National Income

National Income:
National Income is the monetary value of the flow of goods and services produced by
the economy during the year, after indirect taxes.
In other words, it is the amount of all products (apples, chairs, computers, hotels, and T-
shirts) that any society produces using its land, labor, physical capital and human
capital. It is equal to the sum of money values of all consumption and investment goods,
along with government purchases.
 GDP, GNP and NNP
1. Gross Domestic Product (GDP):
Gross Domestic Product (GDP) is the market value of all the products, goods and services,
which are produced within a country during a selected time (commonly in the country’s
financial year).
GDP = C + I + G + (X-M)
Where:

C = amount of consumption in the economy

I = amount of investment in the economy
G = amount of government spending in the economy
X = amount of exports from the economy
M = amount of imports into the economy
 1. Gross Domestic Product (GDP)
GDP is the aggregate demand in an economy.
The circular flow of income implies that the aggregate demand (AD) = the aggregate
supply (AS) in an economy.
In other words, the GDP is the total output from all of the sectors of an economy:
• Primary sector (agriculture, mining etc.)
• Secondary sector (manufacturing and construction; and
• Tertiary sector (services)
GDP per capita is often considered an indicator of a country's standard of living, though it is
not a measure of personal income.
GDP does not include services and products that are produced by the nation in other
countries. In other words, GDP measures products only produced inside a country’s borders.
The GDP for a particular year is measured by two ways:
i. nominal GDP and
ii. real GDP
• Nominal GDP is the value of GDP evaluated at current prices in a specific time period, this
includes the impact of inflation and is normally higher than the GDP.
Same year, same quantity, same price
• Real GDP is an inflation adjusted value of GDP. It expresses the value of goods and services
produced in a country in base-year prices. Since it is an inflation-corrected figure so it is
deemed to be an accurate indicator of economic growth.
Same year, same quantity, base year price
GDP Deflator:
It measures the current level of prices relative to level of prices in base year.
GDPD= (nominal GDP/ real GDP) *100
Inflation rate:
It represents percentage change in prices as compared to previous year.
Inflation rate= [(GDPD current year – GDPD previous year)/ GDPD previous year] *100

year Pa Qa Pb Qb Nominal GDP Real GDP GDPD Inflation rate

2001 1 50 4 100 50+400= 450 50+400= 450 100 -

2002 2 100 5 150 200+750= 950 100+600= 700 135.7 35.7%

2003 3 150 6 200 450+1200= 1650 150+800= 950 173.7 28%

 2. Gross National Product (GNP)
Gross National Product
A country’s GDP, plus any income earned by residents from overseas investments, minus
income earned by overseas residents within the domestic economy
In other words, GDP is the production within the geographical confines of a nation by all
residents in that country (whether citizens or non-citizens) and GNP is the production of the
citizens of a country only, wherever they are located.
Example: GDP compared to GNP
A Japanese company has a subsidiary in Pakistan. The output of the subsidiary would be part
of Pakistan’s GDP and Japan’s GNP.
 3. Net National Product (NNP)
Net National Product
A nation’s Net National Product (NNP) removes capital depreciation from the calculation of
national income.
This is useful when assessing what effect the change in output has had on society as a whole.
Example: Net National Product
A firm has an old machine, and so produces a new one to replace it. A few years later this
machine is also replaced.
In GNP terms, there has been an addition of two machines to the nation, and so the GNP
figure will rise accordingly. However, in that time, two machines have lost value, and are no
longer used by society.
NNP is found by deducting the value of capital depreciation that has occurred (in this case
the two machines that were replaced) from GNP.
The link between GDP, GNP and NNP
Gross Domestic Product (GDP) X
Less: Goods made in the country by foreign citizens (X)
Plus: goods made abroad by the country’s citizens X

Gross National Product (GNP) X

Less: Capital depreciation (X)
Net National Product (NNP)
MEASUREMENT METHODS OF NATIONAL INCOME

Three approaches:

1. Product/ output approach

2. Income approach

3. Expenditure approach
 1. Product/ output approach

Product approach: The total value of final goods and services produced during the year.
The term “final” goods and services relates to those that are consumed. It does not include
components or capital goods which are termed intermediate goods.
This method finds National Income by adding the net values of all production that has taken
place in all sectors during a given period.
The net values of production of all the industries and sectors of the economy plus the net
income from abroad give us the Gross National Product (GNP).
Subtracting the total amount of deprecation of the assets used in production, from the figure
of GNP, gives National Income.
This approach measures the output from an economy.
Example: Bread
In measuring the value of bread in an economy, one could measure the product
value of the grain (Rs.50/kg), then the flour (Rs.75/kg), then the final loaf of
bread (Rs.100/kg). When calculating all the output, an economist could add
up the value of the farmer’s product (grain), and then the miller’s product
(flour), and then the baker’s product (bread).
Doing so would have the value of the product as Rs.225/kg for bread, however
this means the value of the products has been “double counted”, as the final
value is only Rs.100/kg.
The value of the baker’s work is taking flour, and turning it into bread. The
miller takes the grain from the farmer and turns it into flour. If we count the
value of the bread, this already takes into account the value of the farmer and
the miller, and prevents “double counting”.
 2. Income approach

Income approach: The total value of all the incomes earned from producing goods and
services during the year.
This method measures the National Income after it has been distributed and appears as
income earned or received by individuals of the country.
This method estimates National Income by adding up the rent of land, wages of employees,
interest and profit on capital and income of self-employed people.
Illustration: Income approach

Rs.

Income from people in employment X

Income from people in self-employment X

Profits of private sector businesses X

Rent income from the ownership of land X

These incomes will equal the total value added in the process of making the product. Returning to
the bread example, this would involve adding together the incomes earned in the process of
making a loaf of bread, by the farmer, miller and baker. 
The calculation does not include:
i. Transfer Payments (e.g., state pension, unemployment benefits and other social payments)
which are ignored to avoid double counting the income:
when the original household earns it prior to it being taxed
when the household receiving the transfer payment receives it from the government.
ii. Income gained from stock appreciation. This is due to inflation and not a rise in output.
iii. Private transfers of cash from one person to another.
iv. Income not declared to the tax authorities (the “black” or “shadow” economy).
v. Activity such as subsistence farming and barter transactions.
 3. Expenditure approach

Expenditure approach: The total value of expenditure on purchasing final goods and
services during the year.
The expenditure approach involves counting the expenditure in the economy on goods and
service, by different groups of people.
These groups were identified in the original definition of GDP as Consumption, Investment,
Government Spending, Exports and Imports.
This is measured by adding up the expenditure that has happened in the country, and
includes: household consumption, government expenditure on consumables, export
demand.
Conclusion
 Circular flow of income
 There are a number of ways of measuring the national income of a country, which
should theoretically result in the same figure. In practice there are often
imperfections in how it can be measured so several methods are used to get a
better understanding of what the actual number might be.
 The diagram above shows how all three methods
should equate to the same amount, as all of
them are showing the same value at different
stages within the economy. For example, all of
the expenditure that households have will be
equal to the incomes that firms pay to those
households, and the value of the output that
firms produce.
 The circle, however, is not wholly continuous.
There can be withdrawals and injections into the flow at various junctures.
 Circular flow of income
Withdrawals include:
• Savings: Households save an element of their income thus reducing
consumption.
• Taxation: Amounts required by the government reduce households’ ability to
spend.
• Imports: Purchases from abroad result in money leaving the circle.
Injections include:
• Investments: This is a form of spending on future output in addition to
expenditure.
• Government spending: Funds spent by governments inject money to the circle.
• Exports: Sales to abroad result in an injection to the circle.
 Flow of national income – Short term and
long term
In a national economy there are three withdrawals from and three injections into the circular
flow of national income.
Withdrawals from the national income flows are: savings (A), Taxes (T) and Imports (M) and
Injections into the circular flow of national income are: Investment expenditures by firms (I),
Government expenditures (G) and Exports (X).
National income equilibrium is reached not only by the equality of aggregate demand and
aggregate supply but also the planned withdrawals from the flows of national income must
also be equal to planned injections into the circular flow of national income i.e.
withdrawals = Injections or
S+T+M=I+G+X