What is the concept of National Income? (USA CONTEXT)
National income accounting measures the estimate of total economic activity in a country/region.it is the value of final goods and services produced in a county over a specifies period of time. It includes Gross Domestic Product, Gross National Product, Net National Income. In other words, National income measures the value and composition of national income and contribution towards income by different sectors of the economy.
National income is important because it studies the following aspects:
a) Growth rate of the economy.
b) Changes to average living standards
c) Changing distribution of income.
Idea behind national income accounting is
National income=net national product
We will start with Calculating GDP and then we will derive GNP from GDP.
Measures of National Income
Gross Domestic Product: There are three approaches to measure GDP
a) Expenditure approach: Sum of all the expenditure incurred to produce and sell final goods and services that will be purchased by business, government and foreigners. The expenditure includes the following components:
- Consumption expenditure: It includes the expenditure incurred by private individuals to fulfil their daily consumption needs.
- Fixed investments: It is addition or replacement of private fixed investment that can be for residential as well as for non-residential purpose. This does not take into account depreciation. We can also include change in inventories (change in physical volume of inventories) in investment category.
- Government expenditure and investment: It includes expenditure incurred by government organisation to provide goods and services. For example,expenditure for maintaining law and order, expenditure on military services of the country etc.
- Net imports and exports: Exports represents that part of goods and services that has been transferred from US residents to any other part of the world. On the other hand, imports represent that part of goods and services that has been transferred by rest of the world. Net exports is just total exports minus total imports.
Thus the national income identity from expenditure approach can be written as:
Where Y is the total expenditure
C is the consumption expenditure
I is the investment expenditure
G is the government expenditure
X-M is the net exports of goods and services
b) Income approach: In this method we sum all the income payments and other cost of production incurred on producing a good. It has the following components:
- Compensation to employees: This includes wages and salaries paid to employees for their contribution to production process. This may also include their contribution to their pension funds, to various insurance policies etc.
- Taxes on production and imports: Taxes are income for the government. It includes taxes payable on products produced, delivered, sold. It takes into consideration federal excise tax and state and local sales taxes, local real estate taxes. These taxes do not include taxes on income.
- Subsidies: As taxes are added to calculate GDP with the same logic subsidies will be deducted in calculation of national income. As subsidies are expenditure incurred by government to provide goods and services at a lower price.
- Net operating surplus: It is a profits-like measure that shows enterprise income after subtracting each of the above components but before subtracting components such as net interest, transfer payments and corporate profits.
- Consumption of fixed capital: It is the decline in the value of the stock of assets due to wear and tear, obsolescence, accidental damage, and aging.
Thus using income approach national income is the sum of all these components.
c) Product method or value added method: In this method we include the total value added by the individuals to the society in production of final goods and services. We should note that only those goods and services should be valued that are used for final consumption. Consumption of intermediate goods should be deducted. Intermediate goods include raw materials, unfinished goods or goods purchased from other firms. Including intermediate goods may lead to overestimated results as their value has already been taken into account in final goods and services. Thus inclusion of intermediate goods will lead to double counting.
Value of the output=physical output(Q)*market price(P)
Depreciation(wear and tear of goods) has to be subtracted from value added output to arrive at net value added at market price. (NVAMP). For estimating Net National Product at factor cost (NNPFC) i.e. National income we require to estimate net value added at factor cost (NVAFC) by each enterprise in the economy. NVAFC is found out by deducting net indirect taxes (indirect taxes less subsidies)
Under this method, we estimate the output of different sectors such as agriculture, fishing, mining, construction, manufacturing, trade and commerce, transport, communication and other services. Then, the net value added at factor cost (NVAFC) by each productive enterprise as well as by each industry or sector is estimated.
Value added at factor cost(NVAFC)=value of output-intermediate consumption -net indirect taxes
Adding up the net values added at factor cost by all industries or sectors to get net domestic product at factor cost (NDPFC).
NI or NNPFC = NDPFC + Net factor income from abroad
Note: The estimate of national income from expenditure approach, income approach as well as value added approach should be same.
Problems in measuring national income
1. Non market transactions are not included: Only those items are included that brought and sold through market. Services that are provided for free are not included. For example: mother devoting her time to nurture his child, services done by housewife, homeowner living in his own house etc. These services are rendered at a personal level but is accounted nowhere in national income accounting.
2. The Value of Leisure: Satisfaction evolved from leisure time is not taken into consideration. Though every individual receives the same utility from leisure as from goods and services.
3. Cost of Environmental Damage: there are environmental costs involved in production of goods and services that is not accounted for in books.
4. The Underground Economy:underground economy includes transactions that is not reported to tax authorities, illegal trading of drugs and violation of immigration laws. There is no record of such transactions in books.