MCom I Semester Managerial Economics National Income Study Material Notes
Table of Contents
MCom I Semester Managerial Economics National Income Study Material Notes: Meaning and Definition of National Income Basic Concepts Related With National Income Product Method or Output Method of Value Added Method Income Method Expenditure Method or Final Expenditure Method Reconciliation of the Three Methods Measurement of National Income in India Importance of National Income Problems in the Estimation of National income in India
MCom I Semester Managerial Economics Market Structure Study Material Notes
NATIONAL INCOME
MEANING AND DEFINITION OF NATIONAL INCOME
National income is the sum total of value of all the final goods and services produced in an economy during one year. Natioal income includes different goods and services. These goods are measured in different units. For example, foodgrains and pulses are measured in kilograms, milk in litres and cloth in metres etc. Services may also be of different types such as, the services of Doctors, Engineers, Teachers, Clerks, Singers etc. All these goods and services should be measured in terms of a common measure because national income cannot be expressed as so many million metres of cloth, so many million liters of milk and so many tonnes of foodgrains etc. This common measure is money.
Value of all the goods and services produced in an economy is measured in terms of money. Total value of all the goods and services produced in an economy during one year is called national income. The term ‘National Income’ has been defined as under
1 Dr. Alfred Marshall, “The labour and capital of the country acting on its natural resources produce annually a certain net aggregate of commodities, material and immaterial, including services of all kinds. This is the true net annual income or revenue of the country or the national dividend.”
2.A.C. Pigou, “The national dividend is that part of the objective income of the community including of course, income derived from abroad which can be measured in money.”
3. Simon Kuznets, “National income is the net output of commodities and services flowing during the year from the country’s productive system into the hands of the ultimate consumers or into net additions to the country’s stock of capital goods.”
4. National Income Committee of India, 1951. “A national income estimate measures the volume of commodities and services turned out during a given period counted without duplication.”
Thus, national income means the sum total of value of all the final goods and services produced in an economy during one year.
National Income Study Material
BASIC CONCEPTS RELATED WITH NATIONAL INCOME
1 Gross Domestic Product (GDP). Gross Domestic Product is money value of all the goods and services produced within the domestic territory of a country during a certain period. These goods and services may either be consumer goods and services or capital goods and services. These may be durable as well as non-durable. These may be produced in private sector as well as public sector, however, it does not include the value of intermediate goods and services. Thus,
GDP = Cp+Cg + Ip + Ig
Cp = Consumer goods and services produced in private sector.
Cg = Consumer goods and services produced in govt. sector.
Ig = Fixed inventory investment produced in govt. sector.
Ip = Fixed inventory investment produced in private sector.
Union Territory
The term union territory is very important to understand gross domestic product. This is a wider term than political frontiers of country. Domestic territory includes the following
(1) Territory lying within political frontiers, including its territorial waters.
(ii) Ships and aircrafts operated by the country between political frontiers of two or more countries.
(iii) Oil and natural gas rigs, fishing vessels and floating plateforms operated by the country in international waters.
(iv) Embassies, military establishments and consulates of the country located in other countries of the world.
2. Net Domestic Product (NDP). If depreciation of fixed capital used in the production of goods and services is deducted from the value of gross domestic product, we get net domestic product. Relationship between GDP and NDP can be illustrated as follows
NDP = GDP – Depreciation
GDP = NDP + Depreciation
3. Gross National Product (GNP). Gross national product means gross domestic product plus net factor income from abroad. This concept measures gross product in the light of citizenship of a country. Net Factor Income from Abroad
As explained earlier, domestic income of a country means the income generated within the domestic territory of a country during one accounting, year. It includes income generated by foreign nationals working in that country, but does not include the income generated by the citizens of that country working abroad.
For example, many foreign citizens are working in India, sum total of wages, rent, interest and profit earned by them in India is the income of their respective countries and themselves. Similarly, many Indian citizens are working abroad, income of these people is the factor income earned from abroad net factor income from abraod is the difference between income received by the residents of India from abroad and income paid for the factor services of non-resident in India.
Difference between Gross Domestic Product and Gross National Product
Gross Domestic Product is a geographical concept while Gross National Product is a national concept. These two can be differentiate on the basis of Net Factor Income from abroad. Thus,
GNP = GDP + Net Factor Income from abroad.
GDP = GNP – Net Factor Income from abroad.
4. Net National Product (NNP). Net National Product means total value of all the final goods and services produced in an economy during a certain period after allowing for depreciation. In other words, if an allowance for depreciation is made from gross national product, we get net national product. Thus,
Net National Product = Gross National Product – Depreciation
Gross National Product = Net National Product + Depreciation
Net Domestic Product and Net National Product. Difference between t domestic product and net national product is same as the difference Ouween gross domestic product and gorss national product. Net domestic product is a geo-graphical concept while net national product is a national concept. If net factor income from abroad is added to gross domestic product, it becomes net national product. Thus,
NNP = NDP + Net Factor Income from Abroad
NDP = NNP – Net Factor Income from Abroad
5. Net Domestic Product at Factor Cost and Net domestic Product at Market Price. Net domestic product can be calculated either at factor cost at market prices. The difference between these two terms should be clearly understood to understand the measurement of national income fully.
Net Domestic Product at Factor Cost or Domestic Factor Income. Net domestic product at factor cost is the sum of earnings received by all the factors of production in terms of wages and salarie, rent, interest and profit. It is known as domestic factor income also. It is appropriate to repeat here that it a territorial or geographical concept. Thus,
NDP at factor cost- Total value of earnings received by all the
factors of production within the domestic
territory of a country during a certain period.
Net domestic Product at Market Prices. Net domestic product at market prices means market value of all the final goods and services produced in an economy during a certain period. This is also a territorial or geograhical concept Thus,
NDP at Market Market value of all the final goods and services prices = produced within domestic territory of a country
during a certain period. Difference between NDP at Factor Cost and NDP at Market Prices. Theoritically, the value of net domestic product at factor cost and market prices should be equal because total market value of all the final goods and services produced in an economy during a certain period should be equal to the total payments made by producers to all the factors of production during that period. But in real life, NDP at factor cost and NDP at market prices are not equal. NDP at factor cost is the real concept. In order to arrive at real estimate, indirect taxes should be substracted from the subsidies should be added to net domestic product at market prices. Thus,
NDP at factor cost = NDP at market prices – Indirect taxes + Subsidies
NDP at market Prices = NDP at factor cost + Indirect taxes – Subsidies
6. National Income. Now we can define national income in a very simple way. National income is the net national product at factor cost. In other words, national income is the sum of net domestic product at factor cost plus net factor income from abroad. Thus,
National income = Net national product at factor cost Or.
National income = Net domestic product at factor cost + Net
factor income from abraod.
7. Personal Income. Personal income refers to the income actually received by individuals or households in a country during one accounting year. In practice, we find that the firms have to pay a part of their income as taxes. Similarly, a part of profit is retained by enterprises. These two sumes should be deducted from private income because these are not distributed among factor of production. Thus,
Personal Income = Private income – Undistributed profits of
enterprises (corporate savings) – Corporate taxes.
8. Disposable Income. Disposable income is that part of personal income which is available to individuals and households for actual consumption. They cannot spend the entire personal income because they have to pay a part of it to the government as taxes. Therefore, the amount of these taxes should be deducted from personal income to arrive at personal disposable income. Thus,
Personal disposable income =
Personal income – Direct taxes
paid by household – fines and fees etc.
paid by households
National Income Study Material
(1) PRODUCT METHOD OR OUTPUT METHOD OR VALUE ADDED METHOD
When we look at national income from the angle of goods and services produced in an economy, it is called product method or output method or value added method. According to this method, national income is equal to net national product at factor cost. Measurement of national income according to this nethod involved certain steps as follows
Step A-Calculation of Gross Domestic Product at Market Prices. Various goods and services are produced in an economy. Money value of all the goods and services produced in an economy in one accounting year is added. It comes to the value of gross domestic product at market prices.
Step B-Provision for Depreciation. If we deduct depreciation from the value of gross domestic product, we get net domestic product at market prices.
Step C—Net Factor Income from Abraod. If we add net factor income from abroad to net domestic product at market prices, we get net national product at market prices. Net iactor income from abroad may be positive as well as negative.
Step D Provision for Indirect Taxes and Subsidies. Indirect taxes are the taxes that are paid by producing units to the government. Subsidies are granted by government to producing units. If we deduct indirect taxes from the Value of net national product at market prices and add subsidies to it, we get net national product at factor cost. Value of net national product at factor cost will be the value of national inocme. Thus,
(i) Value of all the final goods and services is added together.
(ii) Changes in stock and investment of fixed assets are also added.
(iii) Construction of new houses is added but the sale and purchase of old houses are not added.
(iv) Value of intermediate goods and services is not added.
(v) It does not include the sale and purchase of second-hand goods. It does not include profit or loss on such sale and purchase, however if some commission is paid to an agent to help in such sale and purchase, it is added to national income.
(vi) All the legal activities are added but illegal activities are not added.
(vii) The value so arrived at, is only the Gross Domestic Product at Market Prices (GDPMP), Govt. subsidies and net factor from abroad are added to it. Depreciation and indirect taxes are deducted from it and thus we get the value of national income.
National Income Study Material
(II) INCOME METHOD
When we look at national income from the angle of factor incomes, it is called income method. Production of goods and services is an outcome of combined efforts of various factors of production like land, labour, capital and enterprise. They get reward for their service. Total income received by all the factors of production in an economy during a certain period is called factor income. Total payment made by producers for factor services is called factor payment
National income of a country can be computed either on the basis of total income received by all the factors or on the basis of total payment made by all producers to these factors. These are known as ‘income received variant and ‘income paid out variant’ respectively. The amount of national income, either measured by income received variant or by income paid out variant, must be the same. In India, income paid out variant is used for this purpose. Income method involves following steps
Step A-Classification of Producing Sector. For this purpose whole economy is divided into 14 different sectors. All these sectors employ factor inputs.
Step B-Classification of Factor Income. Income received by all the factors of production can be classified into the three broad categories (0) Wage income, (ii) Non-wage income, (iii) Other income
1 Wages Incomes means the income received by employees either in cash or in kind. It includes the following-(a) Wages and salaries, (b) Compensation in kind, (c) supplementary labour income.
2. Non-wage Income means income paid to the factors of production in the form of interest, rent, profit and dividend including undistributed profit. It! includes the following-(a) Interest, (b) Rent, (c) Undistributed profit, (d) Mixed income of self-employed.
3. All Incomes other than Wage Income and Non-wage Income are called Other Income. It includes the following: (a) Operating surplus of public enterprises, (b) Direct taxes collected by Government, (c) Net factor income from abroad, (d) Value of production for self-consuniption.
Thus, National Wages + Rent + Interest + Dividends + Undistri- buted profits
Income = + Operating surplus of public enterprises + Mixed income of
(Income self-employed + Direct taxes collected by government + Net
Method) factor income from abroad + Value of production for self-consumption.
Precautions to be taken while Estimating Factor Incomes
1 Transfer payments such as pension, scholarship, unemployment allowance, subsidies, etc. should not be included national income.
2. Illegal incomes should not be included in national income.
3. Windfall profits like lotteries should not be included in national income.
4. Wealth tax, gift tax, capital gains tax on windfall profits should not be included in national income.
5. Sales of second-hand goods should not be included in national income. If there is any profit or loss on the sale of these goods, it should also not be included in national income. However, commission etc. paid to brokers and agents in this process should be included in national income.
6. Sales of shares, debentures and bonds etc., (both old and new ones) should not be included in national income.
7. Value of production for self-consumption should be included in national income.
8. Imputed value of the factors of production owned by producers themselves should be included in national income.
National Income Study Material
(ID) EXPENDITURE METHOD OR FINAL EXPENDITURE METHOD
When we look at national income from the angle of expenditure of whole community, it is called final expenditure method. Income generated in an economy through the production of goods and services can be disposed either on the consumption of goods and services or investment.
Components of Final Expenditure
(1) Private Consumption Expenditure. Private we consists of (i) Expenditure on durable consumer goods, (ii) Expenditure on non-durable consumer on non-durable consumer goods, (iii) Expenditure on consumer Private consumption expenditure is calculated by taking the sum of money income spent by consumers on the consumption of un services.
(2) Private Investment. The term investment in this reference means an increase in capital equipments or assets during one accounting year. It is that part of the income of private individuals and business firms which is not spent on consumption. It may be in the form of increase in factory buildings, machines, equipments, godowns, residential buildings and inventories.
(3) Government Consumption. Government disposes her income on the consumption of goods and services. It consists the following-(i) Expenditure on the purchase of consumer and capital goods, (ii) Expenditure on compensation of employees, (iii) Expenditure on providing services to the society.
(4) Government Investment. Government invests some money in creating capital assets like dams, bridges, machines, equipments, transport vehicles, power generation plants etc.
(5) Change in Stock. Change in stock means an increase in the stock of raw-materials, works in progress and finished goods.
(6) Net Exports of Goods and Services. Net exports of goods and services mean exports minus imports. It includes the following-(i) Exports of merchandise, (ii) Exports of services, (iii) Imports of merchandise, (iv) Imports of services. Thus, it may be concluded that,
National Income Study Material
Precautions to be taken while Estimating Final Expenditure
1 Expenditure on second-hand goods should not be included in national income.
2. Purchase of shares, debenture, bonds, bank deposits, saving certificates etc. should not be included in national income.
3. Expenditure on intermediate goods and services should also not be included in national income.
4. Production for self-consumption should be included in national income at market price.
5. Imputed rent of the buildings owned by producers themselves should also be included as a part of private final expenditure.
6. Expenditure method gives the value of gross domestic product at market prices (GDP at market prices). Net factor income from abroad and subsidies are added to it. Net indirect taxes and the amount of depreciation are deducted. Thus, we get Net National Product at factor cost (NNPFC) or national income.
RECONCILIATION OF THE THREE METHODS
Thus, we see that the value of national income can be calculated by three methods-Output method or value added method; income method; and final expenditure method. These three methods looks at national income from three different angles-Total produce, total income, total expenditure respectively. All the three methods give identical results, provided if there is no error or inconsistency in the collection of data.
MEASUREMENT OF NATIONAL INCOME IN INDIA
For the purpose of measurement of national income, central statistical organisation (CSO) has divided whole of the economy into 14 setcors as follows
1 Agriculture
2. Forestry and Logging
3. Fishing
4. Mining and Quarrying
5. Registered Manufacturing
6. Unregistered Manufacturing
7. Construction
8. Electricity, Gas and Water
9. Transport, Communication and Storage
10. Trade, Hotels and Restaurants
11. Banking and Insurance
12. Real Estate, Ownership of Dwellings and Business Services
13. Public Administration
14. Other services
There are three methods of measuring national income of country-Net output method, income method and expenditure method. In India, it has not possible so far to estimate national income by any one of these methods because of non-availability and unreliability of data. Therefore, different methods are used for estimating contribution of different sectors to the national income. Methodology followed by CSO is as follows
1 Net Output Method (Value Added Method) is used to estimate domestic product in the following sectors(i) Agriculture and allied Activities (ii) Forestry and logging. (iii) Fishing, (iv) Mining and quarrying, activities, (ii) Forestry and logu (v) Registered manufacturing.
2. Income method is used t sectors-i) Unregistered manura supply, (iii) Banking and insur storage, (v) Real state, owner le method is used to estimate domestic product in the following ” Banking and insurance, (iv) Transport, communication and Real state, ownership of dwellings and business services, ade, hotels and restaurants. (vii) Public administration and defence,
(viii) Other services.
3. In ‘Construction sector, estimates of domestic product are based on a mbination of commodity-flow and expenditure approach. Sector-wise method of measuring national income followed by SCO can be understood with the help of following table also
National Income Study Material
IMPORTANCE OF NATIONAL INCOME
“National income statistics provide a wide view of the country’s entire economy, as well as of the various groups in the population who participate as producers and income receivers, and that, if available over a substantial period, they reveal clearly the basic changes in the country’s economy in the past and suggest if not fully reveal, trends for the future.”
(1) A View of Economy. National income presents a complete view of the economic progress and development of a country. If national income and per capita income show an increasing trend, it reveals economic development of the country.
(2) A Measure of Economic Welfare. National income and per capita income measure the economic welfare of people. Increasing per capita income implies an increase in economic welfare. It helps in improving the standard of living of people.
(3) Comparative Study. National income and per capita income at constant prices provide a base of comparative study. Economic progress of different years may be compared on the basis of these data.
(4) Helpful at International Level. The data of national income and per capita income help in comparative study at international level also. Economic progress of different countries may easily be compared on the basis of these data.
(5) Helpful in Economic Planning. The data of national income and per capita income provide valuable information on consumption, savings and investments. These data are helpful in economic planning.
(6) Helpful in Forecasting. The data of national income of past several years establish a trend of these data. Such trend is very helpful in estimating the data for future.
National Income Study Material
PROBLEMS IN THE ESTIMATION OF NATIONAL INCOME IN INDIA
Central Statistical Organization collects data from various sources. National sample surveys are conducted to collect data on some specific subjects. Various types of index numbers are used to make the series more viable. Thus, though the CSO is making continuous attempts to make the data more meaningful, even correct estimation of national income is not an easy task. Various difficulties are faced in the estimation of national income. These problems may be divided into two categories—(I) General or procedural problems, (II) Conceptual problems. (1) General Or Procedural Problems
These are the problems that are faced in the process of collection of data. Important problems of this category are as follows
(1) Non-availability of Data. The first problem in the estimation of national income in India is that a large number of individuals, households and firms do not maintain regular accounts. If they do so, accounts maintained by them are not perfect from national income point of view.
(2) Economic Differentiation of Activities. Second problem is that there is no rigid classification of working force in different occupations. For example, a large number of doctors serving in hospitals and medical colleges, do their private practice also. In such cases, it becomes very difficult to estimate their real contribution to national income.
(3) Production for Self-consumption. Production for self-consumption also causes a difficulty in the process of estimation of national income. Farmers retain a considerable part of their produce for self-consumption. practically, it is very difficult to estimate the value of such production.
(4) Non-monetized Sector. about 70% of our total population is still living in villages. In some villages, barter system of exchange is still in use. It means that some transactions do not enter into monetary sector and thus, these transactions are excluded from national income.
(5) False Information Regarding Production and Income. Some individuals, households and producers do not keep proper and fair accounts of their income. They destroy facts and provide false information about their production and income. They do so to evade income tax and wealth tax etc.
(6) Problem of Double Counting. Problem of double counting is a serious problem in the estimation of national income in India. Many goods and services are used for more than one time in the process of production. It is not always possible to make a clear and specific distinction between intermediate goods and final goods. For Example, wheat is a final product for a farmer but for flour mill, it is a raw-material. In such cases, it becomes difficult to estimate real contribution of each of these units to the national income.
(II) Conceptual Problems
(1) Problem of New Goods and Services. National income estimates are prepared at current and constant prices. There are some commodities produced now but were not produced in the base year. Problem arise to fix the base year price for such commodities.
(2) Problem of the Constituents of National Income – difference among different countries on the issue of constitutents income. Some countries include services also in national income countries do not include services. Due to this reason, national income different countries are not comparable.
