National Income

Meaning, Definitions and Measurement

 

Meaning of National Income

National income refers to the total value of goods and services produced within a country’s borders in a specific time period, typically a year. It is a key indicator of a country’s economic performance and is used to measure the overall health and growth of an economy. National income includes all economic activities carried out by individuals, businesses, and the government, and it serves as the foundation for calculating important economic indicators such as GDP (Gross Domestic Product), GNP (Gross National Product), and NNP (Net National Product).

Definitions of National Income

The concept of national income has been defined by various economists and authors over time. Here are definitions provided by some prominent economists:

1. According to Alfred Marshall

Marshall defined national income as “the labour and capital of a country acting on its natural resources, and producing annually a certain net aggregate of commodities, material and immaterial, including services of all kinds. ”

2. According to Adam Smith

Smith, often considered the father of modern economics, discussed national income in terms of the “annual produce of the land and labour of the society.”

3. According to John Maynard Keynes

Keynes emphasized the importance of national income as a measure of economic performance and welfare. He defined national income as “the money value of all goods and services produced in an economy during a period of time.”

4. According to Simon Kuznets

Kuznets developed the concept of GDP (Gross Domestic Product) as a measure of national income. He defined GDP as “the sum of gross value added by all resident producers in the economy plus any product taxes and minus any subsidies not included in the value of the products.”

5. According to Paul Samuelson

Samuelson contributed to the understanding of national income by describing it as “the net national product measured in money.”

 

These definitions reflect different perspectives and emphases, but collectively, they underscore the importance of national income as a measure of economic activity and the overall well-being of a nation.

 

Measurement of National Income

For measuring national income, the economy through which people participate in economic activities, earn their livelihood, produce goods and services and share the national products is viewed from three different angles.

i. The national economy is considered as an aggregate of producing units combining different sectors such as agriculture, mining, manufacturing, trade and commerce etc.

ii. The whole national economy is viewed as a combination of individuals and households owning different kinds of factors of production which they use themselves or sell factor- services to make their livelihood.

iii. The national economy may also be viewed as a collection of consuming saving and inventing units, (individuals, households and government)

Following these notions of a national economy, national income may be measured by three different corresponding methods:

1. Net product method

2. Factor – income method

3. Expenditure method

 

1. Net product method

It is also called net output method or value added method. In its standard form, this method consists of three stages:

i. Estimating the gross value of domestic output in the various branches of production.

ii. Determining the cost of material and services used and also the depreciation of physical assets.

iii. Deducting these costs and depreciation from gross value to obtain the value of domestic output.

The net value of domestic product thus obtained is often called the value added or income product which is equal to the sum of wages, salaries, supplementary labour incomes, interest, profits and net rent paid or accrued.

Value Added​ = Output at Basic Prices−Intermediate Consumption

In this formula:

*Output at Basic Prices is the total value of goods and services produced by a sector .

*Intermediate Consumption​ is the total value of goods and services used up in the production process by sector.

To calculate national income using the value added method, you would sum up the value added across all sectors of the economy, including primary (e.g., agriculture, mining), secondary (e.g., manufacturing), and tertiary sectors (e.g., services).

Lets understand it with the help of an example.

Let’s consider a simplified example with three sectors: Agriculture, Manufacturing, and Services.

i. Agriculture

(a) Output at basic prices – $500,000

(b) Intermediate Consumption : $200, 000

(c) Value Added : $ 500, 000 – $ 200, 000 = $ 300, 000

 

2. Manufacturing

(a)  Output at basic prices – $800,000

(b) Intermediate Consumption : $400, 000

(c)  Value Added : $ 800, 000 – $ 400, 000 = $ 400, 000

3. Services

(a)  Output at basic prices – $1,200,000

(b) Intermediate Consumption : $600, 000

(c)  Value Added : $ 1,200, 000 – $ 600, 000 = $ 600, 000

Now, calculate National income using the value added method:

National Income = Value added (Agriculture) + Value added (Manufacturing) + Value added (Services)

National income = $300,000 + $400,000 + $600,000 = $ 1,300,000

Therefore, the National income using value added method in this simplified example is $1,30,000.

This method is crucial for understanding the contribution of each sector to the economy’s overall output and income generation. It helps policymakers and analysts assess the efficiency of production processes and track changes in productivity over time. It is a widely used method for calculating national income as it avoids double counting, which is quite a serious error while estimating national income.

2. Factor-income method

This method is also known as income method and factor-share method. It calculates national income by summing the incomes that firms pay households for the use of factors of production. Factors of production includes labor (wages and salaries), capital (profits and interest), land (rent), and entrepreneurship (profits).

Thus,

National income = Rent + Wages + Interest + Profit

The total factor incomes are grouped under 3 categories labor income, capital income and mixed-income.

i. Labor incomes

Labor incomes included in the national income have 3 components

• wages and salaries paid to the residents of the country including bonus and commission and social security payments.
• Supplementary labor incomes including employers contribution to social security and employees welfare funds and direct pension payments to retire employees.
• supplementary labor income in kind for example free health and education food and clothing and accommodation etc.

ii. Capital income

According to Studenski,  capital incomes include the following capital earnings

• dividends excluding into corporate dividends;
• undistributed before takes profits of corporations;
• interests on bonds mortgages and saving deposits (excluding interests on war bonds and on consumer credit);
• interest earned by insurance companies and credited to the insurance policy reserves;
• net interest paid out by commercial banks;
• net rents from land buildings etc. including imputed net rents on owner-occupied dwellings ;
• royalties and
• profits of government enterprises.

iii. Mixed-income

Mixed incomes include earnings from

• farming enterprises;
• sole proprietorship not included under profit or capital income and
• other profession for example legal and medical practices Consultancy Services trading and transporting etc. This category also includes the income of those who earn their living through various sources as wages rent on own property interest on own capital etc.

 All these 3 kinds of incomes with labor income capital incomes and mixed incomes added together give the measure of national income by factor income method

The factor income method provides an alternative way to measure national income compared to the expenditure approach (summing up all spending in an economy) and the production approach (summing up the value added at each stage of production). It is particularly useful for understanding how income generated from economic activities is distributed among different factors of production within an economy.

3. Expenditure Method

The expenditure method, also known as final product method. It measures national income by summing up all the expenditures made on final goods and services produced within an economy during a specific period (typically a year).

 Components of Expenditure include :

i. Consumption (C)

This includes spending by households on goods and services. It encompasses purchases of durable goods (like cars and appliances), non-durable goods (like food and clothing), and services (like healthcare and education).

ii. Investment (I)

This refers to spending by businesses on capital goods (machinery, equipment, buildings), changes in inventories (unsold goods produced), and residential construction.

iii. Government Spending (G)

This includes expenditures by all levels of government (federal, state, and local) on goods and services. It covers spending on public goods (like infrastructure and defense), social services (like education and healthcare), and government employee salaries.

iv. Net Exports (Exports – Imports) (X – M)

This represents the difference between exports (goods and services sold to foreign countries) and imports (goods and services purchased from foreign countries). A positive net export value adds to GDP, while a negative value subtracts from GDP.

Calculation: National income using the expenditure method is calculated as follows:

National income =C+I+G+(X−M)

The expenditure method provides a comprehensive view of economic activity by aggregating spending across different sectors of the economy. It is particularly useful for policymakers and analysts to understand the drivers of economic growth, as changes in any of the expenditure components can indicate shifts in consumer behavior, business investment, government priorities, or international trade dynamics.