National Income Accounting

This document provides an overview of National Income Accounting, including its definition, calculation methods (Product Method, Income Method, Expenditure Method), and the importance of GDP. It also discusses the limitations and challenges of measuring national income.

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Amity University Noida, Uttar Pradesh
Amity International Business School
PSDA
Managerial Economics
Topic:
National Income Accounting
Submitted By:
Arjun Kaul A-15
Manvi Thakur A-53
Swasti Jain A-51
Yash Singhal A-19
MBA-IB (Sec. B)
Submitted To: Dr. Kshamta Chauhan Ma’am

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ACKNOWLEDGEMENTS
One of the pleasant aspects of preparing a project
report is the opportunity to thank those who have
contributed to make this project possible.
We are extremely thankful to
Dr. Kshamta Chauhan
For giving us this project. Her active interest and
insight has helped us to formulate, redefine and
implement our approach to the project.
Thank You

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PREFACE
As part of our MBA IB curriculum and to gain
knowledge in the field of management, we are
required to make a report on
"National Income Accounting.”
The Basic Objective behind doing this project
report is to gain a better understanding of various
concepts of Macro-economics.
In this project report we have included the
different topics covered in National Income
Accounting like its types, their differences,
advantages and disadvantages and methods to
calculate it. We have also included the concept of
circular flow of income.
Through this project we came to know about the
importance of teamwork and the role of devotion
towards work.

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INDEX
Particulars Page No.
Introduction 5
Methods To Calculate National Income 6
Gross Domestic Product (GDP) 9
Net Domestic Product (NDP) 13
Gross National Product (GNP) 14
Net National Product (NNP) 17
Gross National Income (GNI) 19
National Income as Good Indicator for Economic
Health
20
National Income as Bad Indicator for Economic
Health
21
Types of Income 22
Circular Flow of Income 25
Importance of National Income Analysis 27
Challenges of National Income Analysis 28
Limitations in Measuring National Income 29
Inter-Relationship Among Different Concepts of NI 30
Summary 31

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INTRODUCTION
National income is an uncertain term which is used interchangeably with national dividend,
national output and national expenditure. On this basis, national income has been defined in a
number of ways. In common parlance, national income means the total value of goods and
services produced annually in a country. In other words, the total amount of income accruing
to a country from economic activities in a year’s time is known as national income. It includes
payments made to all resources in the form of wages, interest, rent and profits. The progress
of a country can be determined by the growth of the national income of the country.
Net national income encompasses the income of households, businesses, and the
government. Net national income is defined as gross domestic product plus net receipts
of wages, salaries and property income from abroad, minus the depreciation of fixed capital
assets (dwellings, buildings, machinery, transport equipment and physical infrastructure)
through wear and tear and obsolescence.
The Marshallian Definition:
According to Marshall: “The labour 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 true net annual income or revenue of the country or
national dividend.” In this definition, the word ‘net’ refers to deductions from the gross
national income in respect of depreciation and wearing out of machines. And to this, must be
added income from abroad.
The Pigouvian Definition:
Marshall’s follower, A.C. Pigou, has in his definition of national income included that income
which can be measured in terms of money. In the words of Pigou, “National income is that
part of objective income of the community, including of course income derived from abroad
which can be measured in money.”
The aggregate economic performance of a nation is calculated with the help of National
income data. The basic purpose of national income is to throw light on aggregate output and
income and provide a basis for the government to formulate their policy, programmes, to
maximize the national welfare of the people. Central Statistical organisation calculates the
national income in India.

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METHODS OF CALCULATION
The Product or Value-Added Method :
In product method we calculate the aggregate annual value of goods and services produced (if
a year is the unit of time). The term that is used to denote the net contribution made by a firm
is called its value added. We have seen that the raw materials that a firm buys from another
firm which are completely used up in the process of production are called ‘intermediate
goods. Therefore, the value added of a firm is, value of production of the firm – value of
intermediate goods used by the firm. The value added of a firm is distributed among its four
factors of production, namely, labour, capital, entrepreneurship and land. Therefore wages,
interest, profits and rents paid out by the firm must add up to the value added of the firm.
Value added is a flow variable.
This is also known as the Value-Added Method to GDP or GDP at Factor Cost by Industry of
Origin.
The following items are included in India in this agriculture and allied services; mining;
manufacturing, construction, electricity, gas and water supply; transport, communication and
trade; banking and insurance, real estates and ownership of dwellings and business services;
and public administration and defence and other services (or government services). In other
words, it is the sum of Gross Value Added.
Steps of the Value-Added Method
1. Identifying and classifying production units: The first step is to recognize every production
unit and then categorise them into three sectors, primary, secondary and tertiary.
2. Calculate GDP at market price: To arrive at this figure, first add Gross Value Added at
Market Price (GVAMP) of every sector and the total sum will represent the Gross
Domestic Product at Market Price (GDPMP). Therefore, GVAMP=GDPMP.
3. Calculate Domestic Income: To calculate the domestic income or Net Domestic Product
at Factor Cost (NDPFC), net direct taxes and depreciation should be subtracted from
GDPMP. The product method formula applicable here is NDPFC=GDPMP – depreciation -
net direct taxes.
4. Add Net Factor Income from Abroad (NFIA) to NDPFC: Finally, NFIA is added with NDPFC
to get the final figure of national income. Therefore, National Income at Factor Cost
(NNPFC) = NDPFC + NFIA.

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The Income Method :
The sum of final expenditures in the economy must be equal to the incomes received by all the
factors of production taken together (final expenditure is the spending on final goods, it does
not include spending on intermediate goods). This follows from the simple idea that the
revenues earned by all the firms put together must be distributed among the factors of
production as salaries, wages, profits, interest earnings and rents.
This method we add net income payments received by all citizens of a country in a particular
year. Net incomes that result to all the factor of production like net rents, wages, interest, and
profits are all added together, but income received in the form of transfer payments are
omitted. Apart from that, self-employed individuals like doctors, CAs, advocates, etc. employ
their own capital and labour. Thus, their income is regarded as mixed-income.
Therefore, in the income method, the national income is measured in terms of these factor
payments. Thus, it is also known as ‘factor payment method.’
Income Method Formula
National Income (NNPFC) = Net Domestic Product at Factor Cost (NDPFC) + Net Factor
Income from Abroad
Here NDPFC = Compensation of Employees + Operating Surplus + Mixed-Income
Here Operating Surplus = Rent + Interest + Profit
Steps of Income Method
1. The first step in calculating national income via income method is to identify and
segregate the units of production. They are classified into three categories, primary,
secondary and tertiary.
2. The next step of the income method of national income is to classify factor payments in
different categories like wages, rent, interest, profit and mixed-income. Otherwise, they
can be classified into compensation to employees, operating surplus and mixed-income.
After classifying, estimate the number of such payments made by enterprises.
3. Summing up all factor incomes of every sector will present the domestic income figure
(NDPFC). NDPFC = Compensation of Employees + Operating Surplus + Mixed-Income
4. The last step to reach the final National Income figure is to estimate Net Factor Income
from Abroad (NFIA) with NDPFC. National Income (NNPFC) = Net Domestic Product at
Factor Cost (NDPFC) + Net Factor Income from Abroad (NFIA)

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The Expenditure Method :
An alternative way to calculate the GDP is by looking at the demand side of the products. This
method is referred to as the expenditure method. This method considers consumption,
investments, net export, and government expenditure to calculate a nation’s annual GDP.
Expenditure method of national income can be considered as the most common way to
calculate GDP as it includes both public and private sector expenses incurred within a nation’s
borders. However, this system can only be used to calculate nominal GDP, which is not adjusted
for inflation.
There are primarily four different types of aggregated expenses that are utilised to determine
GDP. These are –
1. Investments made by businesses.
2. Government expenses on goods and services.
3. Household consumption.
4. Net export (total exports minus the value of imported goods and services).
GDP = C + I + G + (X – M)
Here, C is consumer spending on different goods and services, I represents investments made
by businesses, and on capital goods, G represents government’s spending on goods and services
provided to the public, X is exports, and M is imports.
Precautions Considered While Using Expenditure Method of National Income
1. Any expenses on account of intermediate goods cannot be considered to determine a
nation’s income as these expenses are already included in the value of final goods
produced. Otherwise, it will lead to double-counting of a single expenditure, thus inflating
national income inaccurately.
2. Any transfer payment should not be included under the expenditure formula as these
payments do not add any value to a nation’s economy.
3. Purchase of any second-hand goods is not included in the total expenditure method as
these do not affect the total value of goods and services produced. However, any
brokerage paid on the purchase of such goods or services has to be included in the
calculation.
4. Procurement of assets such as shares, bonds, debentures, etc. is also not included in the
calculation as these represent changes in ownership instead of changes in goods and
services’ values. Contrarily, any brokerage earned on the trading of shares will be
considered as a productive service.

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GROSS DOMESTIC PRODUCT (GDP)
Gross Domestic Product (GDP) is a measure of commercial value that produces final goods and
services in a particular time period. GDP per capita (also called GDP per person) measures a
country’s standard of living. Each country draws up and brings out its GDP data regularly. A
country with a higher rate of GDP is regarded as well off in economic perspectives than a country
with a lower rate.
GDP Calculation in Economics
The subject of Economics, to a large extent, includes the study of the way goods and services
are produced, distributed and consumed. In Economics, a purchaser of goods and services can
be classified into three main categories -
• Households
• Businesses
• Government
GDP is calculated through an expenditure avenue which means adding up those expenditures
made by those three groups of purchasers. If you want to know how GDP is calculated in simpler
forms, please follow the formula that is mentioned below -
GDP = Consumption + Investment + Government Spending + Net Exports
Importance of GDP
GDP qualifies policymakers and central banks to analyse whether the economy is contracting or
developing. It also indicates any signs of recession or uncontrolled inflation. GDP differs because
of the following reasons -
• When the economy is flourishing, GDP is rising, and then it needs to be controlled by
implementing “tighter monetary policy” to get hold of the inflation.
• Similarly, if interest rates rise, companies and consumers reduce spending, and the
economy holds back.
• The ongoing process leads companies to cut out employees and hence affects consumer
confidence and demand.

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GDP as an Economic Welfare
Since GDP estimates both the economy’s total income and expenditure on goods and services,
one may have a question is GDP a good measure of economic welfare or not. Well, GDP cannot
be considered as a perfect measure of economic well-being.
For instance, if everyone in the economy suddenly starts working every day of the week rather
than enjoying leisure periods on holidays. There will be more production of goods and services
and hence would rise. Despite the rise of GDP, the loss from reduced leisure can lead to poor
quality of products and thus would negate the gain from producing and consuming a greater
quantity of goods and services. Therefore, GDP and welfare may not always go hand in hand. It
can be a fair assessment of economic well-being but not all purposes.
More GDP does not necessarily mean an increase in happiness. But more GDP does mean the
measurement of the production of goods and services.
GDP for Economists and Investors
Economists examine constructive GDP growth between different time periods to have an idea
of how much an economy is prospering. Investors also take notice because a notable change in
GDP can have a significant impact on the stock market. If a company faces lower earnings, then
it can lead to lower stock prices.
Understanding of GDP Price Deflator
The GDP price deflator mainly shows the effect of price changes on GDP by initiating a base year
and comparing current prices to prices in the base year. It explains the price level changes, hikes
within the economy, and keeps tracking of the prices paid by the businesses, government and
consumers.
Are you finding a problem in understanding GDP price deflator?? If yes, then please follow the
formula provided below -
GDP Price Deflator = (Nominal GDP/ Real GDP) × 100
For example, GDP Deflator in 1997-98 = 1426-7th- crores/1049.2th. crores at 1993-94 prices =
135.9 It shows that at constant prices (1993-94), GDP in 1997-98 increased by 135.9% due to
inflation (or rise in prices) from Rs. 1049.2 thousand crores in 1993-94 to Rs. 1426.7 thousand
crores in 1997-98.

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What is Nominal GDP?
Nominal Gross Domestic Product or nominal GDP is the Value of GDP calculated as per the
current market prices. So, nominal meaning it will contain all the changes in market prices owing
to inflation and depletion for the current year. So, it represents the current market value of
goods and commodities produced in a specific time.
What is Real GDP?
Unlike nominal GDP of India, real GDP is an inflation-adjusted calculation of GDP. It is the
estimate of the total value of all goods and commodities produced in a year which are accounted
for inflation.
To calculate this, one needs to consider the prices of a selected base year. One needs to first
calculate the change in GDP because of inflation and divide out the inflation for every year.
Therefore, it is concluded that even if the change in prices doesn't lead to a change in output,
then the nominal GDP would show change.
Nominal GDP vs Real GDP
Nominal GDP is also known as unadjusted GDP and is the measure of value of all end-products
manufactured in a nation in a specific period. Here, the market value changes depending upon
the change in quantity of production and change in respective prices of those goods and
commodities.
Real Gross Domestic Product or real GDP explains the change in price because of inflation.
Therefore, it can be concluded that the inflation adjusted nominal GDP and real GDP are the
same. Therefore, in a given financial year, if the price of production changes with the change in
period, while the output remains unchanged, then the value of real GDP will remain the same.
In an ideal scenario wherein, there won't be any inflation/ deflation in a given period, the value
of nominal GDP and real GDP will remain the same. Besides, it is easier to analyse or measure
the real GDP than that of nominal GDP.
Now the general price level of the year for which real GDP is to be calculated is related to
the base year on the basis of the following formula which is called the deflator index:
Real GDP = GDP for the Current Year x Base Year (=100)/Current Year Index
Suppose 1990-91 is the base year and GDP for 1999-2000 is Rs. 6,00,000 crores and the price
index for this year is 300.
Thus, Real GDP for 1999-2000 = Rs. 6,00,000 x 100/300 = Rs. 2,00,000 crores.

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GDP at Market Price
Gross domestic product at market prices aims to measure the wealth created by all private and
public agents in a national territory during a given period. The most key aggregate of national
accounts, it represents the end result of the production activity of resident producing units.
There are three ways of measuring GDP at market prices:
1. the production approach, as the sum of added values of all activities which produce goods
and services, plus taxes and minus subsidies on products;
2. the expenditure approach, as the sum of all final expenditures made in either consuming
the final output of the economy, or in adding to wealth, plus exports and minus imports
of goods and services;
3. the income approach, as the sum of all incomes earned in the process of producing goods
and services (payment of salaries, gross operating margin and mixed income) plus taxes
on production and imports and minus subsidies.
The Expenditure Method is most commonly used for calculating GDP at market Price.
GDP at Market Price : C+ I + G +X -M
GDP at Factor Cost
1. Land - Rent to be paid for the owner of land you hired or the office building you
occupy.
2. Labour - got to pay the boys their wages and salaries, else they would leave you
alone with your factory!
3. Capital - interest on capital is desired on the amount you invested.
4. Entrepreneur - hey, don't you want to take home the profits!?
The Sum of these factor payments is GDP at factor cost for you as a producer. When you add
the GDP at FC contributed by all producers in a country, you get the real GDP FC of the
country.
Now factor cost is the sum of expenditure incurred by you to produce the goods. When u sell
that good in the market, you got to pay the Taxes and you ought to get Subsidies from Govt.
So, these taxes and subsidies determine the Factor Cost.
So, GDP at Factor Cost = GDP at Market Price – Indirect Taxes + Subsidies.

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NET DOMESTIC PRODUCT (NDP)
Net domestic product accounts for capital that has been consumed over the year in the form of
housing, vehicle, or machinery deterioration. The depreciation accounted for is often referred
to as capital consumption allowance and represents the amount of capital that would be needed
to replace those depreciated assets. The portion of investment spending that is used to replace
worn out and obsolete equipment — depreciation — while essential for maintaining the level
of output, does not increase the economy’s capacities in any way. If GDP were to grow simply
as a result of the fact that more money was being spent to maintain the capital stock because
of increased depreciation, it would not mean that anyone had been made better off. Because
of this some economists view NDP as a better measure of social and economic wellbeing than
GDP.
Machinery that is put to regular use may need parts replaced regularly until the entire piece
of equipment is no longer usable. While that may take many years, barring unexpected
damage or defects, there is a cycle of equipment failure and replacement. Part of the
machinery in a factory’s production line may need to be replaced while another set of similar
machines continues to function within the same factory. The acquisition of the replacement
machinery would be factored into the depreciation aspect of the NPI.
This differs from an expansion of factory operations—for example, the opening of a new site,
adding to the total number of factories. The acquisition of new machines for the new factory
would represent a gain because the demand was driven by the need to increase the scope of
the operations, rather than serve as a replacement. This would mean the purchased machine
would qualify as a gain for the NDP.
The construction of new homes on previously unused real estate can also represent a gain for
the NDP if the residences are not intended to replace defunct or demolished property. For
example, in many urban areas, efforts may be made to re-purpose underutilized real estate
that has fallen into disrepair. Instead of expanding the sprawl of the city, older buildings
might be torn down and replaced by new construction intended to fill the same use as the
predecessor building. Such an example would qualify as depreciation and replacement. By
contrast, if a new housing community is developed, the construction of residences would be
contributory to NDP.
FORMULA
1. NDP at Market Price = GDP at Market Price – Depreciation
2. NDP at Factor Cost = NDP at Market Price – Indirect Taxes + Subsidies

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GROSS NATIONAL PRODUCT (GNP)
The gross national product or GNP is the aggregated value of all the goods and services which
are produced by the country’s residents within a particular financial year. GNP categorically
excludes the income which is generated by foreigners who are only residing within the
territory of the country.
GNP includes four types of final goods and services:
1. Consumers’ goods and services to satisfy the immediate wants of the people;
2. Gross private domestic investment in capital goods consisting of fixed capital formation,
residential construction and inventories of finished and unfinished goods;
3. Goods and services produced by the government; and
4. Net exports of goods and services, i.e., the difference between value of exports and
imports of goods and services, known as net income from abroad.
In this concept of GNP, there are certain factors that have to be taken
into consideration:
First, GNP is the measure of money, in which all kinds of goods and services produced in a
country during one year are measured in terms of money at current prices and then added
together. But in this manner, due to an increase or decrease in the prices, the GNP shows a
rise or decline, which may not be real. To guard against erring on this account, a particular
year (say for instance 1990-91) when prices be normal, is taken as the base year and the GNP
is adjusted in accordance with the index number for that year. This will be known as GNP at
1990-91 prices or at constant prices.
Second, in estimating GNP of the economy, the market price of only the final products should
be taken into account. Many of the products pass through a number of stages before they are
ultimately purchased by consumers. If those products were counted at every stage, they
would be included many a time in the national product. Consequently, the GNP would
increase too much. To avoid double counting, therefore, only the final products, and not the
intermediary goods should be taken into account.
Third, goods and services rendered free of charge are not included in the GNP, because it is
not possible to have a correct estimate of their market price. For example, the bringing up of a
child by the mother, imparting instructions to his son by a teacher, recitals to his friends by a
musician, etc.

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Fourth, the transactions which do not arise from the produce of current year or which do not
contribute in any way to production, are not included in the GNP. The sale and purchase of old
goods, and of shares, bonds and assets of existing companies are not included in GNP because
these do not make any addition to the national product, and the goods are simply transferred.
Likewise, the payments received under social security, e.g., unemployment insurance
allowance, old age pension, and interest on public loans are also not included in GNP, because
the recipients do not provide any service in lieu of them. But the depreciation of machines,
plants and other capital goods is not deducted from GNP.
Fifth, the profits earned or losses incurred on account of changes in capital assets as a result of
fluctuations in market prices are not included in the GNP if they are not responsible for current
production or economic activity. For example, if the price of a house or a piece of land
increases due to inflation, the profit earned by selling it will not be a part of GNP. But if, during
the current year, a portion of a house is constructed anew, the increase in the value of the
house (after subtracting the cost of the newly constructed portion) will be included in the
GNP. Similarly, variations in the value of assets, that can be ascertained beforehand and are
insured against flood or fire, are not included in the GNP.
Sixth, the income earned through illegal activities is not included in the GNP. Although the
goods sold in the black market are priced and fulfill the needs of the people, but as they are
not useful from the social point of view, the income received from their sale and purchase is
always excluded from the GNP. There are two main reasons for this. One, it is not known
whether these things were produced during the current year or the preceding years. Two,
many of these goods are foreign made and smuggled and hence not included in the GNP.
FORMULA
1. GNP at Market Prices = GDP at Market Price + Net Income from Abroad.
Net Income earned from abroad:
This is the difference between the value of exports of goods and services and the value of
i imports of goods and services. If this difference is positive, then it is added to the GNP and
i if it is negative it is deducted from the GNP.
2. GNP at Factor Cost = GNP at Market Price – Indirect Taxes + Subsidies.

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GNP v. GDP
The GDP and GNP differences can be understood from the following points.
Parameters GNP GDP
Concept
The gross national product amounts
to the valuation of such services
and goods produced by a citizen of
a country without any constraint on
geographical boundaries. It is
computed within a particular
financial year.
The gross domestic product
amounts to the valuation of such
services and goods which are
produced within the geographical
confines of a country. It is
computed within a particular
financial year.
Purpose
Gross national product is for
measuring all production by the
country’s nationals
Gross domestic product is only
for measuring the domestic
production within the
geographical boundaries of a
country.
Focus
The production made by the
country’s citizens irrespective of the
boundary
The production made only on the
domestic front of a country
What it seeks
to measure
Measurement of the contribution of
its citizens towards its economy
Measurement of the strength of
the economy of a country
Measuring
productivity
Production is measured on an
international scale
Production is measured only on a
domestic scale
Exclusion
Services and goods which are
produced by foreigners residing
within the country is excluded in the
gross national product
Services and goods which are
produced outside the domestic
economy of a country is excluded
in the gross domestic product

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NET NATIONAL PRODUCT (NNP)
NNP is often examined on an annual basis as a way to measure a nation's success in continuing
minimum production standards. It can be a useful method to keep track of an economy as it
takes into account all its citizens, regardless of where they make their money, and
acknowledges the fact that capital must be spent to keep production standards high.
This NNP takes into account the depreciation factor, and what is depreciation?
Depreciation is nothing but the wear and tear of the fixed assets. While in the context of NNP it
also refers to the capital used to maintain the existing stock. NNP is the total value of all the final
goods and services that are produced by the factors of production of a country in a specified
time chalking out or minus the depreciation amount.
Next, we should know that for calculating NNP, the economists take into consideration two very
prior factors that are indirect taxes and subsidies.
The market price of any product comes with taxes, this tax amount goes to the government.
Thus, while calculating the NNP, economists are required to deduct the taxes. Also, the
government provides subsidies to encourage the production of certain goods and services. This
being the case, we are required to add these subsidies while calculating the NNP. The NNP after
considering the taxes and subsidies is called the NNP at the factor cost or the national income.
The relationship between a nation's GNP and NNP is similar to the relationship
between its Gross Domestic Product (GDP) and Net Domestic Product (NDP).
Special Considerations
Environmental Economics
NNP has particular usefulness for the field of environmental economics. NNP is a model
associated with the depletion of natural resources, and it can be used to determine whether
certain activities are sustainable within a particular environment.
Foreign-Made Products
As previously mentioned, NNP also factors in the value of goods and services produced
overseas. That means that the activities of U.S. manufacturers in Asia, for example, count
toward the U.S.' NNP.
That is not the case for GDP and NDP, which limit their interpretation of the economy to the
geographical borders of the country.

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Use in economics
Although the net national product is a key identity in national accounting, its use in economics
research is generally superseded by the use of the gross domestic or national product as a
measure of national income, a preference which has been historically a contentious topic (see
e.g., Boulding (1948) and Burk (1948)). Nonetheless, the net national product has been the
subject of research on its role as a dynamic welfare indicator as well as a means of reconciling
forward and backward views on capital wherein NNP(t) corresponds to the interest on
accumulated capital. Furthermore, the net national product has featured prominently as a
measure in environmental economics such as within models accounting for the depletion of
natural and environmental resources or as an indicator of sustainability.
Recording Depreciation
It is divided into two categories: physical capital and human capital.
Physical capital and human capital depreciate in different ways. Physical capital
experiences depreciation based on physical wear and tear, while human capital experiences
depreciation based on workforce turnover—when staff leave, companies must spend more of
their resources on training and finding new talent.
FORMULA
1. NNP at Market Price = GNP at Market Price – Depreciation
Or
NNP at Market Price = NDP at Market Price + Net Factor Income
from Abroad
2. NNP at Factor Cost = NNP at Market Price – Indirect taxes + Subsidies
Or
NNP at Factor Cost = NDP at Factor Cost + Net Factor Income
from Abroad

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GROSS NATIONAL INCOME (GNI)
Gross National Income (GNI) is the total amount of money earned by a nation's people and
businesses. It is used to measure and track a nation's wealth from year to year. The number
includes the nation's gross domestic product (GDP) plus the income it receives from overseas
sources.
The more widely known term GDP is an estimate of the total value of all goods and services
produced within a nation for a set period, usually a year. GNI is an alternative to gross
domestic product (GDP) as a means of measuring and tracking a nation's wealth and is
considered a more accurate indicator for some nations.
To convert a nation’s GDP to GNI, three terms need to be added to the former:
1. Foreign income paid to resident employees
2. Foreign income paid to residential property owners and investors
3. Net taxes minus subsidies receivable on production and imports.
GDP vs. GNI vs. GNP
Of the three measures, GNP is the least used, possibly because it might be deceptive. For
instance, if a nation's wealthiest citizens routinely move their money offshore, counting that
money would inflate the nation's apparent wealth.
In fact, GNI may now be the most accurate reflection of national wealth given today's mobile
population and global commerce.
• GDP is the total market value of all finished goods and services produced within a
country in a set time period.
• GNI is the total income received by the country from its residents and businesses
regardless of whether they are located in the country or abroad.
• GNP includes the income of all of a country's residents and businesses whether it flows
back to the country or is spent abroad. It also adds subsidies and taxes from foreign
sources.
How Is GNI Calculated?
To calculate GNI, compensation paid to resident employees by foreign firms and income from
overseas property owned by residents is added to GDP, while compensation paid by resident
firms to overseas employees and income generated by foreign owners of domestic property is
subtracted. Product and import taxes that are not already accounted for in GDP are also
added to GNI, while subsidies are subtracted.

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NATIONAL INCOME AS GOOD INDICATOR FOR
ECONOMIC HEALTH
Generally, economic development is a process of change over a long period of time.
Though there are several criteria or principles to measure the economic development,
yet none provides a satisfactory and universally acceptable index of economic
development.
1. A larger real national income is normally a pre-requisite for an increase in real per
capita income and hence, a rising national income can be taken as a token of
economic development.
2. The increase in per capita income is a good measure of economic development. In
the advanced countries, per capita income has been on continuous increases
because the growth rate of national income is greater than the growth rate of
population. This has raised the economic lot of the people. In underdeveloped
countries, there is very less capacity to produce per head. So, as the capacity to
produce goes up these economies proceed towards economic development.
3. When the purchasing power of money goes up, even then there is an increase in
the level of economic welfare. The purchasing power of money can go up when with
the increase in national income there is also increase in the prices of goods. That
means economic welfare can increase if price stability is ensured.
4. Standard of living and not rise in per capita income or national income should be
considered an indicator of economic development. The very objective of
development is to provide better life to its people through improvement or
upliftment of the standard of living. In other words, it refers to increase in average
consumption level of the individual.

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NATIONAL INCOME AS BAD INDICATOR FOR
ECONOMIC HEALTH
1. For one, GDP by definition is an aggregate measure that includes the value of
goods and services produced in an economy over a certain period of time.
There is no scope for the positive or negative effects created in the process of
production and development.
2. Environmental degradation is a significant externality that the measure of GDP
has failed to reflect. The production of more goods adds to an economy’s GDP
irrespective of the environmental damage suffered because of it.
3. In the underdeveloped countries where per capita income is regarded as a
measure of economic development, with the increase in per capita income of
these countries, there is also increase in unemployment, poverty and income
inequalities. This cannot be regarded as development.
4. It is difficult to determine proper deflators to eliminate the effects of price
changes in an underdeveloped country.
5. It is also complicated when average income is rising but unemployment exists
due to the rapid growth of population, thus, such a situation is not consistent
with the development.
6. It cannot definitely be said that economic welfare has increased if the national
and even the per capita income may be rising unless the distribution of income
is equitable.
7. Another aspect of modern economies that makes GDP anachronistic is its
disproportionate focus on what is produced. Today’s societies are increasingly
driven by the growing service economy – from the grocery shopping on
Amazon to the cabs booked on Uber.

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TYPES OF INCOME
Domestic Income:
Income generated (or earned) by factors of production within the country from its own re-
sources is called domestic income or domestic product.
Domestic income includes:
1. Wages and salaries,
2. Rents, including imputed house rents,
3. Interest,
4. Dividends,
5. Undistributed corporate profits, including surpluses of public undertakings,
6. Mixed incomes consisting of profits of unincorporated firms, self-employed persons,
partnerships, etc., and
7. Direct taxes.
Since domestic income does not include income earned from abroad, it can also be shown as:
Domestic Income = National Income – Net Income earned from abroad.
Thus, the difference between national income and domestic income is the net income earned
from abroad. If we add net income from abroad to domestic income, we get national income,
i.e., National Income = Domestic Income + Net income earned from abroad.
Private Income:
Private income is income obtained by private individuals or firms from any source, productive
or otherwise, and the retained income of corporations. It can be arrived at from NNP at Factor
Cost by making certain additions and deductions.
The additions include transfer payments such as pensions, unemployment allowances, and
sickness and other social security benefits, gifts and remittances from abroad, windfall gains
from lotteries or from horse racing, and interest on public debt. The deductions include
income from government departments as well as surpluses from public undertakings, and
employees’ contribution to social security schemes like provident funds, life insurance, etc.

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Private Income = National Income (or NNP at Factor Cost) + Transfer Payments +
Interest on Public Debt – Social Security – Profits and Surpluses of Public
Undertakings.
Personal Income:
Personal income is the total income received by individuals of a country from all sources
before payment of direct taxes in one year. Personal income is never equal to the national
income, because the former includes the transfer payments whereas they are not included in
national income. Personal income is derived from national income by deducting undistributed
corporate profits, profit taxes, and employees’ contributions to social security schemes.
These three components are excluded from national income because they do reach
individuals. But business and government transfer payments, and transfer payments from
abroad in the form of gifts and remittances, windfall gains, and interest on public debt which
are a source of income for individuals are added to national income.
Personal Income = National Income – Undistributed Corporate Profits – Profit
Taxes – Social Security Contribution + Transfer Payments + Interest on Public
Debt.
Disposable Income:
Disposable income or personal disposable income means the actual income which can be
spent on consumption by individuals and families. The whole of the personal income cannot
be spent on consumption, because it is the income that accrues before direct taxes have
actually been paid. Therefore, in order to obtain disposable income, direct taxes are deducted
from personal income.
Disposable Income=Personal Income – Direct Taxes.
But the whole of disposable income is not spent on consumption and a part of it is saved.
Therefore, disposable income is divided into consumption expenditure and savings.
Disposable Income = Consumption Expenditure + Savings.

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If disposable income is to be deduced from national income, we deduct indirect taxes plus
subsidies, direct taxes on persons and on business, social security payments, undistributed
corporate profits or business savings from it and add transfer payments and net income from
abroad to it.
Disposable Income = National Income – Business Savings – Indirect Taxes +
Subsidies – Direct Taxes on Persons – Direct Taxes on Business – Social Security
Payments + Transfer Payments + Net Income from abroad.
Real Income:
Real income is national income expressed in terms of a general level of prices of a particular
year taken as base. National income is the value of goods and services produced, as expressed
in terms of money at current prices. But it does not indicate the real state of the economy. It is
possible that the net national product of goods and services this year might have been less
than that of the last year, but owing to an increase in prices, the NNP might be higher this
year.
For this purpose, the following formula is employed:
Real NNP = NNP for the Current Year x Base Year Index (=100)/Current Year
Index
Suppose 1990-91 is the base year and the national income for 1999-2000 is Rs. 20,000 crores
and the index number for this year is 250. Hence, Real National Income for 1999-2000 will be =
20,000 x 100/250 = Rs. 8,000 crores. This is also known as NI at constant prices.
Per Capita Income:
The average income of the people of a country in a particular year is called Per Capita Income
for that year. This concept also refers to the measurement of income at current prices and at
constant prices. For instance, in order to find out the per capita income at current prices, the
national income of a country is divided by the population of the country in that year.
Per Capita Income = National income /Population
Similarly, for the purpose of arriving at the Real Per Capita Income, this very formula is used.
Real Per Capita Income = Real national income /Population

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CIRCULAR FLOW OF INCOME
Both inflow and expenditure are integral parts of any functional economy. They tend to come
in handy for analysing the performance of an economy and further helps to formulate effective
strategies for different economic sectors. It must also be noted that the circular flow of money
creates a link between consumers and producers and helps create functional market networks.
What is Circular Flow of Income?
The circular flow of income can be explained as a functional economic model which represents
how money flows through the different sectors in an economy. It depicts how produced goods
and services; income and expenditure tend to flow in an economy. One can explain the circular
flow of income and expenditure with three types of economy, namely – two-sector economy,
three-sector economy and four-sector economy.
Typically, there are 3 phases of the circular flow of income in a simple economy or closed
economy –
I. Production Phase: It is primarily concerned with income generation.
II. Income Phase: It includes movement of factor income like rent, wage, interest and profits
from production firms to household.
III. Expenditure Phase: In this phase, the income generated through factors of production is
spent mostly on goods and services which are produced by firms.
Notably, there are several factors of production and consumption like, labour, capital,
enterprise, rent, wage, interest and profit, which tend to affect the circular flow of money. Also,
there are different types of the circular flow of economic activity one should become aware of.
Types of Circular Flow of Income
Generally, they are of 4 types –
1. Real Flow: It indicates the movement of factor services from households in an economy
to its business units. It also shows the movement of goods and services from business
units to households of an economy.
2. Money Flow: It indicates the movement of money from different economic sectors in
terms of factor payments for availing factor services.
3. Injections: In practice, money is introduced into an economy for firms and household
borrowing from financial institutions.
4. Leakages: Typically, indicates the withdrawal of money from the flow.

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Circular Flow of Income: In a Two-Sector Economy
Notably, it is a hypothetical concept, where the economy comprises only two sectors, namely,
households and business firms. In such a setup, the households serve as a source of factors, and
they generate income by providing factor services to business firms. On the other hand, business
firms serve as a provider of goods and services generate income by supplying the same to
households within the economy. In simple words, the circular flow of income in a two-sector
economy can be defined as the flow of money and receipt of goods, service and factor services
between business firms and household sectors.
Take a look at this diagram below to understand the functioning circular flow of income in a
two-sector economy effectively.
Here, the outer flow indicates the monetary flow, while the inner flow indicates the real flow of
income. In turn, it indicates that the expenses incurred by the household sector emerge as an
income source for the business firms and vice versa. Hence, it can be said that,
Money received by producers = Household earnings = Households’ expenses on
consumptions.
However, such a model is based on some assumptions to make it more practical. Such
assumptions which as follow –
a. There are 2 sectors in the economy, i.e., business firms and households.
b. The economic activities are free from government intervention.
c. It is a closed economy, where business firms do not participate in import and export.

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IMPORTANCE OF NATIONAL INCOME ANALYSIS
1. For the Economy:
The national income data are of great importance for the economy of a country. These
days the national income data are regarded as accounts of the economy, which are
known as social accounts. These refer to net national income and net national
expenditure, which ultimately equal each other.
2. National Policies:
The national income data form the basis of national policies such as employment policy,
because these figures enable us to know the direction in which the industrial output,
investment and savings, etc. change, and proper measures can be adopted to bring the
economy to the right path.
3. Economic Planning:
In the present age of planning, the national data are of great importance. For economic
planning, it is essential that the data pertaining to a country’s gross income, output,
saving and consumption from different sources should be available. Without these,
planning is not possible.
4. Research:
The national income data are also made use of by the research scholars of economics.
They make use of the various data of the country’s inputs, outputs, income, saving,
consumption, investment, employment, etc., which are obtained from social accounts.
5. Per Capita Income:
The national income data are significant for a country’s per capita income which reflects
the economic welfare of the country. The higher the per capita income, the higher the
economic welfare and vice versa.
6. Distribution of Income:
The national income statistics enable us to know about the distribution of income in the
country. From the data pertaining to wages, rent, interest and profits, we learn of the
disparities in the incomes of different sections of the society. Similarly, the regional
distribution of income is revealed. It is only on the basis of these that the government
can adopt measures to remove the inequalities in income distribution and to restore
regional equilibrium. With a view to removing these personal and regional disequilibria,
the decisions to levy more taxes and increase public expenditure also rest on national
income statistics.

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CHALLENGES OF NATIONAL INCOME ANALYSIS
1. Intermediate and Final Goods:
The greatest difficulty in estimating national income by product method is the failure to
distinguish properly between intermediate and final goods. There is always the possibility of
including a good or service more than once, whereas only final goods are included in national
income estimates. This leads to the problem of double counting which leads to the
overestimation of national income.
2. Depreciation:
Depreciation is deducted from GNP in order to arrive at NNP. Thus, depreciation lowers the
national income. But the problem is of estimating the current depreciated value of, say, a
machine, whose expected life is supposed to be thirty years. Firms calculate the depreciation
value on the original cost of machines for their expected life. This does not solve the problem
because the prices of machines change almost every year.
3. Price Changes:
National income by product method is measured by the value of final goods and services at
current market prices. But prices do not remain stable. They rise or fall. When the price level
rises, the national income also rises though the national production might have fallen.
On the contrary, with the fall in the price level the national income also falls, though the
national production might have increased. So, price changes do not adequately measure
national income. To solve this problem, economists calculate the real national income at a
constant price level by the consumer price index.
4. Illegal Activities:
Income earned through illegal activities like gambling, smuggling, illicit extraction of wine, etc.
is not included in national income. Such activities have value and satisfy the wants of the
people but they are not considered productive from the point of view of society. But in
countries like Nepal and Monaco where gambling is legalized, it is included in national income.
Similarly, horse-racing is a legal activity in England and is included in national income.

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LIMITATIONS OF NATIONAL INCOME ANALYSIS
1. Non-Monetized Output and Its Transactions:
In the estimation of national income or output, only those goods and services which are
exchanged against money are normally included. But in an under-developed country like India,
a huge portion of our total output is still either being consumed at home or being bartered
away by the producers in exchange of other goods and services leading to the non-inclusion of
huge non-monetized output in the national income estimates of the country.
2. Non-Availability of Information about Petty Income:
The national incomes estimate in India is also facing another problem of non-availability of
information about the income of small producers and household enterprises. In India a very
large number of producers are still carrying on production at a family level or are running
household enterprises on a very small scale.
3. Lack of Differentiation in Economic Functions:
In India the occupational classification is incomplete and thus there is lack of differentiation in
economic functions. As National Income Statistics are collected by industrial origin thus
classification of producers and workers into various occupational categories is very much
essential.
4. Unreported Illegal Income:
In India the parallel economy is fully operational as hidden or subterranean economy. Thus,
there is huge unreported illegal income earned by those people engaged into those parallel
economy which is not included in the national income estimates of our country.
5. Lack of Reliable Statistical Data:
The most important difficulty facing the national income estimation in India is the non-
availability of reliable statistical information. In India national income data are collected by
untrained and semiliterate persons like gram sevaks and thus the statistics are mostly
unreliable.

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INTER-RELATIONSHIP AMONG D/F CONCEPTS OF
NATIONAL INCOME
1. Gross Domestic Product (GDP) = GNP – Net Income from abroad.
2. GNP at market Prices = GNP at Factor cost + Indirect Taxes – Subsidies
3. NNP at Market Prices = GNP at Market Prices – Depreciation or Capital Consumption
Allowance
4. Net Domestic Product (NDP) = NNP at Market Prices – Net Factor at Market Prices
Income from abroad
5. NNP at Factor Cost or National Income or National Product = NNP at Market Prices –
Indirect Taxes + Subsidies
6. NDP at Factor Cost or Domestic = National Income – Net Factor Income or Domestic
Product Income from abroad
7. Private Income = NNP at Factor Cost + Government and Business Transfer Payments +
Current Transfers from abroad in the form of Gifts and Remittances + Windfall Gains +
Net Factor Income from abroad + Interest on Public Debt and Consumer Interest – Social
Security Contribution – Income from Government Departments and property – Profits
and Surpluses of Public Corporations (or Undertakings
8. Income from Domestic Product = NDP at Factor Cost – Income from accruing to Private
Sector Domestic Product accruing to Government Departments – Saving of Non-
Departmental Enterprises.
9. Personal Income = Private Income – Saving of Private Corporate Sector (or Undistributed
Corporate Profits) – Corporation Tax (or Profit Taxes)
10.Personal Disposable Income or = Personal Income – Direct Taxes Disposable Income
paid by Households (or Direct Personal Taxes) and Miscellaneous Fees, Fines, etc.
OR
= National Income at Factor Cost + Transfer Payments + Net Income from abroad –
Corporate Tax – undistributed Corporate Profits – Social Security payments – Direct
Personal Taxes – Indirect Taxes + Subsidies.

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SUMMARY
At a very fundamental level, the macroeconomy (it refers to the economy that
we study in macroeconomics) can be seen as working in a circular way. The
firms employ inputs supplied by households and produce goods and services to
be sold to households. Households get the remuneration from the firms for the
services rendered by them and buy goods and services produced by the firms.
So, we can calculate the aggregate value of goods and services produced in
the economy by any of the three methods:
1. Measuring the aggregate value of factor payments (income method)
2. Measuring the aggregate value of goods and services produced by the
firms (product method)
3. Measuring the aggregate value of spending received by the firms
(expenditure method).
In the product method, to avoid double counting, we need to deduct the value
of intermediate goods and take into account only the aggregate value of final
goods and services. We derive the formulae for calculating the aggregate
income of an economy by each of these methods. We also take note that goods
can also be bought for making investments and these add to the productive
capacity of the investing firms. There may be different categories of aggregate
income depending on whom these are accruing to. We have pointed out the
difference between GDP, GNP, NNP at market price, NNP at factor cost, PI and
PDI. Since prices of goods and services may vary, we have discussed how to
calculate the three important price indices (GDP deflator, CPI, WPI). Finally, we
have noted that it may be incorrect to treat GDP as an index of the welfare of
the country.