13 – Basic National Income Concepts

Introduction

Macroeconomics is concerned with determining the total output of the economy, the price level, the level of employment, interest rates, and other variables. “National income accounting” is a necessary step in understanding how these variables are determined. The national income accounts provide us with regular estimates of GNP — the fundamental measure of the economy’s performance in creating goods and services. National income is the most comprehensive indicator of an economy’s aggregate economic activity. It is a nation’s total income as opposed to an individual’s income, although the concept of national income is not as straightforward and self-explanatory as the concept of individual income.

13.1 National Income Concept

National income can be defined as the aggregate of money value of the annual flow of final goods and services in the national economy during a given period.

Paul Studenski, a well-known writer, writes: “National income is both a flow of goods and services and a flow of money incomes. It is therefore called national product as often as national income”.

When production units combine capital and labour to produce products and services, the flow of national revenue begins. This is referred to as the Gross National Product (GNP), and it is the total value of all final products and services generated by domestically owned factors of production over a certain time period. It comprises the worth of manufactured products like houses and food grains, as well as the value of services like broker services and economist lectures. The output of each of these is valued at its market price, and the total values are summed to give GNP. At the same time, the production units that generate products and services pay incomes to all who contribute to production in the form of wages, rent, interest, and profit; this is referred to as Gross National Income.

GNI is the sum of the money incomes derived from activities involving current production in an economy in a given time period.

As previously stated,

-National income is an aggregative value concept; it uses the value determined by money as the common denominator.

-The concept of national income is a flow: it reflects a specific amount of aggregate production per unit of time, traditionally one year, and is related to a specific year.

-National income indicates the aggregate value of finished goods rather than the overall value of all goods generated in the economy.

We would not want to add the complete cost of a car manufacturer to put on the car. The automobile components sold to manufacturers are classified as “intermediate goods,” and their value is not included in GNP.

In practice, working with the “value-added” avoids double counting.

It should be emphasised that the sum of the value contributed at each stage of processing equals the final selling price of the bread. Directly purchased flour by households for use in home baking is considered a contribution to the GNP because it denotes a final sale. It denotes that national income is an unduplicated total with no double counting. There are three distinct stages or phases in the national economy’s flow of output and money.

1. All production units produce things and services via the employment of labour, capital, and enterprise.

2. Income is distributed to all factors that supply labour, capital, and so on. Wages, interest, rent, and profit are examples of this distribution.

3. Consumption goods (c) and investment goods (I) make up the majority of the goods and services that people spend their money on.

As a result, we have three types of national income estimates:

1. National income as net aggregate output
2. National income as the sum of distributive shares
3. National income as aggregate value of final products

13.1.1 The Gross and Net Concept

Gross emphasises the fact that no allowance for capital consumption or depreciation has been made.

Net denotes that provision for capital consumption or depreciation has already been subtracted.

Depreciation is thus the difference between the gross aggregate and the net aggregate.

GNP at market price/factor cost = NNP at market price/factor cost + Depreciation cost

13.1.2 Concepts of Nationality and Domesticity

The term national signifies that the aggregate under examination represents the overall revenue accruing to a country’s normal people as a result of their participation in global output during the current year. Thus, the term ‘national’ emphasises that the aggregate under examination includes all forms of factor income accruing to normal people of a country, regardless of whether the components of production supplied by them are located at home or elsewhere.

In contrast, the value of total output or income originating within a country’s specific geographical boundaries, known as “domestic territory,” can also be measured. The resulting metric is known as “domestic product.”

In other words, the difference between “national” and “domestic” aggregates is in the frame of reference—the former takes ordinary people of a country, while the latter takes a specific “geographical area.” The amount of net factor income from overseas distinguishes national product from domestic output in this case.

GNP at market price/factor cost = GDP at market price/factor cost + Net factor income from abroad
NNP at market price/factor cost = NDP at market price/factor cost + Net factor income from abroad
Net factor income from abroad = Factor income received from abroad — Factor income paid abroad.

13.1.3 Market Prices and Factor Costs

The valuation of the national product at market prices represents the total amount paid by end buyers. In contrast, the valuation of the national product at factor cost represents the total amount received by the factors of production for their contribution to the final output.

GNP at market price equals GNP at factor cost + Indirect taxes – Subsidies.

NNP at market pricing equals NNP at factor cost + Indirect taxes – Subsidies.

Likewise, vice versa.

	Category A	Category B
Type 1	GNP at market price NNP at market price	GOP at market price NDP at market price
Type 2	GNP at factor cost NNP at factor cost	GDP at factor cost HDP at factor cost

 

1. The difference between aggregates in categories A and B is net factor income from overseas.

2. The difference between aggregates of type 1 and aggregates of type 2 is that indirect taxes are lower for aggregates of type 2.

3. Depreciation is the difference between the two aggregates of each type in each category.

13.1.4 GDP (Gross Domestic Product) and GDP (Gross National Product)

For various purposes, we need to calculate the total income generated by production within the borders of an economy, regardless of whether it belongs to the citizens of that nation or not. This type of income is known as Gross Domestic Product (GDP), and it is calculated as follows:

GDP = GNP – Net factor income from abroad

Factor income received from overseas minus factor income paid abroad equals net factor income from abroad.

Example: If the GNP in 2022 is 8,00,000 million, and the income (including tax on such incomes) received and paid is 60,000 million and 70,000 million, respectively, the GDP in 2022 is: (8,00,000 – 70,000 + 60,000) million = 7,90,000 million.

GNP as a Sum of Expenditures on Final Products

In an economy, final-product expenditure can be divided into the following categories:

1. Personal consumption expenditure (c): The sum of expenditures on both durable and non-durable commodities, as well as consumption services.

2. Gross Private Investment (I_g) is the total amount spent on capital goods replacement and additional investment.

3. Government expenditure (G) is the sum of the government’s expenditure on consumption and capital goods.

4. Net Exports (Exports – Imports) (X – M) are the difference between the expenditure of the rest of the world on the national economy’s output and the expenditure of the national economy on the rest of the world’s output.

GNP is the total of the four categories of consumption spending listed above. In other words, GNP = C + I_g + G + (X – M).

GNP as the Total of Factor Incomes

As previously stated, the national product measures a country’s productive activity, regardless of whether it occurs at home or overseas. When we compute national income after excluding indirect taxes such as excise duty, sales tax, and so on and incorporating subsidies, we get GNP at factor cost, which is the amount received by all the factors of production (indirect taxes being the amount claimed by the government and subsidies becoming a part of factor income).

GNP at factor cost = GNP at market prices – Indirect taxes + Subsidies.

13.1.5 Net National Product

The NNP is a closely related alternative measure of national income. It differs from GNP only in one way. GNP is the total of all final products. Consumption goods plus gross investment plus government expenditures on goods and services plus net exports are all included. In this case, gross investment (GI) is the increase in investment plus fixed assets such as buildings and equipment, and it so exceeds net investment (NI) after depreciation.

GNP = NNP + Depreciation.

Net private investment is included in NNP, whereas gross private domestic investment is included in GNP.

We all know that assets are used or depreciated during the manufacturing process. So, the net contribution to output throughout a year is the production of goods and services less the depreciation. This is known as NNP at market prices because it is the net money worth of final products and services generated during the year at current prices after depreciation.

Gross National Product                                               585.00

Less:

Capital consumption allowances                              51.6

Equals:

Net National Product                                                   533.4

Less:

Indirect business taxes                                                56.6

Other adjustments                                                        -1.6

Equals:

National Income                                                           478.4

 

Equation

NNP = GNP – Depreciation

= C + I_g + G + (X – M) – Depreciation

= C + G + (X – M) + (I_g – Depreciation), where I_g = Government investment

= C + G + (X – M) + I_n, where I_n = Net investment, C = Consumption expenditure,

G = Government Expenditure, X = Export, M = Import

= C + G + In + (X – M)

Where I_n represents net investment which equals gross investment minus depreciation (I_g – Depreciation).

At Factor Cost, NNP (or National Income)

Factors of production are used to create goods and services. National income, or NNP at factor cost, is the total of all income payments received by these production factors.

NI = Gross National Product – Depreciation – Indirect Taxes + Subsidies

Subsidies are added since factors receive them, but indirect taxes are eliminated because they do not form part of the factor income.

NNP at factor cost equals NNP at market prices less indirect taxes and subsidies.

13.1.6 Personal Income

The total income accruing to the factors of production for their contribution to current production is referred to as national income. It does not represent the overall revenue received by individuals.

The discrepancy between national and personal income is explained by two sorts of causes. On the one hand, a portion of the total income that accrues to the factors of production is not distributed to the individuals who own the factors of production. Corporate taxes and undistributed or kept profits are clear examples. However, the total income that persons get often includes some portion that is recognised as payment for the factor services given in the current year, such as gifts, pensions, relief payments, and other welfare payments. Such payments are referred to as “transfer payments” since they do not represent payments made in exchange for any direct contribution to current production.

Thus, personal income is determined by deducting from national income those types of income that are earned but not received and adding those that are received but not yet earned. So

Personal income = NNP at factor cost – Undivided profits – Corporate taxes + Transfer payments

13.1.7 Disposable Income

Disposable income is the entire amount of money that individuals can spend as they see fit. The amount of direct taxes paid by individuals distinguishes it from personal income.

Personal Income – Personal Taxes = Disposable Income

DI = PI – T

As a result, PI = DI + T

People usually divide their disposable income between consumption and personal savings.

As a result, we have the following identities:

DI + T = PI

DI = C + S

It is as follows: PI = C + S + T

13.2 A Few Important Identities

Under the assumption that the simple economy does not have a government or foreign commerce, we represent the value of output by ‘Y.’ Consumption is represented by the letter ‘C,’ whereas investment spending is represented by the letter ‘I.’ The crucial distinction is between output created and output sold.

Because output sold may be expressed in terms of consumption and investment spending, the identity of output generated and output sold can be determined.

Y = C + I                                        (1)

The production produced is the same as the output sold.

Now, a portion of the total, Y, will be spent and a portion will be kept. So

Y = S + C                                        (2)

This means that the entire income is dedicated to either consumption or saving. Identity (1) and (2) can be joined to form the following sentence:

C + I = Y = C + S                            (3)

The components of demand are shown on the left side of identity (3), while the allocation of income is shown on the right side. The identity emphasises the fact that output created equals output sold. The value of output produced equals the value of revenue received, and income received is spent or saved.

Identity (3) can be rephrased as the relationship between saving (S) and investing (I). By subtracting consumption (C) from each component of identity (3), we arrive to

I = Y – C = S                                 (4)

Identity (4) is critical. It demonstrates that in this simple economy, saving is the same as income less consumption, and investing is comparable to saving.

The identity is merely a reflection of our definitions: output minus consumption equals investment, output equals income, and income minus consumption equals saving.

The Reintroduction of the Government and Foreign Trade

We are now going to restore the government sector and the external sector, G. All taxes represent the government’s purchase of goods and services. TR stands for transfer to the private sector (including interest). X represents net exports (X – M).

We revert to the simpler identification of output generated and sold, taking into account extra demand components G and X. So

Y = C + I + G + X                     (5)

We must now acknowledge that a portion of income is spent on taxes and that the private sector receives net transfers (TR) in addition to national income.

Thus, disposable income (YD) equals income plus transfers less taxes.

YD = Y + TR – T                       (6)

Disposable income is allocated to consumption and saving

YD = C + S                               (7)

By combining identities (6) and (7), we can express consumption as the difference between income + transfers minus taxes and savings.

C + S YD = Y + TR – T             (8)

OR

C = YD – S = Y + TR – T – S             (8a)

According to Identity (8), consumption equals disposable income less saving, or consumption equals income plus transfers less taxes and saving. We now use the right-hand side equation (8a) to replace C in identity (5).

Y = Y + TR – T – S + I + G +X

OR

Y – Y + S – I = (G + TR – T) + X

OR

S – I = (G + TR – T) + X                               (9)

In equation (9) the term (G + TR – T) represents the government’s budget deficit. (G + TR) represents overall government spending by combining government purchases of goods and services (G) with government transfer payments (TR). T is the amount of taxes collected by the government, and the difference (G + TR – T) is the government’s surplus. Spending over receipts, or a budget deficit. The second term on the right is the surplus of exports over imports, often known as the net export of goods and services.

Thus, identity (9) states that the business sector’s excess of saving over investment (S – I) equals the government budget deficit plus the trade surplus.