►3 National income: Concepts and

Measurement
► Meaning and definition of national income
► In common parlance/language, 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.
National income is the sum total of factor
incomes earned by normal residents of a
country during the period of one year.
n
NY = ∑ FYi
i =1
NY = National income
∑= Sum or total (∑ is called sigma)
FY = Factor income
n = all normal residents of a country
Rent, interest, profit and wages are the factor
incomes. So national income is the sum total
of rent, interest, profit and wages earned by
normal residents of a country during an
accounting year.
As we know the factors services are utilized for
the production of goods and services.
Accordingly, zero production would mean zero
income and greater production would mean
greater income. Precisely, value of production
is what is distributed as factor income. Thus,
National income is also defined as the sum
total of the market value of final goods and
services, produced by normal residents of a
country in one year.
All income is ultimately spent on the purchase of
goods and services. The final goods and services
must be purchased either for consumption or for
further production. Expenditure on the purchase of
final goods for consumption is called consumption
expenditure (C). While expenditure on the purchase
of final goods for further production is called
investment expenditure (I). Accordingly, all income
generated during the year is also treated as the sum
total of C and I, thus national income is also
estimated and defined in terms of the sum total of
expenditure on the final goods and services
produced by the normal residents of a country
during the period of one year.
NY = C + I
NY = National income
C = Consumption
I = Investment expenditure
From the modern point of view, Simon Kuznets has
defined national income as “ the net output of
commodities and services flowing during the year from
the country’s productive system in the hands of the
ultimate consumers,” whereas, in one of the reports of
United Nations, national income has been defined on
the basis of the system of estimating national income,
as net national product, as addition to the shares of
different factors, and as net national expenditure in a
country in a year’s time.
In practice, while estimating national income, any
of these three definitions may be adopted,
because the same national income would be
derived, if different items were correctly
included in the estimate.
World Bank defines national income as, “Gross
National Product measures the total domestic
and foreign value added claimed by residents.
It comprises gross domestic product plus net
income from abroad which is the income
received by residents from abroad for factor
services (labour and capital) less payments
made to non-residents who contributed in the
production of goods and services to the
domestic economy”.
Various concepts of national income:
*Gross Domestic Product/Output/ Income
The most widely used measure of national
income is known as Gross Domestic Product
(GDP). Gross means total, domestic refers to
the home economy and product means output.
So, for example, Nepal’s GDP is a measure of
the total output by the factors of production
based in Nepal. GDP is calculated by adding up
consumer’s spending, government spending on
goods and services, total investment, changes
in stocks and the difference between exports
and imports.
The important concept of national income is
gross domestic product (GDP). Gross domestic
product is the money value of all final goods
and services produced by normal residence as
well as non-residence in the domestic territory
of a country but do not include net factor
income earned from abroad. Thus difference
between gross domestic product (GDP) and
gross national product (GNP) at market prices
arises due to the existence of ‘net factor
income from abroad’. Gross domestic product
does not include net factor income from
abroad, whereas gross national product
includes it.
To assess how fast the economy has grown we must
have a means of measuring the value of the nation’s
output. The measuring we use is called gross domestic
product.
The three ways of calculating GDP: GDP can be
calculated in three different ways, which should all
result in the same figure. These three methods are
illustrated in the simplified circular flow of income
shown in the figure 1, 2 and 3(of previous chapter2).
The first method of measuring GDP is to add up the
value of all the goods and services produced in the
country, industry by industry. In other words, we
focus on firms and add up all their production. This
first method is known as the product method.
The production of goods and services generates
incomes for households in the form of wages
and salaries, profits, rent and interest. The
second method of measuring GDP, therefore, is
to add up all these incomes. This is known as
the income method.
The third method focuses on the expenditures
necessary to purchase the nation’s production.
In this simple model of the circular flow of
income, with no injections or withdrawals,
whatever is produced is sold. The value of what
is sold must therefore be the value of what is
produced. The expenditure method measures
this sales value.
Because of the way the calculation are made, the three
methods of calculating GDP must yield the same
result. In other words:
National product = National income = National
expenditure
We will look at each of the three methods in turn, and
examine the various factors that have to be taken into
account to ensure that the figures are accurate.

► The output measure

The output method measures the value of output
produced by industries including, for example, the
output of the manufacturing, construction, distributive,
hotel and catering and agricultural industries.
In using this measure it is important to avoid
counting the same output twice. For example, if
the value of cars sold by car manufacturers is
added to the value of output of tyre firms,
double counting will occur. Value added is the
difference between the sales revenue received
and the cost of raw materials used. It is equal
to the payments made to the factors of
production in return for producing the goods or
service. So that if a TV manufacturing firms
buys components costing $60,000 and uses
them to make TVs which it sells for $130,000, it
has added $70,000 to output. It is this $70,000
which will be included in the measure of
output.
The income measure
The value of output produced is based on the
costs involved in producing that output. These
costs include wages, rent, interest and profits.
All these payments represent income paid to
factors of production. For instance, workers
receive wages and entrepreneurs receive
profits. In using this measure it is important to
include only payments received in return for
providing a good or service. So transfer of
payments, which are transfers of income for
welfare payments, are not included.
The expenditure measure
The total amount spent in a year should equal total
output and also total income:
Output = Income = Expenditure
What is produced in a year will either be sold or added
to the stocks. So if addition to stocks is added to
expenditure on goods and services, a measure is
obtained which will equal output and income. In
using this method it is necessary to add expenditure
on exports and deduct expenditure on imports. This
is because the sale of exports represents the
country’s output and creates income in the country,
whereas expenditure on imports is spending on
goods and services made in foreign countries and
creates income for people in those countries.
It is also necessary to deduct indirect taxes and
add subsidies in order to get a value which
corresponds to the income generated in the
production of the output.
*Gross National Product/ Output /
Income
Gross domestic product consists of all output
produced within the boundaries of a country,
whereas GNP includes all output produced by
the country’s economic resources regardless
of where they are domiciled (where they
dowelled). Both measure are of comparable
magnitude and display similar behaviour over
time.
GNP = GDP + net property income from abroad
Net property income from abroad is the income
which the country’s residents earn on their
physical assets (such as factories and leisure
parks) owned abroad and foreign financial
assets (such as shares and bank loans) minus
the returns on assets held in the country but
owned by foreigners. So GNP gives a measure
of the income of the country’s residents.
GNP is the total measure of the flow of goods
and services at market value resulting from
current production during a year in a country,
including net income from abroad. 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, 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 decease in the prices, the GNP
shows a rise or decline, which may not be real.
To guard against erring on his account, a
particular year (say for instance 1960) when
prices be normal, is taken as base year and the
GNP is adjusted in accordance with the index
number for that year.
This will be known as GNP at 1960 prices or at
constant year. This will be known as GNP at
1960 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 and 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 GNP, because it is
not possible to have a correct estimate of
their market prices. For example, the bringing
up of a child by the mother, imparting
instructions to his son by a teacher, recital
(performance) to his friends by a musicians,
sculpturing as hobby by a sculptor, etc.
Fourth, the transaction which do not arise from
the produce of current year or which do not
contribute in any way to production, are
included in GNP, because these do not make
any addition to the national product, and the
goods are simply transferred . Likewise, the
payment received under social security, e.g.,
unemployment insurance allowance, old age
pension, and interest on public welfare are also
not included in GNP, because 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 a capital assets as a result
of fluctuations in market price, 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 food or fire, are not included in the
GNP.
Last, 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.
But 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.
*Net Domestic/ National Product
GNP includes the value of total output of
consumption goods investment goods. But the
process of production uses up a certain amount
of fixed goods equipment wears out, its other
components are damaged or destroyed, and
still others are rendered obsolete through
technological changes. All this process is
termed depreciation or capital consumption
allowance. In order to arrive at NNP, we deduct
depreciation from GNP. The word ‘net’ refers to
the exclusion of that part of total output which
represents depreciation.
NNP (Net National Product) = GNP – capital
consumption/depreciation
NDP (Net Domestic Product) = GDP – capital
consumption/depreciation
This can be also referred to as national income.
Capital consumption can also be called
depreciation or replacement investment as it
covers investment undertaken to replace worn
out and out-of-date capital. So gross measures
include all investment whilst net measures only
include investment which adds to the capital
stock.
Net national product equals GNP less
replacement investment (capital consumption
allowance). Each year, some of the economy’s
capital stock wears out. Thus, investment each
year, i.e., gross investment (Ig), includes
additions to the capital stock (In) and
replacement of worn-out capital stock (D).
thus, GNP = C + Ig (gross investment) + G +
Xn (gross exports less gross imports), while
NNP = C + In (net investment) + G + Xn
*GDP at market price
Gross domestic product is the market value of
the final goods and services produced within
the domestic territory of a country during one
year inclusive of depreciation. There are both
residents as well as foreign producers within
the domestic territory of a country. In Nepal,
for example, there are many international
banks as well as few multinational companies.
Gross domestic product includes the market
value of the final goods and services produced
by all such producers.
Symbolically, n
GDPMP = ∑ Pi Qi
i =1
or, GDPMP = ∑ ( Px Qx + Py Qy + ………. +
Pn Qn )
This concept requires the understanding of
three important observations, as under:
(i) Gross: The term ‘gross’ has been pre-fixed
with domestic product to indicate that the latter
is inclusive of depreciation, i.e., consumption of
fixed capital.
(ii) Domestic: Gross domestic product at market
price is the market value of the final goods and
services produced within the domestic territory
of the country. It does not matter whether
production is done by domestic companies or
the foreign companies. Example: production of
motor bikes by the foreign companies in Nepal
will be treated as a part of GDP of Nepal.
(iii) Value of final goods and services: Only the
market value of final goods and services is
taken into account, not the intermediate goods
and services. Because the value of intermediate
goods (goods used as raw material) is reflected
in the value of final goods.
(iv) It includes only those goods and services,
that have market value; it does not include all
transactions in which money or goods change
hands but in which no new goods and services
such as the capital gains, second-hand sales,
illegal income and transfer payments, are
produced. In other words, they do not add
productive capacity of the economy. So, they
are excluded from GDP.
GDPMP = Total product of primary sector +
total product of secondary sector + total
product of tertiary sector.
Further, on expenditure basis,
GDPMP = C + I + G + (X – M)
Where, C = private consumption expenditure, I
= private investment expenditure, G = public
consumption and investment expenditure and
X- M = Net exports
*GNP at market price
Gross National Product at market price (GNPMP)
is the market value of the final goods and
services produced within the domestic territory
of a country by the normal residents during an
accounting year along with (i) net factor
income earned from abroad, and (ii)
consumption of fixed capital.
GDPMP becomes GNPMP if net factor income
abroad is added to it.
Thus, GNPMP = GDPMP + Net factor income
from abroad
Net factor income from abroad is the difference
between factor income (rent, interest, profit
and wages) earned by domestic residents from
rest of the world and factor income earned by
non-residents within the country.
Net Factor Income From Abroad (NFIA) = Factor
income earned by our residents from abroad —
Factor income earned by non-residents
(residents of other countries) within our
country.
GNPMP = C + I + G + (X-M) + (Fd – Ff)
Where, Fd = factor income earned by domestic
people from abroad
Ff = factor income earned by foreigners within
the country
If net factor income from abroad is positive,
gross national product would be greater than
gross domestic product. On the other hand, if
net factor income from abroad is negative,
gross national product would be less than the
gross domestic product.
Component of Net Factor Income fro Abroad
1. Net Compensation of Employees: It is the
difference between compensation (of
employees) received by resident workers,
temporarily employed abroad and a similar
payment made to non-resident workers who are
employed temporarily within the domestic
territory of a country.
2. Net income from property and
entrepreneurship (other than retained earnings
of resident companies of abroad): it is the
difference between income in the form of rent,
interest and profit received by the residents of a
country and similar payments made to the rest
of the world.
3. Net retained earnings of resident companies abroad:
It is the difference between the retained earnings of
resident companies located abroad and retained
earnings of foreign companies located within the
domestic territory of a country.

*NNP at market price

Net National Product at market prices is the net value of
final goods and services evaluated at market prices in
the course of one year in a country.
It measures the value of final goods and services
produced by the normal residents in the domestic
territory and abroad in an accounting year after worn
out capital goods have been replaced.
Some capital goods are used up in the production
process through normal wear and tear,
obsolescence and accidental destruction (for
example, the machinery that breaks down and
no longer works). The cost to replace these
capital goods is called the capital consumption
allowance and depreciation. Replacing
depreciated capital does not actually represent
new production, therefore we reduce the value
of total production by this amount to show net
production of the year.
Net national product at market price = Market
value of final goods and services produced
during a year + Net factor income from abroad
– Depreciation or capital consumption
Thus, NNPMP = GDPMP + NFIA– CCA
Where, NFIA= Fd – Ff
CCA = Capital Consumption Allowance
 Final Gods are different from Intermediate Goods
Final Goods Intermediate Goods
(i) These are those goods which (i) These are those goods which are
have crossed the boundary line of within the boundary line of
production. production.
(ii) No value is to be added to (ii) Value is at to be added to
final goods. intermediate goods.
(iii) Final goods are ready for use (iii) Intermediate goods are not
by their final users (which ready for use by their final users.
include consumers and
producers).

(iv) Final goods are included in (iv) Intermediate goods are not
the estimation of national included in the estimation of
product or national income. national product or national
income.
Example: Firm-X produces paper. It is to be
treated as an intermediate product or a final
product. Check its end-use. A part of paper
produced by firm-X may be directly sold to the
household who are the final users of paper. To
that extent paper is a final product. Some part
of the paper produced by firm-X may be
purchased by firm-Y to be used as a raw
material in the publication of books. To that
extent paper is an intermediate product.
Conclusion: If the end-use is raw material or for
further sale, the product is intermediate, if the
end-use is final consumption or investment the
product is final.
It may be pointed out that depreciation or capital
consumption involves three types of expenses
viz:
(a) Normal wear and tear: It refers to those
expenses which are borne on account of wear
and tear of fixed capital like machines due to
their continuous use.
(b) Obsolescence: It refers to these expenses
which are incurred by the producers because of
some capital equipment becoming obsolete or
out of date with the introduction of latest
machines and equipment.
(c) Accidental Breakdown of the Machinery.
*NDP at market price
Net domestic product at market price is the
market value of the final goods and services
produced within the domestic territory of a
country, exclusive of depreciation.
GDPMP and NDPMP differ from each other only
in one sense.
While GDPMP includes depreciation, NDPMP does
not.
Thus, NDPMP = GDPMP – Depreciation
Or, GDPMP = NDPMP + Depreciation
*GDP at factor cost
Gross Domestic Product at Factor Cost is the sum
total of factor incomes (rent + interest + profit
+ wage) generated within the domestic
territory of a country, along with consumption
of fixed capital, during a year. As it refers to
Gross, it makes no provision for the
depreciation. Market value of goods and
services differs from the earnings of factors of
production because of net indirect taxes.
Therefore, if we deduct net indirect taxes from
gross domestic product at market price, we get
domestic product at factor cost.
Thus, GDPFC = Rent + compensation of
employees + interest + profits + mixed
income + depreciation
GDPFC = GDPMP - Net Indirect Taxes
GDPFC includes depreciation, while NDPFC does
not. Hence,
GDPFC = NDPFC + Depreciation
*GNP at factor cost
Gross national product at factor cost is the sum of the
money value of the income produced by and accruing
to the various factors of production in one year in a
country or it is the sum total of factor incomes earned
by normal residents of a country, along with
consumption of fixed capital, during a year.
It includes all items mentioned above under income
approach to GNP less indirect taxes. GNP at market
prices always includes indirect taxes levied by the
government on goods which raise their prices. But
GNP at factor cost is the income which the factors of
production receive in return for their services alone. It
is the cost of production.
Thus GNP at market prices is always higher than
GNP at factor cost. Therefore, in order to arrive
at GNP at factor cost, we deduct indirect taxes
from GNP at market prices. Again, it often
happens that the cost of production of a
commodity to the producer is higher than the
price of a similar commodity in the market. In
order to protect such producers, the
government helps them by granting monetary
help in the form of a subsidy equal to the
difference between the market price and the
cost of production of the commodity.
As a result, the price of the commodity to the
producer is reduced and equals the market
price of similar commodity. For example, if the
market price of rice is Rs. 40 per kg but it costs
the producers in certain area Rs. 42 the
government gives a subsidy of Rs.2 per kg to
them in order to meet their cost of production.
Thus in order to arrive at GNP at factor cost,
subsidies are added to GNP at market prices.
GNPFC = GNPMP – indirect taxes + subsidies
GNPFC = GNPMP – net indirect taxes
GNPFC = Rent + compensation of employees +
interest + profits + mixed income +
depreciation + net factor income from abroad
*NNP at factor cost
Net National Product at factor cost is the net
output evaluated at factor prices. It includes
income earned by factors of production through
participation in the production process such as
wages and salaries, rents, profits, etc. It is also
called National income. This measure differs
from NNP at market prices in that indirect taxes
are deducted and subsidies are added to NNP
at market prices in order to arrive at NNP at
factor cost.
Thus NNPFC = NNPMP – Indirect taxes +
Subsidies
= GNPMP – Depreciation – Indirect
Taxes + Subsidies
= National income
Normally, NNP at market prices is higher than
NNP at factor cost because indirect taxes
exceed government subsidies. However, NNP at
market prices can be less than NNP at factor
cost when government subsidies exceed
indirect taxes.
Real and Nominal GDP/GNP/NNP
Money (or nominal) GDP is GDP measured in
terms of the prices operating in the year in
which the output is produced. It is sometimes
referred to as GDP at current prices and is a
measure which has not been adjusted for
inflation.
Money GDP may give a misleading impression of
how well a country is performing. This is
because the value of money GDP may rise not
because more goods and services are being
produced but merely because prices have risen.
For example, if 100 million products are
produced at an average price of $4, GDP will be
$400 million.
If the next year the same output of 100 million
products is produced but the average price
rises to $5, money GDP will rise to $400 million.
So to get a truer picture of what is happening
to output, economists convert money into real
GDP. They do this by measuring GDP at
constant prices, that is, at the prices operating
in a selected base year. By doing this they
remove the distorting effect of inflation. For
example, in 2007 Nepal’s GDP is $700 billion
and the price index is 100. Then in 2008,
money GDP rises to $768 billion and the price
index is 105.
Real GDP of Nepal = money GDP × Price index in
base year
Price index in current year
= $768 bn × 100
105
= $731.43 bn
The price index used to convert money into real
GDP is the GDP deflator, which measures the
prices of products produced rather than
consumed in a country. So it includes the prices
of capital as well as consumer products and
includes the prices of exports but excludes the
prices of imports.
*(1) Nominal National Income (Money GDP
or National Income at Current Price)
While estimating national product, goods and
services produced are multiplied by their price.
If national product is multiplied by the current
prices (that is, the prevailing market prices), we
obtain national income at current prices. But
prices do not remain constant. These keep on
changing. If prices increase without any
increase in the production of goods and
services, then national product at current prices
would also increase.
Likewise, if prices decrease, it would cause a
reduction in national product at current prices
without any reduction in goods and services
produced. National income at current prices is
also called monetary income.
Monetary national income or national income at
current prices is money value of all final goods
and services measured at current prices
produced by the normal residents of a country
during one year.
*(2) Real National Income (or National
Income at Constant Price)
Growth of an economy can be rightly assessed
only when national income is measured at the
constant price level of a particular year known
as base year. The national income at constant
prices is also called real national income. This
increases only when there is an increase in the
production of goods and services.
Real national income or national income at
constant prices is the value measured at
constant prices of all the final goods and
services produced by the normal residents of a
country during one year.
*Difference between Money and Real
GDP/GNP/NNP
The main differences between national income at
current prices or monetary national income and
national income at constant prices or real national
income are as follows:
(1) National income at current prices is the sum total of
market value of final goods and services produced by
the normal residents of a country during the year and
estimated at current prices of the current year. On the
other hand, national income at constant prices is the
sum total of market value of the final gods and
services produced by the normal residents of a
country during the year, but estimated at the prices of
the base year.
(2), National income at current prices can
increase even when there is no increase in the
flow of goods and services in the economy, but
only prices happen to increase. In contrast,
national income at constant prices will increase
only when there is an increase in the flow of
goods and services.
The national income at constant prices is a more
appropriate index of the growth of an economy
like Nepalese economy than the national
income at current prices. It is because national
income at constant prices refers to the flow of
goods and services.
GDP at current prices refers to the market
value of goods and services, estimated by using
prices prevailing during the year of estimation.
Here, income changes when either output
changes or price. This is also known as Nominal
GDP.
GDP any constant prices refer to the market
value of goods and services estimated by single
prices prevailing during the base year, the year
of comparison. Here, income changes only
when output changes. This is also known as
Real GDP.
#GNP deflator
The GNP deflator measures the average level of
the prices of all the goods and services that
make up GNP. GNP deflator is measured as the
ratio of nominal GNP to real GNP, multiplied by
100. GNP deflator shows change in the GNP
because of change in price level. In other
words, GNP deflator refers to change in price
index for GNP.
GNP Deflator = Nominal GNP × 100
Real GNP
 Computing the GNP Deflator
(1) (2) (3) (4) (5) (6)
Goo Current Current Nominal Base Real
ds Year Year GNP Year GNP
Quantitie Prices(R (Current Prices (Current
s s.) Year (Rs) Year
Prices) Prices)
(2) ×(3) (Rs)
(2) ×(5)
Rice 200 30 6000 15 3000
Whe 100 25 2500 10 1000
at
∑ = 8500 ∑ = 4000
GNP Deflator current Year
= Nominal GNP current year × 100
Real GNP current year
= 8500 × 100
4000
= 212.5
GDP Deflator current Year
= Nominal GDP for current year × 100
Real GDP for current year
#Methods of computing/ measuring
GDP/GNP/NNP:
*Income method
According to this method, the net income payments
received by all citizens of a country in a particular year
are added up, i.e., net incomes that accrue to all
factors of production by way of net rents, net wages,
net interest and net profits are all added together but
incomes received in the form of transfer payments are
not included in it. The data pertaining (relating) to
income are obtained from different sources, for
instance, from income tax department in respect of
high income groups and in case of workers from their
wages bills.
(i) Wages and salaries. Under this head fall all
forms of wages and salaries earned through
productive activities by workers and
entrepreneurs. It includes all sums received or
deposited during a year by way of all types of
contributions like overtime, commission,
provident fund, insurance etc.
(ii) Rents. Total rent includes the rents of land,
shop, house factory, etc. and the estimated
rents of all such assets as are used by the
owners themselves.
(iii) Interest. Under interest comes the income by
way of interest received by the individual of a
country from different sources. To this is added
the estimated interest on that private capital
which is invested and not borrowed by the
businessman in his personal business. But the
interest received o governmental loans has to
be excluded, because it is a mere transfer of
national income.
(iv) Dividends. Dividends eared by the
shareholders from companies are included in
the GNP.
(v) Undistributed corporate profits. Profits which
are not distributed by companies and are
retained by them are included in the GNP.
(vi) Mixed incomes. These include profits of
unincorporated businesses, self-employed
persons and partnerships. They form part of
GNP.
(vii) Direct taxes. Taxes levied on individuals,
corporations and other businesses are included
in the GNP.
(viii) Indirect taxes. The government levies a
number of indirect taxes, like excise duties and
sales tax. These taxes are included in the prices
of commodities. But revenue from these goes to
the government treasury and not to the factors
of production. Therefore, the income due to
such taxes is added to the national income.
(ix) Depreciation. Every corporation makes
allowance for expenditure on wearing out and
deprecation of machines, plants and other
capita equipment. Since this sum also is not a
part of the income received by the factors of
production, it is, therefore, also included in
GNP.
(x) Net income earned from abroad. This is the
difference between the value of exports of
goods and services and the value of imports of
goods and services. If this difference is
positive, the it is added to GNP and if it is
negative it is deducted from GNP.
Thus GNP according to Income Method = Wages
and Salaries + Rents + Interest + Dividends +
Undistributed Corporate Profits + Mixed
Incomes + Direct axes + Indirect Taxes +
Depreciation + Net Income from abroad
*Expenditure method
According to this method, the total expenditure
incurred by the society in a particular year is
added together and includes personal
consumption expenditure, net domestic
investment, government expenditure on goods
and services, and net foreign investment. This
concept is based on the assumption that
national income equals national expenditure.
(i) Private consumption expenditure. It includes
all types of expenditure on personal
consumption by the individuals of a country. It
comprises expenses on durable goods like
watch, bicycle, radio etc., expenditure on
single-used consumers’ goods like milk, bread,
ghee, clothes, etc., as also the expenditure
incurred on services of all kinds like fees or for
school, doctor, lawyer and transport. All these
are taken as final goods.
(ii) Gross domestic private investment. Under this comes
the expenditure incurred by private enterprises on
new investment and on replacement of old capital. It
includes expenditure on house-construction, factory
buildings, all types of machinery, plants and capital
equipment. In particular the increase or decrease in
the inventory is added to or subtracted from it. The
inventory includes produced but unsold manufactured
and semi-manufactured goods during the year and the
stocks of raw material, which have to be accounted
for in GNP. It does not take into account the financial
exchange of shares and stocks, because their sale and
purchase is not real investment. But depreciation is
added.
(iii) Net foreign investment. It means the
difference between exports and imports or
export surplus. Every country exports to or
imports from certain foreign countries. The
imported good are not produced within the
country and hence cannot be included in
national income, but the exported goods are
manufactured within the country. Therefore,
the differences of value between exports (X)
and imports (M), where positive or negative, is
included in the GNP.
(iv) Government expenditure on goods and
services. The expenditure incurred by the
government on goods and services is a part of
GNP. Central, State or Local governments
spend a lot on their employees, police and
army. To run the offices the government has
also to spend on contingencies which include
paper, pen, pencil and various expenditure on
government enterprises. But expenditure on
transfer payment is not added, because these
payments are not in exchange for goods and
services produced during the current year.
Thus, GNP according to Expenditure Method =
Private Consumption Expenditure (C) + Gross
Domestic Private Investment (I) + Net
Foreign Investment (X – M) + Government
Expenditure on goods and services (G) = C +
I + (X – M) + G.
As already pointed out above, GNP estimated
by either the income or the expenditure
method would work out to be the same, if all
the items are correctly calculated.
*Value added method
Another method of measuring national income is
the value added by industries. The difference
between the value of material outputs and
inputs at each stage of production is the value
added. If all such differences are added up for
all industries in the economy, we arrive at the
gross domestic product.
Another method of measuring GNP is by value
added. In calculating GNP the money value of
final goods and services produced at current
prices during a year is taken into account. This
is one of the ways to avoid double counting. But
it is difficult to distinguish properly between a
final product and an intermediate product.
For instance, raw materials, semi-finished
products, fuels and services, etc. are sold as
inputs by one industry to the other. They may
be final goods for one industry and
intermediate for others. So, to avoid
duplication, the value of intermediate products
must be subtracted from the value of total
output of each industry in the economy. Thus
the difference between the value of material
outputs and inputs at each stage of production
is called the value added. If all such differences
are added up for all industries in the economy,
we arrive at the GNP by value added. Its
calculation is shown in Table I.
 Table I: GNP by Value Added
Industry Total Intermediate Value
(1) Output Purchase Added
(2) (3) (4) = (2-3)

1. Agriculture 30 10 20
2.Manufacturing 70 45 25
3. Others 55 25 30
Total 155 80 75
The table is constructed on the supposition that
the entire economy for purposes of total
production consists of three sectors. They are
agriculture, manufacturing and others,
consisting of the tertiary sector. Out of the
value of total output of each sector is
deducted the value of its intermediate
purchases (or primary inputs) to arrive at the
value added for the entire economy. Thus the
value of total output of the entire economy as
per table I, is Rs 155 crores and the value of
its primary inputs come to Rs 80 crores. Thus
the GNP by value added is Rs 75 crores (Rs
155 minus 80 crores).
The total value added equals the value of gross
national (domestic) product of the economy.
Out of this value added, the major portion
goes in the form of wages and salaries, rent,
interest and profits, a small portion goes to
the government as indirect taxes and the
remaining amount is meant for depreciation.
This is shown in table II.
 Table II: Gross Domestic Product
(Rs, Crores)
1. Wages and salaries 45

2. Income from rent 3

3. Net interest 4
4. Profits of companies 8
5. Indirect taxes 7
6. Depreciation 8
Gross Domestic Product 75
Thus we find that the total gross value of an
economy equals the value of its gross
domestic product. If depreciation is deducted
from the gross value added, we have net
value added which comes to Rs 67 crores
(Rs75crores – Rs 8 crores). This is nothing
but net domestic product at market prices.
Again, if indirect taxes (Rs 7 crores) are
deducted from the net domestic product of Rs
67 crores, we get Rs 60 crores at the net
value added at factor cost which is equivalent
to net domestic product at factor cost. This is
illustrated in the following Table III.
 Table III

1. Market Value of output 155

2. Less cost of intermediate goods 80

3. Gross Value added 75
4. Less depreciation 8
5. Net value added or net domestic product at 67
market prices
6. Less direct taxes 7
7. Value added at factor cost 60
This value added at factor cost is equal to the
net domestic product at factor cost, as given
by the total of items 1 to 4 of table II (Rs
45+3+4+8 crores = Rs 60 cores)
If we add net income received from abroad to
the gross value added, this given us gross
national income. Suppose net income from
abroad is Rs 5 crores. Then the gross national
income is Rs 80 crores (Rs 75 crores + Rs 5
crores).
The value added method for measuring national
income is more realistic than the product and
income methods because it avoids the
problem of double counting by excluding the
value of intermediate products.
Thus this method establishes the importance of
intermediate products in the national economy.
Second, by studying the national income
accounts relating to the value added, the
contribution of each production sector to the
value of GNP can be found out. For instance, it
can tell us whether agriculture is contributing
more or the share of manufacturing is falling,
or of the tertiary sector is increasing, in the
current year as compared to some previous
years. Third, this method is highly used
because “it provides a means of checking the
GNP estimates obtained by summing the
various types of commodity purchases.”
However, difficulties are arise in the calculation
of value added in the case of certain public
services like police, military, health,
education, etc. which cannot be estimated
accurately in money terms. Similarly it is
difficult to estimate the contribution made to
value added by profits earned on irrigation
and power projects.
*Product method
According to this method, the total value of final
goods and services produced in a country
during a year is calculated at market prices. To
find out the GNP, the data of all productive
activities, such as agriculture products, wood
received from forests, mineral received from
mines, commodities produced by industries, the
contributions to production made by transport,
communications, insurance companies,
lawyers, doctors, teachers etc. are collected
and assessed at market prices. Only the final
goods and services are included and the
intermediary goods and services are left out.
*Personal Income
Personal income is the total income received by
the individuals of a country from all sources
before 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 ad 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. Thus, Personal Income (PI)=
National Income – Undistributed Corporate
Profits – Profits Taxes – Social Security
Contributions + Transfer Payments + Interest
on Public Debt.
► Personal income differs from private income in
that it is less than the latter because it excludes
undistributed corporate profits. Thus Personal
Income = Private Income – Undistributed
Corporate Profits – Profits Taxes.
*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 can not be
spent on consumption, because it is the income
that accrues before direct taxes have actually
been paid. Therefore, in order to obtain the
disposable income, direct taxes are deducted
from personal income. Thus, Disposable income
(DI) = Personal Income (PI) – Direct Taxes
(DT).
But the whole of the disposable income is not
spent on consumption and a part of it is saved.
Therefore, the disposable income is divided into
consumption expenditure and savings.
Thus Disposable Income (DI) = Consumption
Expenditure (C) + Savings (S)
If disposable income is to be deducted 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 transfer payments and net
income from abroad to it.
Thus Disposable Income (DI) = National
Income – Business Savings – Indirect taxes
plus Subsidies – Direct Taxes on Persons –
Direct Taxes on Business – Social Security
Payments + Transfer Payments + Net
Income from Abroad.
*Per Capita Income
The average income of the people of a country in
a particular country in a particular year is called
Per Capita Income fo 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 for 1981, at current prices, the national
income of a country is divided by the
population of the country in that year.
Per Capita Income for 2008
= National income for 2008
Population in 2008
Similarly, for the purpose of arriving at the Real
Per Capita Income also, this very formula is
employed.
Real Per Capita Income for 2008
= Real national income for 2008
Population in 2008
This concept enables us to know the average
income and the standard of living of the
people. But it is not very reliable, because in
every country due to unequal distribution of
national income a major portion of it goes to
the richer sections of the society and thus
income received by the common man is lower
than the per capita income.
Difficulties in the measurement of National
Income
To calculate the national income of a country is a
complicated problem and beset with the
following difficulties:
(1) First there is the difficulty defining ‘nation’ in
national income. Every nation has its political
boundaries, but in the national income is also
included the income earned by the nationals of
a country in a foreign country beyond the
territorial boundaries of that country.
(2) National income is always measured in
money, but there are a number of goods and
services which are difficult to be assessed in
terms of money, e.g., painting as a hobby by
an individual, the bringing up of children by
the mother. Similarly, when the owner of a
firm gets married to his lady secretly, her
services, though a part of national income,
are not included in it. By excluding all such
services from it, the national income will work
out to be less than what it actually is.
(3) The greater difficulty in calculating the
national income is of double counting, which
arises from the failure to distinguish properly
between a final and an intermediate product.
There always exists the fear of a good or a
service being included more than once. If it so
happens, the national income would work out
to be many times the actual. Flour used by a
bakery is an intermediate product and that by a
household the final product. To solve this
difficulty, only that is not so easy a task.
(4) Income earned through illegal activities such
as gambling, or illicit extraction of wine, etc., is
not included in national income. Such goods
and services do have value and meet the needs
of the consumers. But by leaving them out, the
national income works out to less than the
actual.
(5) Then there arises the difficulty of including transfer
payments in the national income. Individuals get
pension, unemployment allowance and interest on
public loans, but whether these should be included in
national income is a difficult problem on the other
hand, these earnings are a part of individual income
and on the other, they are government expenditure.
To avoid this difficulty, these are deducted from
national income.
(6) Capital gains or losses which accrue to property
owners by increases or decreases in the market value
of their capital assts or changes in demand are
excluded from the GNP because such changes do not
result from current economic activities.
It is only when capital gains or losses are the
result of the current flow or non-flow of
productive activities that they are included in
the GNP. “Those changes in the value of goods
that result from ungovernable or unpredictable
causes are treated as accidental shifts that are
outside current activity proper. Those changes
in value that can be anticipated and insured
against, such as fire and flood, are also
excluded because the adjustment for such
shifts in value has already been charged
against the operation of previous years through
insurance premiums.”
(7) All inventory changes whether negative or
positive are included in the GNP. The procedure
is to take positive or negative changes in
physical units of inventories and multiply them
by current prices. Then this figure is added to
total current production of the firm. But the
problem is that firms record inventories at their
original costs rather than at replacement costs.
When prices rise there are gains in the book
value of inventories. Contrariwise, there are
losses when prices fall. So the book value of
the inventories overstates or understates the
actual inventories.
Thus for correct imputation of GNP, inventory
evaluation is required. A negative valuation
adjustment is made for gains and a positive
valuation is a very difficult and cumbersome
procedure.
(8) When we deduct capital depreciation from
GNP, the resulting measure is NNP.
Depreciation is a charge on profits which lowers
national income. But the problem of estimating
the current depreciated value of a piece of
capital whose expected life is fifty years is very
difficult. The usual practice on the part of firms
is to base their depreciation provisions on the
original cost of their assets.
When price of capital goods are changing, the
annual depreciation provision will then measure
the cost of using fixed assets for some fifty
years (i.e., the time when the assets were
bought) rather than the current cost of using
them. Unlike inventories, a depreciation
valuation adjustment is full of statistical
difficulties, such as the age-composition of the
whole capital stock, and changes in prices of
capital goods every year since the assets were
bought.
(9) Another difficulty in calculating national
income is that of price changes which will fail to
keep stable the measuring rod of money for
national income. When the price level in the
country rises, the national income also shows
an increase even though the production might
have fallen. On the contrary, with a fall in price
level, the national income shows a decline even
though the production might have gone up.
Thus due to price-changes the national income
can not be adequately measured.
► To solve this difficulty, the statisticians have
introduced the concept of real national
income, according to which the prices of the
year in question are assessed in terms of
prices of the base year. But this does not
solve the problem of calculating the national
income, because the index numbers which
measure the price-changes are just rough
estimates. Thus the national income data are
misleading and unreliable.
► 10) Moreover, the calculation of national
income in terms of money is under-estimation
of real national income. It does not include
the leisure foregone in the process of
production of a commodity. The incomes
earned by two individuals may be equal, but
if one of them works for longer hours than
the other would be correct to some extent to
say that the real income of the former has
been understated. Thus national income does
not take into consideration the actual cost of
production of a commodity.
(11) In calculating national income, a good
number of public services are also taken
which can not be estimated correctly. How
should the police and military services be
estimated? In the days of war, the forces are
active, but during peace they rest in
cantonments. Similarly, to estimate the
contribution made to national income by
profits earned on irrigation and power
projects in terms of money is also a difficult
problem.
Importance of National income analysis
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. Social accounts tell us how
the aggregates of a nation’s income, output
and product result from the income of different
individuals, products of industries and
transaction of international trade. Their main
constraints are inter-related and each particular
account can be used to verify the correctness
of any other account.
Based very much on social accounts, the national
income data have following importance.
National income data from 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.
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,
consumption from different sources should be
available.
Without these, planning is not possible. Similarly the
economists propound short-run as well as long-run
economic models or long-run investment models in
which the national income data are very widely used.
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 input, output, income,
saving, consumption, investment, employment etc.,
which are obtained from social accounts.
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.
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 reveled. 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 spastics.
Problems of Measurement of National
Income in a developing Economy
In a developing economy, complete and reliable
information relating to the various methods of
estimating national income are not available
due to the following problems.
(1) Non-monetized Sector. There is a large non-
monetised sector in a developing economy.
This is the subsistence sector in rural areas in
which a large portion of production is partly
exchanged for the other goods and is partly
kept for personal consumption. Such production
and consumption can not be calculated in
national income.
(2) Lack of Occupational Specialization. There is
the lack of occupational specialization in such a
country which makes the calculation of national
income by product difficult. Besides the crop,
farmers in a developing country are engaged in
supplementary occupations like dairying,
poultry, cloth making, etc. but income from
such productive activities is not included in the
national income estimates.
(3) Non-market Transactions. People living in
rural areas in a developing country are able
expenses by building their own huts, tools,
implements, garments and other essential
commodities.
Similarly, people in urban areas having kitchen
gardens produce vegetables which they
consume them selves. All such productive
activities do not enter the market transactions
and hence are not included in the national
income estimates.
(4) Illiteracy. The majority of people in such a
country are illiterate and hey do not keep any
accounts about the production and sales of their
products. Under the circumstances, the
estimates of production and earned incomes are
simply guesses.
(5) Non-availability of Data. Adequate and correct
production and cost data are not available in a
developing country.
Such data relate to crops, forestry, fisheries,
animal husbandry and the activities of petty
shopkeepers, small enterprises, construction
workers, etc. for estimating national income by
the income method, data on unearned incomes
and on persons employed in the service sector
are not available. Moreover, data on
consumption and investment expenditures of
the rural and urban population are not available
for the estimation of national income by the
expenditure method. Moreover, there is no
machinery for the collection of data in such
countries.