Question

What is personal income? How can one arrive at the personal income from the national income?

Short answer

Answer: The final step in calculating personal income from national income is to subtract social contributions and add government transfer payments to the personal income after considering corporate income. The formula is: Personal_Income = Personal_Income_after_corporate_income - Social Contributions + Government Transfer Payments

Step-by-step solution

Understand the Components of National Income

National income refers to the total value of income generated within a country during a specific period. It considers three factors: wages, interest, rents, and profits of businesses. It includes the net factor income from abroad (NFIA) and taxes on production and imports, minus any subsidies. The formula for National Income (NI) is: NI = GDP + NFIA Where GDP is the Gross Domestic Product and NFIA is the Net Factor Income from Abroad.

Calculate Net National Income at Factor Cost

To arrive at personal income from national income, first, calculate the Net National Income at Factor Cost (NNI_FC). Subtract taxes on production and imports, and add subsidies to get NNI_FC: NNI_FC = NI - Taxes on production and imports + Subsidies

Subtract Corporate Profits and Retained Earnings

Next, remove the portion of the national income that goes to corporations in the form of profits and retained earnings: Personal_Income_after_corporate_income = NNI_FC - Corporate Profits - Retained Earnings by Businesses

Subtract Social Contributions and Add Government Transfers

To calculate personal income, consider social contributions and government transfers. Subtract compulsory social security contributions and similar payments that individuals pay, such as pension contributions, and add the value of government transfers to individuals, such as unemployment benefits or social security pensions: Personal_Income = Personal_Income_after_corporate_income - Social Contributions + Government Transfer Payments This final value represents the personal income derived from the national income.

Key concepts

National Income

National income is a comprehensive measure of a country's economic performance. It represents the total income generated within a country over a specific period, usually a year. National income includes the sum of all earnings from production and services, which comprises wages received by labor, interest earned on investments, rents from property, and profits made by businesses. A critical component of national income is the inclusion of net factor income from abroad (NFIA). This accounts for the difference between income residents receive from foreign investments and the income paid to foreign residents investing in the country. Hence, we can express national income as:

• National Income (NI) = Gross Domestic Product (GDP) + Net Factor Income from Abroad (NFIA)

Understanding national income is crucial because it lays the foundation for calculating other income measures, such as personal and disposable income.

Gross Domestic Product (GDP)

Gross Domestic Product (GDP) is a key economic indicator that reflects the total monetary value of all finished goods and services produced within a country's borders in a specific time frame. It serves as a broad measure of national economic activity and is used to gauge the health of an economy. GDP can be calculated using three different approaches:

• Production Approach: Adds up the value of output produced by various sectors within the economy.
• Income Approach: Sums all incomes generated by production, i.e., wages, rents, interest, and profits.
• Expenditure Approach: Totals the spending on final goods and services within the economy, i.e., consumption, investments, government spending, and net exports.

Each method provides unique insights, but all aim to reflect the economic output genuinely. GDP is an essential input for deriving national income.

Net Factor Income from Abroad (NFIA)

Net Factor Income from Abroad (NFIA) represents the difference between the income residents of a country earn from foreign investments and the income foreign residents earn from domestic investments. NFIA is crucial because it adjusts the GDP, reflecting net income flows between a nation and the rest of the world. By considering NFIA, we can derive national income, providing a more comprehensive view than GDP alone.

• If NFIA is positive, local residents earn more from abroad than what is paid to foreign investors.
• If negative, more income is paid out to foreign residents than what is earned abroad.

Incorporating NFIA is essential in the formula for national income:

• National Income (NI) = GDP + NFIA

Net National Income at Factor Cost (NNI_FC)

Net National Income at Factor Cost (NNI_FC) presents the national income adjusted for indirect taxes and subsidies. To obtain NNI_FC, start by subtracting indirect taxes imposed on production and imports from the national income. Then, add subsidies to businesses and households, which reduce the overall cost of goods and services. NNI_FC can be expressed with the formula:

• NNI_FC = National Income (NI) - Taxes on production and imports + Subsidies

The importance of NNI_FC lies in its ability to provide a clearer picture of the income generated at factor cost, facilitating calculations to derive net incomes such as personal or disposable income. NNI_FC forms a necessary step in transitioning from the total national income to individual earnings levels, ultimately helping determine personal income.