National Income

Concepts and Measurement

 National Income Accounting
• Process of estimating National Income
• Classification and estimation of NI and its
components is called National Income
Accounting.
• Structure of Macro Economic theory and
policy is linked with concept of NI.
 Importance of NI Accounting
• Macro Variables are dependent upon changes in NI.
• To analyze present economic situation and to
predict future course of events.
• NI Statistics help economists to gauge performance
of the economy and formulate policies.
• NI acts as the rudimentary method of judging
standard of living of people.
• So reliable and accurate data on NI is necessary for
efficient policy making and growth.
 National Income
• What is “Income”?

• What are main “Sources of Income”?

• How can we describe “Nation’s Income”

keeping in view answers of preceding
question?
 Definition Of
“National Income”
• Total market value of all final goods and services
produced in a country in one year.
OR
• Sum of all Incomes received by households during
one year.
OR
• Sum of All Expenditures made by Households,
Firms, Government and Foreigners on goods and
services produced in the country in one year.
 Three Different Approaches to One
Destination

• Product Approach

• Income Approach National Income

• Expenditures Approach
 Product Approach
• Price times Output gives market value.
– Money Value of a good = Price of Good x Quantity

– Economy is divided into various sectors and value of

output produced by each sector is then calculated.
– Precautions while using Product Approach:
• Double Counting: Use of Value Added Method
• Non Marketed or Unpaid Services are not included
• Addition to inventories, If any, must be included.
 Income Approach
• Sum of income of all individuals.
• Individuals earn income by contributing their own
services and services of their property to national
production.
• As individuals can be classified as Labour, Landlord,
Capitalist and Entrepreneur; so,
• NI = Wages+ Rent+ Interest+ Profit
• As this method show distribution of NI among various
groups of people so it is called NI by Distributive
Shares.
 Expenditure Approach
• Expenditure means to spend on goods and
services either to satisfy wants or to produce
new goods
• Expenditure to satisfy wants is termed as
Consumption Expenditure (C )
• Expenditure to produce new goods is known as
Investment Expenditure (I)
• As sum of all expenditures is NI, So for Two-
Sector Economy NI = C + I
 Expenditure Approach . . .
• In Three-Sector Economy Government would enter
with Taxes and Expenditures. So NI Equation
becomes: NI = C + I + G
• When we take into account Foreign Trade, it becomes
a Four-Sector Economy & NI equation takes the
following shape:
• NI = C + I + G + (X – M)
– where X is exports and M is Imports.
– Exports: Expenditure by Foreigners on Local goods
– Imports: Expenditure by Locals on Foreign Goods.
 Concepts Of National Income
• Gross Domestic Product (GDP)
• Gross National Product (GNP)
• Net National Product (NNP)
• National Income at Factor Cost (NI)
• Personal Income (PI)
• Disposable National Income (DI)
 Gross Domestic Product (GDP)
• GDP is the sum of market value of all final goods
and services produced within geographical
boundaries of a country in one year.
– Features
• Money Measure
• Goods produced in current year only.
• Increase in GDP indicates growing and expanding economy
• It is calculated using all three approaches of NI
simultaneously.
 Gross National Product (GNP)
• GNP is the sum of market value of all final
goods and services produced by the nationals
of a country in one year.

• Who are the Nationals of a Country?

• How to take into Account the goods and

services produced by nationals of a country?
 GNP . . .
• Nationals means Residents/Citizens of a
country.
• Pakistanis go to work in other countries and
Foreigners from various countries work in
Pakistan.
• In calculating GNP while we add the income
earned by Pakistanis working abroad, at the
same time we must subtract income earned by
Foreigners working in Pakistan.
 GNP . . .
• GNP = GDP + Net Factor Income Earned from
Abroad
• Net Factor Income = Income earned by
Pakistanis working Abroad – Income earned by
Foreigners working in Pakistan
• Food for Thought: Keeping in mind the above,
What relationship between GDP and GNP can
be established?
 Net National Product (NNP)
• Moving away from GNP we get to NNP.
• Wear and tear in capital equipment during the
production process must be taken care of in
order to be able to replace it after its useful life.
• Fall in value of capital due to wear and tear is
known as Depreciation.
• Also called Capital Consumption
Allowance/Replacement Investment
 NNP. . .
• When charges for depreciation are deducted
from GNP, we get NNP.
• Market value of goods and services after
providing for depreciation.
• It is also called NI at Market Prices.
• NNP = GNP- Depreciation
 National Income or NI @ Factor Cost
• The sum of all income earned by resource suppliers
for their contribution of land, labour, capital and
entrepreneurship which go into year net production.
• NI at factor cost shows how much it cost society, in
terms of economic resources, to produce net
output.
• NI shows the income earned by the factor of
production.
• Factor cost = Market Price - Indirect Taxes
 NI @ Factor Cost . . .
• Market Price of cloth = 10 Rs includes Rs 2 as GST
then only Rs 8 is to be distributed among four
factors.
• Hence Rs. 8 is income earned by all factors.
• Indirect Taxes raise market prices while subsidies
reduce them.
• If the Govt. provides subsidy on any good then
Factor Cost = Market Price + Subsidy
• Thus NI = NNP + Subsidies – Indirect Taxes
 Personal Income (PI)
• Income received and income earned are
different.
• NI @ Factor Cost shows income earned in a
year while PI shows income actually received.
• Personal Income is income actually received
by the household from all sources during a
year.
 Personal Income . . .
• Two reasons
• First, deductions like
– Social Security Contributions,
– Corporates Taxes
– Retained Income /Undistributed Profits
are made from the income earned by households.
• Second, Payments received which are not earned
during the year.
– Transfer Payments
 Personal Income . . .
• PI = NI – SS Contribution – Corporate Taxes –
Undistributed profits + Transfer Payments.
• Undistributed profits, also called Retained Profits is
the portion of Total profit that is not distributed
among the factors of production but kept aside for
further expansion of business.
• Transfer payments are payments made by govt. to
individuals for which there is no direct exchange of
goods and services. Also called Negative Taxes. e.g
scholarship, pension, BISP etc
 Disposable Income (DI)
• Income left with individuals and households after
payment of Direct Taxes in the form of Income Tax,
Wealth Tax, Property Tax.
– DPI = PI – Direct taxes
• It is called disposable income because the consumer
can spend it any way.
• It is finally what persons have to spend on goods and
services.
• They can Spend or Save as they like.
– DPI = Consumption + Saving
 Per Capita Income
• Per Head Income/ Average Income of people
of a country.

• It measures average standard living of people

• Food for Thought:
– What will happen if Rate of increase in population
is greater than rate of growth in NI?
– What will be ideal situation?
 Circular Flow of Income
• Economy is like a pool of water.
• Water represents the Goods and services
• Two Inlets
– From the first enter Factors to produce goods and services.
– From the second enters money to purchase Goods and
services
• Two Outlets
– From the first leave the money in the form of Income of
factors of Production
– From the second leave the Goods and Services
 Circular Flow of Income . . .
• When Factors of Production enter the pool they work to produce
Goods and Services and leave the pool with equivalent amount of
Money as Income.
• Income reaches the household, which now moves to purchase
Goods and Services, leaving the money for firms as Revenue and
taking Goods and Services to satisfy their wants.
• Everyone either takes goods and leaves money or takes money
and leaves goods in the pool of economy.
• This pool can be comprised of
– Whole of Money
– Whole of Goods and Services
– Part money and Part Goods (Most Common State)
 Go
o ds
a nd
S er v Expenditure
ice
s

Household
Firms
Economy

Inc
om
e

Revenue
 Circular Flow of Income . . .
• Size of the pool (economy) is the GDP.
Increase in GDP would mean widening of the
pool,(more goods and services, more
incomes) and vice versa.
• This circular flow of income can be studied in
2- Sector, 3-Sector and 4- Sector economy.
 2 Sector Economy
• Assumptions:
– Household are owners of Factors of Production
– Firms employ these factor to produce Goods &
Services.
– Household and firms do not save any part of
income/profit (Will be Relaxed later)
– No Govt. (No taxes and No expenditure)
– Closed Economy (No Exports and No Imports)
Investment Financial Savings
Markets
 Leakages & Injections
• Leakages are • Injections are
withdrawals from the additions to income
income stream. stream.
– Savings – Investment
– Taxes – Govt. Expenditure
– Imports – Exports