Introduction to National Income

National income is the aggregate economic indicator that measures the activities of an economy. Although the concept of national income began in the seventeenth century, it was only in the 1930s that Nobel laureate Simon Kuznets first developed the process of calculating national income.

The calculation of national income refers to the science of calculating aggregate production, income, and expenditure. This task is mainly done by the government to properly assess the economic progress of the country over a specified period. Economic policies are formulated based on the study of national income. Economic plans are formulated.

The economic structure is analyzed. Inflation and deflation are studied. Grants and aid are distributed, and a comparative study of the living standards of the people is conducted. The government and its related bodies need information on national income. In addition, national income provides a basis for the comparative study of economic activities between different countries.

In the production process, on the one hand, goods and services are produced, and on the other hand, the factors of production—land, labor, capital, and entrepreneur—receive income in the form of rent, wages, interest, and profit, respectively.

Some part of this income is again spent on purchasing those produced goods and services, while the remaining part becomes savings. That savings is again invested in production. Thus, modern economists have shown national income as a flow of production, income, and expenditure.

There is a cyclical flow of production, income, and expenditure in the economy, and overall, national production, national income, and national expenditure become equal.

Therefore, national income is the sum of the income earned by all the factors of production owned by a country, both inside and outside the country, within a certain period.

Various Concepts of National Income

In the modern era, the state of economic development of any country can be known only through the data on national income and its various concepts. The past and present economic conditions of a country can be compared from these data. 

Similarly, the economic conditions of different countries can be compared. Therefore, under the various concepts of national income, the following is a discussion about Gross Domestic Product, Gross National Product, Net National Product, National Income, and Per Capita Income:

Gross Domestic Product (GDP)

Gross Domestic Product is the sum of the monetary value of final/ready goods and services produced within the boundary of a country, generally within a period of one year. 

When calculating Gross Domestic Product, the total quantity of each good and service produced within the country in a period of one year is multiplied by its respective price. Then, the products of the quantity and price of all goods and services are added.

This can be expressed symbolically as follows:

$$GDP\; =\; P₁Q₁\; +\; P₂Q₂+...+$$PnQn

Where:

• $P_1, P_2, ..., P_n$= Prices of goods and services

• $Q_1, Q_2, ..., Q_n$ = Quantities of goods and services

• GDP = Gross Domestic Product

The following should be taken into consideration when calculating Gross Domestic Product:

(a) Only goods and services produced within the boundary of the country are included in Gross Domestic Product.

(b) Only goods and services produced within a specific period, especially one year, are included in Gross Domestic Product. If there are goods that were produced in a certain year but remain unsold, their value is included in the Gross Domestic Product of that year. 

(c) Only final/ready goods and services are taken into account when calculating Gross Domestic Product, i.e., intermediate goods used for the production of final/ready goods are not calculated separately because the value of such goods is already included in the value of the final/ready goods. 

(d) Only the monetary value of goods and services that have a market price, i.e., are bought and sold in the market, is included in Gross Domestic Product. 

(e) Only the monetary value of goods and services produced legally and transparently within the country is included in Gross Domestic Product. 

(f) When calculating Gross Domestic Product, the total quantity of each good/service produced within the country in a period of one year is multiplied by its price, and the resulting values are added.

Methods of Measuring Gross Domestic Product

First of all, after calculating the Gross Domestic Product, it becomes easy to calculate various other concepts of national income, such as Gross National Product, Net National Product, National Income, Per Capita Income, etc., by adjusting the necessary data.

Therefore, the method of calculating/ measuring Gross Domestic Product is discussed here. These methods can also be called methods of calculating/ measuring national income.

There are three such methods. Whatever method is used among these three, the result obtained will be the same. However, which method to use depends on the objective of method selection, available data and resources, the state of development of the country, etc.

Below is a brief discussion about the three methods of calculating/ measuring Gross Domestic Product—Production Method, Income Method, and Expenditure Method:

(a) Production Method: 

Under this method, Gross Domestic Product is calculated from the production side. For this, the economy is divided into various production sectors. The Gross Domestic Product (GDP) is calculated by adding the net value of all goods and services produced by these various sectors within one year. 

To find the net value of production of a specific industry or sector, the value of production purchased by that industry or sector from other industries or sectors is subtracted from the total value of production of that industry or sector. 

This method can be used when production data for a specific year is available. This method helps to compare the contribution of various sectors of the economy to the Gross Domestic Product or national income.

(b) Income Method: 

Under this method, Gross Domestic Product is measured from the distribution side. All the factors of production present within the country—land, capital, labor, and entrepreneur—receive income in the form of rent, interest, wages, and profit, respectively, for contributing to the Gross Domestic Product. 

By adding these factor incomes and then adding the undistributed profits and profit tax of corporations, social security contributions, income from self-employment, and the value of depreciation funds to that sum, the value of Gross Domestic Product is obtained.

(c) Expenditure Method: 

When calculating Gross Domestic Product using this method, the total expenditure or spending on goods and services produced within an economy in one year is added. The total expenditure incurred by all individuals in a country, as well as the government and the foreign sector, on consumer goods and investment goods produced in that country within a period of one year can be added to calculate the Gross Domestic Product or expenditure. 

Therefore, according to the expenditure method, Gross Domestic Product is the sum of consumption expenditure (C), investment expenditure (I), government expenditure (G), and net exports (NX).

Therefore, GDP = C + I + G + NX can be written.

The components of this expenditure method of calculating Gross Domestic Product are discussed below:

1. Consumption Expenditure: This is the expenditure incurred by the household sector on the consumption of durable and non-durable goods and services produced in the current year.
2. Investment Expenditure: Fixed investment by the business sector, investment in housing construction, and inventory investment expenditures fall under this category.
3. Government Expenditure on Goods and Services: Expenditures incurred by the central or local government on goods and services produced in the current year are placed under this category.
4. Net Exports: Goods and services produced domestically in the current year that remain after consumption are exported abroad. The value of exports represents the expenditure incurred by the foreign sector on domestic goods and services. Similarly, goods and services produced abroad are imported into the country. The value of imports represents the expenditure incurred from domestic income on foreign goods and services. The value of net exports is obtained by subtracting the value of total imports from the value of total exports. The value of net exports can be positive, zero, or negative.