National Income: Types of National Income, Importance, and Limitations (2024)

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National income is a crucial economic indicator that provides insights into the economic health and well-being of a country. It serves as a yardstick for measuring a nation’s economic performance and helps policymakers make informed decisions.

Types of National Income

  1. Gross Domestic Product (GDP)
  2. Gross National Product (GNP)
  3. Private Income
  4. Net National Product (NNP)
  5. Net National Product at Factor Cost (NNPfc)
  6. Net Domestic Product at Market Prices (NDPMP)

Gross Domestic Product (GDP)

GDP represents the total monetary value of all goods and services produced within a country’s borders during a specific period, usually a year. It is a fundamental component of national income and is often used to gauge the overall economic activity of a nation.

GDP is a measure of the total monetary value of all goods and services produced within a country’s borders during a specific period, and it is a fundamental component of national income.

It is calculated using different approaches and is used to guide policymakers, investors, and businesses in strategic decision-making. 

However, it falls short of providing a suitable measure of people’s material well-being, and alternative indicators may be more appropriate. GDP is also used to compare the economic performance of different countries.

national income

Gross National Product (GNP)

GNP goes beyond GDP by considering not only the production that occurs within a country but also the income earned by its residents from abroad and income sent by residents working in foreign countries.

The main difference between GNP and GDP is how they account for income earned by citizens of a country from abroad. GNP includes income earned by citizens of a country from abroad, while GDP does not.

This discrepancy can lead to a higher GNP than GDP, especially in countries with a significant number of citizens working abroad.

For example, if a country has a large number of expatriates working in foreign countries, the income they earn and send back to their home country is included in the GNP, but not in the GDP.

This can give a misleading view of the country’s economic performance, as it can appear as though the country is doing better than it really is.

Other hand, if a country has a large number of foreign investments, GNP can be lower than GDP because the income earned by the country from these investments is included in the GDP, but not in the GNP.

Private Income

Private income comprises the total income earned by individuals and businesses, excluding government and foreign income. 

This income is typically categorized into two main types: personal income and corporate income.

  1. Personal Income: This includes the income earned by individuals from various sources such as salaries, wages, capital gains, and investments. It also includes the income earned by self-employed individuals from their businesses.
  1. Corporate Income: This includes the profits earned by companies, which are basically the surplus income that a company generates from its operations. It is calculated as the difference between a company’s total revenue and its total expenses.

Net National Product (NNP)

NNP is derived by subtracting depreciation (wear and tear on capital assets) from GNP. It provides a more accurate picture of a nation’s economic well-being by accounting for the depletion of capital.

To better illustrate the concept of depreciation and its role in calculating the Net National Product (NNP), consider a simple example. Let’s say a company purchases a machine in 2016 for $100,000. Over the next few years, the machine deteriorates due to wear and tear, reducing its usefulness and hence its value. By the end of the year, the machine might only be worth $80,000. This reduction in value, or “wearing out,” is what economists refer to as depreciation.

In terms of national income calculation, depreciation plays a crucial role. When calculating the NNP, depreciation is subtracted from the Gross National Product (GNP). This is because depreciation represents the loss of value of physical capital over time. If not accounted for, the GNP could be artificially inflated, leading to a skewed view of a nation’s economic well-being.

In mathematical terms, the formula for calculating the NNP is:

NNP = GNP – Depreciation

Here, GNP represents the total value of a nation’s annual output, and Depreciation is the value of how much physical capital is worn out.

This adjustment for depreciation helps to give a more accurate picture of a nation’s economic health, as it accounts for the natural process of physical capital decay and the need for replacement.

Net National Product at Factor Cost (NNPfc)

This measure takes into account indirect taxes and subsidies, providing a view of national income from the perspective of factors of production.

  • NNPfc is equal to the Net National Product (NNP) at market price minus the net indirect taxes and addition of subsidies.
  • Basically, NNPfc is the net money value of all goods and services produced by normal citizens of a country.
  • It is a measure of national income that takes into account the cost of production, including indirect taxes and subsidies.
  • NNPfc is a more accurate measure of national income than NNP at market price because it accounts for the cost of production.
  • It is used to measure the economic performance of a country and is often used by policymakers to make strategic decisions.
  • NNPfc can be calculated using the formula: NNPfc = NNP at market price – Indirect taxes + Subsidies.
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National Income at Market Price (NNP) and National Income at Factor Cost (NNPf) are two ways to measure the total income generated within a country. The main difference between them lies in the method of calculation and what they represent.

National Income at Market Price (NNP) is calculated using the market prices of goods and services produced in a country. This means it includes the cost of resources used, labor, and other inputs required to produce these goods and services. However, it also takes into consideration indirect taxes paid by businesses. For instance, if a business sells a product worth $100 at a market price, and it pays an indirect tax of $20, the NNP would consider the total amount of $120.

On the other hand, National Income at Factor Cost (NNPf) measures the total income generated within a country based on the cost of factors of production, excluding indirect taxes. This means it considers the actual costs of resources used, labor, and other inputs required to produce goods and services, without considering any indirect taxes paid by businesses. Using the same example, if a business uses $80 worth of resources to produce a product worth $100 at a market price, and it pays an indirect tax of $20, the NNPf would consider only the $80.

National Income at Market Price (NNP) car

To illustrate the difference with an analogy, imagine you own a factory that produces cars. If you calculate your income based on the market price of the cars you sell, you would consider the full retail price of the cars, even though you might only spend $80 worth of resources to actually produce each car. On the other hand, if you calculate your income based on the factor cost, you would only consider the $80 worth of resources you spent to produce each car, regardless of the retail price of the cars

Net Domestic Product at Market Prices (NDPMP)

NDPMP adjusts NNPfc for any changes in market prices. It is a measure that reflects the value of goods and services in the market.

  • NDPMP refers to the net market value of all the final goods and services produced during a year within the domestic territory of a country.
  • NDPMP can be determined by subtracting depreciation from Gross Domestic Product at Market Price (GDPMP).
  • NDPMP is a more accurate measure of national income than NNPfc because it accounts for changes in market prices.
  • NDPMP is used to measure the economic performance of a country and is often used by policymakers to make strategic decisions.
  • To determine “real” NDPMP, its nominal value must be adjusted to take into account price changes to allow us to see whether the value of output has gone up or down.

Importance of National Income

  • Indicator of Prosperity:- National income is a barometer of a nation’s economic well-being. A rising national income generally signifies improved living standards and increased prosperity.
  • Economic Planning & Policy Formulation:- Governments use national income data to formulate economic policies and plan for future development, ensuring resources are allocated effectively.
  • Economic Welfare:- National income is closely linked to the overall welfare of a country’s citizens. It helps identify areas where improvement is needed to enhance the quality of life.
  • Economic Structure:- National income data aids in understanding the structure of the economy, such as the contributions of different sectors like agriculture, manufacturing, and services.
  • Distribution of National Income:- It provides insights into income distribution among different sections of society, helping policymakers address inequality issues.
  • Budgetary Policies:- Governments use national income figures to prepare budgets, allocate resources, and set fiscal policies.
  • National Expenditure:- National income is linked to expenditure patterns, helping analyze consumption, investment, and savings trends.
  • International Sphere:- It plays a vital role in international economic relations, facilitating trade negotiations and foreign aid decisions.
  • Distribution of Grants and helps:- Countries often use national income data to determine eligibility for international grants and aid.
  • Business Forecasting:- Businesses use national income trends to forecast demand, plan production, and make investment decisions.
  • Economic Progress:- National income data helps track a country’s economic progress over time, aiding in long-term planning and development strategies.

Methods of Measuring National Income

National income can be calculated using various methods:

Product Method

This method involves calculating national income by summing up the value of all products and services produced within a country.

  1. Identify all products and services: The first step is to identify everything that is produced within a country, including both tangible goods (like cars, houses, clothes, etc.) and intangible services (like healthcare, education, police protection, etc.).
  2. Calculate the value of each product or service: Next, the value of each product or service is calculated. This is usually done by multiplying the quantity of each product or service by its price.
  3. Sum up the values: Finally, all the values are added together to get the total value of everything produced within the country. This total is the country’s national income.

Income Method

Income earned by individuals and businesses is collected and aggregated to determine national income.

  1. Identify and classify the factors of production of all the producing firms into primary, secondary, and tertiary sectors.
  2. Estimate the factor income paid by each sector. The factor income paid by various sectors is grouped under the primary, secondary, and tertiary sectors.
  3. Add up all the factor incomes to determine the National Income of an economy.

Expenditure Method

This method calculates national income by summing up the total expenditures made by households, businesses, and the government.

  1. Identify and classify the types of expenditures made by households, businesses, and the government.
  2. Add up all the expenditures made on final goods and services to determine the Gross Domestic Product (GDP) of an economy.
  3. Adjust the nominal GDP for inflation to arrive at the actual GDP.

Value Added Method

It calculates national income by adding up the value added at each stage of production.

  1. Identify and classify all the producing units of an economy into primary, secondary, and tertiary sectors.
  2. Calculate the Gross Value Added (GVA) at each stage of production by subtracting the cost of intermediate goods from the value of output.
  3. Add up the GVA of all sectors to determine the Gross Domestic Product (GDP) of an economy.

Limitations of National Income Accounting

  • It does not include the rate of growth of population
  • Does not reflect the distribution of GDP
  • It does not include non-economic or non-monetary exchanges
  • Composition of GDP
  • Problems in calculating national income
  • It is the problems of non-monetary economy
  • It creates Regional imbalances
  • Does not include externalities
  • Does not consider a change in prices
  • 1 more big issue that is problem in collection of correct data
  • Difficult to know the value of services

How to Increase National Income

Raising national income is a complex task that involves multiple strategies:

Development of Industrial Sector

Promoting industrialization can boost production and employment opportunities, leading to higher national income.

Practical Training for Effective Administration

Providing training and education to government officials can improve policy implementation and economic management.

Proper Utilization of Resources

Efficient resource allocation and utilization can enhance productivity and increase national income.

Development of Science and Technology

Investing in research and innovation can drive technological advancements, leading to economic growth.

Development of Credit Facilities

Access to credit can help businesses expand and invest in productive activities.

Vocational Guidance and Technical Training

Investing in human capital development can lead to a skilled and productive workforce.

Equal Distribution of Wealth

Addressing income inequality through policies and social programs can promote economic growth that benefits all segments of society.

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