Table of Contents
- Definitions of national income
- Major concepts of national income
- Importance of national income
- Measurement of national income
- Limitations of using national income data
- Circular flow of income
National income is the total value of income that individuals and enterprises earn in a country. It means the value of goods and services a country produces during a financial year. It is therefore the net income of all economic activities of a country during a year period. We view national income in terms of money. People use the term interchangeably with National Output, National Dividend, or National Expenditure. It includes all payments made to resources and this comes in form of either wages, rent, interests, or profits. Basically, a country’s growth in national income determines its progress. We can also refer to national income as the value of the aggregate output of the different sectors of the economy. This aggregate output is within a time period, mostly one year.
The concept of national income occupies a vital place in carrying out a macroeconomic analysis. A government evaluates the economic performance of her economy with the help of national income data. Through this data, the government formulates her different policies for solving different problems of the economy. This helps to maximize the people’s welfare. In general terms, national income is the total value of goods and services a country produces per annum. They are normally distributed among factors of production in form of rent, wages, interests, and profits.
Definitions of national income
There are two basic national income definitions which are the traditional definition and the modern definition.
Under the traditional approach, we shall look at different definitions by different economists. These economists include Marshall, Pigou, Cairncross, and Kuznets.
According to Marshall’s view, “The labor and capital of a 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 net annual income of or the revenue of the country or national dividend”.
The word ‘net’ means deductions from total gross production concerning depreciation. Depreciation involves wearing out of plants and machinery. Net income from abroad is inclusive. We may view it as a national dividend, a flow of goods and services excluding funds.
Quoting Marshall’s words, “the national dividend is at once the aggregate net product of and the sole source of and the sole source of payment for all agents of production within a country”. That means what an economy produces is distributed among different factors of production.
A.C. Pigou defined national income as “That part of the objective income of a community, including, of course, income derived from abroad which can be measured in money”. This definition is narrow because it does not include non-marketed goods and services. that is those goods and services which do not involve money payment. Pigou’s definition omitted some components. He argued that when a man marries his housemaid, the national income will reduce. This is because he is not supposed to pay any wages to his wife whom he used to pay before marriage. The major criticism of this definition is that it is narrow.
Prof. Cairncross’s definition
Prof. Cairncross said, “National income is, in fact, simply the output upside down. What we produce flows in a reservoir, from the joint output of the community”.
Simon Kuznets’s definition
Simon Kuznets defined national income as “the net output of commodities and services flowing during a year from a country’s productive system in the hands of the ultimate consumers”.
Looking at the above definitions, Marshall’s definition seems to be more detailed.
The modern definition
National income is the monetary measure of all the goods and services a nation produced in a year. It is the total of all personal income. That is, the sum of all wages, rent received, interests and profits in a country in a year period. This implies the total income that accrues to all factors of production in the country. It is therefore the value of goods and services produced within a time period usually a year. We estimate the value of these goods and services in monetary terms.
The National Sample Survey defined national income as “the money measures of net aggregates of all commodities and services accruing to the inhabitants of a country during a specific period”.
Froyen defined national income as “the sum of all factor earnings from current production of goods and services. Factor earnings are incomes of factors of production”. Also, Gardner Ackley stated that “National income is the sum of all (I) wages, salaries, commissions, bonuses and other forms of income (ii) net income from rents and royalties (iii) interest (iv) profit”.
Prof. Lipsey and Chrystal stated that national income in general terms is “the value of the nation’s total output and the value of the income generated by the production of that output”.
The National Income Committee of India pointed out that “A national estimate measures the volume of commodities and services turned-out during a given period counted with duplication”.
National income, therefore, is the monetary value of all production and earnings of the country within a time period usually one year. National incomes equal net national product excluding direct business taxes.
Major concepts of national income
This is an individual’s earnings in monetary terms. Individuals earn when they partake in the production of goods or for rendering services. Personal income includes wages and salaries, payment for services, rent paid to landlords, interest received by a capital owner, and profit received by an entrepreneur.
Personal income minus personal income tax is equal to disposable income. When you deduct personal income tax from your personal income, what is remaining is the disposable income. It is the amount left for spending and saving.
Gross domestic product (GDP)
This is the total monetary value of all goods and services a country produces within a year. Here all residents of a country produce these goods and services irrespective of whether they are citizens or foreigners. This concept places more emphasis on the geographical aspect of production. That is the total value of output in a country. It does not include the earnings of citizens and their investments outside the country. It includes the earnings of foreigners and the earnings a country gets from foreign investments. Also, there is no allowance for the depreciation of assets. Gross domestic product is the same as for Gross Domestic Income. This is because the income received for producing goods and services has to be equal to the value of the products (goods and services). It is only concerned with the internal production of the country.
Gross national product (GNP) [Gross National Income]
Gross national product was initially referred to as the Gross National Income (GNI) and it is the total monetary value of goods and services that a country’s citizens produce. This includes income from their investments both within the county and abroad. In other words, it includes net income from abroad. The gross national product includes the earnings of citizens and their investments outside the country. It does not include the earnings of foreigners and their investments in the country. This also does not give allowance for depreciation. Some residents receive their income from abroad. Foreigners also receive income payments from the country. The difference between the two types of income is what we call the net income from above.
GDP vs GNP
Comparing the gross domestic product and gross national product, you think they are similar but they are not; this is because GDP measures the income from goods and services of a country in a year, irrespective of income from citizens and non-citizens; whereas GNP measures income from only the citizens of a given country, irrespective whether they are currently living in the country or another country. While GDP includes the earnings and investments of foreigners in the country, GNP does not include them.
Net domestic product (NDP)
Net domestic product is simply the gross domestic product less depreciation. Depreciation is a decrease in the economic value of an asset. There is an allowance for depreciation, usually, wear and tear of capital. We can describe it as the total monetary value of goods and services in which all residents of a country produce. It includes the earnings they get from their investments, whether citizens or foreigners. After summing up these variables, we deduct depreciation.
Net national product (NNP)
We get our net national product after deducting depreciation from the gross national product. This depreciation occurs in form of wear and tear, disuse, etc. of assets that are used in production. It is the total monetary value of goods that a country produces. This also includes income from their investments, whether home or abroad after deducting depreciation.
Per capita income
Per capita income is the income we get after dividing the national income by the country’s population. In essence, it is the income per head of the population.
Importance of national income
National income estimates are very important to any economy of the world. Various aspects of a nation’s economy need to measure the national income. This helps to determine the type of policy they should formulate. We shall discuss the uses of national income estimates below;
National income estimates provide detailed data on the contribution on the contribution of various sectors in the economy. This also includes their national output. It includes information which states the government’s revenue and expenditure. It displays the various sources of income such as wages, rent, profit, and interest. National income gives a clear picture of the country’s economic growth. It helps to indicate the status of an economy. This data helps economists to formulate economic policies for economic development. Policymakers and economic planners will be able to know the right line of action to take. For example, if the planners are aimed at increasing employment and output, national income estimates will be a guide. It will help to determine whether the policymakers were able to achieve their desired goals. Economic planners set growth rate plans during development plans.
National income has an influence on foreign investments. Foreign investors run to countries that have rich and fast-growing economies. Per capita income usually gives policymakers a rough idea of a demand for foreign investors.
Standard of living
National income helps to compare the standard of living between countries and the people in the same country. Economists compare the standard of living in a country in a country at different times. Mostly the per capita income of a country serves this purpose. It becomes possible to compare the standard of living of different countries. Economists do this by reducing the per capita income of different countries to the same currency. This currency is usually the U.S. Dollar. Countries with higher per capita incomes have a higher standard of living. The capita income of the same country at different periods is relevant in comparing the standards of living per time. The per capita income roughly indicates the general well-being of a country’s citizens. A higher per capita income indicates a higher standard of living.
The government uses national income figures to measure economic progress. These figures provide clear information about the growth rate and performance of an economy. By comparing the different data for different years, the status of the economy will be clear. We will be able to know what is happening to the entire economy. It shows whether the economic growth rate is high or low. Also, whether there is an increase or decrease. When the economic growth is low, the policymakers do something about it. They adopt measures to improve the performance of the economy. Here it is easy to find out the contribution of various sectors of the economy and identify those sectors that need more attention.
Determines technical assistance
Through national income data, the World Bank and the United Nations sometimes give priority to poorer countries. It gives an avenue for technical assistance when they have a rough idea of the national income of different countries.
A country’s contribution to international organizations is highly dependent on the degree of its prosperity. These international organizations include the Commonwealth, United Nations, etc. National income estimates greatly determine the progress of a country’s economy. This most times form the basis for contributing to international organizations.
A country’s budget highly depends on the net national income and its concepts. The government formulates its annual budgets through the help of national income estimates. This is to avoid selfish or desire-based policies.
Inflation and deflationary gaps
For timely policies that are meant to curb inflation and deflations, the government needs aggregate national income data. if expenditure increases, it shows inflationary gaps while it shows deflationary gap when expenditure decreases.
Defense and development
National income estimates help to divide the national product between the defense and development purpose of the country. From national income data, the government will know how much to set aside for the defense budget.
Measurement of national income
There are three methods of measuring national income, the income approach, the net product (output approach), and the expenditure approach. The three approaches arrive at the same goal.
When factors of production produce goods and services, consumers pay for them. The sum total of this income constitutes the national income. The income received by factors of production has to be equal to the expenditure incurred in producing the goods and services. The sum total of all expenditures constitutes the national expenditure.
Under this method, we take account of all the income received within a year period. These income receipts involve individuals, firms, and the government. All wages and salaries, rent, profit, and interest are summed up. In order to avoid double-counting, economists do not include transfer payments. Examples of transfer income include gifts to orphans, aged, students and beggars, and pension to retirees. These are part of people’s income which is already counted. The income must be that which arises from the production of goods and services. Aside from excluding transfer payments, we also exclude business expenses.
Using the income approach, we either arrive at the gross domestic product or the gross national product at factor cost. This is because we find the total figure by adding up all costs, that is, the income of all the factors of production. We add taxes and subtract subsidies in order to get the GDP and GNP.
Output or net product approach
Under this method, we measure national income in terms of the value (monetary) of all the goods and services the various economic units produce in a year. under this method, we add up the value of the net contributions of the different sectors in a country. To avoid double-counting, we measure income on a value-added basis. Value-added is the value of outputs minus the cost of inputs. Examples are, the cost of raw materials like maize and soya beans in making poultry feeds must be subtracted from the poultry feeds to get the contribution of milling companies to national output.
The calculation includes the value of exports and less the value of imports. It includes the value of goods and services the producers themselves produce and consume. The value of houses (owner-occupied) is included. They should also include the value of the services house helps and voluntary organizations. Also, the value of public services such as justice and defense must reflect. The output approach reveals the GDP at market prices. We exclude taxes and subsidies to get the GDP at factor prices.
This approach measures the total expenditure by individuals, firms, and government on goods and services. Here, it is necessary to avoid double counting by identifying the expenditure (consumption or investment). This includes only expenditure on final goods and services. For instance, in the value of poultry feeds, we are careful not to add the prices of the ingredients used in making the feeds. Under this approach, we do not include transfer payments as well.
Under this approach, the formula for calculating national income is;
Y = National income
C = Private consumption expenditure
I = Private investment expenditure
G = Government expenditure on consumption and investment
X = Exports
M = Imports
P = Income from property
We can simplify the formula by reducing it to Y=C+I where
Y = National income
C = All expenditure on consumer goods and services
I = All expenditure on investment goods and services
Limitations of using national income data
Though national income estimates are important which we have stated above, there are limitations.
National income data does not state whether income is widely spread or concentrated in the hands of few. It does not disclose income distribution within a country. Per capita income is almost useless when it comes to measuring the standard of living of the people.
There are variations in the structure of production such as non-marketed products tend to be neglected. These non-marketed products are important in underdeveloped economies.
Quality of life
National income ignores the quality of life. Though it measures the monetary value of economic activities, it does not measure how happy and comfortable people are. It ignores the actual welfare of the people.
Different approaches in measurement
Different countries might have measured their national income using different approaches. The different methods of valuation among countries differ. In this instance, it is possible that what a country includes, another country may exclude. What makes up the national income of one country may be different from that of another country. For example, one country may include self-service while another may exclude it. Some may work out GDP at factor price while others will work it out at a market price.
Also, the method of computing national income figures can change over time. Economists may include certain items that were not part of the national income measurements. National income may increase but yet the standard of living low.
The population statistics may change over time and there may be problems in that area as well. The size of national income is not the actual measurement of the welfare of an economy. This is because of the changes in population sizes, population sizes can never be the same. Problems may arise as wrong population figures may be used to calculate the per capita income. Some countries do not have reliable data and using per capita income in such countries may give the wrong picture.
Changes in the value of money
The value of money changes over time. It can either increase or decrease. When prices increase, an increase in the national income does not mean an increase in the standard of living. This is because a certain amount of money can buy fewer goods. Changes in price level greatly limit the comparison of national income among yeas.
Also, converting the national income of different countries to the same currency is possible. Using foreign exchange rates there are still limitations in comparing the standards of living. The Standard of living largely depends on the value/purchasing power of money. Some countries may be having a high rate of inflation while others deflation.
National income ignores whether economic activities have positive or negative effects which cannot be measured in monetary terms. For example, if a manufacturing industry pollutes the environment and reduces the quality of life. It only shows the money the manufacturing industry generated.
Circular flow of income
Usually commodities and money flow between households and firms. There is a steady flow of inputs and outputs among the different sectors in an economy. Let us assume that there are only two sectors in the economy, the personal sector (households) and the firms (business sector). Households supply inputs (factors of production) to firms for the purpose of production. Firms pay the households wages, rent, interests, and profits which form part of their incomes. Households use the income to buy goods and services the firms produced. Household spending forms part of the firm’s income. This activity leads to the circular flow of income. Firms again will use the income they got through households to pay for the productive services of the households. As a result of this, income continues to move in a circle. Income flows towards one direction while commodities flow in the other direction.
Chyou is a published author who focuses on the field of international business. After an established career facilitating mergers and acquisitions for medium to large corporations, Chyou turned to writing to help students better understand international business concepts.