Definition
What is national income? Every individual has certain income. I have some income. You also have some income, so likewise a nation also has some income. So when we say income, this is measured in terms of some Value. This value is the monetary value, or the money value of something. So when we say National income, it is in terms of money or monetary value. This is one thing that we should remember. So by definition, National Income is the money value of all the goods and services produced in a financial year. So the definition mentions National Income as the total money value of all final goods and services produced in a financial year. Important thing is it is final goods and within the financial year. That means the goods do not include intermediate goods, and the time period is one Financial year. Financial year in India starts from 1st of April to 31st of March. So first thing it is final goods and services. Second thing, it is within a financial year.
When we see this definition there can be two questions in your mind. Where are these goods produced, and, who produces this goods? So two questions can be where these goods are produced and who produces these goods and services. Keep these two questions in your mind, and as we progress with this article, you will get clear answers.
Importance
What is the importance of national income or what is the importance of measuring or calculating national income in the country? Measuring or calculating the national income of a country helps you to identify or find out whether the national income trend is increasing or decreasing. Ideally, the national income of a country must increase. An increase in national income is ideally expected. So, what are the implications of an increase in national income on the economy or an individual? When the national income of a country increases, it means that the growth of the country is also on the higher side. So growth also increases with an increase in the national income. Second thing is that with an increase in national income, the output or the produce of firms also increases. This means that when the firms are growing, there are more employment opportunities in the economy. That means more employment is generated in the economy. More employment in the economy will lead to an increase in income of individuals in that economy, so ideally the national income of a country should increase annually. Now let us see what are the measurements are important measurements of national income.
GDP
GDP means gross domestic product. GDP is also a National Income. But what is the difference between GDP and National Income. GDP means Gross Domestic Product. Here the word, or the term domestic is very important. So in GDP, domestic territory or domestic, that term domestic is given importance. So GDP refers to the monetary value of all the final goods and services produced in an economy within a financial year. The term ‘within an economy’ is given the importance. So under Gross Domestic Product, domestic territory of an economy is given importance, answering our question on where are these goods and services produced.
Coming to the definition, it says that monetary value of final goods and services produced in an economy in a financial year. We need to remember few important terms. Important term to be remembered is final goods and services. This means that only the final goods and services are taken into consideration, not intermediate goods. Second thing and the most important thing is in an economy or within the economy. It means that GDP considers only those goods and services which are produced in the domestic territory of the country. So other things are not taken into consideration. Other things means those goods and services which are produced outside the territory of the country. They are not taken into consideration. And third thing is within a financial year. The time period is One Financial year.
Example – Let’s understand the meaning of domestic territory. For example, Shahrukh Khan has a restaurant in Dubai. So Shah Rukh Khan is an Indian but he is owning the restaurant in Dubai. So he will be earning some profits in his restaurant from Dubai. So is that income earned in India or in the domestic territory? No. Even though he’s an Indian, the income earned is from a different country. So it is not included in the domestic territory of the country. So we can say the income earned by Shahrukh Khan from his restaurant in Dubai is not added to the GDP of the country.
And let us take another example. A foreigner is having a company in India, and he earns income from that company. So the foreigner is not a resident of the country or he does not belong to this country, but he has a company in our country and the income is earned from the company within the territory of our country. So this will be included in GDP. In the first example, an Indian earning income from abroad, it is not included in the GDP. But in this second example, a foreigner who earns income within the territory of India is included in the GDP. Hope the idea of domestic territories clear for you now.
So coming back to this definition of GDP, it is the total monetary value of all the final goods and services produced in an economy within a financial year. In an economy or the domestic territory is the most important term to consider here. Here we must understand that when we say final goods and services, intermediate goods and services are not taken into consideration. Example of intermediate goods and services is raw materials. They are not taken into consideration while calculating the GDP. The second thing you must remember is domestic territory. And when it says domestic territory, it includes the political boundaries of the country, the embassies of the country, consulates and military establishments located abroad, ships, aircrafts, or shipping vessels which are owned by the residents of a country but situated abroad. All this are taken into consideration when we say domestic territory of a country. And financial year as we learnt begins from April 1st and ends on 31st of March.
GNP
Now let us see another important measurement of National Income, that is the GNP, or the Gross National Product. While learning GDP, we answered the first question which arises from the National Income – where are these goods and services produced? So the second question was who produces this goods and services. From GNP let us try to understand who produces this goods and services. So GNP means Gross National Product. Here the term national is given importance. It means the nationals, or the residents of a country are the producers in GNP. So let us see what is the definition of GNP? GNP means – “the total monetary value of all the final goods and services which are produced by the normal residents of the country in a financial year”. That means these goods and services are produced by the normal residents of a country.
So now taking the definition, the most important term is normal residents. Let us see who are the ‘normal residents’ of a country. Normal residents refers to those individuals who usually reside in the country and whose long term economic interest is in that country. These kind of people are known as normal residents of a country. And while calculating the GNP or Gross National Product, we take into consideration the goods and services produced by the normal residents of the country. Here we must understand one thing, when we say normal residents here territory is not a consideration. It means that the criteria is normal residence. So say I am an Indian who stays in India so income earned by me will be considered in the GNP. Also if an Indian has some business abroad that is outside the domestic territory of India, and if he earns income from that business, that also will be added in GNP. But in GDP we said that that will not be added because under GDP domestic territory is taken into consideration. And here the consideration is normal residents, because he is a normal resident his income from abroad will also be calculated in the calculation of GNP.
Example – So to make it more clear, let us take an example. Let us take the previous example of Shah Rukh Khan. Shah Rukh Khan is an Indian who earns income from his restaurant in Dubai. So his restaurant in Dubai has certain income. Even though the restaurant is not within the domestic territory of India, the income earned by that restaurant will be added in the GNP of the country, because it is earned by a normal residence of the country. But second example, a foreigner having a company in India earning profits from the company. Now he is a foreigner, and because he is not a normal resident of the country, the income earned by his company in India will not be added in calculation of the GNP or Gross National Product.
Relationships
Now let us come back to the relationship between GDP and GNP. If we add Net Factor Income from abroad to the GDP of a country we will arrive at the GNP of a country. GDP means the total monetary value of the goods and services which are produced in the domestic territory of a country within a particular year. Let us see some important concepts that are related to national income and the aggregates. The first concept is Gross versus Net. If we purchase a machinery in the year 2018 and after 15 years or 20 years or even after 5 years, the machinery will not have the same value as it had in 2018. Why is this? This is because that the machinery undergoes certain wear and tear and this we call it as depreciation. Depreciation is the wear and tear that happens to capital goods. While calculating the National Income, we said all final goods and services are taken into consideration. But these final goods also include certain capital goods, so these capital goods would have some depreciation, so this must be deducted.
NDP and NNP
So before coming to the concept, let us see what is depreciation. So depreciation is the wear and tear, which leads to reduction in the value of capital goods. If we deduct depreciation from gross values, we will get net. Net is simply their depreciation deducted from the gross. So GDP minus depreciation will give NDP, i.e. Net Domestic Product. GNP minus Depreciation will give us NNP, i.e. Net National product. So to arrive at Net we must deduct the depreciation from the gross.
The second concept is National and Domestic. To derive National, we must add Net Factor Income from Abroad to domestic, so National = Domestic + Net Factor Income from Abroad. We have seen that GNP = GDP + Net Factor Income from Abroad. Thus, if we add Net Factor Income from Abroad to GDP, we will get GNP.
Next concept is Factor Cost vs Market Price. So let us first see what is Factor Cost? Factor Cost refers to cost incurred on factors of production. There are four factors of production – land, labor, capital and entrepreneur. Land has to be given rent, labor has to be given wages, capital needs to be paid interest, and the entrepreneur has to be provided with profit. So these are the four costs. These are known as the costs on factors of production, or the remuneration to the factors of production. These costs culminate to form the Factor Cost. So Factor Cost simply means the cost incurred on these four factors of production. And when we say Factor Cost, we must remember one thing, the Factor Cost is taken into consideration in order to estimate growth in an economy. So growth is calculated in terms of Factor Cost. Now let us see what is Market Price.
Market Price = Factor Cost + Net Indirect Taxes.
So if you add Net Indirect Taxes with Factor Costs, you will get Market Price. Now let us see what is Net Indirect Taxes. So here the term ‘Net’ is used.
Net Indirect Taxes = Indirect Taxes – Subsidies.
Current Prices and Constant Prices – Current Prices means that the values of the good and services are valued at the same year’s price, so same year’s price. Constant Prices means that the values of the good and services are valued at base year prices. This must be very clear if you need to know better national income and accounting methods.
Let’s take a look at another type of national income accounting i.e. Net Domestic Product or NDP. We have seen the difference between GDP and NDP is in one word, i.e.. ‘Net’. And we have already seen what is the difference between gross and net, i.e. Net = Gross – Depreciation. So if you reduce depreciation from GDP we will get NDP. So, GDP – Depreciation = NDP. Next let see NNP i.e. Net National Product. The difference here is also with the term ‘Net’. We have GNP as Gross national Product. So, GNP – Depreciation = NNP. NNP is the purest form of income of a country. And if we take the case of per capita income, it is measured by NNP / Population. These concepts of the economy form key topics for various competitive exams.
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