National Income: Components, Importance, Methods, Limitation

What is National Income?

A national income estimate measures the volume of commodities and services turned out during a given period counted without duplication. In other words, Is defined as the total market value of all the final goods and services produced in an economy in a given period of time.

Thus it measures the monetary value of the flow of output of final goods and services produced in an economy over a period of time.


Components of National Income

These are the component of national income which discussed below:

  1. Gross Domestic Product GDP
  2. Gross National Product GNP
  3. Net National Product NNP
  4. Net National Product at Factor Cost NNPfc
  5. Net Domestic Product At Market Prices NDPMP
  6. Income From Domestic Product Accruing To Private Sector
  7. Private Income
  8. Personal Income
  9. Personal Disposable Income

Gross Domestic Product GDP

Gross domestic product relates to the product of the factors of production employed within the political boundaries i.e., within domestic territory. It is defined as a measure of the total flow of goods and services produced by an economy over a specified time period, usually a year.

All value of intermediate products is excluded. So only the market value of final products is included to define GDP.

Gross National Product GNP

Gross National Product has been defined as the total market value of all final goods and services produced in a year. It is the money value of all the final goods and services which the labour and capital of a country working on its natural resources have produced in a year.

It includes not only the part of the production which is brought to the market for sale but also that part of the product that is kept for self-consumption.

Formula: GNP= GDP + Net income from abroad(X-M) , where X= Export, M= Import

If the value of (X-M) is negative then, GDP > GNP

Net National Product NNP

Net National Product (NNP) refers to the value of the net output of the economy during the year.
It is obtained by deducting the value of depreciation or replacement allowance of the capital
assets from the GNP. IN other words, The amount which comes after subtracting the depreciation or consumption of fixed capital from the gross domestic product is known as NDP.

Formula: NNP = GNP – D

where D = depreciation allowances

This value is measured at current prices, while GNP is expressed at the current market price. Net National Product, in fact, is the value of total consumption plus the value of net investment of the community.

It is the sum total of net values added by each producer in the productive process of an economy during one year period.

Net National Product at Factor Cost NNPfc

Net national product at factor cost is the net output evaluated at factor prices. It includes income earn by factors of production through participation in the production process such as wages and salaries, rents profits, etc. NNP at factor cost is also called National Income.

Formula: NNPmp = NNPfc – S + (IT+ GS) or, NNPmp or,

NNPmp = NNPfc – subsidies + (indirect tax+ surpluses from government enterprises)

NNPfc = NNPmp + S – (IT+ GS) or,

NNPfc = NNPmp + subsidies – (indirect tax+ surpluses from government enterprises)

Normally, NNP at market prices is higher than NNP at factor cost because indirect taxes exceed government subsidies. However, NNP at market prices can be less than NNP at factor cost when government subsidies exceed indirect taxes.

Net Domestic Product At Market Prices NDPMP

When net domestic product value is measured on the basis of the current prices in the market then it is known as a net domestic product at market prices. (NDPMP=NNPMP-NFIA).

In other words, NDPmp refers to the market value of final goods and services produced by all the production units in the domestic territory of a country during a given time period. It excludes depreciation and includes indirect taxes. It is equal to the net value added at market price.

Income From Domestic Product Accruing To Private Sector

In India, the creation of domestic income is being made by both the sectors i.e. public sector and the private sector. Income from domestic products accruing to the private sector refers to that part of the domestic product at factor cost which is accrued by the private sector. It may be calculated by applying the following formula:- income from domestic product accruing to private sector=NDFC- govt income – non-departmental and enterprises savings.

Private Income

Private income is income obtained by private individuals from any source, produce or otherwise, and retained income of corporations. It can be obtained from NNP at factor cost by making certain additions and deductions.

In other words, It refers to the income earned by individuals from whatever sources it also includes the retained income of companies

Formula: Private Income = National income (NNP at factor cost) +Transfer Payments + Interest on

Public Debt – Social Security – Profits and Surpluses of Public Undertakings.

Personal Income

Personal income is the total income received by the individuals of a country from all sources before direct taxes in one year. Personal income is never equal to the national income because the former includes the transfer payments whereas they are not included in national income.

Personal income is derived from national income by deducting undistributed corporate profits, profit taxes, and employee’s contributions to social security schemes. Personal income differs from private income actually it is less than private income because it excludes undistributed corporate profits.

Formula: Personal Income = National Income – Undistributed Corporate Profits – Profit Taxes – Social

Security Contributions + Transfer Payments + Interest on Public Debt.

Personal Disposable Income

It refers to that part of the personal income which is actually available to the consumers for consumption purposes or saving.

Though the concepts of national income are very clear in India there is difficulty is measuring it because there is a considerable non monetized section. The central statistical organization (CSO) who estimates the national income has gradually fined the method of estimation and has made estimates more accurate.

Formula: Disposable Income = National Income – Business Savings – Indirect taxes plus Subsidies –

Direct Taxes on persons – Direct Taxes on Business – Social Security

Direct Taxes on persons – Direct Taxes on Business – Social Security


Importance Of National Income

These followings are the importance of national income:

  • Since the national income data represent the monetary measure ofthe volume of production in a country in a year. They give us anidea of the aggregate production in the country concerned.

  • An increasing national income is a symptom of growing economic progress.

  • The national income data give an idea of the rate of national income growth in country.

  • The economic welfare of a country is closely connected with the magnitude of its national income. An increasing in the National income of a country if other thing remaining the same also implies an increase in the economic welfare of the community.

  • The national income data throw light on the contributions of the various sectors of the economy to the gross national product of the country concerned. These data also reveal the comparative importance of the various sectors in the national economy.

  • The national income data also show how the national income of a country is distributed among the various sectors of the population.

  • The national income data also throw light on the volume of consumption saving and investment in the economy.

  • By comparing national income of different countries we can compare their living standard and level of economic welfare achieved by them.

  • The national income data are indispensable for the formulation of economic policy of government. No economic plan can indeed be formulated without adequate national income date.

Methods of Measuring National Income

According to this method, the incomes accruing to all the factors of production during the process of production are aggregated together to arrive at the national income of the country. This is known as national income at factor cost.

As is well known the various factors of production are paid remuneration for the services rendered by them in production. These payments are known as factor payments. They represent the cost of the producers

thus according to this method, the national product is obtained by adding up the factor incomes accruing to the concerned factors during the process of production.

Following are methods of measuring national income:

  1. Census of Product Method
  2. Census of Income Method
  3. Census of Expenditure Method
  4. Value Added Method

Census of Product Method

According to this method, the aggregate production of the final goods and services in an economy in any one year is equivalent in terms of money. The entire output of final goods and services is multiplied by their respective market prices to find out the gross national product.

From the gross national product so estimated, we have to deduct the depreciation of equipment and machinery involved in the process of production to arrive at the country’s national income. This method is sometimes referred to as the inventory method.

Census of Income Method

According to this method, the incomes accruing to all the factors of production during the process of production are aggregated together to arrive at the national income of the country. This is known as national income at factor cost.

As is well known the various factors of production are paid remuneration for the services rendered by them in production.

These payments are known as factor payments. They represent the cost of the producers; thus according to this method, the national product is obtained by adding up the factor incomes accruing to the concerned factors during the process of production.

Census of Expenditure Method

According to this method, the national product is obtained by adding up :

  • Personal Consumption Expenditure
  • Gross domestic Private Investment
  • Govts Purchase of goods and services
  • Net foreign investment

Value Added Method

The difference between the value of national outputs and inputs at each stage of production is the value-added.

In other words, the Product or value-added method is a way of computing the national income of a country. This system is also known as the output or inventory method. This method calculates national income by adding value to a product at every stage of its production.


Limitation In The Measurement Of National Income Of India

However, GDP may not be taken as a satisfactory measure of economic welfare due to certain limitations. These are:

  1. Does Not Include the Rate of Growth of Population
  2. Does Not Reflect the Distribution of GDP
  3. Does Not Include Non Economic or Non Monetary Exchanges
  4. Does Not Include Externalities
  5. Does not consider a change in prices
  6. Composition of GDP
  7. Contribution of Some Products in GDP may be Negative

Does Not Include the Rate of Growth of Population

Real GDP indicates the overall performance of the country. But Real GDP does not consider the changes in the population of a country. The prosperity of the country is better judged by the per capita real GDP. The per capita real GDP equals total real GDP divided by population.

An increase in per capita real GDP indicates an increase in the per capita availability of goods and services. If the rate of growth of the population is higher than the rate of growth of real GDP, then it will decrease the per capita availability of goods and services, which will adversely affect the economic welfare.

Does Not Reflect the Distribution of GDP

There is inequality in the distribution of income in the economy. GDP does not take into account changes in inequalities in the distribution of income. If with an increase in per capita real income or GDP, the inequality in the distribution of income/ GDP increases i.e. rich becoming richer and poor becoming poorer, then it may lead to a decline in welfare (because the utility of a rupee of income to the poor is more than to the rich).

In such a situation, if welfare rises, it may rise in less proportion as compared to the rise in per capita GDP.

Does Not Include Non Economic or Non Monetary Exchanges

There are many goods and services which contribute to economic welfare but are not included in the GDP. For example services of housewives and other family members (leisure time activities) etc.

These are non-monetary exchanges i.e. those exchanges and activities which are left out from the estimation of GDP or national income on account of non-availability of data and problem of valuation. Since these activities do not command a price i.e. no price is attached to them, although they contribute to economic welfare.

Does Not Include Externalities

Externalities refer to benefits or harms accompanying the production process for which no payment is made or received. They are excluded from the estimation of GDP. There are two types of externalities:

  • Positive Externalities: These are the benefits that accompany the production process but for which no payment is received. They are not included in GDP although they result in increase in welfare.

    For example, construction of flyovers or highways reduces transport cost and journey time of its users who have not contributed anything towards its cost. Expenditure on construction is included in GDP but not the positive effects flowing from it hence underestimating the welfare indicated by GDP.

  • Negative Externalities: These are the negative effects which accompany the production process and decrease the welfare of the people for which they are not penalized. For example: environmental pollution caused by industrial plants. The output produced by plants in included in GDP but decrease in welfare arising out of pollution of water and air caused by plants is not considered in the estimation of GDP.

    This pollution adversely affects the health of the people thus producing goods increases welfare but creating pollution decreases welfare. Therefore, taking only GDP as an index of welfare overstates the welfare.

Does not consider a change in prices

If the increase in GDP is due to an increase in prices and not due to an increase in physical output, then it will not be a reliable index of economic welfare.

Composition of GDP

GDP includes different types of products like clothes, food articles, police and military services, house etc. Some of these products contribute more to the welfare of the people like food, clothes etc. whereas other products like police services and military services etc. may comparatively contribute less and may not directly affect the standard of living of the people.

Thus, if GDP increases, the increase in welfare may not be in the same proportion. Therefore, how much is the economic welfare, should depend more on the types of goods and services produced and not simply how much is produced.

Contribution of Some Products in GDP may be Negative

GDP includes all final goods whether it is milk or liquor, some goods included in GDP measurement may reduce economic welfare. For example, liquor, cigarettes etc. because of their harmful effect on health. GDP includes only the monetary value of the products and not their contribution to welfare.

Therefore, economic welfare depends not only on the volume of consumption but also on the type of goods and services consumed. This should be considered while drawing conclusions about economic welfare from GDP.


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