theories and function of national income

1. National Income and Related Aggregates
National income or national product is defined as
the total market value of all the final goods and
services produced in an economy in a given period
of time.
This suggests that the labor and capital of a country,
working on the natural resources produces certain net
amount of goods and services, the aggregates of
which as known as national income or national
products.
There are many concepts of national income which
are used by different economists and all of which are
inter-related. These concepts are:
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2. 1. Gross National Product at Market Price
(GNP mp)
GNP mp refers to the total value of all the final goods and
services produced during the period of one year plus the net
factor incomes earned from abroad during the year.
The word “gross” is used to indicate that the total national

product includes in it that part of product which represents
depreciation.
Depreciation means the wear and tear of the machinery and

other fixed capital during the process of production.
GNP includes the economic activities of all the residents of a

nation whether operating within the country or outside it.
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3.  It takes into account the incomes which the residents get from
rest of the world and at the same time it excludes those
incomes which arise from the economic activities within the
country but have to paid out to the non-residents operating in
the country.
 GNP being the monetary measure of all final goods and
services produced, is widely used as an index for judging the
performance of an economy.
2. Net National Product at Marker Price (NNP mp):
 NNP at market price is equal to GNP minus the charges of
depreciation and replacements, where depreciation
represents the values of fixed capital consumed during the
process of production.
 NNP mp = GNP mp – Depreciation
 The concept of NNP is important because it gives an estimate
of the net increase in the output of final goods and services.
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4. 3. Net National Product at Factor Cost (NNP
fc) or National Income:
NNP fc or national income is equal to the sum total of factor
incomes received by the factors of production during the year. It
is equal to the sum of rent, wages, interests and profits in a
given year.
The sum total of incomes of the factors of production is known
as national income or net national product at factor cost.
Thus, the national income is equal to the NNP at mp minus
revenue of the government by way of indirect taxes plus
subsidies provided by the government to the business sector.
NNP fc = NNP mp – Indirect taxes + Subsidies
(or)
NNP fc = NNP mp – net Indirect taxes.
taxes
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5.  The importance of estimating national income lies in
the fact that it throws light on the distribution of
income in a society.
 It helps to see how equitably income is distributed in
the societies.
 Which tells us whether there are inequalities of
income distribution , and if so, how vast is the
inequalities.
 It is regarded as the fair measure of over all
economic activity of the nation and is therefore,
commonly accepted as an index of economic
conditions prevailing in the country.
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6. 4. National Income at Current Price and Constant Price:
when the value of goods and services is found out by multiplying the
quantity produced during one year by the prices prevailing in that year, we
call it National income at Current Prices.
on the other hand, when the value of goods and services is
calculated by multiplying the quantity during one year with prices of the base
year, we call it National Income at Constant Prices.
Example:
(1) q1 is the quantity of final product I in year 1980 and p1 is the price of
that year.
Then, the value of the final product I = q1p1
Similarly, q2 is the quantity of final product II in year 1980 and p2 is the
price of that year.
Then, the value of the final product II = q2p2
If we add up the value of all final goods and services produced, we get
National Income at Current Prices.
So, National Income at Current Price will be: q1p1+q2p2+
…………….qnpn = NI at Current Prices.
Prices
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7. (2) Suppose we want to compare the national income figures of
1980 and 1990, we may find that the national income in 1990 is
higher than that of 1980.
This increase in income may be due to (a) increase in output
(b) increase in prices which may be higher in 1990 than 1980.
To get the exact increase in real income, we need to multiply
the quantity of goods produced in 1990 with the 1980 prices.
This shows: National Income at Constant Prices: Quantity
of Current period x Prices of Base period.
period
Formula for Real National Income:
Income
Money National Income (Current year) x Price Index of Base year
____________________________________________________
Price Index of Current year
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8. Measurement of National Income
 The methods of estimating national income of a
country depends upon the availability of proper
statistics.
 This can be viewed from three interrelated angles,
such as, in terms of production, income and
expenditure.
 These three terms are broadly related to GNP, GNI
and GNE respectively.
 The ideal national income equation shows that
National Income or
NI =GNP=GNI=GNE
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9.  To measure the national income of a country, we
use three different methods, such as:
(b) The product method
(c) The income method
(d) The expenditure method
The Product Method
The production method measures national income as the

sum of net products produced by the production units in the
given period.
 Therefore, the production method involves the following
steps:
(h) Identifying the production unit
(i) Estimating their net products
(j) Valuing the goods and services
(k) Estimation of net income from abroad
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10.  The next step in the production method is the
estimation of net product of each sector.
 This comes from the Gross products minus the
intermediate products minus the depreciation during
the process of production.
NNP = GNP – Intermediate products –
Depreciation
 The total estimates would give us Net Domestic
Product at factor cost.
 The addition of net income from abroad to this total
would give us net national income at factor cost or
National Income.
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11. The Income Method
 The income method measures national income as the sum
total of factor income shares accruing to the factor owners.
 Factors of Production: Land, Labour, Capital and Organization.
 Factor Incomes: Rent, Wage, Interest and Profit.
 One can easily aggregate all the factor incomes over a period
of time and this aggregate figure is known as national income
at factor cost.
 There are major additions and deductions to the national
income accounting.
 Additions: Income from foreign sectors in the form of rent,
profits etc.
 Deductions: Incomes from all illegal activities: theft, rubbery,
smuggling, child labor, prostitutions etc.
 Incomes to the foreign sector acting in domestic sectors.
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12. Comparison between Product method and Income method:

NI fc = NI mp – Indirect tax + Subsidies.
Subsidies
For the sake of convenience, economists suggests that the

Product method is for Primary sector and the Income
method is for tertiary sectors.
The Expenditure Method
 Because of identical relation the GNP=GNI=GNE, the
GNP=GNI=GNE
expenditure of one becomes the income of other. Hence,
the GNE is calculated which will be identical with GNI.
 The Expenditure in the Economy can be broadly divided into
three types, such as,
(g) Consumption Expenditure
(h) Investment Expenditure, and
(i) The pure Govt. Expenditure
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13. Consumption expenditure provides direct satisfaction where

as the investment expenditure is necessary to increase the
productivity of the nation.
 Pure Govt. expenditure is necessary for maintenance of law
and order situation and providing the infrastructural facilities
to the nation.
In details, all expenses are again divide into five different

categories:
(v) Private Consumption Expenditure
(vi) Public Consumption Expenditure
(vii) Private Investment Expenditure
(viii) Public Investment Expenditure
(ix) Pure Government Expenditure
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14. Comparison f three Methods:
 The product method is very suitable for the primary
sector such as agriculture, industries etc.
 The income method is appropriate for the tertiary
and service sectors.
 The Expenditure method is only for the calculation
of identical relationship between three method. It is
because we may not get the details of all
expenditure correctly. Neither it is possible nor it is
desirable to reveal all types of expenditure.
 In fact, the expenditure method is only to complete
the identical relationship i.e.
GNP=GNI=GNE=NI
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15. Reconciling the three methods of Measuring
National Income:
 The three methods of measuring national income represents
three aspects of the national income of the country, such as:
(d) National income as an aggregate of net products
(e) National income as an aggregate of factor shares
(f) National income as an aggregate of final expenditure
 These represents three ways of looking the national income
as:
(x) National income as viewed from the point of view of the
production enterprise
(xi) As viewed from the point of view from owners of the primary
factors of production, and
(xii) As viewed by the purchasers of the final goods and services
available in the country during a period of time.
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16. Three Aspects of National Income
Production Method Income Method Expenditure Method
1. Total Product from 1. Rent…………….1,000 1.Household
Household and 2. Wage……………3,200 Consumption………5,000
Government………..8000 3. Interest…………1,000 2. Govt. Consumption………
2. Inventory 4. Profits…………..3,200 1,000
Investment…………..500 5. Surplus of 3. Private Fixed
3. Net Export…………..500 Govt………………200 Investment…………1,100
4. Minus 6. Minus: 4. Public Fixed
(e) Depreciation………...500 Interest paid by Govt. Investment……………900
(f) Net Indirect …………………………200 5. Inventory
Taxes………………..500 Investment……………500
7. Plus: Net Income from 6. Minus:
abroad………………400 (a) Depreciation…....500
(b) Net Indirect
Taxes…………....500
7.Plus: Net Foreign
Investment…………...900
Total: NNP fc. Total: National Income = Total: Net expenditure:
=…………………..8,400 …………………………..8,400 ……….8,400
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17. Difficulties in Estimating National Income
(2)The first difficulty regarding the concept of national
income relates to the treatment of non-monetary
transactions.
Example: Services of Housewife, Services of house-
maid.
The services of house-maid are part of national
income, but if suppose the master marries the hose-
maid, although she still performs the same services,
her contribution to the national income becomes zero.
This is because now these services do not contribute
to the economic activity.
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18. (2) Second conceptual difficulty arises with regard to
the treatment of output produced by the foreign
firms in the country.
Should their income form a part of national income
of the country in which they are located?
Or, should this income be treated as a part of
national income of the country to which the
ownership of the firms belongs?
It is generally agreed that the income of such firm
should be taken into account in the national income
of the country in which the firm is located.
However, the profit earned by such firms will be sent
to their own country, and hence, would form apart of
that country’s income.
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19. (3) The national income accounts involves inventory
adjustments.
The unused stock of the previous year may be sold
in the current year, but the income will be included in
the previous years account.
This adjustment is not at all logical and creates
problem in the calculation of national income of the
current year.
(4) Another difficulty in national income arises with
regard to the Govt. sector.
How should we treat govt. functions like civil
administration of maintenance of law and those
regarding the defense of the country?
It is difficult to account the wages and salaries paid
the workers who are in service to that.
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20. (5) There are some difficulties which are particular to
underdeveloped country: Barter System.
In the underdeveloped countries there is large non-
monetized sector. A non-monetized sector refers to
that part of economy where output is not bought or
sold with the help of money.
Money does not enter into exchange, and hence the
value of commodities is not expressed in terms of
money.
The problem therefore arises that what value should
be imputed to this art of output which does not enter
into monetary transactions.
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21. (6) In underdeveloped countries, agriculture is the
predominant form of economic activity.
But the farming being still of subsistence in nature, a
considerable amount of production is consumed by
the farmers themselves.
This is that part of output which has been produced
in the country, but does not come to the market.
How should we estimate such production?
Obviously, again this involves the guess work or
imagination of the satisfaction who is estimating the
national income of the country.
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22. (7) Illiteracy: A large majority of people in the underdeveloped
countries being illiterate , do not keep any accounts of the
actual quantity of goods they have produced.
 No record of such transactions is available and the majority of
the people do not have any idea about their income and
expenditure.
 Which again leads the inaccurate estimation of national
income.
(8) More than one Jobs: in the underdeveloped countries, there
is no clear-cut demarcation of the occupations from which
people derive their income.
 Many people are simultaneously engaged in more than one
occupation and thus derive their income from many source of
livelihood.
 Example: A “farmer” in “Slack season”, take up jobs in
industries in some casual jobs like washing and painting etc.
 Therefore, it becomes difficult to place a worker under
particular occupation.
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23. (9) Inadequate Information: information regarding
small agriculturists, household industries, and other
unorganized enterprises is generally not available.
Whatever little information is available is not
adequate and reliable to estimate the national
income.
(10) Biasness in statistical process: the national
income accounting is a statistical process and it
involves huge time, energy and money costs.
Because of these inherent difficulties, an individual
investigator may cheat in the process of accounting.
He/she may give fake information/figures only to
complete the process of accounting which is very
subjective and can not be checked.
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