A normal resident may have one or more sources of income. Some of them derive income from work while others provide their income earning assets for productive activities. Income from work is known as compensation of employees.
This may be in cash (salaries, wages and social security contributions) or in kind (rent free accommodation, free uniform, free medical care, free telephone facility, free furniture, free education to workers’ children, etc.).
Income from letting the productive assets comprises rent (on land and building), interest (on liquid assets such as money), dividend (on financial assets such as shares and debentures) and profit (on entrepreneurial activities). Individuals who provide labour or those who provide productive assets are all known as factor owners or simply as factors of production.
Incomes accruing to them are known as factor incomes. Sum total of factor incomes accruing to normal residents from all types of production is thus known as the national income (NI).
Factors of production convert basic inputs into finished product called output. Hence the difference of money value of outputs over that of inputs must be equal to the factor income or the national income.
The process of conversion of basic inputs into finished products is known as value addition. The total value added at different stages of production by all the factors is also known as the national product (NP).
It must represent money value of outputs of all the industries; but, for obvious reasons, it does not. Outputs of a large number of industries feed several other industries as their inputs. Accounting of outputs of all the industries thus leads to double counting of those which serve as inputs to other industries.
This is so because money value of output of an industry comprises its value addition and the value of inputs consumed by it in the process of production. One way of avoiding the double counting is to include money value of the output of the industry of origin and the total value added to it by the subsequent industries.
By the expression industry of origin we imply the industry where the product originates. Such industries don’t use basic inputs. In the chain of cloth industries, farm industry is the industry of origin where raw cotton is grown. Value of raw cotton is treated as the value addition of the farm industry as the value of its inputs is assumed negligible.
Thus value of the product of the cloth industry is the sum of the value of the output of the industry of origin and the values added by the subsequent industries in the chain. The other way of avoiding over-estimation of the value of national product is to include money values of only those products that are meant for final consumption.
Such products are called final goods. Ready to wear garments are final products while cotton and cloth are intermediate products. They are used as inputs in further production. Whatever the methodology of arriving at the money value of the national product (NP), it is equal in value to value added by all the industries and hence to total factor income or national income (NI).
Products are bundles of utility the consumers need to satisfy their wants. They are thus exchanged for money in the market. Consumers spend their money income on these products. Expenditures made on the national product must be equal to the value of national product in a steady state. Expenditure incurred by the normal residents of a country on national product (NP) is known as national expenditure (NE). It is financed by national income (NI). This leads, in a steady state, to the identity
NI = NP = NE