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Meaning of National Income
National income is a measure of value of entire production activity of a country. Production generates income. So, it is in the production process of goods and services that income generates. Production is the result of combined efforts four primary inputs, also called factors of production. They are:
3. Capital and
An entrepreneur put together the land, labour, capital and form an enterprise to produce goods. He hire some employees and they provide the labour. They are paid for the activities performed at the production unit in the form of wages. Entrepreneur also use some space/building for the smooth functioning of his production unit. There must be capital employed for the production process for which he has to pay the interest. The profit out of production process will be distributed among the following factors:
Rent will be paid for Land/building
Wages will be paid for labour
Interest will be paid for capital
Profit will be given to the enterprise/entrepreneur.
From the above we can understand that production produces income. Factors of production divide the profit in the form of rent, wages, interest and profit. National income is a measure of value of production activity of a country.
There are three phases in the circular flow of national income. They are:
Income first generated through the production process. The earned income in the form of rent, labour, profit and interest will give rise for expenditure to satisfy the increased wants. Increased want produce demand and the demand induce the production.
Therefore national income can be defined in three different ways---as a flow of goods and services produced, as a flow of income distributed and as a flow of expenditure.
From the production point of view, "National income is the sum of money value of net flow of all the final goods and services produced by normal residents of a country during a period of account"
From expenditure point of view, Simon Kuznets defines "National product is the net output of commodities and services flowing during the year from the country's productive system into the hands of ultimate consumer or into the net addition to the country's capital goods."
From income point of view, CSO (Central Statistical Organisation) has defined, "National income is the sum of factor incomes earned by normal residents of a country in the form of wages, rent, profit and interest in an accounting year".
From the above definitions we can conclude that national income is either money value of all the final goods and services produced or the sum total of final expenditure(consumption and investment expenditure) or the sum total of all factor incomes earned.
National income can be measured at current prices and constant prices.
National income at current price and constant price
National Income at Current Prices
If the goods and services produced in a year are valued at current prices i.e., prices prevailing in that particular year, we get national income at current prices. National income at current prices is called nominal national income. For example the cost of a shoe is Rs. 1000 in the year 2011 and the total production is 200 units, then the national income of the year 2011 is Rs. 1000 x 200 = Rs. 2,00,000
And the price of a shoe is Rs. 1300 in the year 2012 and the production is reduced to 175 units, the national income of the year 2012 would be Rs. 1300 x 175 = Rs.2,27,000
From the above we can understand that the production decreased from 200 to 175 units and the price increased from Rs. 1000 to Rs. 1300. Even though the production decreased the national income increase from Rs. 2,00,000 to Rs. 2,27,000.
Evidently, it is the change in price of physical output produced during the year which affects national income at current prices because prices fluctuate constantly.
If we calculate the national income at current price, it would be difficult for us to understand whether the economic growth is taking place or not in that particular country or industry in the assessing year. Here comes the importance of finding out National income at constant price.
National Income at Constant Price
If goods and services produced in a year are valued at fixed prices, i.e., prices of the base year, we get national income at constant prices. National income at constant price is called Real National Income. A base year is a carefully chosen year which is a normal year free from price fluctuations. Constant price refer to the price prevailing in the base year.
From the above example, the price of a shoe on the base year is 900 and the production of the year 2011 is 200 units, then the total national income is Rs. 900 x 200 =Rs. 1,80,000
For 2012 the price remain same i.e, Rs. 900 and the unit produced is 175 units, then the national income will be Rs. 900 x 175 =Rs. 1,57,500
From the above example we can understand that the production declined and the national income also declined.
Evidently, it is the change in volume of physical output produced during the year which affects national income at constant prices because prices remain fixed/constant.
Difference between current prices and constant prices.
Change in prices and change in physical output affects the national income at current prices. If the current prices increase rapidly, national income at current prices will also increase even if there is no increase in the level of physical output. National income at current price fails to reflect the growth of an economy.
On the other hand, Change in physical output only will affect the national income at constant prices. Increase in the level of physical out put only can increase the National income at constant prices. Since a country is interested in its physical output, it is considered proper and desirable to estimate national income at constant prices for a number of years. We can say a country is growing economically when there is continuous rise in national income at constant prices for a number of years.
Advantage of National income at Constant price
Real national income or Gross National Product (GNP) enables us to make a year to year comparison of changes in the volume of output of goods and services.
The real change in physical output of a country can be measured by determining the National Income at constant price.
International comparison of economic performance of different countries are possible only if we calculate national income at constant price.
Gross National Product calculated at constant price is called Real Gross National Product whereas GNP calculated at current prices, it is called Nominal Gross National Product.