National Income (NI) and its Measurement

What is National Income (NI)?

National Income (NI) is the sum total of all incomes earned by individuals and businesses within a country’s borders over a specific period. It includes all the earnings from wages, salaries, rents, interest, and profits. National Income is a critical economic indicator that helps measure the health and growth of a country’s economy. By calculating the National Income, we can assess the country’s economic performance and evaluate the standard of living of its citizens.

NI is calculated using the following formula:

NI = GDP – Depreciation + Net Foreign Factor Income

Where,

• GDP is Gross Domestic Product, the total value of goods and services produced within a country’s borders
• Depreciation is the reduction in the value of capital goods over time
• Net Foreign Factor Income is the difference between income earned by domestic residents from foreign sources and income earned by foreign residents from domestic sources.

John Maynard Keynes defined National Income as “the sum of all incomes earned in a country over a given period, including wages, profits, and rents.”

Paul A Samuelson defined National Income as “the net output of goods and services produced by a country’s residents.”

Simon Kuznets defined National Income as “the total income earned by all the individuals and companies in a country, including income earned from foreign sources.”

There are several ways to calculate National Income, including the production, expenditure, and income approaches. The production approach calculates the National Income by adding the total value of all goods and services produced in a country. On the other hand, the expenditure approach calculates the National Income by adding up all the expenditures made on goods and services, including consumption, investments, and government spending. Finally, the income approach calculates the National Income by adding up all the income earned by individuals and businesses, including wages, profits, and rents.

Key Features of NI with comparison to other indicators

National Income (NI) is a measure of the total income earned by a country’s factors of production, including labor and capital. Some key features of NI and how it compares to other economic indicators are explained below:

1. Focus on income: Unlike GDP and GNP, which measure the total output of goods and services produced within a country’s borders, NI measures the income earned by factors of production within a country. This makes it a more direct measure of a country’s economic well-being, as it reflects the actual income earned by individuals and businesses.
2. Excludes certain types of income: NI excludes transfer payments, such as social security and welfare payments, which are not considered part of the income earned by factors of production. This means that NI may provide a more accurate picture of individuals and businesses’ income than other measures.
3. Includes depreciation: NI takes into account the depreciation of capital goods, which is the decline in value of assets over time due to wear and tear or obsolescence. This is important because it reflects the true cost of producing goods and services and can help identify investment and economic growth trends.
4. Different methods of calculation: Like other economic indicators, NI can be calculated using different methods, such as the income approach, expenditure approach, or production approach. Each method has its own strengths and weaknesses, and the choice of method may depend on the specific research question or policy goal.

Methods or Approaches of calculating National Income (NI)

There are various methods or approaches to calculating National Income (NI), which include:

A. Income Method:

The income method of calculating NI adds up all the factor incomes that the households receive in an economy. This includes wages, salaries, profits, and rental income. It also includes indirect taxes and subsidies. The formula for calculating NI using the income method is:

NI = Compensation of employees + Proprietor’s income + Rental income + Corporate profits + Net interest + Indirect taxes – Subsidies

Suppose the following are the income details of a country in a year:

• Wages and Salaries = $50 million
• Rent = $10 million
• Interest = $5 million
• Profit = $15 million

Using the income approach, we can calculate NI as follows:

NI = Wages and Salaries + Rent + Interest + Profit

NI = $50 million + $10 million + $5 million + $15 million

NI = $80 million

B. Expenditure Method:

The expenditure method of calculating NI adds up all the expenditures made by households, firms, and the government in an economy. This includes personal consumption expenditures, investment expenditures, government spending, and net exports. The formula for calculating NI using the expenditure method is:

NI = Personal consumption expenditures + Gross private domestic investment + Government consumption expenditures and gross investment + Net exports

Suppose the following is the expenditure details of a country in a year:

• Personal Consumption Expenditure (C) = $50 million
• Gross Private Domestic Investment (I) = $20 million
• Government Expenditure (G) = $10 million
• Net Exports (X – M) = $5 million

Using the expenditure approach, we can calculate NI as follows:

NI = C + I + G + (X – M)

NI = $50 million + $20 million + $10 million + ($5 million)

NI = $85 million

Note that the value of (X – M) is positive here, indicating the country’s trade surplus.

C. Output/ Production Method:

The output/ Production method of calculating NI adds up the value of all goods and services produced in an economy. It involves summing up the value added at each stage of production. The formula for calculating NI using the output method is:

NI = Value of output – Value of intermediate consumption

Suppose a country produces the following goods and services in a year:

• 10,000 units of smartphones worth $100 each
• 5,000 units of laptops worth $500 each
• 1,000 units of cars worth $20,000 each
• 500 units of houses worth $200,000 each

Using the Output or production approach, we can calculate NI as follows:

NI = Value of Total Output – Value of Intermediate Consumption

Now,

Value of Total Output = (10,000 x $100) + (5,000 x $500) + (1,000 x $20,000) + (500 x $200,000) = $150 million

Value of Intermediate Consumption (also known as cost of goods sold) = Cost of smartphones + Cost of laptops + Cost of cars + Cost of houses = (10,000 x $50) + (5,000 x $250) + (1,000 x $10,000) + (500 x $100,000) = $80 million

NI = $150 million – $80 million = $70 million

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D. Adjusted National Income Method:

The Adjusted National Income (ANI) method accounts for capital equipment and asset depreciation. The formula for calculating Adjusted NI is:

NI_Adjusted = NI + Indirect taxes – Subsidies – Depreciation

This method accurately measures an economy’s income by accounting for the wear and tear on capital equipment and assets.

Let’s break down the formula to understand the Adjusted National Income (NI_Adjusted) method. Adjusted NI is calculated by adding the National Income (NI) to indirect taxes and subtracting subsidies and depreciation.

Depreciation refers to the decline in the value of capital assets over time due to wear and tear or obsolescence. It is a crucial factor that needs to be accounted for in measuring a country’s overall income as it affects the future production capacity. Subsidies, on the other hand, refer to the financial assistance given by the government to specific industries or sectors to promote their growth.

The Adjusted NI method helps to account for the effect of depreciation on the income of an economy. It provides a more accurate representation of a country’s income and ability to produce future goods and services.

For example, let’s say a country’s NI is $500 billion, indirect taxes are $50 billion, subsidies are $30 billion, and depreciation is $40 billion. Using the ANI formula, we can calculate the Adjusted National Income as follows:

NI_Adjusted= NI + Indirect taxes – Subsidies – Depreciation

= $500 billion + $50 billion – $30 billion – $40 billion

= $480 billion

Therefore, the Adjusted NI for the given country is $480 billion. This indicates that after accounting for depreciation and subsidies, the country’s actual income is $480 billion.

E. Value-Added Method

The Value Added Approach is one of the methods used to calculate National Income (NI). This method involves summing up the value added by each firm or industry in the production process. The value added is the difference between the value of the output and the cost of inputs used in the production process.

The formula for calculating National Income using the Value Added Approach is as follows:

National Income = Sum of Value Added by all firms and industries

National Income = Value Added at each stage – Cost of Intermediate Goods

The value added by each firm or industry is calculated as follows:

Value Added = Value of Output – Cost of Inputs

The value of output is the total revenue the firm or industry earns from selling its products. The cost of inputs includes raw materials, labor, and other expenses incurred in the production process.

For example, suppose a firm produces 100 units of a product for $10 per unit. The cost of raw materials, labor, and other expenses incurred in the production process is $500. Then, the value added by the firm can be calculated as follows:

Value Added = (100 x $10) – $500 = $1,000 – $500 = $500

Suppose there are multiple firms or industries involved in the production process. In that case, the value added by each firm or industry is calculated separately, and the sum of all the value added is taken to calculate National Income using the Value Added Approach.

Suppose a country has the following production stages:

• A farm produces wheat worth $100,000
• A flour mill buys the wheat and produces flour worth $300,000
• A bakery buys the flour and produces bread worth $500,000

Using the value-added approach, we can calculate NI as follows:

NI = Value Added at each stage – Cost of Intermediate Goods

Value Added at Farm = $100,000 – $0 = $100,000

Value Added at Flour Mill = $300,000 – $100,000 = $200,000

Value Added at Bakery = $500,000 – $300,000 = $200,000

NI = $100,000 + $200,000 + $200,000 = $500,000

Why is NI Important?

National Income (NI) is an important economic indicator that measures the total value of goods and services produced by an economy in a given period of time. The significance of NI lies in its ability to provide valuable insights into the performance of an economy. Some significant reasons why NI is important are:

1. Economic Growth: NI is a useful tool for measuring the economic growth of a country over time. As NI increases, the economy grows, which is a positive sign of economic progress.
2. Standard of Living: NI is also an important indicator of the standard of living in a country. A higher NI generally means that people have higher incomes and can afford to purchase more goods and services, improving their quality of life.
3. Government Policy: NI can help governments evaluate their economic policies’ effectiveness. By monitoring changes in NI over time, governments can see whether their policies are having the desired effect on the economy and can make adjustments accordingly.
4. International Comparisons: NI can be used to compare the performance of different countries on an international level. This allows countries to identify areas where they can improve and learn from the successes and failures of other nations.
5. Investment Decisions: NI is an important factor that investors consider when making investment decisions. Higher NI generally indicates a more stable and prosperous economy, which can attract more investment from both domestic and international sources.