National Income Accounting in India

National income of a country can be defined as the total market value of goods and services produced in the economy in a year.

The three-important measure of calculating National Income of a country are:

• The sum of the value of all final goods and services produced.
• The sum of all incomes accruing to factors of production, i.e., Rent, Interest, Profit and Wages.
• The sum of consumer’s expenditure, net investment, and government expenditure on goods and services.

Circular Flow of Income in a Three Sector Economy

• The modern economy is a monetary economy. Money changes hand from one sector to another.
• The Household sector supplies their services like labour, land, Capital and entrepreneurial abilities to firms and receives payments in return in terms of money.
• In the first stage of the model, the Household sector provides their services of labour, land, capital and entrepreneurial skills to the Business firms.
• In the second stage, the Business firms pay back in monetary terms to the Household sector in the form of Wages, Rent, Interest and Profits.
• In the third stage, the money received by household is spent on the goods and services produced by the firms in the form of consumption expenditure. At the same time, the Firms provides their goods and services to the Household in return for the money.
• Thus, we see, that money flows from business firms to households as payments for a factor of production (Labour, Land, Rent and Entrepreneurial skills), and then it flows from Household to firms when Household purchased goods and services produced by the firms. This money flow is called circular flow of income.

Saving and Investment in the Circular Flow

• Along with consumption, the household also saves part of their money.
• When Household saves, their expenditure on purchase of goods and services decline. The decline in the purchase will result in a decline in money received by firms. This will result in less money flow to the household as the firms will reduce hiring and production operations. Thus, saving act as a leakage from the economic system.
• But the important question to ask is, where will savings go in the economy?
• The savings in the economy does not lead to any reduction in aggregate spending and income as the savings flows back into the economic system through Financial Markets (Banks, Stock markets, insurance etc.)
• From Financial Markets, the savings flows back to the Business firms who borrow them and invest it into new forms of investments.
• Thus, the saving which is a leakage in the system also flows back into the system through investment by a firm which acts as injections.

Government Sector in the Circular Flow

• Government affects the economy in a number of ways. The main components of government intervention are in the form of taxes, spending and borrowings.
• Government purchase goods and services just as household and firms do.
• Government financed its expenditure through taxes and borrowings.
• The money flow from Household and firms to the government is in the form of taxes.
• The other form of money flow from Household and firms to government is in the form of Borrowings through financial markets.
• The Government pay back to household and firms in the form of provision of public goods like health, education, Policing, National Defence etc.

National Income and National Product

Net National Product or National Income

• In the production of GNP of a year, a country uses some fixed assets or capital goods like Machinery, Equipments and technology etc.
• The capital goods like machinery, building and equipment’s undergo regular wear and tear during the production process, which reduces their value. This fall in the value of capital assets due to regular wear and tear is called depreciation.
• When the Depreciation is deducted from the Gross National Product, then we get Net National Product.
• It simply means to include all market value of goods and services produced in a year after deducting depreciation.
• NNPMP = GNP- Depreciation.

National Income at Factor Cost

• National Income from Factor Cost is also called National Income of a country.
• National Income means the sum of all incomes earned by the citizens in the form of Rent, Wages, Interest and Profits.
• The difference between National Income at Factor Cost and National Income at Market Price (NNPMP) arises from the fact that indirect taxes and subsidies cause the market price to be different from the factor income received by the citizens.
• Example, A mobile handset of Rs10,000 purchased by you includes a GST of 12%. In this case, while the market price of RS 10,000 includes the GST. The factor of production used to produce mobile handset will only get RS 8800. Thus, the difference between market price and factor cost is the tax.
• Similarly, a subsidy results in the market price of a product to be less than the factor cost.
• Therefore, while calculating National Income, we must deduct indirect taxes and add subsidies into Net National Product at Market Price.
• NNPFC = NNPMP – Indirect Taxes + Subsidies.

Personal Income

• Personal Income includes the sum of all incomes actually received by all the individuals or households during a given year.
• The individual pays income taxes, firms pay corporate taxes, individual also contribute towards social securities in the form of Cess etc., and some individuals receive social security benefits (transfer payments) like pension, unemployment allowances from the government.
• In order to move from National Income to Personal Income of individuals and firms, we must deduct all forms of direct taxes and social security contribution by the individuals and must add transfer payment received by the individuals.
• The basic idea here is to subtract all those income from National Income that is earned by an individual but has not been received like taxes and add all those incomes which are received by the individuals but has not been earned like Old age Pensions.
• Personal Income= National Income – (Undistributed Corporate Profits+ Corporate Taxes + Social Security Contribution) + (Transfer Payments).

By
Himanshu Arora
Doctoral Scholar in Economics & Senior Research Fellow, CDS, Jawaharlal Nehru University