National Income is defined as the sum total of all the factor incomes such as wages, rent, interest, and profits accruing to the factors of production in a given year. Since, GNP is produced by the joint efforts of factors of production, thus these factors have a legitimate claim on this product and the income generated in the production process. These claims on GNP are thus met by distributing GNP among various factors of production in the form of rent, wages, interest and profits. The sum total of these factors rewards like rent, wages and interest, whatever remains (positive or negative) is the profit. Thus, profit being a residue after all other payments of rent, wages, and interest. On the other hand, profits would be negative (losses) when payments to factors other than the entrepreneur exceed value of national product equal to income generated.
However, all the national product (GNP) is not available for distribution as factor incomes. Since, during the production process a lot of wear and tear of machinery and production in the next period. Thus, a part of the current production is kept aside as depreciation for replacement of worn-out equipment. what is thus left after deducting depreciation from the GNP is called Net National Product at market prices(NNPmp).
GNP - Depreciation = NNP(mp).
what is available for distribution is this NNP at market price, i.e., the amount of the final goods and services valued at their market prices after making allowance for depreciation. Value at market price is arrived at by multiplying the quantity of a good produced by the per unit price of the good. But market price itself contains an element due to which a part of production is claimed by the government and is thus not available for distribution as factor incomes. This element is what are known as indirect taxes or business taxes such as excise duties. While such indirect taxes (excise duties) are included in price and thus form a part of the total value of production, but this par t goes to the government rather than the factors of production. The government also grants subsidies to the business enterprises in the form of financial help with a view to encourage production and employment in some industrial and commercial sectors. While such subsides do not form a part of market price, they get distributed as factor incomes. Therefore, indirect taxes need to be deducted while subsidies must be added to NNpmp to arrive at the income which accrues to the factors of production, which called National Income or Net National Product at Factor Cost (NNPfc). Thus,
NNPmp - Indirect taxes + subsidies = NNPfc or National Income.
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