National Income for a particular year relates to the prices prevailing in that year. Such an estimate of national income is known as national income at current prices. Here, the term national income may refer to any of the eight national income aggregates.
It should be borne in mind, however, that the use of national income, in particular, has reference to Net National Income, or more popularly, Net National Product, each at factor cost.
National Income at Constant Prices:
National Income at constant prices refers to national income expressed in terms of prices of a fixed year of reference. It requires conversion of national income at current prices in terms of the prices of the year of reference, called the base year.
To illustrate the point, suppose national income at current prices for an economy is Rs 10,000 crores. And the price index of the current year with respect to 1991 as the base year is 250. Also suppose that the national income estimate for the said economy in 1991 was Rs 4,000 crores.
One would, at the outset, think that the national income in the current year has more than doubled of what it was in the base year. A little reasoning shows that the inference is quite misleading. For such comparisons, we need to convert the two estimates in terms of same prices.
It is more convenient to convert the current year’s estimate in terms of the base year’s prices. The method is known as deflation of national income. The current year’s estimate of national income in terms of the base year’s prices can be obtained from the simple unitary method or from the following formula:
Thus national income at current prices, when deflated, reduces to a value equal to base year’s national income in this illustration. What appeared to be a sizeable growth (250%) turns out no growth (0%), in reality, as soon as the current estimate is adjusted for inflation.
Clearly, purchasing power of current national income is no better than that of the base year.
The purpose of deflating national income is twofold:
1. It helps to study the annual growth rate of the national income in historical perspective. This is essential for evaluation of performance of various growth oriented economic policies employed.
2. It helps to compare the purchasing power of the current year’s national income with that of any year of reference.
The process of national income deflation can be cut short if national income deflators for different years were given.