PRESCRIBED COVERAGE
➔Meaning and Scope of National Income
➔Concept of Depreciation ➔ Measures of National Income ➔ Goods and Services
➔Factor Cost vs Market Prices
INTRODUCTION
National Income Accounting is a macroeconomic concept. It assesses the level of economic activity, which is crucial for any economy since it determines the number of goods and services produced in the country in a particular year. A country’s level of production is a measure that determines the health and strength of the economy. National Income gives us an insight into the country’s economic activity. These aggregates provide a clear outlook of a country’s fiscal health.
The concept of National Income is very similar to the concept of the household budget. You must be familiar that there are three components in every household: sources of income, expenses incurred, and total savings. These estimates guide the families to form a budget and make financial decisions. Similarly, national income estimates provide a clear picture of the government's expenses, given the revenue received in that particular year.
In this article, you should understand the different ways in which National Income is calculated, the scope of the terms GDP, GNP, NNP, NDP, their difference and their usage at both factor cost and market prices.
What is National Income ?
The National Income of a country is the total market value of all final goods and services produced in a fiscal year. It is the net output of all economic activities of a country during a given financial year and is valued in terms of money. Measuring National Income is not as easy as measuring household income. To measure it accurately, over counting should be avoided. All goods and services produced in any given year must be counted only once. To avoid double counting, the estimates consider only the market value of final goods and services. It does not include the transactions involving intermediate goods.
CONCEPT OF DEPRECIATION
You must have come across the phrase, “ Buying a depreciating asset is a poor investment decision.” Depreciation is a fall in the value of goods over some time. Car, household furniture or electronics are examples of depreciating assets because their monetary value reduces over time. The resale value of a mobile phone, furniture or car is less than the price the consumer bought it. The amount by which the value of the good falls is called the cost of depreciation.
In the production process, some capital such as equipment and machines get worn out over time, which leads to a gradual decrease in its economic value. This is called capital depreciation.
MEASURES OF NATIONAL INCOME ACCOUNTING
There are four measures of National Income.
1. GDP(Gross Domestic Product)
● It is the money value of all final goods and services produced within the domestic territory of the economy.
● It includes output produced within the domestic territory regardless of whether it is produced by the country’s factors or not. This implies that output produced by National or Non National individuals or institutions residing in the country of their economic interest, is included in GDP calculations.
2. GNP (Gross National Product)
● It is the final value of all goods and services produced by the country’s factors
irrespective of where they are located at a given period of time.
● It is the sum of GDP and Net factor income added from abroad.
3. NNP (Net National Product)
● It is the net value of final goods and services produced by the country’s factors.
● It is calculated by subtracting depreciation from GNP.
4. NDP (Net Domestic Product)
● It is the net value of final goods and services produced within domestic frontiers by individuals or firms irrespective of their nationality.
● It is calculated by subtracting depreciation from GDP.
What constitutes the term domestic territory?
The domestic territory is much bigger than the political frontier of a country. It also includes the territorial waters of the country. Thereby ships and aircrafts operated by the factors of the country also fall under domestic territory.
Note:-
Some of the country's national output will be produced by factors owned by foreigners or foreign firms. Similarly, some of the domestic factors or domestically owned firms may be growing in a foreign country.
The measure of domestic output considers the output produced by the domestic factors and foreign factors as long as it is produced within the domestic frontiers of the country. Conversely, the measure of national output considers the output produced by only domestic factors irrespective of their country of residence.
The gross output includes depreciation, whereas the net production is nothing but gross output minus the cost of depreciation.
Why is NNP considered to be the better measure?
When the output is measured after taking into account the cost of depreciation, it gives us an accurate picture of the nation's wealth. Therefore, the relatively net output gives a clearer picture than gross output. But when we have to compare countries, gross output is a better representative. Thus, the net is a better measure for internal purposes, whereas gross comes out as the better alternative for external comparison. Also, the National measure of output is considered superior to the domestic measure of output because the latter does not consider the output produced by the domestic factors staying outside the domestic territory of the nation. Comparatively, domestic is a restrictive measure in terms of national income accounting. Combining the two reasons, NNP is the better measure.
Why is GDP used more often as compared to NNP despite NNP being a better measure?
Even though NNP is considered the better measure, GDP is more comparable on a global scale. Moreover, countries usually do not have a universal method of calculating depreciation, so GDP acts as a more reliable measure in terms of comparability.
GOODS AND SERVICES
Goods are physical objects that can be used or felt, and services are performing activities for others for a stipulated price. These are the outputs produced by the firms and industries to meet the demand of consumers and the industrial markets. To make the concept clearer, let us consider the following example. When you go and buy a car, you are purchasing a good, but when you are using uber to book your taxi, you are using the services provided by uber.
What are the differences between goods and services ?
Goods
Services
They are tangible, can be seen and touched.
They are intangible, they can only be felt.
They can be stored.
They cannot be stored.
There is time gap between production and consumption of goods.
Production and Consumption of goods happen simultaneously.
Example - Pen, Paper, Clothes
Example - Teaching, plumbing,
Factor Cost vs Market Prices
The factor cost is the amount paid to the factors involved in production. But the market price is a price that is distorted with indirect taxes and subsidies. Indirect taxes like the goods and services tax increase the product's price, while subsidies reduce the cost of the goods and services.
Let us consider two consecutive years. In year 1, 100 units of 1 rupee each were produced. A tax of 10% was levied on it. It amounts to 110 rupees. Now, in year 2, 90 units were produced, but the tax was 30%, then the total amounts to 117 rupees. By looking at the final values, it would seem like the production level in year 2 was higher than in year 1. But in reality, units produced in year 2 was lesser in comparison. Thus calculating it at market prices does not give us an accurate picture of the economy. Hence calculating national income at factor cost gives us the most accurate picture.
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