From GNP to National Income

The final complication of which we must take account is depreciation.

Depreciation or capital consumption measures the rate at which the value of the existing capital stock declines per period as a result of wear and tear or of obsolescence.

Depreciation is a flow concept telling us how much our effective capital stock is being used up in each time period. Depreciation is an economic cost because it measures resources ling used up in the production process.

In our simple example we ignored depreciation completely. We assumed that the machine purchased by the car producer would last forever. We now recognize that machinery wears out. In consequence, the net output of the economy is reduced. Some of the economy's gross output has to be used merely to replace existing capital, and this part of gross output is not available for consumption, investment in net additions to the capital stock, government spending, or exports. Similarly, we need to reduce our measure of the incomes available for spending on these goods.

Accordingly, we subtract depreciation from GNP to arrive at net national product (NNP) or national income.

National income is the economy's net national product. It is calculated by subtracting depreciation from GNP at factor cost.

National income measures the amount of money the economy has available for spending on goods and services after setting aside enough money to maintain its capital stock intact by offsetting depreciation.

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