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In this article we will discuss about the methods adopted for calculating and measuring national income. Also learn about the difficulties faced in its measurement.
Answer 1. Measurement of National Income:
(1) The Output or the Value Added Method:
The output method or the value added method is also known as the product method When this method is used, an economy is divided into three different sectors or segments, viz.,
(i) The primary sector which includes agriculture and allied activities such as forestry, fishing and mining,
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(ii) The secondary sector, which includes manufacturing (of all types—large, medium and small) and construction and
(iii) The tertiary sector which includes all types of service-rendering activities such as education and health care, trade and commerce, transport and communication, insurance, banking and tourism.
Then net value added at factor cost by each producing unit also as well as for each industry and sector is calculated. Initially, the gross value of output of each producing unit limit is calculated by multiplying the value of output produced of a good or service by its market pi Ice.
For example, if a firm produces 10 electric fans and the market price of a fan is Rs. 500, then the market value of its output is Rs. 5,000. This is done for each item which is produced or each type of service which is rendered.
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However, in order to avoid double or multiple counting, we have to calculate the net value added at factor cost by each producing unit such as a bakery.
This is done by subtracting the following three items from the gross value of output:
1. Cost of raw materials purchased and used such as flour, fuel, etc. This is known as intermediate consumption.
2. Depreciation of capital goods such as oven (also called consumption of fixed capital).
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3. Net indirect taxes, i.e., taxes paid less subsidies received by producers.
By adding up the value added figures of all producing units or enterprises belonging to a particular sector or industry, we arrive at net value added at factor cost of each industry or sector, such as the automobile industry or the large manufacturing sector.
Then we add up net value added at factor cost by all industries or sectors to arrive at net domestic product at factor cost (NDPFC). Finally, if we add net factor income from abroad to NDPFC, we arrive at NNPFC or, simply, national income.
This method is widely used in those countries where the government takes a census of production every year. However, in many LDCs data of production of the organised sector are available. But data on agriculture and unorganised sectors of industry are not available. This is why two other methods of estimating national incomes are used.
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However, the most important advantage to be secured from this method is that it clearly indicates the sectoral composition (division) of national income, i.e., the relative importance of the three sectors — primary, secondary and tertiary, in national income.
And the sectoral composition of national income indicates the state of development of an economy. The larger is the contribution of agriculture in particular and the primary sector in general to the national income of a country, the more economically backward the country is supposed to be.
And economic development implies a fall in the relative contribution of the primary sector to national income and a corresponding increase in the share of the secondary and tertiary sectors. The sectoral distribution of income also indicates the occupational pattern of the population.
Precautions:
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Certain precautionary measures are to be taken while measuring national income from the output side. There are some inclusions and a few exclusions also.
(i) Imputed Rent:
Imputed rent values of owner-occupied houses should be included for a very simple reason. Those who stay in their own houses receive a flow of service — housing service and they are both tenants and landlords at the same time. Though the beneficiaries do not make any payment to outsiders, the value of the services they receive can be counted from the rents paid on similar houses in the locality. Such income is known as notional rent.
(ii) Value of Production for Self-Consumption:
The production of goods for self-consumption as in subsistence agriculture has to be valued at the prevailing market price. So there is need for imputation of the value of output on the basis of present market prices of such goods which are sold and not consumed or partly consumed and partly sold.
(iii) Brokerage:
If an individual has purchased a share last year and sells it in the current year, the brokerage fee which he pays this year will be a part of India’s national income.
(i) Transactions Involving Old Goods:
The sale and purchase of second-hand goods has to be excluded from the market value of output to avoid double counting. For example, if an individual has purchased a car last year (when it was produced) it was included in last year’s GNP. But if he sells the same car this year, it will not be a part of this year’s output. Hence it has to be excluded from GNP.
(ii) Do-It-Your-Exercise:
The value of services rendered by housewives such as cooking, nursing, washing clothes, etc. and other works of the family are to be excluded. For example, if a person coaches his son or cleans his own car, the value of his services can be imputed no doubt.
In spite of this such services are to be excluded while estimating national income from the output side. The reason is that the correct imputation of such services is not possible. However, the fact remains that if an individual stops driving his own car and keeps a driver, India’s national income will increase.
(iii) The Value of Intermediate Goods:
The cost of raw materials and intermediate goods used in the production of final goods has to be excluded. Otherwise there would be double or multiple counting.
(2) The Income (Flow of Earnings) Method:
Just as the output or the value added method shows the sectoral composition of national income and the occupational pattern of the population, the income method enables us to study how national income gets divided into four main types of factor incomes. According to this method national income is the total income earned by the people of a country through their contribution to the production of goods and services.
The following five main types of incomes are earned by the people of a country:
1. Income from labour— wages/salaries and other types of compensation (as also employers’ contribution to provident fund) or health insurance,
2. Income from real property — rent of land and buildings,
3. Income from financial assets (loanable funds) — interest,
4. Income from personal and intellectual capital — consultancy fees and royalty of books and musical cassets (CDs) and
5. Income from entrepreneurship—profits (which include dividends, undistributed profits and corporation income tax).
Such income has several components and is known as mixed income. This type of income is an important component of national income in developing countries like India. The reason is a large number of people are included in household production (as in small-scale and cottage industries as also in family farms) and various unorganised enterprises (such as selling tea, fast food or cigarettes on the pavement).
Since the owners of such enterprises do all types of work themselves in their respective units, it is difficult to separate wages for the work done by them from rent, interest and profits earned by them for risk-taking, for using out their property and supplying their own funds as also for risk-taking. Therefore the incomes earned by them contain wage, rent, interest and profits. Such incomes are called mixed income of self-employed persons or proprietors’ income.
Now the question here is: how to measure different types of factor incomes (which are factor payments from the side of the producing units)? The income earned by each factor is calculated by multiplying the number of units of each factor employed by all the producing units by its price per unit.
To do this, we have to identify the different producing units and collect data on the number of units of each factor employed by each producing unit and the factor payments made by each such unit. Suppose there are 10 identical firms in an economy and each employs 5 workers per day at a daily wage of Rs. 20. So each firm makes a wage payment of Rs. 100 and total wage payment per day is Rs. 1,000.
This means that the income from labour will be Rs. 1,000 per day. If all the workers work for 300 days a year, then total annual wage income will be Rs. 3 lacs. In the same way we can calculate rent of land and buildings, interest on loans and profit (which is a residue — surplus left with entrepreneurs after making all contractual factor payments).
By adding up the factor payments made by all producing units in the current year, we arrive at domestic income at factor cost which is also known as net domestic product at factor cost (NDPFC). To this we have to add net factor income earned from abroad (NFIFA) to arrive at net national product at factor cost (NNPFC) which is indeed national income.
In Fig. 2.10 we show different components of income and other related aggregates by using the income method. Note that the income approach is also known as the flow of earnings approach to national income estimation.
Equivalence of Value Added and Factor Payments:
It may be noted that the sum of value added is equal to the sum of all factor incomes. All factor payments are made from the value additions made by producing units. This shows the equivalence of national output and national income. And we can show that the net value of output produced in an economy in an accounting year is identically equal to the net flow of income generated from the production process.
Certain precautions are to be taken while measuring national income by using the income approach.
This becomes clear if we note the following points:
1. Notional Rent:
Imputed or notional rent of owner-occupied houses is included in national income. The reason is that these houses provide a flow of services to the owners. Notional rent can be calculated from rents of similar houses or buildings in the locality.
2. Self-Consumption:
The income equivalent of the value of current output used for self- consumption (such as consumption of wheat by subsistence farmers) has to be estimated and included in national income.
3. Personal Taxes:
Two types of personal taxes, viz., income tax and capital gains tax are included. If an individual in India buys a share and sells it at a higher price within the same financial year, then 15% capital gains tax has to be paid.
1. Transfer Incomes:
All types of transfer incomes (including interest earned from government bonds) are to be excluded because these are not associated with the current production of goods and services.
2. Illegal Income(s):
Since it is not possible to officially estimate illegal incomes such as income from gambling, smuggling, black marketing, money laundering, etc., these should be excluded.
3. Windfall Gains:
Since windfall gains are essentially unearned incomes, they are also excluded from national income.
4. Corporate Income Tax:
There is no need to separately include corporate income tax (which is essentially a tax on corporate profits). The reason is that it is included as a part of profits (which have three components).
5. Other Taxes:
Various other taxes are paid by individuals from their past savings or accumulated wealth and not from their current income. Examples of such taxes are death duties (abolished in India in 1985), gift tax, wealth tax and tax on lotteries. These are excluded from national income.
6. Second-Hand Goods:
The receipts from the sale of second-hand goods are to be excluded. The reason that the money received by selling old goods such as used cars or furniture’s are not part of current year’s production. So receipts from the sale of such goods do not represent payment for factors of production which have made their respective contributions to current year’s output of goods and services.
(3) The Expenditure Method:
According to the expenditure method national income is calculated by adding up all types of expenditures made by households, “business firms and government(s). The total of these three types of expenditure is known as total domestic expenditure (TDE).
If we add net exports to TDE, we arrive at total final expenditure (TFE). It may be noted that net exports represent two things—foreigners’ expenditure on Indian goods (which constitutes India’s exports) and India’s expenditure on foreign goods (which constitutes India’s imports).
So the four components of TFE are the following:
i. Consumption:
This is expenditure of individuals and households on consumption goods, called final private consumption expenditure. It is denoted by the symbol C, which includes expenditure on both durable and non-durable goods.
ii. Investment:
This is business expenditure on fixed capital as also on inventories (i.e., stocks of finished goods). It is a broad term and is also called gross domestic capital formation or gross domestic investment and denoted by I. It has two main components, viz., (i) gross fixed capital formation, and (ii) addition to the stocks of finished goods (i.e., goods which have been produced in the current year but not sold within the same year and carried on for future sales).
iii. Government Purchase of Goods and Services:
These represent government expenditure on currently produced goods and services, but not transfer expenditure. Examples of such expenditure are FCI purchase of foodgrains from farmers for distribution through ration (fair price) shops, purchase of medicines for distribution through government hospitals and purchase of books by national (public) libraries. The government also purchases steel and cement for road construction. All these purchases are made for satisfying wants of all people of the country, called social (collective) wants.
iv. Net Exports:
The expenditure made by foreigners on Indian goods is called exports (X). Similarly the expenditure made by households, enterpreneurs and Government of India on foreign goods is called imports (M). The difference between exports and imports is net exports (X-M).
By adding up these four types of expenditure we arrive at final expenditure on GDP at market price (GDPMP). Thus
GDPMP = C + I + G + X – M
= C + I + G ± NX
where all the terms have their usual meaning. Now if we deduct depreciation, D, i.e., consumption of fixed capital, from GDPMP, we arrive at NDPMP.
Again if we subtract net indirect business taxes (i.e., indirect taxes paid by business firms less subsidies received by them) we arrive at NDPFC. Finally, if we add NFIFA to NDPFC, we arrive at NNPFC which is another name of national income.
In Fig. 2.11, we illustrate the expenditure method of measuring national income.
The last histogram (4) shows the different components of expenditure which add up to national income. Thus
National income = NNPFC = GDPMP – depreciation – NIT + NFIFA
In short, national income from the expenditure side is a measure of final expenditure on GNP.
Precautions:
Even in case of the expenditure method certain precautions are to be taken so as to arrive at an accurate measure of national income.
So the following points are to be noted in this context:
1. Second-Hand Goods:
The expenditure on old goods should not be included because they do not correspond to the current year’s production of goods and services.
2. Purchase of Existing Shares:
The purchase of existing shares and securities from other people and not from businesses (at the stage of their initial public offering) has to be excluded from total final expenditure. The reason is that shares are just financial claims and do not represent expenditure on currently produced goods and services.
3. Transfer Expenditures:
Transfer expenditure made by the government in the form of unemployment benefits, retirement pensions, and interest on government bonds is not to be included. The reason is that these are not associated with any current production of goods and services. Those who receive such benefits from the government do not provide anything to the government in exchange.
4. Expenditure on Raw Materials and Intermediate Goods:
As in the product method, expenditure on raw materials such as flour, raw cotton, fertiliser, oil, coal, etc. used by producing units should be excluded. The objective is to avoid double (multiple) counting. This means that for estimating national income from the expenditure side, we have to include only expenditure on final goods and services.
Difficulties in the Measurement of National Income:
There are various conceptual (theoretical) and practical problems associated with the measurement of a country’s national income.
Some of those difficulties (problems) are the following:
1. Treatment of Non-Market Transactions:
Some transactions do not occur through the markets. For example, work done by housewives within their families such as washing clothes, cooking food, coaching children and looking after elderly persons remain unpaid because they do not enter the market.
Such non-market transactions are excluded from national income. Another example is production of wheat by the members of a farmer’s family for their own consumption (as is found in subsistence farming) and not for sale through the market (as is found in commercialised agriculture). However, the value of wheat or any farm output consumed at home is included in national income. But, this type of accounting practice gives rise to certain anomalies.
For example, if an individual, who was driving car over the years, suddenly keeps a full-time driver, then India’s national income will rise. But if a working lady marries her driver, she will not pay any salary to her husband and India’s national income will fall (since the driver will do the same job as before but without receiving any payment in cash).
In the first case, the value of national income would increase, but in the second case it would fall, although in each case the real amount of services performed remains the same.
2. Treatment of Final Goods:
The national income, from the output side, includes only the money value of all final goods (and services) produced in an economy in an accounting year. We have also noted that final goods are those which are not used in further production of other goods and are destroyed after consumption.
However, in reality it becomes difficult at times to draw a distinction between a raw material (or an intermediate good) and a final good. For example, paint used by a commercial artist for his artwork which he sells in the market is a raw material and has to be excluded from GDPMP. However, suppose he is left with some surplus paint with which he paints his house or car. In this case it is a final good and is a part of GDPMP.
3. Treatment of Government Activities:
The government has to pay wages and salaries and incur other expenses for performing various administrative functions such as maintenance of law and order, defending the country from foreign aggression, providing economic and social infrastructure in the form of roads, highways, education and healthcare.
Since there is no market for the services provided by the government, the convention is to calculate the cost of providing such services and include this in national income. In fact, government expenditure on such public goods and services gives rise to final consumption of such goods and services by all members of society collectively. So the contribution of general government services has to be equal to the amount of wages and salaries paid by government.
As for investment by government there is no difference between private investment on setting up factories or buying new machines and government investment on infrastructure building.
4. Treatment of Income Generated by Foreign Firms:
The production of goods and services by foreign companies operating in India and incomes therefrom have to be included in India’s national income. However, any remittance made by foreign companies or multinational corporations (MNCs) in the form of interest, dividends, royalties or technical consultancy fees are to be deducted from India’s national income because these represent incomes earned by foreigners from India.
Answer 2. Measurement of National Income:
Since factor incomes arise from the production of goods and services, and since incomes are spent on goods and services produced, three alternative methods of measuring national income are possible.
(1) Output Method:
This method measures the national income from the output side. Under this method, the economy is divided into three sectors, i.e., primary, secondary and tertiary sectors. Then the gross product is found out by adding up net values added that has taken place in various production units and industries during a given year.
In order to arrive at the net value added of a given industry, the purchases of the producers of this industry from producers of other industries are deducted from the gross value of production of that industry. The aggregate of net values added of all the industries and sectors of the economy plus the net income from abroad will give us the Gross National Product.
By subtracting the total amount of depreciation from the figure of gross national product or income. This method of estimating national income enables us to trace the origin of the national income aggregate to the different sectors of the economy. Therefore, this is called national income by industrial origin.
This method of calculating national income can be used where there exists a census of production for the year. In many countries, figures of production of only important industries are known. Hence, this method is employed alongwith other methods to arrive at the national income. The one great advantage of this method is that it reveals the relative importance of the different sectors of the economy by showing their respective contributions to the national income.
(2) Income Method:
National income through this method utilises the data of income earned by four factors of production. In other words, this method measures the national income after it has been distributed and appears as income earned or received by individuals of the country.
Thus, under this method, national income is obtained by summing up of the incomes of all individuals of a country. Individuals earn income by contributing their own services and the services of their property such as land and capital to the national production.
Therefore, national income is calculated by adding up the rent of land, wages and salaries of employees, interest on capital, profits of entrepreneurs (including undistributed profits of joint stock companies) and incomes of self-employed people.
This method of estimating national income has a lot of advantage of indicating the distribution of national income among different income groups such as landlords, capitalists, workers, etc. Therefore, this is called national income by distributive shares.
(3) Expenditure Method:
This method uses the sum total of expenditure incurred on goods and services during a given period of time by consumers, producers, government and foreign sector. This method arrives at national income by adding up all the expenditure made on goods and services during a year. Income can be spent either on consumers’ goods or investment goods.
Thus, we can get national income by summing up all consumption expenditure and investment expenditure made by all individuals as well as by government of a country during a year.
Thus, the gross national product is found out by adding up:
(a) What private individuals spend on consumer goods and services. This is called private consumption expenditure. This is denoted by the letter C,
(b) What private businessmen spend on replacement, renewal and new investment. This is called gross domestic private investment. This is denoted by I,
(c) What the government spends on the purchase of goods and services, i.e., government expenditure and is denoted by G,
(d) What the foreign countries spend on the goods and services of the national economy over and above what this economy spends on the output of the foreign countries, i.e., exports minus imports. This is called net exports and is depicted by Xn which is net of country’s exports (X) over its imports (M). Thus Xn = X – M.
In brief, in the expenditure method, the national income is measured by adding up the four flows, namely C, I, G and Xn. Thus,
Y = C + I + G + Xn
We have explained above the three alternative methods of estimating national income. The best way to arrive at national income will be to employee all these three methods so as to permit their cross-checking ensuring greater accuracy and throwing more light on details.
Difficulties in the Measurement of National Income:
The basic concepts related to national income has a lot of significance for the economies. But in case of developing economies, due to some inherent problems, it becomes difficult to measure the national income of the country.
In the following paragraphs the various problems encountered by the countries to measure its national income has been discussed below:
1. Informal Sector:
In common language, it is known as unorganised or unregistered sector of the economy. A major proportion of economic activities are undertaken by the informal sector of the economy. Informal sector does not keep the record of all the transactions that are taking place within the informal sector. It becomes difficult to know the exact value added of this sector. Due to lack of availability of data of this sector, it becomes difficult to include the activities of this sector in the national income.
2. Barter System:
In the developing economies, there exist barter system. It means the goods are exchange for goods in the Barter system. In the rural areas, people exchange goods for goods. It becomes difficult in the Barter system to know the actual production of goods and services in the rural areas. It becomes difficult to measure the national income by output method.
Similarly, there are large number of services which are not included in the national income. For example, a person taking help of his family members in management of their businesses and family members are not being paid for their services. The contribution of family members in the business is not recorded and these services are not included in the national income.
3. Mixed Income:
In developing economies, people have to work in the different sectors of the economy during the given year. For example, a small farmer works in his fields a part of year and he has to work as part time labourer in the manufacturing or services sector or even in unorganised sector. Thus, earning from various sources make the collection of data more cumbersome.
4. Lack of Data:
In the developing or underdeveloped economies, people do not keep record of all information and even do not provide exact information such as their earnings, etc. Lack of authentic information or data makes the work more tedious for the concerned people to estimate exact national income.
Answer 3. Measurement of National Income in India:
In India, a systematic measurement of national income was first tried in 1949. Earlier attempts were made either by some individuals or institutions. The earliest estimate of India’s national income was attempted by Dadabhai Naroji in 1867-68. Since then several attempts were made, mostly by economists and the government authorities, to estimate India’s national income. These estimates differ in coverage, concepts and methodology and not comparable. They were mostly for one year, only some estimates covered a period of 3 to 4 year. It was therefore, not possible to construct a consistent series of national income and assess the performance of the economy over a period of time.
In 1949, A National Income Committee (NIC) was appointed with P.C. Mahalanobis as its Chairman, and D.R. Gadgil and V.K.R.V. Rao as members. The NIC not only highlighted the limitations of the statistical system of that time but also suggested ways and means to improve data collection systems. On the recommendation of NIC, the Directorate of National Sample Survey was -set up to collect additional data required for estimating national income. Besides, the NIC estimated the country’s national income for the period from 1948-49 to 1950-52. In its estimates, the NIC also provided the methodology for estimating national income, which was followed till 1967.
In 1967, the task of estimating national income was given to the Central Statistical Organization (CSO). Till 1967, the CSO had followed the methodology laid down by the NIC. Thereafter, the CSO adopted a relatively improved methodology and procedure which had become possible due to increased availability of data. The improvements pertain mainly to the industrial classification of the activities. The CSO publishes its estimates in the publication, Estimates of National Income.
Methodology:
For valuation of the products, both the output and the income method have been applied. The output method has been used largely in the commodity producing sectors like agriculture and manufacturing. The income method has been used in the tertiary or service sector like trade, public administration etc. This method has also been applied to some segments of commodity sectors where there is absence of output data. The third expenditure method has been used, but in a very limited way in respect of, for example, kacha construction.
In using the output method, the “value added” approach has been adopted. The “value added” is equal to the value of goods minus the cost of production. In other words, this method measures the net contribution of a producing unit to national income. The sum total of value added by all the producing units in the commodity sector gives the value of this sector’s contribution to national income.
The estimation is done by evaluating the value of goods at ex-factory prices and deducting from the value or the cost of inputs supplied by other enterprises, and the estimated value of depreciation (or capital consumption). In the income method, the procedure is to find out the number of people working or the workforce in a profession, and per head/ average earnings. The two are then multiplied to get the value of income contributed by the profession. The expenditure method involves estimation of spending (or disposition of income) on final goods and services.
Difficulties in the Measurement of National Income:
National income analysis has importance in economic theory. There are various difficulties in the measurement of national income.
These difficulties are discussed below:
(1) Non-Monetised Sector:
In a developing country there is a large non-monetised sector where goods and services are exchanged for goods and services. A part of production is kept for self-consumption. It is not taken into consideration while calculating national income.
(2) Unreliable and Inadequate Statistical Data:
In most of the developing countries statistical data relating to national income are not adequate and reliable and on account of this difficulty accurate measurement of national income is not possible.
(3) Mass Illiteracy and Ignorance:
There is a mass illiteracy and ignorance among the people in developing and underdeveloped countries. They are unable to maintain up to date account of their own regarding production, income, consumption, saving and investment. It makes the work of calculating the national income difficult.
(4) Problem of Double Counting:
In developing countries there is always a possibility of double counting of a commodity or service and to that extent correct calculation of national income is not possible.
(5) Errors in the Calculation:
Generally the national income is calculated on current prices and for its comparison purpose it is changed into base year price. The perfect calculation of national income is not possible because such facilities are not available in developing and undeveloped countries.
(6) Diversified Economic Activities and Methods:
The calculation of national income is based on diversified economic activities and methods. An identical method cannot be used for various economic activities, namely, agriculture, industry, trade and transport, telecommunication, construction, etc.
(7) Problem of Calculating the Value of Services:
There are various services rendered by policemen, teacher and defence personnel. What should be the basis for calculating the value of these different personnel. Expenditure incurred on these services is taken care of for the calculation of national income.
(8) Diversified Occupations and Specialisation:
In a country there is a diversified occupations and specialisation. There are many persons who take diversified activities to earn their livelihood. For example, small farmers and marginal farmers not only work in agricultural sector but they also work in industrial units to meet their expenditure. The information from all these sectors are not available. Hence, the calculation of national income becomes difficult.
(9) Regional Disparities:
There is difficulty in the calculation of national income on account of regional disparities prevailing in a country. Some sectors of economy are developed and others are underdeveloped. What should be the basis for the calculation of national income in such a situation.
(10) Indifferent Attitude of the Public:
In a developing country like India public do not take interest in the study and calculation of national income. They do not provide any information for the calculation of national income.
Answer 4. Measurement of National Income:
Production of goods and services gives rise to income; income gives rise to demand for goods and services; demand gives rise to expenditure; and expenditure gives rise to further production. Thus, there is a circular flow of production, income and expenditure.
On the basis of these three related flows, national income can be looked at- (a) as a flow of goods and services; or (b) as a flow of incomes; or (c) as a flow of expenditures on goods and services. In this ways, there are three phases in the circular flow, i.e.., production, distribution or income, and expenditure, and national income can be calculated at each phase.
Thus, there are three methods of measurement of national income:
(1) Product Method, which measures national income at the phase of production.
(2) Income Method, which measures national income at the phase of distribution or income.
(3) Expenditure Method, which measures national income at the phase of expenditure.
(1) Product Method:
Product method measures national income at the phase of production in the circular flow. This method is, also called value added method.
Under this method, there are two approaches to the estimation of national income:
1. Final product approach and
2. Value added approach.
1. Final Product Approach:
In this approach, national income is estimated by finding the market value of final goods and services produced in the economy in a given period.
Various steps in the final product approach of calculating national income are:
(i) The market value of all final goods and services produced within the territorial limits of the country gives the estimate of Gross Domestic Product at Market Price.
Thus, GDP at MP = Market Value of All Goods and Services Produced within the Country.
(ii) By adding net factor income from abroad to the Gross Domestic Product at Market Price, we get Gross National Product price.
Thus, GNP at MP = GDP at MP + Net Factor Income from Abroad.
(iii) In order to obtain Net National Product at market Prices, depreciation is deducted from Gross National Product at Market Price.
Thus, NNP at MP = GNP at MP – Depreciation
(iv) Further deducting indirect taxes from Net National Product at Market Prices, will give us Net National Product at Factor Cost or National income. Thus, NNP at FC or NI = NNP at MP – Net Indirect Taxes.
Problem of Double Counting:
While calculating national income through final product approach, the market value of only final goods and services is taken into account. The value of intermediate goods is not considered. If the value of intermediate goods is also considered.
It will result in the problem of double counting. Double counting means that certain items are counted more than once while calculating national income.
Double counting, thus, leads to overestimation of national income. In order to avoid double counting, only the value of final products should not be included in national income; the value of intermediate goods should be considered. For example, bread is the final good, while wheat and flour are intermediate goods.
The price of bread already inter-corporates the costs of wheat and flour because these costs have been paid during the production process. Thus, while calculating national income, separate inclusion of the value of wheat and flour along with the value of the final good bread will lead to double counting and this should be avoided.
2. Value Added Approach:
In this approach, instead of taking market value of final product, the value added or created at different stages of production is counted for estimating national income. Thus, according to this method, national income is the sum total of value added by different producing units of a country in their production process.
Value added means the addition to the value of raw materials and other inputs during the process of production. Value added, in fact, refers to the productive contribution of an enterprise. In order to calculate the value added at a particular state of production, the cost of intermediate products is deducted from the total value of output. Thus,
Value Added = Value of Output – Cost of Intermediate Goods.
Steps in the Value Added Approach:
The value added method measures the contribution of each producing unit in the domestic territory of the country.
This method involves the following steps:
(i) All producing units in the country are divided into various industrial sectors according to their activities.
The broad industrial sectors are:
(a) Primary Sector which includes agriculture and allied activities, forestry, fishing, and mining and quarrying.
(b) Secondary Sector which includes manufacturing, construction, electricity, gas, water supply.
(c) Tertiary Sector which includes banking, insurance, transport and communication, trade and commerce, etc.
(ii) Gross value added is computed by deducting the cost of intermediate goods from the value of output. Thus,
Gross Value Added = Value of Output – Cost of intermediate Goods.
(iii) Net value added is obtained by subtracting depreciation from gross value added. Thus,
Net Value Added = Gross Value Added – Depreciation.
(iv) By adding all the net values of all sectors, we get Net Domestic Product at Factor Cost. Thus, NDP at FC = Sum of Net Value Added in all Sectors.
(v) By adding net factor income from abroad to Net Domestic product at Factor Cost, we get Net National Product at Factor Cost or National Income. Thus,
NNP at FC or NI = NDP at FC + Net Factor Income from Abroad.
(2) Income Method:
Income method measures national income from the side of factor incomes. Income method is also known as distributive share method or factor payment method. According to this method, the incomes received by the residents of a country for their productive services during a year are added up to obtain national income.
Thus, income method consists in adding together all the incomes that accrue to the factors of production by way of wages, profits, rent interest, etc. This gives national income classified by distributive shares.
It is to be noted that the net value added in each producing enterprise is equal to the factor income generated in that enterprise, and, at domestic level. Net Domestic Product at Factor Cost is equal to the domestic factor income.
Thus, income method should give the same figures of national income as the value added method gives, provided there are no errors, no deficiencies or inconsistencies in the data or in the estimating procedures.
Steps in Income Method:
Calculation of national income through income method involves the following steps:
(i) All producing enterprises are classified into primary, secondary and tertiary sectors.
(ii) Factor payments made by the producing units are generally classified into:
(a) Rent, including imputed rent;
(b) Compensation of employees or wages and salaries-
(c) Interests;
(d) Profits, which include-
(e) Mixed income of the self-employed;
(f) Income from government sector, which includes-
I. Profits of government enterprises;
II. Property income of the government;
III. Savings of non-departmental enterprises, such as Air India.
(iii) The sum of incomes earned in the form of wage income, property income as rent, interest, profits, mixed income, etc. Within the territorial limits of a country is the domestic factor income or the Net Domestic Product at Factor Cost. Thus,
NDP at FC = Rent (including imputed rent);
(+) Compensation of Employees or wages and salaries;
(+) Interests;
(+) Dividends to the shareholders;
(+) Corporate and other direct taxes;
(+) Reserve Fund of the form or corporate saving;
(+) Mixed income of the self-employed;
(+) Property and entrepreneurial Income of the government;
(+) Property income of the government;
(+) Savings of non-departmental under-takings.
(iv) To this Net Domestic Product at Factor Cost, net factor income is to-
NNP at FC or NI = NDP at FC + Net Factor Income from Abroad,
(v) To this Net Domestic Product at Factor Cost, net factor income or not, we have to note that incomes from only those sources are to be included in national income which are productive and legal.
The following precautions are to be taken while estimating factor incomes:
(i) Transfer payments should not be included because there is no corresponding production of goods and services.
(ii) Value of production for self-consumption should be included.
(iii) Imputed rent is to be included.
(iv) Illegal incomes should not be included.
(v) Windfall gains (like winning a lottery) should not be included.
(vi) Corporation tax is a part of profit and therefore should be included.
(vii) Gift tax, wealth tax and tax on windfall gains are to be excluded because they are not paid from current income.
(viii) Money received from selling second hand goods are not to be included because there is no corresponding production of goods and services.
(ix) Interest on national debt is considered as a transfer payment and, therefore, should not be included.
(3) Expenditure Method:
Expenditure Method measures national income as the aggregate of all the final expenditure on gross domestic product in an economy during a year. In other words, the expenditure method measures the disposal of gross domestic product. This method is also known as ‘income disposal method’ or ‘consumption and investment method’.
Final expenditure means expenditure on final product. The total income generated in the economy is spent either on consumption goods or investment goods. Accordingly, total final expenditure or national expenditure (Y) represents the sum total of final expenditure incurred on consumption goods (C) and investment goods (I). Symbolically, Y = C + I.
Final consumption expenditure includes- (a) private house-hold consumption expenditure; and (b) government final consumption expenditure. Similarly, final investment expenditure comprises of (a) gross final investment or gross fixed capital formation; (b) changes in stock or inventory investment; and (c) net export of goods and services or net foreign investment.
Calculation of national income by expenditure method involves the following steps:
(i) GDP at MP = Gross National Expenditure
= Private Final Consumption Expenditure (C);
(+) Government Final Consumption Expenditure (G);
(+) Gross Domestic Private Investment
(I), which includes Gross fixed Capital
Formation + Changes in Stocks);
(+) Net Export or Export minus imports (X – M)
or GDP at MP = GNE = C + G + I + (X-M)
(ii) By adding net factor income from abroad to the Gross Domestic Product at Market Price, we get Gross National Product at Market Price. Thus,
GNP at MP = GDP at MP + Net Factor Income from Abroad
(iii) By deducting net indirect taxes from Gross National Product at Market Price, we get Gross National Product at Factor Cost. Thus,
GNP at FC = GNP at MP – Net Indirect Taxes,
(iv) By deducting depreciation from Gross National Product at Factor Cost, we get Net National Product at Factor Cost or National Income. Thus,
NNP at MP or NI = GNP at FC – Depreciation.
Precautions in Expenditure Method:
(i) Expenditure on second hand goods should be excluded because such an expenditure is not on currently produced goods,
(ii) Expenditures on the purchase of new or old shares and bonds should be excluded because they are not payments for goods and services,
(iii) Government expenditure in the form of transfer payments should be excluded because these payments do not make any contribution to the flow of goods and services,
(iv) Expenditure on intermediate goods and services should be excluded, otherwise this will lead to the problem of double counting.
Reconciliation of Three Methods:
Since all the three methods are used to measure the same physical output at three phases, namely, production, distribution and expenditure, they will provide the same national income figures. Chart-1 shows the reconciliation of the three methods of calculating Gross Domestic Product at Market Price.
Difficulties in the Calculation of National Income:
Calculation of national income is faced with a number of conceptual and statistical difficulties.
Important among them are given below:
i. Definition of Nation:
First of all there is the difficulty of defining the term ‘Nation’. In national income studies, the definition of ‘nation’ goes beyond the political boundaries. National income does not include income produced within the geographical boundaries of the country, but also income earned by the nationals in foreign countries.
ii. Choice of Goods:
Then there is the problem of choice of goods and services to be included in national income. Generally, the goods and services having money value are included in national income, but there are goods and services which do not have corresponding flow of money payments.
The services performed out of love or mercy does have economic value, but have not money value. The difficulty is whether to include such services in national income, and, if included, how to measure their money value.
iii. Choice of Method:
It is also difficult to decide which method is to be used in the estimation of national income. The general view is to use these methods simultaneously depending upon the availability of statistical data.
iv. Stage of Economic Activity:
Another difficulty relates to the determination of stage of economic activity at which income should be calculated. The general agreement is that any stage of economic activity (i.e., production, distribution and expenditure) may be adopted depending upon the objective of national income calculation.
If the aim is to show the economic progress and power of the economy, then the production stage is more suitable. On the other hand, if the aim is to measure the welfare of the people, then the consumption stage will be preferred.
v. Double Counting:
Double counting is also a major problem in the calculation of national income. It refers to a commodity (like cost of raw material) being included in national income estimate more than once. To solve this problem, only the value of final goods and services should be considered.
vi. Transfer Payments:
Another difficulty is of including transfer payments in national income. It is not easy to decide whether to include the payments received on account of pension, unemployment allowance, interest on loans, etc.in national income. These payments are in the nature of the individual or of the government. The best way to solve the difficulty is to consider only the disposable income of the individuals or groups, i.e., personal income minus all transfer payments.
vii. Illegal Income:
Income earned through illegal activities (such as gambling, illicit production of wine) is not included in national income. By excluding such activities the national income is underestimated.
viii. Non-Availability of Data:
Non-Availability of statistical data is another difficulty regarding the calculation of national income. This difficulty is not particular to the underdeveloped countries, but even advanced countries face the lack of adequate and reliable data.
ix. Non-Monetised Sector:
Existence of non-monetised sector poses another difficulty in the way of national income calculation. This difficulty is specially related to the underdeveloped countries where a sizable part of total output does not come to the market for sale. A major portion of the produce is either retained for self-consumption or bartered for other goods.
x. Depreciation Valuation:
Depreciation is deducted from Gross National Product to get Net National Product. But, depreciation valuation involves statistical difficulties like the age- composition of the capital stock, year-to-year changes in the prices of capital goods since when they were purchased.
xi. Price-Level Changes:
National income is measured in money terms. But, the measuring rod of money itself does not remain stable because of changes in price level. This implies that national income can change even without any change in output. To solve this problem, the concept of real national income has been introduced which is assessed in terms of prices of the base year. Then there are problems of constructing price index numbers.
xii. Difficulties in Underdeveloped Countries:
In the underdeveloped or developing countries like India, conceptual and statistical difficulties of national income calculations become more severe.
Major difficulties are given below:
(a) A large portion of the produce, particularly in the agricultural sector, is not brought to the market for sale, it is either directly consumed by the producers or is exchanged for other goods.
(b) People are socially backward. They are superstitious and do not disclose their incomes easily and correctly.
(c) Most of the producers do not keep accounts of their produce because of illiteracy
(d) It is difficult to estimate national income by industrial origin because there is little specialisation of functions. People are engaged in a number of economic activities simultaneously.
(e) Adequate statistical data are not available; and, if available, they are not reliable.
(f) There is lack of trained and efficient statistical staff.
(g) Problems of calculating national income also arise due to regional disparities of language, customers, etc.
(h) Mostly people are indifferent and non-cooperative to the enquiries regarding the national income estimates.
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