector = NDPIC – Income from property and entrepreneurship accruing to government administrative departments – Savings of non-departmental enterprises.

Private Income

Private income is a measure of the income (both factor income and transfer income) which accrues to the private sector from all sources within and outside the country.

Private Income = Factor income from net domestic product accruing to the private sector + Net factor income from abroad + National debt interest + Current transfers from government + Other net transfers from the rest of the world.

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