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National Income Essay Sample

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National Income Essay Sample

This paper aims at providing a detailed discussion on the concept of national income and challenges that are faced by developing countries in the measurement of their national income. Under section one, a brief introduction of the structure of the paper and overview of issues regarding national income worldwide is given. Section two, illustrate the concept of national income, section three discusses challenges that are faced by developing countries in measurement of their national incomes and section four layout recommendations and conclusion. 1.1HISTORICAL BACKGROUND OF NATIONAL INCOME.

Arriving at a figure for the total production of goods and services in a large region like a country entails a large amount of data-collection and calculation. Although some attempts were made to estimate national incomes as long ago as the 17th century, the systematic keeping of national accounts, of which these figures are a part, only began in the 1930s, in the United States and some European countries. The impetus for that major statistical effort was the Great Depression and the rise of Keynesian economics, which prescribed a greater role for the government in managing an economy, and made it necessary for governments to obtain accurate information so that their interventions into the economy could proceed as well-informed as possible. (Wikipedia; 2012)

In every country there is a body which is responsible for keeping the national accounts and produces statistics through them. National income plays a crucial role in the economy of the country and these includes; Determination of the level of aggregate demand of goods. Determination of the business level and environment in a country. Its distribution pattern determines the pattern of demand for goods and services. However keeping the national accounts is not an easy exercise, there are stiff challenges that are always faced across the world and these includes Conceptual difficulties and

Practical difficulties.
In chapter three of the paper the usefulness and challenges concerning national incomes will be explained in details with examples.

National income is the sum total of wages, rent, interest, and profit earned by the factors of production of a country in a year. Thus it is the aggregate values of goods and services rendered during a given period counted without duplication. (Varun; 2012) There are various concepts of National Income. The main concepts of national income are: gross domestic product (GDP), gross national product (GNP), NNP, NI, PI, DI, and PCI. These different concepts explain about the phenomenon of economic activities of the various sectors of the economy. (Thapa; 2012) They are specifically concerned with counting the total amount of goods and services produced within some “boundary”. The boundary is usually defined by geography or citizenship, and may also restrict the goods and services that are counted. For instance, some measures count only goods and services that are exchanged for money, excluding bartered goods, while other measures may attempt to include bartered goods by imputing monetary values to them. 2.2. FACTORS THAT DETERMINE NATIONAL INCOME

National income is determined by the following factors.
2.2.1. Quality and quantity of factors of production
The quality and quantity of land, the climate, the rainfall, etc., determine the quantity and quality of agricultural production. This determines the size of national income. The quantity of labor has double influence since labor is both a factor of production as well as the consumer of what is produced. The quality of labor depends upon intelligence, training, which in turn decides the volume of industrial productivity. This will have decisive influence on output. Likewise, the quantity and quality of entrepreneurial ability is also a main element in the determination of national income 2.2.2. State of technical know-how

The extent of technical know-how and technology in production determine the capital formation in the country. A country with abundant resources will be dormant without any determination if the resources are not scientifically exploited. Natural resources combined with advanced technology will go a long way in increasing the size of national income.

2.2.3. Political stability
The key to increase the national income rests with important factors like capital formation, natural resources, technical know-how and political stability. (Economiclass;2012) 2.3. METHODS TO MEASURE NATIONAL INCOM E

There are three methods by which national income can be calculated, these include; Value added method, factor income method and expenditure method. 2.3.1. Value Added method
The method consists of three stages:
Estimating the gross value of domestic output in production Deducting these costs and depreciation from gross value to obtain the net value of domestic output. This is the value added. Determining the cost of materials and services used and also the depreciation of physical assets. In measuring Gross value, income has to be grouped under various economic activities like Agriculture activities and social activities. Classification of economic activities varies from nation to nation depending on; The nature of domestic activities

Their significance in economic activities
Availability of data.
Gross output is then computed by multiplying output of each category of sector by their respective market prices then adding them. Through value method in estimating cost of production it is slightly complicated due to lack of data and difficulties in the computation of depreciation.(class notes; 2012) This method has a merit because it helps us to have a comparative idea of the imporntance of various activities in economy like agriculture, manufacturing, and trade. However in advanced countries this method may be successful as it is very easy to get data from government records. But in underdeveloped countries this method may give rise to various problems like imputation of money values to no-monetized sector. 2.3.2. Factor – Income Method

This method refers to the gross national income obtained by adding together wages and salaries, interests, profits and rents of persons and institution and including government incomes are earned either from property or through work. Some of the factors of production are land, labor, and capital. In this case then National Income = Rent + Wages + Interest + Profit. This method gives national income at factor cost. 2.3.3. Expenditure Method.

The expenditure approach is also known as the final product approach. As the name implies, the approach attempts to measure the total final product spent by households, firms and governments both domestically and abroad. Since the expenditure approach measures the ‘sales’ at which the various parties pay, the GDP/GNP measured is at market price. However market price values do not usually reflect the true national income of the country’s economy since transfers like taxes and subsidies can distort prices of goods. These transfers do not contribute to the production level of the economy. Therefore to convert GDP/GNP at market price to GDP/GNP at factor price, the former has to deduct indirect taxes less subsidies from the final sales value of each product group. In the System of National Accounts, the expenditures are usually classified according to the types of final products spent. Private consumption of goods and services can be classified to; 1) Consumer durable (except land and building)’

2) Non durable goods like food and
3) Value on the services provided by the government and private enterprises (like hotels, catering and restaurants). (Yin S.C; 2003) Money expenditure at market prices are computed and added and these include the private consumption expenditure, direct tax payments, payment to nonprofit organization and private savings. Value of all the products finally disposed of are computed and added to get total national expenditure. These will include private consumer goods and services, private investment goods, public goods and services and net investment abroad.

The merit of this method is that it believes in the identity between national expenditure, income and total product. Whichever method we use the result should be more or less the same. In other words, they can be used to cross-check reliability of each other. 2.4. TREATMENT OF NET INCOME FROM ABROAD

Most economies are open and undertake foreign trade and financial transactions with other countries. For national Income, the net result of external transactions is adjusted to the total. Net incomes from abroad are added and net losses to foreigners are deducted. Exports of goods and services like insurance, banking, tourism, gifts, foreign investment income, are added and imports are deducted to get national income. (From notes ) 2.5 USES OF NATIONAL INCOME STATISTICS

National income figures help governments in planning, policy making, preparation of budgets and forecasting the level of economic activity. Formulation of economic policies.
National income statistics are valuable instruments of economic analysis and a guide to economic policies to be pursued. It is more useful in context of planning and formulation of realistic plans. Studying economic structure.

It gives an idea of the structure of the economy. It helps to make inter- sectoral comparisons and to study the rate of growth of the economy. The growth of national income is an index of the growth of the productive capacity of an economy.

Inter- sectoral comparisons
It helps to study inter-sectoral growth. Such comparisons are useful. Share of various sectors can be studied to find out structural defects and weaknesses of the economy.

Indicator of economic welfare
It enables us to study per capita income or per capita consumption which are general indicators of economic growth. But it is not helpful in revealing distribution of income in the society.

 Making international comparison
National income estimates enables us to make international comparisons and standard of living of people. Contribution to international institutions

It shows the capacity of a country to bear some common burden of international institutions like the U.N.O. (Economiclass; 2012)

3.1 CHALLENGES FACED BY DEVELOPING COUNTRIES IN MEASUREMENT OF THEIR NATIONAL INCOME The measurement of national income is beset with difficulties. In under developed countries these difficulties are more prominent than in developed countries and they may be classified as conceptual or theoretical difficulties and practical difficulties. Conceptual or Theoretical Difficulties

There has been a difference of opinion regarding the term ‘nation’ in the concept of national income. It has to define exactly, whether it is geographical entity of the country or the nationals including those residing abroad. Since national income constitutes a quantitative measure of economic activity rather than verbal description and Since everything has to be equated to the money value, services produced in economy for love of humanity, affection and philosophy could not be taken into consideration in calculating national income.

Practical Difficulties
Non-monetized activities may be poorly estimated (for example, the products of peasant agriculture) or excluded (for example, domestic work maintaining the home).

Inclusion of Services: There has been some debate about whether to include services in the counting of national income, and if it counts as output. Marxian economists are of the belief that services should be excluded from national income, most other economists though are in agreement that services should be included. (Blurtit; 2012) Identifying Intermediate Goods: The basic concept of national income is to only include final goods, intermediate goods are never included, but in reality it is very hard to draw a clear cut line as to what intermediate goods are. Many goods can be justified as intermediate as well as final goods depending on their use.(Blurtit; 2012) Identifying Factor Incomes: Separating factor incomes and non factor incomes is also a huge problem. Factor incomes are those paid in exchange for factor services like wages, rent, interest etc. Non factor are sale of shares selling old cars property etc, but these are made to look like factor incomes and hence are mistakenly included in national income (Blurtit; 2012)

Services of Housewives and other similar services: National income includes those goods and services for which payment has been made, but there are scores of jobs, for which money as such is not paid, also there are jobs which people do themselves like maintain the gardens etc, so if they hired someone else to do this for them, then national income would increase, the argument then is why are these acts not accounted for now, but the bigger issue would be how to keep a track of these activities and include them in national income.( Wikipedia; 2012 ) Transfer payments: Transfer payments are the sources of income for the households and the business firms, but these do not form part of the national income. Individual get pension and interest on public loans, but these payments creates difficulty in the measurement of national income. These earnings are a part of individual income and they are also a part of government expenditures.(Thapa;2012) Pricing of products: Valuation of the final products for the purposes of national income estimation is a difficult task. For example, in many developing countries peasants do not have a fair idea of the expenses of their occupation hence the net value of their products cannot be estimated precisely.

National income consists of not one but innumerable goods, service, and they have to be somehow added up to arrive at a measure of national income. The real difficulty arises from the fact that dissimilar things cannot be added up. They have to be converted into some common denominator before doing so and the only practical way of doing so is to take their market prices. However it is widely recognized that market prices do not represent the true social valuation of the goods and services. In the case of officially determined prices, they reflect only what the authorities decide them to be and in the case of market determined prices, all kinds of market imperfections distort them. The market prices are deeply influenced by: The market structure, The sales and marketing campaigns of the suppliers, Taxation, subsidies and other rules, regulations and restrictions of the authorities, The prices of productive resources and distribution of income and wealth, The role of speculative forces, and Shifts in prices of imports and exports.

In other words, we do not have a reliable method of adding flows of diverse goods and services(Nanda; 2012) Several economic activities only add to the disutility of the members of society and entail use of resources (resource cost) which could be used for more productive purposes. But an increase in such activities is taken to add to national income rather than reduce it. For example, let us take the case of a worker who has shifted his residence to a greater distance from his work place. Therefore, compared with the earlier situation, he has to commute a longer distance to his work and has to spend additional time, effort and money for doing so. Though, in reality, both the individual worker and the country are losers on account of the shifting of residence of this worker, national income estimates record the additional resource cost as an addition to national income.(Nanda; 2012) 3.1.2 PRACTICAL DIFFICULTIES

Unreported Illegal Income: Sometimes, people don’t provide all the right information about their incomes to evade taxes so this obviously causes disparities in the counting of national income.(Wikipedia;2012) The national income estimates do not cover illegal activities even though they may be adding to national product. These include smuggling, inland trade activities, production and income generation concealed from the authorities for avoiding tax obligations and prosecution. (Nanda 2012) Since, these incomes are not included in the national income, the national income seems to be less than the actual amount as they are not included in the accounting.(Thapa;2012) Non Monetized Sector: In many developing nations, there is this issue that goods and services are traded through barter trade. Such goods and services should be included in accounting of national income, but the absence of data makes this inclusion difficult. (Wikipedia; 2012) Overlapping of occupations: In many developing countries there is an overlapping of occupation in rural sector which makes it difficult to know the income by origin.

A worker in a peak season works in a farm drives a country cart in off season and takes up unskilled work. Under such circumstances it is very difficult to trace out the main source of earning of an individual. Due to this, a large part of income remains excluded from the national income. (Economicsclass; 2012) Un-availability of reliable data: In many developing countries there are also serious problems regarding the reliability of information to be used in estimating national income. They include the following-; (a) Several pieces of information are available with undue delay and it is not possible to use them in time for formulation of effective policy measures. At the most, this information may be used to revise the past estimates. (b) A modern economy is so complex that it is next to impossible to gather complete information needed for estimates of national income. A number of intelligent guesses have to be made and used for this purpose. These omissions can be quite serious, particularly in the case of developing countries where adequate records are not maintained. Moreover, in the absence of records, most individuals and households are not able to provide correct information of their consumption and investment values. (c)

In some cases, relevant information may not be available to the authorities because the households and business units required to provide the information may have reasons to hide the information. In still other cases, they may not have the exact information (Nanda;2012)  Goods for self-consumption: Goods which are retained by the producer for personal consumption do not fetch money price, and are therefore excluded from the national income.  Double counting: Only final goods and services should be included in the national income accounting. But, it is very difficult to distinguish between final goods and intermediate goods and services. An intermediate goods and service used for final consumption.

The difference between final goods and services and intermediate goods and services depends on the use of those goods and services so there are possibilities of double counting.(Thapa; 2012) Petty Production: There are large numbers of petty producers and it is difficult to include their production in national income because they do not maintain any account. (Thapa;2012) Wages and Salaries paid in Kind: Additional payments made in kind may not be included in national income. But, the facilities given in kind are calculated as the supplements of wages and salaries on the income side.(Thapa; 2012)

The theoretical difficulties appear in almost all countries but the practical difficulties are generally witnessed in the underdeveloped countries. Given all these potential sources of error and of differences in usage, the interpretation of the resulting aggregates of national product is subject to serious limitations. 3.2. NATIONAL INCOME AND WELFARE

GDP per capita (per person) is often used as a measure of a person’s welfare. Countries with higher GDP may be more likely to also score highly on other measures of welfare, such as life expectancy. However, there are serious limitations to the usefulness of GDP as a measure of welfare: •Measures of GDP typically exclude unpaid economic activity, most importantly domestic work such as childcare. This leads to distortions; for example, a paid nanny’s income contributes to GDP, but an unpaid parent’s time spent caring for children will not, even though they are both carrying out the same economic activity. •GDP takes no account of the inputs used to produce the output. For example, if everyone worked for twice the number of hours, then GDP might roughly double, but this does not necessarily mean that workers are better off as they would have less leisure time. Similarly, the impact of economic activity on the environment is not measured in calculating GDP. •Comparison of GDP from one country to another may be distorted by movements in exchange rates. Measuring national income at purchasing power parity may overcome this problem at the risk of overvaluing basic goods and services, for example subsistence farming. •GDP does not measure factors that affect quality of life, such as the quality of the environment (as distinct from the input value) and security from crime.

This leads to distortions – for example, spending on cleaning up an oil spill is included in GDP, but the negative impact of the spill on well-being (e.g. loss of clean beaches) is not measured. •GDP is the mean (average) wealth rather than median (middle-point) wealth. Countries with a skewed income distribution may have a relatively high per-capita GDP while the majority of its citizens have a relatively low level of income, due to concentration of wealth in the hands of a small fraction of the population. Because of this, other measures of welfare such as the Human Development Index (HDI), Index of Sustainable Economic Welfare (ISEW), Genuine Progress Indicator (GPI), gross national happiness (GNH), and sustainable national income (SNI) are used.(Wikipedia; 2012)


Since problems of measuring national income are more witnessed in developing countries than in developed countries, then developing countries should learn from developed countries and adopt their ways of handling economic activities, record keeping and approaches of measuring national income. However, this may take long to successful be put in place but the current generation should do some initiative that will be carried on by the future generation so as to reduce barriers towards effective and efficient measurement of national income in developing countries.

To conclude, National Income is the backbone of the welfare of the country. It is a very useful tool for countries to know varied levels of welfare of its people, for example, life expectancy. However, measurement of national income is subject to limitations all over the world but these limitations are more serious in developing countries than in developed countries. Due to the nature of lifestyle in most of the developing countries these limitation has almost be unavoidable.


Economics class; (2012) Homepage on-line, Available from http://economicsclass.weebly.comnational-income-concepts.html ; Internet India Blurtit, (2012) Homepage on-line, Available from http://india.blurtit.com/q4543124.html; internet Nanda Sushil, (2012) Homepage on-line, Available from http://www.preservearticles.com/201102083958/difficulties-in-estimating-national-income.html; Internet

Thapa Jeevan, (2012). Homepage on-line, Available from http://economydetail.blogspot.com/2010/02/concepts-of-national-income.html; Internet Varun, ( 2012) Homepage on-line, Available from http://www.preservearticles.com/201106178078/10-most-essential-concepts-of-national-income-explained.html; Internet

Wikipedia, (2012). Homepage on-line, Available from http://en.wikipedia.org/wiki/Measures_of_national_income_and_output; Internet

Yin S. C, (2003) Homepage on-line, Available from http://choonyin.tripod.com/nationalincome/ ;Internet

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