National Income

National income is the total money value of all the final goods and services produced by a country during a year. It is the single most important measure of a nation's economic performance — a rising national income means the economy is growing. To understand it, we need a few related concepts. (Two key adjustments keep appearing: depreciation, the wear and tear of capital, and net factor income from abroad (NFIA), the income our residents earn abroad minus what foreigners earn here.)

Gross Domestic Product (GDP) is the total money value of all final goods and services produced within the geographical boundaries of a country in a year, no matter who produces them. The word "domestic" means within the country's borders. GDP is the most widely quoted measure of an economy's size.

Gross National Product (GNP) is the total money value of all final goods and services produced by the normal residents (nationals) of a country in a year, whether they are inside the country or abroad. The difference between the two is the net factor income from abroad:

GNP = GDP + Net Factor Income from Abroad (NFIA)

So GDP is based on territory (where production happens), while GNP is based on residents (who produces). If a country's residents earn a lot abroad, its GNP will be higher than its GDP. These two are the starting point for all the other national-income measures.

From GDP and GNP we derive several further measures by making two adjustments — subtracting depreciation and choosing whether to value output at market prices or at factor cost (market price minus net indirect taxes).

• Net National Product (NNP) — GNP minus depreciation (the wear and tear of capital). Because some output merely replaces worn-out machinery, NNP is the net addition: NNP = GNP − Depreciation.
• National Income (NNP at factor cost) — NNP measured at factor cost is the true national income: it equals NNP at market price minus net indirect taxes. This is the income actually earned by the factors of production (as rent, wages, interest and profit).
• Personal Income — the total income actually received by individuals and households (it differs from national income because some income, like undistributed company profits and corporate taxes, is not received by people, while some receipts, like pensions and transfer payments, are added).
• Disposable Income — personal income minus direct taxes (like income tax). It is the income people are actually free to spend or save: Disposable Income = Personal Income − Direct Taxes. It is divided between consumption and saving.

A related idea is per-capita income = national income ÷ population, which measures the average income per person and is used to compare living standards across countries. These concepts form a "ladder" from the broadest measure (GDP) down to the income a family can actually spend (disposable income).

National income can be measured in three ways, and because every product's value equals the income it generates and the spending on it, all three give the same total. They simply look at the economy from three angles — production, income and expenditure.

• Product (Value-Added) Method — adds up the value of all final goods and services produced in the economy (or, equivalently, the value added at each stage of production). To avoid double counting, we count only final goods or only the value added at each stage, never the intermediate goods twice.
• Income Method — adds up all the incomes earned by the factors of production — rent (for land), wages (for labour), interest (for capital) and profit (for enterprise). The sum of these factor incomes equals national income.
• Expenditure Method — adds up all the final expenditure in the economy: consumption (C) by households, investment (I) by firms, government spending (G), and net exports (exports minus imports). National income = C + I + G + (X − M).

Whichever method is used, the result is the same, because production = income = expenditure in the economy. Measuring national income is difficult in practice (problems include the unorganised sector, non-monetary transactions, and the danger of double counting), but it is essential — it tells us the size of the economy, its rate of growth, and the average standard of living, and guides government policy. National income is therefore the grand summary measure of the whole economy.