Basic Concepts in National Income

Various concepts of national income and related aggregates used in national accounts connote a particular meaning which may not necessarily conform to the one used in common parlance. It is, therefore, necessary that these are made familiar to the users to enable them to appreciate these in right perspective. It is with this objective that it has been considered necessary to refer to these in this publication.

The basic concepts and definitions of the terms used in national accounts largely follow those given in the SNA. It is intended to give in the following paragraphs the major concepts used in National Accounts Statistics and the inter relationship particularly of those relating to macro-economic aggregates of national product, consumption, saving and capital formation. taken of the rental of buildings which are owned and occupied by the owners themselves. Own account construction activities are also similarly to be included. However, certain other activities like services of house-wives are excluded from production mainly due to the problem of measurement.

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Also excluded are illegal activities such as smuggling, black marketing, etc. Another important feature of the measure is that it is an unduplicated value of output or in other words only the value added at each stage of processing is taken into account while measuring the total, i. e. , in the measurement of national output a distinction is made between “final” and “intermediate” products and unduplicated total is one that is confined to the value of the final products and excludes all intermediate products.

To use a simple example, if the production process during a year involves the production of wheat, its milling into flour and the baking of bread which is sold to consumers then the value of national output should equal the final value of the bread and should not count the separate value of the wheat and flour which have been used up in the course of producing bread. Thus the national product is not the total value of goods and services produced but only the value of the final product excluding the value of inputs of raw materials and services used in the process of production.

National product by definition is a measure in monetary terms of the volume of all goods and services produced by an economy during a given period of time, accounted without duplication. The measure obviously has to be in value terms as the different units of production and different measures of services are not directly additive. In the case of a closed economy the measure amounts to domestic product. An important characteristic of this measure is its comprehensiveness. The measure covers all the goods and services produced by the residents of a country.

Thus the goods cover all possible items produced, as for example, agricultural crops, livestock and livestock products, fish, forest products, mineral products, 2. 5 manufacturing of various consumer items for consumption, machinery, transport equipments, defence equipments etc. , construction of buildings, roads, dams, bridges etc. The services similarly cover a wide spectrum including medical and educational services, defence services, financial services, transport services, trading services, domestic services, sanitary services, government services, etc.

All goods and services produced during the period have to be included whether they are marketed i. e. , exchanged for money or bartered or produced for own use. For example, some of the products of agriculture, forestry and fishing are used for own consumption of producers and therefore an imputed value of these products are also to be included.

The national product measures all goods and services arising out of economic activity while national income is the sum of all incomes as a result of the economic activity. These two are synonymous. Since the production of goods and services is the result of the use of primary factors of inputs, namely, capital and labour, along with the raw materials, the process automatically generates income. This income is in the form of return to capital and labour used in production process.

For example the total product originating in a firm making steel could be obtained by adding the total product and then deducting the intermediate product to obtain the value added. The value added of this firm consists of the income that accrued in the course of production, namely, wages and salaries and operating surplus.

Thus the product of a firm must be income to someone whether it is their employees in the form of employment 22 National Accounts Statistics-Sources and Methods, 2007 income or to the owners in the form of operating surplus. Hence, the unduplicated production is equivalent to the income which accrues to the factors of production. In other words national income of a country can also be viewed in terms of the money value of income flowing from the producing units to factors of production. National income is not simply an aggregate of all incomes.

It includes only those incomes which are derived directly from the current production of goods and services called factor incomes. Other forms of income such as old age pensions, education grants, unemployment benefits, gifts etc. , cannot be regarded as payments for current services to production. They are paid out of factor incomes and are called transfer incomes. Payments for which no goods or services are received in return are transfer payments. The national income, being the value of goods and services becoming available cannot include both factor incomes and transfer incomes. National Product and Expenditure .

The production within the economy over a given period of time is spent either for consumption of its members or for addition of fixed assets or for addition to the stock of 2. 8 existing productive assets within the country. Hence, production can also be measured by considering the expenditure of those who purchase the finished or final goods and services.

The national expenditure is the sum of expenditure of all spending of institutional sectors viz. , government, households and enterprises. Here also, it is necessary to include only the expenditures on “final use” in order to avoid duplication i. . , one has to omit the network of intermediate sales of all products needed in further production. The expenditure on final goods and services may be purely for consumption purposes like consumption of food, clothing, shelter; services etc. , or for capital formation such as addition to buildings, plant, machinery, transport equipment, etc. Some goods may not be immediately sold and may be kept aside as stocks. These goods which are added to stocks are also accounted for as final expenditure.

This production process generates a given amount of money income which is distributed by the productive units to the factors of production, namely, capital and labour. The measure of income this way indicates the share of national product distributed to the factors of production or in other words the national income by factor shares. The income thus received by the factors of production is then spent either by the labour in their capacity as households in terms of acquisition and consumption of goods and services or by the producers in acquiring more capital and thus increasing the physical assets of their production units.

The national income by definition is the same whether measured at the point of production or at the point of income generation or at the point of final utilisation. In other words the total of net output, income flows and final expenditure will be identical. The significance of each arises from the fact that they reflect total operations of the economy at the levels of three basic economic functions, namely, production, distribution and disposition.

Although national income can be measured in any one of the three alternative approaches but if a complete analysis of the economy is the object then it should be measured by all the three different approaches. For measurement of national income at the point of production, the method generally followed is to divide the whole economy into a given set of economic activities and to estimate the total value of output and the corresponding value of inputs of raw materials and services used for production and then arrive at the value added of each sector as a total value of output minus the value of inputs of raw materials and services.

In the case of services the value added is measured in terms of the total amount of money paid in return for the services received minus the cost of inputs like expenditure on transport, advertisement, and other miscellaneous services. Forms of income As has already been pointed out the net value added available for each unit of production is equal to the amount of income generated by the unit in the process of production. This income is distributed between the two primary factor inputs, namely, capital and labour.

It may be noted from the above discussion that the national income of a country can be measured in three different ways, from the angle of production, from income generation and from final utilization. These three forms are circular in nature. It begins at the production stage where the productive units engage capital and labour and turn out goods and services, the total measure of which National Accounts Statistics-Sources and Methods, 2007 profits (operating surplus) cannot be made in the case of incomes of persons working on their own account. Such incomes are, therefore, separately classified as mixed income of the self employed.

The labour income takes the form of either wages and salaries including commission, pensionary benefits, bonus, etc. , or supplementary contribution of the employers towards payments in kind. Some portion of operating surplus is retained by the producer which remains undistributed and is partly used for further investment and balance is distributed.

The distributed capital income is mainly in the form of dividends, interest and rent. The rent in the Indian context includes not only rent on land but also rent on buildings and structures. The capital income other than profit retained by enterprises distributed to the owners of capital who are either individuals or enterprises in the form of dividends. The mixed income generally accrues to the self-employed people who employ their own capital and labour for production. This 2. 15 income consists partly of profits of unincorporated enterprises and partly of labour income of the self employed.

Thus the total income generated in the form of factor shares consists of

  • wages & salaries
  • interest,
  • rent,
  • dividends,
  • undistributed profits,
  • mixed income of self employed.

Purchase and construction of residential buildings are not treated as consumption expenditure of the households but are included in the gross capital formation. In the case of owner occupied buildings, the imputed rent is included in the final consumption expenditure. Similarly, the primary products of sectors like agriculture, forestry, fishing etc. which are produced for own consumption by the households will form part of consumption expenditure.

Payments for domestic services which one household renders to another, such as services of maid servants, cooking, child nursing and gardening are also included under consumption. However, as in the production measurement, activities such as cooking meals, scrubbing floor and minding children undertaken by household members fall outside the production boundary and are, therefore, excluded from consumption expenditure as well.

The income available to the individuals in the form of labour income or capital income or to the productive units in the form of retained income is then spent. This utilisation of the income can take various forms, namely,  household consumption expenditure,  government consumption expenditure, and capital formation comprising fixed capital formation, and stock accumulation. Household consumption expenditureю

The household consumption expenditure referred to as private final consumption expenditure (PFCE) in National Accounts Statistics (NAS), consists of expenditure by households (including non-profit institutions) on non-durable consumer goods and services and all durable goods except land and buildings. The durable goods are defined as those whose life time are more than one year and consist of items such as furniture, radios,  The concept of government consumption expenditure has been debated by economists for a long time. The role of the government in the economy is essentially different from that of enterprises and households.

To cite a few examples, the government offers services both to entrepreneurs and consumers and in most cases it receives no payment for that or even if it does receive payment, the same is likely to bear little or no relation to the value of the services to the user. In the course of organising collective services such as defence, justice, health and education, government purchases the services of its officials and also many non-durable goods and other services from other suppliers. Since these services are rendered free, these do not appear in the household consumer expenditure.

These services are not only of economic value, but also create real final consumption value to the people. It is, therefore, necessary to reckon them in the national expenditure. Once it is agreed to include government services as part of national expenditure it would be necessary to find methods for valuing the services. Since these collective services are not sold, they can be valued in money terms only by adding up the money spent by the government in buying these services of teachers, doctors, public administrative employees, the armed forces etc. , together with the goods and other materials purchased.

This total is the consumption expenditure of the government and it consists of purchase of non-durable 24 National Accounts Statistics-Sources and Methods, 2007 goods and services by the government. By convention, expenditure on durable goods which are used for defence is also treated as part of consumption expenditure of the government.

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Basic Concepts in National Income. (2018, May 27). Retrieved from