1. Meaning of National Income
National income is the total economic activity in a country over a period (usually a year).
It captures three perspectives of the same thing:
- Output → value of goods and services produced
- Income → wages, profits, rent, interest earned
- Expenditure → total spending on goods and services
Why they are equal (important logic)
- When a firm produces output → it sells it → someone spends money
- That spending becomes income for workers and firms
👉 So:
2. Measurement of National Income
A. Gross Domestic Product (GDP)
GDP measures how much is produced inside a country’s borders, regardless of who owns the resources.
Example
- A Japanese company produces cars in the UK → included in UK GDP
- A UK company produces goods in France → NOT included in UK GDP
Why “final goods only”?
To avoid double counting:
- Flour (intermediate good) → used to make bread
- Bread (final good) → sold to consumers
If both were counted → output would be overstated
Why GDP matters
- Indicates economic growth
- Helps governments make policy decisions
- Used to compare economies
B. Gross National Income (GNI)
GNI focuses on who earns the income, not where production happens.
Key idea
It includes:
- Income earned by citizens abroad
- Excludes income earned by foreigners domestically
Example
- UK worker in USA sends income home → included in UK GNI
- Foreign company profits taken out of UK → excluded
Why GNI is useful
- Better measure of living standards for citizens
- Important for developing countries with lots of foreign firms
C. Net National Income (NNI)
NNI adjusts for the fact that capital wears out over time.
What is depreciation?
- Machines break down
- Buildings wear out
- Equipment becomes outdated
Why subtract depreciation?
Because some output is used just to:
👉 maintain existing production capacity
Key insight
- Gross values can exaggerate economic well-being
- Net values show what’s actually “new” income
3. Market Prices vs Basic Prices
Why this adjustment is needed
Prices in the economy are affected by government intervention:
Indirect Taxes (e.g. VAT)
- Increase the price consumers pay
- Do NOT reflect actual production value
Subsidies
- Lower prices for consumers
- Artificially reduce market price
So what happens?
- Market price = distorted price
- Basic price = true production value
Example
- A product costs $100
- Includes $20 tax
- True value = $80
Formula (explained)
Basic price=Market price−tax+subsidy
Why this matters
- Gives a more accurate picture of firm output
- Important when comparing economies
4. Gross vs Net Values
Core idea
- Gross = total output (including replacement of worn-out capital)
- Net = output after replacing capital
Simple example
A country produces $1 million worth of goods:
- $200,000 is used to replace worn-out machines
👉 Net output = $800,000
Why this matters
- Gross may look high → but part of it is just maintenance
- Net shows real improvement in living standards
Key exam insight
- Economists often prefer net measures for long-term analysis
5. Putting It All Together (Big Picture)
Step-by-step understanding
- Start with GDP → production inside country
- Adjust to GNI → include income from abroad
- Adjust to NNI → remove depreciation
- Adjust prices → get more accurate production value
Chain Summary
Each step makes the measure:
👉 more accurate and meaningful
6. Evaluation
1. GDP ≠ Living Standards
- High GDP ≠ high quality of life
- Doesn’t include:
- Leisure time
- Pollution
- Happiness
2. Informal Economy
- In developing countries → large hidden economic activity
- GDP is often underestimated
3. Income Distribution
- GDP per capita is an average
- Doesn’t show inequality
4. Externalities
- Pollution may increase GDP (more production)
- But reduces welfare
5. Exchange Rate Issues
- Comparisons between countries can be misleading
7. Exam Technique
To score high marks:
- Define clearly (GDP, GNI, NNI)
- Show formulas + explanation
- Use examples
- Add evaluation:
- “however, this measure may not reflect…”