What is National Income?
Before defining national income, it is necessary to define income. Any benefit either in form of money or other that is received against a service is called income. There are four sources of income for an individual.
- Rent: It is the income receive from lending their land or property to others.
- Wage: Income receive from providing their own services or work. The work can be manual such as daily wage laborers or mental such as teacher or doctor.
- Interest: Income received from lending money or capital invested.
- Profit: Income received from running a business.
When we add rent, wages, interest, and profit of all individuals in a country in a year it is called national income. Thus, it is defined as ” National Income is the sum of income earned by all factors like land, labor, capital and entrepreneur in form of rent, wages, interest and profit in a year”. It can also be defined as the total market value of all final goods and services produced in the economy in a year.
National income simultaneously represents three things.
- Total market value of all goods and services produced.
- Total income received by all individuals such as firms and households.
- Total expenditure made on all goods and services produced
Alfred Marshall in his book “Principles of Economics” in 1890 defines NI as “
NI is the sum of all physical goods produced, and services provided by utilizing all its natural resources with the help of capital and labor. Net income from abroad is also included.”
National Income and National Product
National income is the sum of all incomes of the people of a country. National income is generated when goods and services are produced in a country in a year. These goods and services are produced by four factors of production including land, labor, capital and organisation and in turn earn incomes in form of rent, wages, interest and profit. Thus,
National income is the sum of all incomes earned by the four factors of production—land, labour, capital, and entrepreneurship—in the form of rent, wages, interest, and profit for their contribution to producing goods and services during a year.
National product is the total value of all final goods and services produced by various firms in a year. It is estimated by multiplying the total output of final goods and services with their market prices. Since this national product which is produced by the contribution of four factors of production – land, labor, capital and entrepreneurship distributed among them.
Therefore, out of this national product wages will be paid to those households which have sold their labor, landowners would get rent for the contribution of the services of land capitalists would get interest for lending money capital and what is left is the profits of the entrepreneurs. Thus, value of output produced is equal to national income.
Various Concepts of National Income
- Gross Domestic Product (GDP)
- Gross National Product (GNP)
- Net National Product (NNP)
- National Income (NI)
- Personal Income (PI)
- Disposable Personal Income (DPI)
- Per Capita Income (PCI)
Gross Domestic Product (GDP)
Gross domestic product (GDP) is the total market value of all final goods and services produced within a country in a given period of time.
Now we explain this definition step by step.
“GDP Is the Market Value . . .”
GDP is a monetary measure of output produced. It is calculated by adding market value of all the goods and services produced. Market value of a good or service can be calculated by multiplying physical output with price per unit.
For example, if the price of 1 kg apple is RS.100, then the market value of 50 kg of apples would be 50×100=”RS.” 5000. If the price of one dozen of orange is RS.150, then the market value of 100 dozens of oranges would be 100×150=RS.15000. Adding the market value of apples and oranges we get GDP=5000+15000=RS.20,000.
Two types of market prices (value)
- Current market price is the price level currently prevailing in the economy. It is used to measure the nominal GDP.
- Constant prices is the price level of some base year. It is used to measure the real GDP.
If there are n goods and services are produced in the country, then
GDP = P1 × Q1 + P2 × Q2 + … + Pn × Qn
- P1, …, Pn are prices of n goods
- Q1, …, Qn are quantities of n goods produced
“. . . of All . . .”
GDP tries to be comprehensive. It includes all items produced in the economy and sold legally in markets. Some goods and services are not sold at marketplace and therefor do not have market price such as homemakers’ services, output grown for their own use, unreported output from illegal activities such as sale of narcotics, drugs, gambling etc. These are not included in the GDP.
“. . . Final . . .”
GDP includes only the value of final goods because the value of intermediate goods is already included in the prices of the final goods. Final goods are those goods which are purchased for final use and not for resale or further processing. Intermediate goods are those goods which are purchased for further processing or for resale. The sale of intermediate goods is excluded from GDP because the value of final goods includes the value of all intermediate goods.
For example, an iPad is a final good, but an apple chip inside it is an intermediate good. Similarly, tire is an intermediate good while car is a final good.
Double counting occurs when intermediate goods are counted along with final goods in GDP calculation. It results in overestimation of GDP. It can be avoided by:
- Include only the value of final goods and exclude intermediate goods.
- Add value added at each stage of production, not total sales.
“. . . Goods and Services . . .”
GDP includes both tangible goods (food, clothing, cars, electronics and other) and intangible services (haircuts, housecleaning, doctor visits and others).
“. . .Produced . . .”
GDP includes only those goods and services which are produced in a current year. Goods produced in previous year are not included in GDP. For example, a used car isn’t part of GDP. It was part of GDP in the year in which it was produced.
“. . . Within a Country . . .”
GDP measures the value of production within the geographic boundaries of a country. When a Pakistani citizen works temporarily in the United States, her production counts toward U.S GDP. When an American citizen owns a factory in Pakistan, the production at her factory is included in Pakistan`s GDP). Thus, items are included in a nation’s GDP if they are produced domestically, regardless of the nationality of the producer.
“. . . In a Given Period of Time.”
GDP measures the value of production that takes place within a specific interval of time usually, a year or a quarter.
Gross National Product (GNP)
Gross national product (GNP) is the total market value of all final goods and services produced by the residents of a nation irrespective of geographical boundary.
To obtain GNP we add factor payments from abroad and subtract factor payment to abroad from GDP. Therefore, GNP includes income that our citizens earn abroad and excludes income that foreigners earn here. Thus,
GNP = GDP + Factor payment from abroad – Factor payment to abroad
Net Factor Income from Abroad (NFIA)
Net factor income from abroad is the difference between factor incomes earned by domestic residents abroad and factor incomes earned by foreign residents in the domestic country.
NFIA = Factor income received from abroad – Factor income paid to foreigners
For example, when a Pakistani citizen go abroad and work in other countries to earn wages and salaries is added in Pakistan`s GNP. Similarly, when foreign residents work in Pakistan and earn income is subtracted from Pakistan`s GNP because it is not earned by domestic resident. It is added in foreign country`s GNP.
NFIA vs Net Exports
Note that net factor income from aboard (NFIA) is not the same as net exports (NX). NFIA is included in GNP of a country but not in GDP. Net exports are included in both GNP and GDP. Net exports is the difference between value of exporta and value of imports. Exports are domestically produced goods and services sold to foreign buyers in a year and is a part of GDP. Imports are goods and services produced in foreign country but purchased by the domestic buyers in a year and is not the part of GDP.
Net National Product (NNP)
Net national product (NNP) is the net market value of all final goods and services produced by residents of a country in a year after deducting depreciation of fixed capital.
NNP = GNP – Depreciation
Depreciation is the wear and tear on the economy’s stock of equipment, plants, machines and residential structures. In fact, depreciation is the reduction in value of capital goods that is used to produce consumer goods. Because depreciation represents cost of capital not a factor income, so it is not included in GNP. It is also called fixed capital consumption or replacement investment.
National Income or National Income at Factor Cost
National income (or national income at factor cost) is the sum of all incomes earned by the four factors of production—land, labour, capital, and entrepreneurship—in the form of rent, wages, interest, and profit by producing net output. It measures how much everyone in the economy has earned.
NI at factor cost vs NI at market price (NNP)
The difference between national income (or national income at factor cost) and net national product (national income at market prices) arises from the fact that indirect taxes and subsidies cause market prices of output to be different from the factor incomes.
Suppose a meter of cloth is sold for RS. 200 in the market. Sales tax is RS. 25 and factor cost of producing is RS.175. Thus, value of cloth at factor cost=market price of cloth-indirect tax. We see that indirect tax causes market price be greater than factor cost.
Now suppose that government provide subsidy of RS.10 per meter cloth production. Factor cost of cloth is RS.175. Market price of cloth is RS.165 that consumers pay. Thus, value of cloth at factor cost=market price of cloth plus subsidy. We see that subsidy causes market price to be less than factor cost. Therefore, national income at factor cost is equal to net national product minus indirect taxes plus subsidies.
NIfc = NNPmp – Indirect Taxes + Subsidies
Net Indirect Taxes = Indirect Taxes – Subsidies
Personal Income (PI)
Personal income (PI) is the sum of all incomes actually received by all individuals or households during a given year.
The difference between national income and personal income is that national income is the total income that is earned and personal income is the total income that is received. The difference arises because not all received income is earned and not all earned income is received. Therefore, to obtain personal income we must subtract those types of income which are earned but not received and add those incomes which are received but currently not earned to national income.
PI = National Income
– Corporate Income Tax
– Undistributed Corporate Profits
– Social Security Contributions
+ Dividends
+ Transfer Payments
+ Personal Interest Income
Disposal Personal Income (DPI)
Disposable Personal Income (DPI) is the net income available to households after deducting personal taxes such as income tax, wealth tax, inheritance tax, etc. This income can either be spent on consumption or saved.
DPI = PI – Personal Taxes
DPI = C + S
Per Capital income (PCI)
Per capita income is the average income of all people in a country. It is the measure of average standard of living of the people.
Per Capita Income = National Income / Total Population
Solved Problem
Calculate the national income and personal disposable income from the information given in table:
| Item | Amount (Billion Rs.) |
|---|---|
| GDP at Market Price (GDPMP) | 6,000 |
| Receipts of Factor Income from the Rest of the World | 150 |
| Payments of Factor Income to the Rest of the World | 225 |
| Depreciation | 800 |
| Indirect Taxes minus Subsidies | 700 |
| Corporate Profits | 1,200 |
| Dividend | 600 |
| Transfer Payments to Persons | 1,300 |
| Personal Taxes | 1,500 |
Solution
NIFC = NNPMP – Net Indirect Taxes
NNPMP = GNP – Depreciation
GNP = GDP + Net Factor Income from Abroad
Net Factor Income from Abroad = Factor Payment from Abroad – Factor Payment to Abroad
PI = NI – Undistributed Corporate Profit + Dividends + Transfer Payment
DPI = PI – Personal Taxes
Step 1: Net Factor Income from Abroad
Net Factor Income from Abroad = 150 – 225 = -75
Step 2: GNP
GNP = GDP + Net Factor Income from Abroad = 6000 + (-75) = 5925
Step 3: NNP
NNP = GNP – Depreciation = 5925 – 800 = 5125
Step 4: NI or NNPFC
NI (NNPFC) = NNP – Net Indirect Taxes = 5125 – 700 = 4425
Step 5: PI (Private Income)
PI = NI – Undistributed Corporate Profits + Dividends + Transfer Payments = 4425 – 1200 + 600 + 1300 = 5125
Step 6: DPI (Disposable Personal Income)
DPI = PI – Personal Taxes = 5125 – 1500 = 3625
Solve Yourself
Given the data in table find the following:
- National income
- Disposable personal income
| Item | Amount (Billion Rs.) |
|---|---|
| GDP at Market Price (GDPMP) | 140 |
| Incomes of Pakistanis from Abroad | 30 |
| Income to Foreigners | 20 |
| Depreciation | 20 |
| Indirect Taxes | 15 |
| Subsidies | 5 |
| Corporate Taxes | 8 |
| Undistributed Corporate Profit | 12 |
| Transfer Payments | 25 |
| Personal Taxes | 10 |
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