In this article, we propose to discuss how national income is related to national product of a country.
The sum of all incomes of the people of a country is called national income. This national income is greatly related to the national product.
In fact in a two sector economy without the Government and its imposition of indirect taxes and grant of subsidies and also assuming no depreciation national income and national product are one and the same thing.
The incomes which different people of the society get are obtained by them for their contribution of labour, land, capital and entrepreneurial services to the national production. Hence the income which the labourers get are wages for the productive services which labourers lend to the various firms which undertake the work of production.
Similarly, the owners of land get income as rent because of their contribution of land to the productive firms; the capitalists get interest for lending their money capital to the entrepreneurs for undertaking any work of production or business.
The entrepreneurs get profits for starting and organizing the work of production and bearing risk and uncertainty involved in it. It is thus clear that the different individuals of a country obtain their income either as wages of their labour, or as interest on their money capital, or as rent for their land, or as profits for their enterprise. The sum of incomes obtained as wages, rent, interest and profits is the national income of the country.
Various households obtain their income from the productive firms or businesses which utilize their labour, land, capital and other services for the production of goods and services. The incomes earned by the various households and individuals from the work of production are in fact costs of production of the goods produced.
The total value of all final goods and services produced by various productive firms or businesses in a year is known as national product. Therefore, the national product of a country can be estimated by multiplying the total output of final goods and services with their market prices.
Hence the total national product in terms of rupees or value which is produced by various productive firms in a year, will be distributed among the various productive factors which have contributed to its production.
Therefore, out of this national production (in value terms) wages will be paid to those households which have sold their labour to the productive firms. Out of this total value of the national product, land owners would get rent for the contribution of the services of land and capital lists would get interest for lending money capital to the productive firms.
After the payment of wages, rent, interest, what is left is the profits of the entrepreneurs who set up productive firms, organize their work and bear risk and uncertainty and because of these services they get profits. It is thus clear the national product (value of total output of final goods and services in a year of a country) is distributed among wages, rents, interests and profits.
The sum of total wages, total interest, total rents and total profits is national income. Hence national product will be equal to the national income.
The above conclusion that in a two-sector economy national income equals national product can be expressed in the form of the following equation:
π = 275/250 × 100 = 25/250 × 100 = 10%
From the above analysis it is evident that national income and national product are one and the same thing. Professor J.R. Hicks rightly writes, “The value of the net social product of the community and the sum of the incomes of its members are exactly equal. The net social product and the social income are one and the same thing.”
It needs to be emphasized that the above conclusion regarding equality of national product and national income is valid only in our simple two sector economy where we have assumed no depreciation funds are kept and also no role of Government (and therefore no indirect taxes collected by it and no subsidies granted by if). In case of a real economy, firms keep a part of some value created as depreciation allowance which therefore do not become a part of the income of the factors.
When role of Government is brought into our analysis, a part of the value of output is taken away by the Government as indirect taxes and therefore the incomes of factor owners are reduced to that extent. Thus, only in the absence of depreciation funds and net indirect taxes, national product will be equal to national income.
In our simple economy we assume away these depreciation funds and net indirect taxes levied by the Government on business firms to emphasize the point that national income does not come out of thin air, it is in fact generated by the production of goods and services. Therefore, growth in national income can be achieved by the increase in production of goods and services.