Define National
Income
Prior to Keynes
both Adam Smith and David Ricardo took a note of the problem of National Income
but their faith in Say’s Law was so strong that they could not think of any
economy operating below its capacity. Since the equilibrium at full employment
level was guaranteed classical economists turned to matter related to
microeconomics.
In 1929 the world
experienced the biggest, deepest and the most prolonged depression also known
as the Great Economic Depression. Say’s law began to weaken. At this juncture
Keynes appeared on the stage with less than full employment equilibrium level
of national income. This increased the
interest in the study of aggregate income consumption and employment. The
subject has further gained in interest and importance as a result of the quest
for rapid economic development in less developed countries of the world. This
entirely shifted the focus of the economists from micro to macro issues related
to the economy as a whole. The problems which now became significant were: What
determines the level of total output and employment in an economy. And what
cause fluctuations in this level from time to time? In order to understand the
concept it is better to start with its definitions:
The essential
things are to realize how it is defined in each case and to choose the most
definition for any particular purpose. National income has been defined by many
economists. Definitions, as given by Marshall, Pigou and Fisher, are in order.
Marshall is his Principles
of Economics has defined national income or the National dividend as follows:
“The labour and
capital of a country, acting on its natural resources, produce annually a
certain net aggregate of commodities, material and immaterial, including
services of all kinds and net income due on account of foreign investments must
be added in. This is the true net annual income or revenue of the country, or
the national dividend.” (Principles of
Economics, 1920, p. 434)
No doubt, Marshall’s
definition is theoretically precise, simple and comprehensive; even then it has
serious practical limitations;
(i)
It is not easy to make statistically correct estimate of the
total production of goods and services in a country.
(ii)
There are difficulties of double counting.
(iii)
Marshall’s definition is too broad.
(iv)
The definition classifies goods and services in to material and
immaterial.
(v)
Some commodities produced in the country are not traded some of
the portion of the produce is retained for personal consumption.
A.C. Pigou, has defined
national income as:
National dividend
is “that part of the objective income of the community including, of course,
income derived from abroad, which can be measured in money …” ( The Economics of Welfare, 1932, p.31)
According to Prof.
Pigou, only those goods and services should be included (double counting being
avoided) that are actually sold for money.
Pigou’s definition
is precise, convenient, elastic and workable because it does away with the
difficulty of measuring the national income dividend inherent in Marshall’s
definition. Therefore this is better than Marshall’s definition. Pigou’s
definition also has certain limitations:
(i)
This definition makes an
artificial distinction between goods that are exchanged for money and goods
that are not so exchanged. The bought and the un bought goods do not differ in
kinds from one another in any fundamental respect.
(ii)
As per Pigou’s definition, we cannot find the total amount of
national dividend because we are to include only those goods and services that
are exchanged for money. In a developing country, where most of the goods and
services are not exchanged for money but simply bartered away, Pigou’s
definition is of no use.
(iii)
Pigou Narrows down the scope of National income
(iv)
This definition includes the income derived from abroad and thus relates to an open economy.
(v)
Pigou’s definition cannot be applied to a barter economy.
Prof. Fisher adopts consumption
instead of production as the basis of the nation dividend. According to Prof.
Fisher,
“The national
dividend or income consists solely of services as received by ultimate
consumers, whether from their material or from their human environment. Thus, a
piano or an overcoat made for me this year is not a part of this year’s income,
but an addition to capital. Only the services rendered to use during this year
by these things are income.”
Thus, according to
Fisher, the national income of country is determined not by its annual
production, but by its annual consumption. Prof. Fisher’s definition is better
than Dr. Marshall’s and Prof. Pigou’s is as much as it is nearer to the concept
of economic welfare, because welfare depends upon the goods and services that
are made available to the individuals of the community. But it is more
difficult to have an idea of net consumption than net production.
Moreover, the life
of durable goods which last beyond one year is very difficult to measure.
Estimates are at best estimates and they can at times differ from the actual.
Again, according to the Nobel Prize Winner Prof. Simon Kuznets, “It is the net
output of commodities and services flowing during the year from the country’s
productive system in the hands of the ultimate consumers or into the net
addition to the country’s capital goods.”
Another Noble Prize
Winner Prof. Samuelson says, “It is the loose name we give for the money
measure of the overall annual flow of goods and services in an economy.” Prof.
Ackley defines national income as the sum of all:
(a) Wages,
salaries, commissions, bonuses, and other forms of employee earnings;
(b) Net income from
rentals and royalties;
(c) Interest
income, and
(d) Profits.
However, none of
these definitions suited Keynes as he wanted to know the factors that go to
determine the level of income and employment in an economy at a particular
time. He wanted to know the considerations that weight with the entrepreneurs
when they decide to employ a certain number of men.
However, it may be
noted that the suitability of any particular definition depends upon the
purpose, for which, it is to be used. Keynes himself said, “One thing which
impeded my progress in writing the ‘General Theory’ was the suitable definition
of national Income.” Keynes defines income in such a manner as enables him to
determine employment in a community
It is in this
respect that his definition differed from those of his predecessors, as their
definitions did not throw any light on the factors which go to determine income
or its relation with employment; this purpose was amply achieved in the
definition adopted by Keynes.
Keynes’ Approach:
Keynes wanted to know
the factors that determine the level of income and employment in an economy.
Keys gave the following approaches to National income:
·
Aggregate
Expenditure oe Aggregate Consumption and Investment approach
·
Factor
income approach
·
User
Cost approach
The Aggregate
Expenditure Approach:
This approach measures the aggregate expenditure on consumption and Investment.
Thus,
Y=C+I
The
Factor Income Approach: This approach measures the total income received by all the
factors of Production. Thus it is the sum of the receipts of the factors of
production in the form of wages, salaries, profits, interest and rent.
The
user Cost approach:
The third approach is called user cost approach. This is also known as sale
proceeds minus cost approach. Keynes did not deduct the depreciation charges
from GNP but only a part of the depreciation which is known as user cost is
deducted. The user cost is the difference between the depreciation in the value
of a machine when it is put to use plus the expenditure which is required for
the maintenance of the machine. Thus,
U= D1- (D2+Em)
Where
U = User
Cost
D1=
Depreciation when Machine in Use
D2=Depreciation
when machine is idle
Em=
Maintenance Cost
Keynes
said that D2 is lower than D1 that is depreciation will
be more when machine is in use. National income as per Keynes’ approach will be
equivalent to the amount when the user cost U is deducted from gross national
product.
Y= A-U
Where;
Y=
National Income
A= GNP
U= User
Cost
According
to Keynes the concept of Net Income is more important for analysis of
consumption. He deducts the supplementary cost (v) from the national income to
arrive at net national income;
Yn= Y- (A-U) -V
The
supplementary costs (v) are not always known in advance. These include many
contingent costs like loss due to fire, natural calamities, obsolescence and so
on According to Keynes employment is a function of gross national income and
consumption is a function of net income.
In recent
times many attempts have been made to make the national income analysis more
dynamic and realistic. National income may be defined as aggregate factor
income which arises from current production
of goods and services in an economy. National income committee of India
defines, A national income estimate measures the volume of commodities and
services turned out during a period, counted without duplication,” There is
a circular flow of income. In modern complex economy production takes place
as a result of cooperation among various factors of production. These different
factors of production receive payments in the form of rent, wages, interest,
salary and profit. Owners of the resources not only supply resources to firms
but also consume the final output as consumers in the economy. Thus income received as resource suppliers is
spent back on the purchase of final output. Consumers’ spending are business
earning. Income is earned in the form of Money, hence income flow and money
flow are the same thing. In a barter economy where money is not used there will
be now of flow of money. In such economy there will be only real flows
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