National Income

1. UNIT 2: NATIONAL INCOME

2. NATIONAL INCOME
 National Income refers to the money
value of all the goods and services
produced in a country during a financial
year.
 In other words, the final outcome of all
the economic activities of the nation
during a period of one year, valued in
terms of money is called as a National
income.

3. CIRCULAR FLOW OF INCOME
 Circular flow of Income refers to the movement of money and goods, in the economy,
across the various sectors, i.e. household, firm, government and foreign sector, in a circular
flow.
 An economy can be defined as a unified arrangement of production, distribution,
exchange, consumption and investment.
 These processes play a crucial role in the survival and growth of the economy. Consumers
buy the goods and services produced by the producers for money, which generates income.
And so, the income generated in the process moves in a circular motion. This is called the
circular flow of income.

4. ECONOMIC SECTORS

5. CONT…
 Household Sector: This sector covers consumer of goods and services, who buys them
for their personal consumption. The household sector owns the inputs, i.e. factors of
production and renders factor services to the producer sector.
 Producer Sector: All the producer firms and establishments fall under this category. Firm
employ factors of production, i.e. land, labour, capital and entrepreneur, so as to
produce goods and services. As the inputs are owned by the households, factors
payments are made to them in the form of rent, salary and wages, interest and profit.

6. CONT…
 Government Sector: It is the third sector of the economy which earns revenue in the
firms, households and foreign sectors, in the form of taxes, fees, duties, and proceeds
from the sale of goods and services. Also, the government makes factor payments to the
households and provides public utility services to the general public.
 External Sector: It is the foreign sector which receives money for the export of goods and
services to the firms, household and government. Also makes payment to the other
sectors for the import of goods and services.

7. CIRCULAR FLOW OF INCOME AND
EXPENDITURE
 To present the flow of income and expenditure, the economy is divided into 4 sectors:
 Household sector
 Business sectors or firms
 Government sector
 Foreign sector

8. TYPES OF CIRCULAR FLOW OF INCOME

9. CONT…
 Real Flow: Otherwise called as Product Flow or Output Flow, it implies the movement of
factor services and, goods and services among different sectors of the economy. Thus, it
comprises of:
Factor Flow
Product Flow
 Money Flow: Money Flow or Nominal flow involves the exchange of goods and services for
money. Households provide factor services to the firm, in the form of land labour, capital
and entrepreneur and get factor payments for the same, in terms of money.

10. Phases of Circular Flow of Income

11. Circular Flow of Income in a Two-Sector Economy
 To indicate the circulation of income and expenditure in a two-sector economy,
the economy is broadly divided into two groups –
Household
 Firms.

12. 2 SECTOR MODEL OF CIRCULAR FLOW OF
INCOME

13. Circular Flow of Income in a Two-Sector Economy with
the Financial System
 Firms and households often save a part of their income, which results in leakage from the
circular flow of income. The amount is saved in the financial institutions like banks.
Further, the firms also borrow money from the financial system for making an investment,
which results in the injection of money into the circular flow.
 Hence, financial institutions perform the role of intermediaries amidst savers and
investors. So, without referring to the financial system, the understanding of the economic
activities will not be complete.

15. Circular Flow of Income in Three Sector Economy
 In a three-sector economy, there are three major sectors:
Households
Firms
Government.

16. 3 SECTOR MODEL OF INCOME AND
EXPENDITURE

17. Circular Flow of Income in Four Sector Economy
 Four Sector Economy, as the name suggests is broadly classified into four major groups,
Households
 Firms
 Government
 External Sector.
 It represents an open economy, wherein imports and exports with the other countries
of the world take place.

19. BASIC CONCEPTS
 Gross Domestic Product (GDP)
 Net Domestic Product (NDP)
 Gross National Product (GNP)
 Net National Product (NNP)
 Personal Income (PI)
 Personal Disposable Income (PDI)
 Real Income

20. GROSS DOMESTIC PRODUCT
 GDP is a measure of market value of all finished goods and services which are newly
produced, during a particular period and that too within the domestic territory of the
country.
 GDP is considered as the best measure, that is used to roughly estimate the size and
growth of the economy. It also reflects the economic soundness of the country
and standard of living of its residents. In short, it tells us, how the economy is doing, i.e.
good or bad.

21. CONT…
Where,
 C denotes consumer spending, it encompasses all private and public
consumption
 G represents government outlays
 I indicate total investment made by country
 NX refers to the net of exports, i.e. total exports minus total imports.
GDP = C + G + I + NX

22. CONCEPT OF DOMESTIC TERRITORY
 In economics, it refers to economic territory which refers to the geographical territory
administered by a government within which persons, goods and capital circulate freely.
 Domestic territory of a nation includes the following:
o Territory lying within the political frontier including territorial waters of a country.
o Ships and air crafts operated by residents of the country across different parts of the world.
o Embassies, consulates and military establishments of a country located in abroad.

23. GDP AT CURRENT PRICE & CONSTANT PRICE
 GDP can be estimated at current prices and at constant prices .
 If the domestic product is estimated on the basis of prevailing prices it is called
gross domestic product at current prices.
 If GDP is measured on the basis of some fixed price, that is price prevailing at a
point of time or in some base year it is known as GDP at constant price or real
gross domestic product

24. NET DOMESTIC PRODUCT (NDP)
 While calculating GDP no provision is made for depreciation allowance, also known as
capital consumption allowance. In such a situation GDP will not reveal complete flow of
goods and services through various sectors. Therefore NDP is calculated.
 Net domestic product (NDP) is an annual measure of the economic output of a nation
that is adjusted to account for depreciation.
 It is calculated by subtracting depreciation from the gross domestic product (GDP).
NDP = GDP - Depreciation

25. GROSS NATIONAL PRODUCT (GNP)
 Gross national product (GNP) is an estimate of total value of all the final products and
services turned out in a given period by the means of production owned by a country's
residents.
 GNP is commonly calculated by taking the sum of personal consumption expenditures,
private domestic investment, government expenditure, net exports and any income
earned by residents from overseas investments, minus income earned within the
domestic economy by foreign residents

26. NET NATIONAL PRODUCT (NNP)
 Net national product or NNP is the market value of all the finished goods and services
that are produced by citizens of a nation, living domestically and internationally during
a year.
 It considers all the goods, products and services that are manufactured by the
country’s citizens, irrespective of their location, or in other words, net national
product considers products that are produced domestically and also from overseas.
NNP = GNP – Depreciation

27. PERSONAL INCOME
 Personal income refers to all income collectively received by all individuals or households
in a country.
 Personal income includes compensation from a number of sources, including salaries,
wages, and bonuses received from employment or self-employment, dividends
and distributions received from investments, rental receipts from real estate investments,
and profit sharing from businesses.

28. PERSONAL DISPOSABLE INCOME
 Disposable income also known as Disposable Personal Income (DPI), is the amount of
money that an individual or household has to spend or save after income taxes have been
deducted.
 It is used by analysts to measure consumer spending, payment ability, probable future
savings, and the overall health of a nation’s economy.
Disposable Personal Income = Personal Income – (Payable Taxes + other Deductions)

29. REAL INCOME
 Real income is the earnings of individuals or the nation after adjusting to the extent of
inflation.
 It is the amount of money you have and the buying power of that money, based on the
rate of inflation. Real income can go up or down based on whether the inflation rate is
going up or down. When real income goes up, a person's purchasing power increases.
Likewise, when real income goes down, purchasing power decreases.

30. SOME IMPORTANT TERMINOLOGIES
 Net Factor Income from Abroad (NFIA) : This is the difference between the income earned
from abroad for rendering factor services by the normal residents of the country to the rest
of the world and the income paid for the factor services rendered by non-residents in the
domestic territory of a country. .
 Factor income : These are incomes received by the owners of factors of production for
rendering their factor services to the producers i.e. wages to the labour , rent to land,
interest to capital and profit to the entrepreneur.
 Transfer payments : These are all those unilateral payments (one way payments)
corresponding to which there is no value addition in the economy, e.g. gifts, donations, etc.

31. CONT…
 Nominal Gross Domestic Product : It refers to market value of the final goods and services
produced within the domestic territory of a country during a financial year, as estimated using the
current year prices. It is also called GDP at current price.
 Real Gross Domestic Product : It refers to market value of the final goods and services produced
within the domestic territory of a country during a financial year, as estimated using the base year
prices. It is also called GDP at constant price.
 Normal Residents of a Country : These are the residents of a country or are those ‘individuals’ or
‘institutions’ who normally reside in a country and their economic interest lies in that country. For
becoming a normal resident, an individual or an institution has to reside/operate for more than
one year in that country.

32. CONT…
 GDP Deflator : GDP Deflator is also known as GDP Price Deflator or implicit price deflator.
 It measures the impact of inflation on the GDP of an economy during a period of one
specific year.
 GDP deflator is a factor by which nominal GDP is adjusted to calculate real GDP.

33. NUMERICAL ORIENTATION
GROSS NET
LESS: Depreciation
NET
ADD: Depreciation
GROSS

34. CONT…
DOMESTIC ADD: NFIA NATIONAL
DOMESTIC LESS: NFIA NATIONAL
Net Factor income from abroad (NFIA) = Factor income from abroad (FIFA) – Factor income to abroad (FITA)

35. CONT…
MARKET
PRICE LESS: NIT
FACTOR
COST
MARKET
PRICE
FACTOR
COST
ADD: NIT
Net Indirect Taxes (NIT) = Indirect Taxes - Subsidies

36. MEASUREMENT OF NATIONAL INCOME

37. PRODUCT METHOD / VALUE ADDED METHOD
Product method is also known as output method or value added method. In this
method we calculate the national income in terms of final goods and services
produced in an economy during the particular period of time.
The final goods are those which are either available to the consumer for
consumption or become a part of national wealth in the form of investment.
Product method is that which estimates the national income by measuring the
contribution of final output and services by each enterprise producing enterprise in
the domestic territory of a country during a given accounting period.

38. CONT…
Value Addition or Value Added = Value of output – Intermediate consumption

39. CONT…
 Here value of output stands for the market value of goods produced by an enterprise
during a financial year . Intermediate consumption stands for the value of non-factor
inputs like the value of raw material.
 Suppose a baker buys flour worth Rs. 100 from a miller and then converts that flour into
bread worth Rs. 120
So here, flour is an intermediate good valued at Rs. 100 and its value is regarded as
intermediate consumption.
Bread, an output product valued at Rs. 120 is regarded as value of output.
Therefore the difference of Rs. 20 is the value added and it is the net value added to
the economy by the baker.

40. EXAMPLE
PRODUCER/ SECTOR VALUE OF OUTPUT INTERMEDIATE CONSUMPTION VALUE ADDED
Farmer 600 200 400
Flour Mill 800 600 200
Bakery 1000 800 200
Shopkeeper 1200 1000 200
Total 3600 2600 1000

41. Precautions While Using Value Added Method
 The value of intermediate goods should not be included.
 Purchase and sale of second hand goods should not be included.
 Imputed value of self-consumed goods should be included, but self-consumed services
should not be included.
 Own account production should be included.
 Commission earned on account of sale and purchase of second hand goods is included.
 If sales are given, then exports are not included separately.
 If intermediate purchases are given, then imports are not included.

42. EXPENDITURE METHOD
 The expenditure method is a system used for determining the GDP of a country, this
method considers consumptions, investments, net exports and government expenditure
to calculate nation’s annual GDP.
 There are primarily 4 different types of aggregated expenses that are utilized to determine
GDP These are:
Investment made by businesses
 Government expenditure on goods and services
Household consumption
Net exports ( X - M)

43. Final Consumption
expenditure
Gross
(domestic) Capital
Formation
Net exports
(X – M)
GDP
MP
Private Final
Consumption
Expenditure
Government
Final
Consumption
Expenditure
Gross Domestic
Fixed Capital
Formation
Business Fixed
Investments
Government Fixed
Investments
Residential Construction
Investments
Change in Stock

44. Precautions While Using Expenditure Method
 Only final expenditure is to be taken into account to avoid error of double counting.
 Expenditure on second hand goods is not to be included.
 Expenditure on transfer payments by the government is not to be included.
 Imputed value of expenditure on goods produced for self consumption should be taken
into account.
 Expenditure on shares and bonds is not to be included in Total Expenditure.

45. Q. Calculate National Income Using expenditure method
S.NO CONTENTS Rs. (in crore)
1. Net Imports (-) 10
2. Net Domestic Fixed Capital Formation 100
3. Private Final Consumption Expenditure 600
4. Consumption of Fixed Capital 60
5. Change in Stock (-) 50
6. Government Final Consumption Expenditure 200
7. Net Factor Income to Abroad 20
8. Net Current Transfers to Abroad 30
9. Net Indirect Tax 70
10. Factor Income From Abroad 10

46. SOLUTION :
Gross Domestic Product at Market Price (GDP MP) = Private Final Consumption
Expenditure + Government Final Consumption Expenditure + Net Domestic Fixed Capital
Formation + Change in Stock + Consumption of Fixed Capital - Net Imports
GDP MP = 600 + 200 + 100 + (-50) +60 - (-10)
GDP MP = 970 - 50 = 920 crore
Again,
National Income (NNP FC) = GDP MP - Net Factor Income to Abroad – Net Indirect Tax -
Consumption of Fixed Capital
NNP FC = 920 - 20 - 70 - 60 = 770 crore

47. S.NO CONTENTS Rs. (in crore)
1 Gross Value Added at Market Price by the Primary Sector 300
2 Private Final Consumption Expenditure 750
3 Consumption of fixed Capital 150
4 Net Indirect Taxes 120
5 Gross Value Added at Market Price by the Secondary Sector 200
6 Net Domestic Fixed Capital Formation 220
7 Change in Stocks (-) 20
8 Gross Value Added by the Tertiary Sector 700
9 Net Imports 50
10 Government Final Consumption Expenditure 150
11 Net Factor Income from Abroad 20
Q. Calculate National Income by the :
i Expenditure Method
ii Production Method

48. Ans. (a) By Expenditure Method
National Income (NNP FC)= Private Final Consumption Expenditure + Government Final
Consumption Expenditure + Net Domestic Fixed Capital Formation + Change in Stocks –
Net Imports - Net Indirect Taxes + Net Factor income from Abroad
= 750 +150 + 220 + (-20) - 50 - 120 + 20
= 1140 - 190= 950 crore
b) By Production Method
National income (NNP FC) = Gross Value Added at Market Price by the Primary Sector+
Gross Value Added at Market Price by the Secondary Sector - Gross Value Added at
Market Price by the Tertiary Sector - Net Indirect Taxes- Consumption of Fixed Capital +
Net Factor income from Abroad
= 300+200 + 700 - 120 - 150 + 20
= 1220-270 = Rs. 950 crore

49. INCOME METHOD
 The Income Method measures national income from the side of payments made to the
primary factors of production in the form of rent, wages, interest and profit for their
productive services in an accounting year. Thus, national income is calculated by adding up
factor incomes generated by all the producing units located within the domestic economy
during a period of account.
 The resulting total is called Domestic Income or Net Domestic Product at FC (NDPFC)- By
adding net factor income from abroad to domestic income, we get National Income
(NNPFC)

51. Precautions While Using Income Method
 Income from illegal activities like smuggling, theft, gambling, etc, should not be included.
 Corresponding to production for self consumption, the generation of income of economy
to be taken into account.
 Brokerage on the sale/purchase of shares and bonds is to be included.
 Income in terms of windfall gains should not be included.
 Transfer earnings like old age pensions, unemployment allowances, scholarships, pocket
expenses etc, should not be included.

53. Q. Calculate National Income
S.NO CONTENTS Rs. (in crore)
1 Net domestic Capital formation 150
2 Government Final Consumption Expenditure 300
3 Net Factor Income from Abroad (-) 20
4 Private Final Consumption Expenditure 600
5 Depreciation 30
6 Net Exports 50
7 Net Indirect Taxes 90
8 Net Current transfer from Rest of the World 40

54. SOLUTION :
National Income (NNP FC) = Government Final Consumption Expenditure + Private Final
Consumption Expenditure + Net domestic capital formation + Net Exports – NIT + NFIA
NNP FC = 300 + 600 + 150 + 50 - 90 + (-20)
NNP FC = Rs. 990 crore

55. S.NO CONTENT Rs. (in crore)
1 Sale 400
2 Change in stock (-) 20
3 Depreciation 30
4 Net indirect taxes 40
5 Purchase of machinery 200
6 Purchase of an intermediate product 250
Q. Calculate net value added at the market price of a firm :

56. Value of output = Sale + Change in stock
= 400 + (-) 20
= Rs. 380
Gross value added at MP = Value of output – Purchase of an intermediate
product
= 380 – 250 = Rs. 130
Net value added at MP = Gross value added at MP – Depreciation
= 130 – 30 = Rs. 100
SOLUTION :

57. Q. Calculate Net National Disposable Income and personal disposable income from the
following data :
S.NO CONTENT Rs. (in Crore)
1 Net Factor income to abroad 50
2 Current transfers by government 30
3 Corporation tax 60
4 Net current transfers from abroad (-) 20
5 Undistributed profits of Private organizations 10
6 Net domestic product at factor cost 1020
7 National Debt Interest 40
8 Personal Tax 70
9 Domestic product accruing to government 200
10 Indirect Taxes 100

58. Net National Disposable Income = NDP Fc - Net Factor Income to Abroad + Indirect Taxes
+ Net Current Transfers from Abroad
= 1020 - 50 + 100 + (-20)
= Rs.1050 crore
Personal Disposable Income = NDPFC - Domestic Product Accruing to Government – Net
Factor Income to Abroad + Current Transfers by Government + Net Current Transfers from
Abroad + National Debt Interest - Corporation Tax - Undistributed Profits of Private
Organizations - Personal Tax
= 1020 - 200 - 50 + 30 + (-20) + 40 - 60 - 10 - 70
= Rs. 680 crore
SOLUTION:

59. Problems in Measurement of National Income
 Non Monetized Sector
 Unorganized Sector
 Multiple sources of Earnings
 Inadequate Data
 Lack of Distinction Between intermediate and Final Goods
 Black Money
 Double Counting
 Transfer Incomes