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National Income

INTRODUCTION

In macroeconomics, we deal with economic aggregates like saving, consumption, investment, employment, national income and national product. Though all these aggregates play an important role, this chapter focuses on an analysis of the national income, national product and related aggregates like personal income and disposable personal income. It is not only important to have an understanding of the different concepts but also equally important to understand as to how these aggregates are measured.

NATIONAL INCOME AGGREGATES

Here we focus on the different concepts of the national income and the related aggregates.

Gross National Product

Gross national product (GNP) is defined as the total value of all the final goods and services produced in a country in a particular year, plus the income which is earned by its citizens who are located abroad minus the income of non-residents located within that country. GNP is a measure of the value of goods and services that the nationals or residents of the country produce regardless of where they are located. It is, thus, the total income of a nation as earned by the citizens of a nation.

 

Gross Domestic Product

Gross domestic product (GDP) is defined as the total value of all the final goods and services produced by all the enterprises (both resident and non-resident) within the domestic territory of a country in a particular year.

 

The GDP, one of the most essential macroeconomic variables, can be said to measure both a nation’ total income and its total output of goods and services. It is believed to be one of the best indicators of judging an economy’ performance.

In calculating the GDP,

1. only market prices are used as they reveal the willingness of the public to pay for a good or a service;
2. only the value of currently produced goods and services are included.

Treatment of Inventories in the GDP

In general when a firm adds to its inventories of goods, it involves expenditure by the firms. Hence like production for the final sale of the product, the accumulation of inventories also increases the GDP.

Treatment of Intermediate Goods in the GDP

Production involves many stages: raw materials, intermediate goods and then the finished goods. It is important to note that only the values of the final goods are included in the GDP. The values of the intermediate goods are already a part of the market price of the final goods in the production of which they are used. This avoids duplication.

Imputations in the GDP

Imputed values have to be used in the GDP calculations for goods, which are not sold in the market. For example, for people living on their own for durable goods which are owned by households, meals which are cooked at home, etc.

Nominal GDP and Real GDP

Nominal GDP is the total of the value of the goods and services calculated at current prices. Real GDP is the total of the value of the goods and services calculated at constant prices.

 

Overall GDP Growth in India

Table 3.1 shows the overall growth of GDP in India. The rate of growth of GDP in India (at factor cost at constant 1999–2000 prices) in 2008–09, as per revised estimates released by the Central Statistical Organization (CSO) (29 May 2009) was 6.7 per cent. The growth of GDP represents a deceleration from high growth of 9.0 per cent and 9.7 per cent in 2007–08 and 2006–07, respectively.

 

Table 3.1 Overall growth of GDP in India (2003–2004 to 2008–2009)

Year	Rate of growth of total GDP at factor cost in India (in per cent)
2003–2004	8.5
2004–2005	7.5
2005–2006	9.5
2006–2007	9.7
2007–2008	9.0
2008–2009	6.7

GDP and Economic Activity

It is important to note that, often, the value of many goods and services do not get included in the GDP. Also, the imputations involved in the calculations of the GDP may not be accurate. Hence, the GDP is an imperfect measure of economic activity.

To some extent it can be pointed out that real GDP, as compared to nominal GDP, is a better measure of economic well being because it is not affected by a change in the prices.

Measurement of Real GDP

Real GDP can be calculated in following two ways:

1. by using base year prices;
2. by using chain weighted measures.

In general, and most often, the two methods are interlinked and used to measure variations in the production of goods and services in the economy.

GDP and the Other Measures of Income

From the GDP, we can arrive at the other measures of income in the national income accounts.

Gross National Product (GNP)

 

GNP = GDP + factor payments from abroad – factor payments to abroad

Net National Product (NNP)

 

NNP = GNP – depreciation

National Income (NI)

 

NI = NNP – Indirect business taxes

where,	depreciation = quantity of the economy’ stock of plants and equipment that wears out during the period of a year.
	indirect business taxes = like sales tax and value added taxes account for the difference between the price received by the firms and the price paid by the consumers for a good.

Personal income is the income received by the households and the non-corporate businesses. It includes income from all sources.

 

Personal Income

=

National Income (NI) – (Corporate Profits + Social Security Contributions + Net Interest) + (Dividends + Transfers from Government to individuals + Personal Interest Income)

We can arrive at the personal income from the national income by making some adjustments in the following sectors:

1. Corporate sector:
   1. Deduction to be made from the national income of undistributed corporate profits (or retained earnings) and the corporate taxes paid to the state.
   2. Addition to be made to the national income of dividends.
2. Government sector:
   1. Deduction of the contributions to social insurance.
   2. Addition to be made of the net amount the government pays as transfer payments to the individuals.
3. Household sector:
   1. Deduction of net interest.
   2. Addition to be made of the personal interest income.

Disposable Personal Income

Disposable personal income or personal disposable income is the amount, which is actually available to the households and to the non-corporate businesses after they have fulfilled their tax obligations to the government. It is the income available to the households for saving and consumption.

 

Disposable Personal Income = Personal Income – Personal Tax and Non-tax Payments

• Real GDP, as compared to nominal GDP, is a better measure of economic well being because it is not affected by a change in the prices.
• Real GDP can be calculated in two ways: by using base year prices and chain-weighted measures.

TABLE 3.2 Selected Indicators of the Indian Economy

MEASUREMENT OF NATIONAL INCOME

Many measures are used to estimate the aggregate economic activity in a country, mainly GDP, GNP and NNP. Among these, GDP is perhaps one of the most important macroeconomic variables and one of the best measures to judge an economy’ performance. Three approaches to calculating the GDP are the output approach, the income approach and the expenditure approach. Theoretically, the three approaches must yield the same result because the total expenditures on goods and services (GNE) must be equal to the total income paid out to the producers (GNI), and that in turn must also be equal to the total value of the output of goods and services (GNP).

We now attempt an analysis of the three approaches:

1. The output approach: It is also called the product method or the value added method. To estimate the GDP by this approach, the total value of all the final goods and services produced in an economy during a given time period are estimated.

   The stages involved are:

   1. Estimation of gross value of the domestic product: Firstly, this involves a classification of the production enterprises according to their activities. The three sectors here are the primary sector that relates to agriculture and allied activities, secondary sector (manufacturing sector) that includes all units engaged in producing material goods and tertiary sector (services sector) that includes all the units engaged in producing services like banking and transport.

      Secondly, the gross value or the value of the output is estimated from all the sectors in two ways:

      1. By multiplying the output of each sector with the respective price and then summing them up.
      2. By adding up the sales and change in stocks.
   2. Estimation of the intermediate cost of production and depreciation: While intermediate costs are estimated by including expenditure on non-factor inputs like raw materials, electricity and fuel used in the production process, depreciation may be estimated as a percentage of output or as a percentage of capital.
   3. Deduction of the intermediate cost of production and depreciation from the gross value to arrive at the net value of the domestic product.
2. The income approach: It is also called the factor income method or factor share method. To estimate the GDP by this approach, the total sum of the factor payments received during a given period is estimated. Depending on the way the income is earned, it can be classified into five components:
   1. Employee’ compensation, which includes the wages, salaries, and the fringe benefits received by the workers.
   2. Proprietor’ income, which includes the incomes of non-corporate businesses including small firms.
   3. Rental income, which includes all the rental income earned by the owners of properties including the imputed rent on the houses which are self owned.
   4. Corporate profits, which include the incomes of corporations after having made payments to the workers, creditors and others.
   5. Net interest, which includes the interest paid by the domestic business after deducting the interest received and also interest earned from abroad.

   All the different categories of income are added together to obtain the GDP from the income method.

3. The expenditure approach: The GDP can be classified into following four components of expenditure:
   1. Private Consumption Expenditure: It includes goods and services, which are purchased by households. These can be further grouped into three categories:
      1. Non-durable goods are goods, which last only for a short period like food and clothing.
      2. Durable goods are goods, which last for a long period like cars and electronic goods.
      3. Services include the work performed or services provided by firms, individuals and others for the benefit of the consumers like banking, accounting and auditing services.
   2. Investment Expenditure: It consists of goods and services bought for use in the future. It can be further grouped into three categories:
      1. Business fixed investment is the purchase of new plant and equipment by firms.
      2. Residential investment is the purchase of new housing by households and others.
      3. Inventory investment is the change in the inventory of goods of the firm. This change can be positive or negative depending on whether the inventories increase or decrease.
   3. Government Purchases: They include the goods and services bought by the different governments like defense equipment. It is to be noted that transfer payments to the individuals like social security payments are not included in the GDP as they are not the payments for any goods and services.
   4. Net Exports: They are the values of goods and services exported to other countries minus the value of goods and services imported into the country.

   A sum of all these different expenditures will give the GDP by the expenditure method.

Net Income from Abroad

It is important to understand that all the three methods discussed above yield the GDP at market price or the GDP for a closed economy. To arrive at the GDP for an open economy, we need to add to it the net factor incomes earned from abroad. Hence we will now obtain what is called the Gross National Income, GNI.

As already mentioned, theoretically, the three approaches must yield the same result. However, in practice there exist minor differences in results obtained from the various methods for several reasons; some of them are:

1. Changes in inventory levels and errors in the statistics. This occurs because the goods, which are in inventory have been produced (and are therefore included in GNP), but they are not yet sold (and are therefore not yet included in GNE).
2. Issues relating to timing can cause a slight difference between the value of goods produced (GNP) and the payments to the factors involved in the production of the goods. This is particularly so if the inputs are bought on credit, and also because the wages are often collected after the production period.

• To estimate the GDP by the output approach, the total value of all the final goods and services produced in an economy during a given time period is estimated.
• To estimate the GDP by the income approach, the total sum of factor payments received during a given period is estimated.

INTRODUCTION

The present chapter focuses on an analysis of the national income, national product and related aggregates like person income and disposable personal income.

NATIONAL INCOME AGGREGATES

1. GNP is the total value of all the final goods and services produced in a country in a particular year, plus the income which is earned by its citizens who are located abroad minus the income of non-residents located within that country.
2. GDP is the total value of all the final goods and services produced by all the enterprises (both resident and non-resident) within the domestic territory of a country in a particular year. It is taken to be one of the best indicators of judging an economy’ performance.
3. In calculating the GDP, only market prices are used and only the value of currently produced goods and services are included.
4. As far as inventories are concerned, accumulation of inventories also increases the GDP.
5. As far as intermediate goods are concerned, in the GDP only the value of the final goods (and not the intermediate goods) is included. This avoids duplication.
6. Imputed values have to be used in the GDP calculations for the goods that are not sold in the market.
7. Nominal GDP is the total of the value of the goods and services calculated at current prices whereas real GDP is the total of the value of goods and services calculated at constant prices.
8. GDP is an imperfect measure of economic activity because, often, the value of many goods and services do not get included in the GDP and the imputations involved in the calculations of the GDP may not be accurate. Real GDP is a better measure of economic well being because it is not affected by a change in the prices.
9. Real GDP can be calculated either by using base year prices or by using chain weighted measures.
10. GNP = GDP + Factor payments from abroad – Factor payments to abroad
11. NNP = GNP – Depreciation
12. NI = NNP – Indirect business taxes

PERSONAL INCOME

1. Personal Income is the income received by the households and the non-corporate businesses from all sources.
2. Personal Income = National Income (NI) – (Corporate Profits + Social Security Contributions + Net Interest) + (Dividends + Transfers from Government to individuals + Personal Interest Income).

DISPOSABLE PERSONAL INCOME

1. Disposable personal income or personal disposable is the amount, which is actually available to the households and to the non-corporate businesses after they have fulfilled their tax obligations to the government.
2. Disposable Personal Income = Personal Income – Personal Tax and Non-tax payments.

MEASUREMENT OF NATIONAL INCOME

1. GDP is one of the most important macroeconomic variables and one of the best measures to judge an economy’s performance.
2. Three ways of calculating the GDP are the output approach, the income approach and the expenditure approach.
3. The output approach is also called the product method or the value added method. Here, the total value of all the final goods and services produced in an economy during a given time period are estimated in three stages.
4. The income approach is also called the factor income method or factor share method. To estimate the GDP by this approach, the total sum of factor payments received during a given period is estimated.
5. In the expenditure approach, there are four components: private consumption expenditure, investment expenditure, government purchases and net exports.
6. Net Income from abroad is to be added to the GDP to arrive at the GNI.
7. The three approaches must, theoretically, yield the same result. However, in practice there exist minor differences in the various methods due to changes in inventory levels and errors in the statistics and due to issues related to timing.

TRUE OR FALSE QUESTIONS

1. GDP is a measure of the value of goods and services that the nationals or residents of the country produce regardless of where they are located.
2. Personal Income is the income received by the households and the non-corporate businesses.
3. Disposable personal income is the amount, which is actually available to the households and to the non-corporate businesses after they have fulfilled their tax obligations to the government.
4. Personal Income is perhaps one of the most important macroeconomic variables and one of the best measures to judge an economy’ performance.
5. Three approaches to calculating the GDP are the output approach, the income approach and the expenditure approach.

VERY SHORT-ANSWER QUESTIONS

1. Explain (a) GNP and (b) GDP
2. Explain the difference between personal income and disposable personal income.
3. What are the different approaches to the calculation of the GDP? Why should the three approaches yield the same result?
4. ‘Theoretically the three approaches to the calculation of the GDP must yield the same result. However, in practice there exist minor differences from the various methods for several reasons.’ Comment.
5. Give the other names for the income approach. What are the five components of income?

SHORT-ANSWER QUESTIONS

1. What is personal income? How can one arrive at the personal income from the national income?
2. How is the GDP calculated by the output approach? What are the different stages involved?
3. How is the GDP calculated by the income approach? What are the different components of income?
4. How is the GDP calculated by the expenditure approach? What are the different components of expenditure?
5. Differentiate between the GNP and the GDP. In the computation of the GDP, what is the treatment given to (a) inventories, (b) intermediate goods and (c) goods not sold in the market?

LONG-ANSWER QUESTIONS

1. Write a short note on the GNP and the GDP bringing out the difference between the two national income aggregates. Is the GDP a perfect measure of economic activity? Discuss.
2. Which are the three approaches to calculating the GDP? Discuss.
3. Write short notes on the following:
   1. GNP
   2. GDP
   3. Nominal GDP and Real GDP
   4. Personal income
   5. Disposable personal income
4. (a) How is the real GDP measured?

   (b) How can we arrive at the other measures of income in the national income accounts from the Gross Domestic Product, namely Gross National Product (GNP), Net National Product (NNP) and National Income (NI)?

5. ‘A sum of all the different expenditures will give the GDP by the expenditure method.’ Which are these expenditures? Discuss.

TRUE OR FALSE QUESTIONS

1. False. GNP is a measure of the value of goods and services, which the nationals or residents of the country produce regardless of where they are located.
2. True. Personal Income is the income received by the households and the non-corporate businesses. It includes income from all sources.
3. True. Disposable personal income is the amount, which is actually available to the households and to the non-corporate businesses after they have fulfilled their tax obligations to the government. It is, in fact, the income available to the households for saving and consumption.
4. False. GDP is one of the most important macroeconomic variables and one of the best measures to judge an economy’ performance.
5. True. Three approaches to calculating the GDP are the output approach, the income approach and the expenditure approach. Theoretically, the three approaches must yield the same result.