A country’s national income refers to the income earned by the people by contributing factors of production to the production process. This is one of the most important macroeconomic factors which is calculated annually. Macroeconomic studies are carried out annually to evaluate the performance of the economy. National income calculation is one of the criteria to consider how much is being produced within the country over a period of one year.
In addition, national income statistics are used to do an inter-country comparison of the economic standard between countries. In addition, National income statistics are used to measure the living standard of the people and formulate the economic policy and inter-country comparison of economic standards. There are three ways that the national income is calculated.
- Product method
- Income method
- Expenditure method
The main source of reserving income by the people of a country is by selling the factors of production to the producers. The factors, Land, Labour, and Capital are owned by the people and they are sold in the factor market. The producers or the Firms by them in the factor market paying the price. The payments made by the firms are added to the value of the product. The value of the total product is calculated based on the market prices and it is considered as Gross Domestic Product (GDP).
It is clear that the firms’ expenditure or the cost of production creates a flow of income to the factor owners. The value of the total product of a country becomes equal to the income received by the people by way of factor income.
In a simple sense, this is the value of the income paid by the firms to the households in return for factors, land, labor, and capital. A perusal of the following flow chart indicates all the sources of income in addition to the factor income. After considering the factor income, necessary adjustments are made to derive the Net National income.
This is the total value of spending by the households on goods and services. In a simple economy where there is no saving, it is considered that the factor income received by the households is spent on the products produced by the firms. This is termed the gross domestic expenditure.
It is considered that all three methods – Income, Output, or Expenditure – are three different methods of looking at the same process and all three values are equal.
This can be further illustrated by using a simple economic model in which only the firms and households are there, as below.
Circular Flow of National Income – Simple Model
As per the above diagram, there is a flow of factor services from Households to the Firms and it creates a corresponding flow of factor payments from firms to the households. At the next stage, the goods produced by using the factors create a flow of goods and services from Firms to Households with a similar flow of household spending as the payment for finished goods. It’s clear that the methods of national output, spending, or income are different aspects of looking at the same thing and their values too should be identical.
But the activities of an economy more complicated than the simple model. There are leakages from the flow of income shown above as savings, exports, taxes, etc, and similar addition to the flow as injections, such as investments, imports, and government spending. To include the effects of Government intervention and foreign trade when calculating the country’s income, the national income flow model is modified as below.
As per the above, the government receives taxes from the households and firms and it will be added to the income flow as govt. expenditure. In addition, leakages as exports are compensated as imports.
In calculating a country’s National Income, there are some limitations to the accuracy of the statistics. Only the values of the products sold in the markets are included and certain estimated values are for accuracy. Though the weaknesses are possible, still the national income along with other social indices are used to evaluate the performance of the economy and the living standard of the people.
Economic growth is the increase in total output or the GDP of a country. Economic growth can be achieved due to an increase in productive resources or an increase in the efficiency of existing resources. An increase in output or economic growth can be illustrated by using the production possibility frontier. The production possibility curve is a line that covers all the available resources in an economy. The rightward shift of the production possibility curve shows the possibility of producing more goods and services, thus occurring in economic growth.
As per the above diagram, the production possibility curve has shifted to the right and as a result, the production of product Y has increased from A – A1, and the production of X has increased from E – E1. The increase in the stock of resources increases the total output of the country. The rightward shift of PPC occurs due to any of the following reasons.
- Exploring new productive resources
- Increase in factor efficiency due to technological development
- Increase in population
The economic growth of a country is measured as the rate of growth. The rate of growth is the percentage increase in the GDP of a country between two consecutive years. This is one of the macroeconomic indicators of the economic performance of a country.