CONCEPT OF NATIONAL INCOME
National income means the value of goods and services
produced by a country during a financial year. Thus, it is the
net result of all economic activities of any country during a
period of one year and is valued in terms of money. National
income is an uncertain term and is often used interchangeably
with the national dividend, national output, and national
expenditure.
NATIONAL INCOME
• National income is the sum total of the value of all the goods and services
manufactured by the residents of the country, in a year., within its domestic boundaries
or outside. It is the net amount of income of the citizens by production in a year.
• To be more precise, national income is the accumulated money value of all final goods
and services produced in a country during one financial year. Computation of National
Income is very vital as it indicates the overall health of our economy for that particular
year.
• The aggregate economic performance of a nation is calculated with the help of National
income data. The basic purpose of national income is to throw light on aggregate output
and income and provide a basis for the government to formulate its policy, programs, to
maximize the national welfare of the people. Central Statistical Organization calculates
the national income in India.
IMPORTANCE OF NATIONAL INCOME
• Setting Economic Policy
National Income indicates the status of the economy and can give a clear picture of the country’s economic growth.
National Income statistics can help economists in formulating economic policies for economic development.
• Inflation and Deflationary Gaps
For timely anti-inflationary and deflationary policies, we need aggregate data of national income. If expenditure
increases from the total output, it shows inflammatory gaps and vice versa.
• Budget Preparation
The budget of the country is highly dependent on the net national income and its concepts. The Government
formulates the yearly budget with the help of national income statistics in order to avoid any cynical policies.
• Standard of Living
National income data assists the government in comparing the standard of living amongst countries and people living
in the same country at different times.
• Defense and Development
National income estimates help us to bifurcate the national product between defense and development purposes of
the country. From such figures, we can easily know, how much can be set aside for the defense budget.
WHAT IS THE NATIONAL INCOME
ACCOUNTING EQUATION?
• National income accounting equation is an equation that shows the relationship
between income and expense of an economy and other categories. It is represented by
the following equation:
• Y = C + I + G + (X – M)
Where
• Y = National income
• C = Personal consumption expenditure
• I = Private investment
• G = Government spending
• X = Net exports
• M = Imports
GDP
• GDP = C + I + G + (X – M)
• Where,
• C = Consumption spending
• I = Business investments (Capital equipments, inventories)
• G = Government purchases
• X = Exports
• M = Imports
UNDERSTANDING THE CIRCULAR FLOW
MODEL
• The idea of circular flow was first introduced by economist Richard Cantillon in the
18th century and then progressively developed by Quesnay, Marx, Keynes, and
many other economists. It is one of the most basic concepts in macroeconomics.
• How an economy runs can be simplified as two cycles flowing in opposite
directions. One is goods and services flowing from businesses to individuals, and
individuals provide resources for production (labor force) back to the businesses.
• In the other direction, money flows from individuals to businesses as consumer
expenditures on goods and services and flows back to individuals as personal
income (wages, dividends, etc.) for the labor force provided. This is the most basic
circular flow model of an economy. In reality, there are more parties participating in
a more complex structure of circular flows
TWO FACTOR MODEL
• The model described above is the two-sector model, which is the most basic
model containing only two sectors: individuals or households and
businesses. In the two-sector model, it is assumed that households spend all
their incomes as consumer expenditures and purchase the goods and services
produced by businesses.
• This means that all household expenditures become income for firms. The firms
then spend all of this income on factors of production such as labor, capital and
raw materials, "transferring" all of their income to the factor owners (which are
households).
THREE SECTOR MODEL
• In the three-sector model, we include the government as well.
However, it is still all within the national boundaries. And this
model still is a closed economy where there are no foreign
transactions taken into account or assumed. Hence, another
name for this model is the closed economy model.
• So, this model introduces government purchases or expenditures
and taxation to our two-sector model theory of income
determination. The purchases, expenditures, and subsidies from
the government inject more money into the economy, while
taxation takes out money from circulation.
• The 3-sector model includes government as another sector, besides the
household and firms sectors. The government affects the economy in a
number of ways. It absorbs a good part of the incomes in the form of
taxes and other levies. The government also purchases goods and
services like households and the firms. The government expenditure
takes many forms including spending on capital goods and infrastructure
(highways, power, communication), on defence goods, and on education
and public health etc. Also, it may pump investments in the income, in
order to fill the gap left by the leakage income. The 3-sector model
assumes closed economy of a country.
4-SECTOR MODEL
• The 4-sector model includes foreign sector and there are trade relations with foreign countries. The foreign
firms interact with the domestic firms and households through export and import of goods and services. Also,
the foreign sector gets involved in borrowing and lending operations in a country through financial market. The
goods and services produced within the domestic territory which are sold to the foreigners are called exports.
• While 2-sector and 3-sector models are closed economic models, meaning that rest of the world is cut-off from
the country; the 4-sector model is open economic model and is most prominent today. That means that besides
domestic production and consumption, the countries are also involved in exports and imports of goods,
services, financial instruments etc. Most of the countries are not self-sufficient to be able to produce or
consume all the goods required by them. These could be raw material, oil, finished goods, financing etc. Due to
this, they are dependent upon the other countries to fulfil their requirements and/or to contribute in their
economic development. The open trade in the world market makes this possible.
