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National Income
What is Price?

A price is the quantity of payment/compensation given by one party to another in return for
one unit of goods or services. A price is influenced by both factors: production costs and
demand for the product.

Types of Price: Current & Constant

Current Prices measures GDP/inflation/asset prices using the actual prices we notice in the
economy. Current prices make no adjustment for inflation.

Constant prices adjust for the effects of inflation. Using constant prices enables us to measure
the actual change in output (and not just an increase due to the effects of inflation.

Example:

This shows that between 2000 and 2003, GDP (at current market prices) rose 14%.

However, in this period, inflation was 6%.

Therefore, adjusting for effects of inflation, GDP has increased in real terms by 8%.

• At current market prices, GDP rose 14%

• At constant prices (ignoring inflation) GDP rose 8%

The importance of current and constant prices

If your wage went from Rs 40,000 a year to Rs 70,000 – that would seem a very substantial
improvement in living standards.

However, if inflation was running at 50% a year, the purchasing power of that extra 75%
income would be reduced by the effects of inflation. Using constant prices would give a
better guide to your real wage.

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National Income

• National Income is usually defined as the total Value of all final goods and services
produced in a country in a particular period (Generally one year).
• Following are the measures of National Income-
(A) GDP (Gross Domestic Product)
(B) GNP (Gross National Product)
(C) NNP (Net National Product)
(D) PI (Personal Income)
(E) DPI (Disposable Personal Income)

(A) GDP (Gross Domestic Product)-

• GDP is the total value of all final goods and services produced within the
geographical boundary of the country during a particular period (Generally one year).
• In this, we consider all goods/ services, produced by both resident citizens and foreign
nationals who reside within the boundary of that country.
• Example-
Suppose there are 100 crore Indians who earn RS. 100 crores in Indian territory and 1
crore foreigners who earn RS. 10 crores in Indian territory and send it to their
respective countries. At the same time, 10 crores Indians living in foreign countries
earn RS. 40 crores and send it to India. Here, GDP is (100 + 10 = 110 crores).

Methods of calculating GDP:

Income Method: This method sums up all the incomes accruing to the factors of production,
viz. Rent for Land, Interest for Capital, Profit for Entrepreneurs and Wages for Labourers.

The incomes attained by all the factors of production taken together must be equal to the sum
of final expenditures in the economy. It is derived 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.

Value Added Method: This method includes the summing up of the value of all the final
goods and services in the production.

Let us suppose there are only two kinds of production process taking place in the economy:
they are the farmers growing tomato and ketchup-producer. The farmer needs only human
labour to grow tomato. The farmer sells a part of the produced tomatoes to the ketchup-
producer. The manufacturer uses tomatoes as inputs to produce ketchup.

In a given year, farmer grows tomato worth of 1000 INR. Out of this, he sells 500 INR worth
of tomato to the ketchup-producer. The ketchup-producer using tomatoes as input produces
ketchup worth of 1500 INR.

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So, what is the total value added in this entire process?

The farmer grows tomatoes of Rs 1000 which will be added to total value added since that’s
the final output produced by the farmers.

The producer used tomatoes worth Rs 500 as an input to produce ketchup worth of Rs 1500.
The input used by the producer must be subtracted from the final output of ketchup produced
by him ,i.e.1500-500=1000. The reason for the deduction is that the value of tomatoes
produced by the farmer have already been included in the value added. If this is again
included in calculating the value added, we commit the mistake of Double counting.

Hence, the net value added will be the contribution of the farmer (1000) + net contribution of
the ketchup manufacturer (1000) = 2000 INR.

The raw materials which one firm buys from another one that are completely used up in the
process of production are called ‘intermediate goods’. Therefore,

The value added by a firm = Value of production of the firm – Value of intermediate goods
used by the firm in the process.

The value added by a firm is distributed among its 4 factors of production, those are: labour,
capital, entrepreneurship and land. So wages, interest, profits and rents paid out by the firm
must add up to the value added of the firm.

Expenditure Method: The sum of net investment, government expenditure and consumer’s
expenditure on goods and services.

The expenditure method is concerned with the demand side of the GDP. In this method we
add the final expenditures incurred by all the firms in the economy. in the farmer- Ketchup
producer example, the value of output in the economy by expenditure method will be
calculated in the following way:

Final expenditure is that part of the expenditure which does not count intermediate inputs. In
our example, the Rs 500 worth of tomatoes that the ketchup manufacturer purchases from the
farmer will not be included in the final expenditure. The aggregate value of output of the
economy is Rs 1500 (final expenditure received by the ketchup manufacturer) + Rs 500 (final
expenditure received by the farmer) = Rs 2000.

Firms make final expenditure on the following accounts:

C, consumption expenditure incurred by the firms

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I, Investment expenditure incurred by firms on capital goods

G, expenditure incurred by government on the purchase of final goods and services produced
by the firms

X, Exports revenues earned by firms by selling its goods and services abroad

Sum total of final consumption, investment, government and exports expenditures received
by the firms ≡ C + I + G + X

Merits and Demerits of using GDP methodology to measure the growth of a nation:

• Merits:
1. GDP provides the information that an economy is in recession or inflation.
2. GDP helps in analysing and comparing the economic growth of different nations.
3. Investors consider GDP data before investing in a country.
4. High GDP means industrial development and may attract more investment in a
country.

• Demerits:
1. GDP does not take in consideration productive non-market activities like builder
decorating his own house, mother cooking food, carpenter making products for himself.
2. GDP does not show income-inequality in a nation.
3. GDP does not take in consideration social aspects like terrorism, intolerance, casteism,
democracy, health and education penetration, women empowerment etc.

So, GDP may not be the true reflector of development in a country.

• The National Statistical Office (NSO), Ministry of Statistics and Programme

Implementation has released the First Advance Estimates of National Income at both
Constant (2011-12) and Current Prices, for the financial year 2019-20.
• GDP (Constant Prices, 2011-12) in the year 2019-20 is estimated to be around ₹147.79
lakh crore.
• Growth in real GDP during 2019-20 is projected at 5.0 per cent as compared to the
growth rate of 6.8 per cent in 2018-19.
• Different organisations such as WB, IMF and Moody’s have given India’s GDP Forecast
2020 to be 6%, 6.1% and 5.6%, respectively.

• Alternative measures -
1. GINI coefficient - GINI coefficient gives information on income-inequality, but it
fails to take in account social measures and government intervention for social upliftment.

2. Gross National Happiness - Adopted by Bhutan in 1970s, GNH measures happiness

of people as criteria of national development but it does not take in account gender
equality, quality education, infrastructure development.

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3. Human Development Index - First published in 1990 by United Nations Development

Programme (UNDP), HDI is measured on the basis of per capita income (economic
wellness), quality education penetration and life expectancy (healthcare access). But HDI
ignores important factors like colonial history of a nation, form of political institution,
justice, fraternity, fundamental rights guaranteed to citizens etc in a country.

Understanding Purchasing Power Parity:

It is a popular macroeconomic analysis metric to compare the economic productivity and
standards of living between countries. PPP compares different countries' currencies through a
"basket of goods" approach.

Exchange rate of Currency 1 to Currency 2 = P1÷P2

where, P1 is price of good X in Currency 1 &
P2 is price of good X in Currency 2.

The economy of India is categorised as a developing market economy. It is the world's fifth-
largest economy by nominal GDP and the third-largest by purchasing power parity (PPP).

(B) GNP (Gross National Product)

• GNP is defined as the total value of the final goods and services produced by Indians
in India as well as abroad during a particular period.
• GNP includes the value of goods produced by resident and non-resident citizens of a
country whereas the income of foreigners who reside in India is excluded.
• Example-
Suppose there are 100 crore Indians who earn 100 crores in Indian territory and 1
crore foreigners who earn 10 crores in Indian territory and send it to their respective
countries. At the same time, 10 crores Indians living in foreign countries earn 40
crores and send it to India.
Here, GNP is (100 + 40 = 140 crore)
We can say GNP = GDP + Net Factor Income from Abroad (Export-Import)
GNP = 110 + (40 – 10) = Rs. 140 crores
(Inward remittances come in export and outward remittances in Import)

(C) Net National Product (NNP)-

• It is calculated by deducting depreciation from Gross National Product (GNP)

• NNP = GNP – Depreciation
Note-
Factor Cost- Cost incurred to produce goods and service
Market price- For calculating market price we add Indirect taxes and deduct
subsidies given by the government in Factor cost.
Market Price = Factor cost + Indirect Taxes – Subsidy

• NNP at factor cost = NNP at market price – Indirect taxes + subsidy

• Usually, we call NNP at factor cost as National Income.
• Likewise NNP at factor cost, we can also calculate GDP at factor cost.

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(D) Personal income-

• It is the sum of all the income received by the people of the country in one year.
Personal Income = National Income + Transfer payments – Undisclosed profits of
corporate + Payment for social security provisions

• Transfer Payments are the payments that are not against any productive work.
(Example- Old Age Pension, Unemployment compensation etc.)
• Social Security Provisions- Payment made by employees towards PF, Insurance etc.

(E) Disposable Personal Income-

• Income available to individuals after deducting direct taxes.

• Disposable Personal Income = Personal Income – Direct Taxes

Real Income and Nominal Income-

• If we use base year price for calculating National Income, this is called the Real
income. It takes inflation into the consideration to reflect changes in real output.
• If we use particular year (current year) price for calculating National Income, this
income is called the Nominal income. This price is unadjusted for inflation.

GDP Deflator-

The GDP deflator, also called implicit price deflator, is a measure of inflation. It is the ratio
of the value of goods and services an economy produces in a particular year at current prices
to that of prices that prevailed during the base year.

This ratio helps show the extent to which the increase in gross domestic product has
happened on account of higher prices rather than increase in output.

With the use of the GDP deflator, economists can compare the levels of real economic
activity from one year to another.

GDP Price Deflator=(Nominal GDP÷Real GDP)×100

Estimation of National Income in India

• In 1868, Dadabhai Naoroji wrote a book ‘Poverty and Un British Rule in India’. It
was the first attempt at the calculation of National Income.
• The first person to estimate National Income scientifically was Dr V. K. R. V. Rao
who estimated national income for the period 1925-29.
• After Independence National Income committee was formed in 1949 under the
chairmanship of P.C. Mahalanobis.
• After some years Central Statistical Organisation (CSO) was formed. Since then,
National Income is calculated by CSO, MoSPI.

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