1- Methods of Measuring National Income
There are three main methods of measuring national income as follows.
1.1- Product method/approach
1.2- Income method/approach
1.3- Expenditure method/approach
1.2- Product method
The product method of measuring national income is also called output or value added method. According to this method, national income is measured adding up the market value of the goods and services produced in different sectors of the economy. The economy is divided into different sectors like, agriculture, industry, transportation, communication, health, education, other services and so on. The final goods and services produced in all these sectors are converted into their current market prices and are summed up to calculate GDP of a country. When GDP is once found out, net foreign receipts (R-P) are added to GDP to arrive at GNP. After calculating GNP, the value of depreciation is subtracted from GNP to estimate NNP. Finally, deducting indirect taxes from and adding subsidies to NNP we arrive at national income NI, which is also equal to national income at factor cost.
Symbolically,
GDP = Goods and services produced in agriculture + industry + transport + communication + health + education + and others, + net exports (X-M)
GNP = GDP + net foreign receipts (R-P)
NNP = GNP – Depreciation
NI = NNP – indirect taxes + subsides
1.1.1- Problem of double counting
While estimating national income by product method, as already mentioned, market value of final goods and services are summed up. But some of the goods and services are found to be of dual nature and difficult to differentiate either they are intermediate or final goods. For instance, wheat and sugarcane can be treated as both intermediate and final goods. When wheat is used for direct consumption, it is a final good but if it is used for producing breads, it is an intermediate good, and bread is final good. There are so many goods of such dual nature in the economy. So there is always possibility of getting the value of goods and services included to GDP more than once. When the value of some goods and service includes to GDP twice or more, it is called the problem of double counting.
This problem of double counting overstates GDP. So this problem should be avoided to estimate the accurate size of GDP. There are two methods of avoiding the problem of double counting frequently used by national income estimators. They are final product and valued added methods as described below.
1.1.2- Final product method
The problem of double counting is solved by distinguishing between two types of output. Intermediate goods and services are the outputs of some firms that are used as inputs for other firms. Final goods and services are the outputs that are not used as inputs or raw materials by other firms in the given period of time. Therefore, in final product method of measuring national income, only the market values of final goods and services which are purchased for final consumption, are summed up to estimate GDP at market prices.
1.1.3- Value added method
The value added method is also one of the methods of measuring national income used for avoiding the problem of double counting. According to this method national income is estimated by summing up the value of goods and services added by productive units in the economy at every stage of production during a given time period.
The production process of goods and services passes through different stages of production. The value of goods and services produced at each stage of production keeps on adding up and up, until it reaches its final stage. The net value added by every producing units of the country at every stage of production is taken into account for the estimation of GDP.
2- Components of product Method
The product method of measuring national income includes the market value of final goods and services or the value added on goods and services at different stages of production. Mainly, the value is added on goods and services in the economy by different sectors which are called the components of product method of measuring national. The main components of this method are as given below.
2.1-Primary sector: - This sector of economy consists of agriculture and allied activities, forestry, fishing, mining and quarrying etc. The values added on goods by these sub-sectors are included for the estimation of national income.
2.2-Secondary sector: - The secondary sector of economy includes all kinds manufacturing, i.e. registered, and unregistered manufacturing, construction, electricity, water, and gas supply. All of the values added on goods and services from these sectors also are summed up together for the estimation of NI.
2.3-Tertiary sector: - This sector is related with the generating and providing services like transport, communication, trade, hotel and restaurant, banking and insurance, public administration and defense and other services. The values added on all the services from these sectors are included to national income.
2.4-Net export: - The net export (X-M) is also the component which is included to GDP in the process of estimating national income.
2.5-Others: - There are other components of product method of measuring national income which also play significant role, i.e. net foreign receipt (R-P) depreciation, indirect taxes, and subsidies. For the estimation of national income, depreciation and indirect taxes are excluded and subsidies are included to NI.
Examples of product method;
1- In the year 2020, it has been found that the contribution of agriculture, industry, transport, communication, and financial sector to GDP is $600, $550, $325, $300, and $350 million respectively. Net foreign export is nil and the total income received by domestic factors of production from abroad is $200 million and factor payments taken away by foreigners is equal to $175 million. At the end of the year is it estimated that the amount of depreciation is equal to $150, taxes levied on business firms is $300 and subsidies provided by government is $125. From the given information calculate:
a-Gross domestic product at market prices (GDPMP)
b-Net domestic product at factor cost (NDPFC)
c-Gross national product at market prices (GNPMP)
d-Net national product at market prices (NNPMP)
e-Net national product at factor cost (NNPFC) or NI
Solution:
GDP at market prices = 600+550+325+300+350
= 2,125 Million
NDP at factor cost = GDPMP – Depreciation – indirect taxes + subsidies
= 2,125 – 150 – 300 + 125
= 1, 800 Million
GNP at market price = GDPMP + (R – P)
= 2, 125 + (200 – 175)
= 2, 150 Million
NNP at market prices = GNPMP – Depreciation
= 2150 – 150
= 2, 000 Million
NNP at factor cost = NNPMP – indirect taxes + subsidies
= 2, 000 – 300 + 125
= 1, 825 Million
National income NI = 1, 825 Million
2-Ramdin Chaudhary, a farmer, produces wheat, which he sells to Omprakash, a miller, for $300. Omprakash turns the wheat into fine-flour, which he sells to Ajanta Bakery for $450. The bakery turns the fine-flour into bread, which it sells to traders for $600 and the traders sell to final consumers for $1000. From the information, find out the combined contribution of all these economic agents to GDP?
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The total amount of value added by all the economic agents is equal to $1000. Hence, the contribution of these economic agents to $1000.
Total value added = Gross value added (Selling price) – Purchasing price
= 2350 – 1350
= 1000
1.2- Income method/approach
According to income method, national income is measured by summing up the incomes generated by different factors of production from their contribution in the production process of goods and services during an accounting year. These factors of production are paid remuneration in the form of wages and salaries, rents, interest, profits and other incomes for their efforts in production of goods and services. Hence, by adding these items we arrive at GDI or GDPMP. After finding out GDPmp, other process is applied as applied in product method to find out Net National income.
3-Components of Income Method
The components of income method are as follow.
3.1-Compensation of Employees
It includes the income received in the form of wages salaries and social security funds etc. provided by private firms and the government during a year.
3.2- Rent
It includes the rent of land, shop, houses, factories and royalties of author, brand name etc. These factor incomes are added to calculate GDI.
3.3- Interest
Another component is interest. It includes interest paid on money capital. But interest on govt. loan and individual transaction are just transfer of income. So these types of interest are excluded.
3.4- Profits
Profit includes the profits received by different business organizations which are used by the organization in corporate profit tax (CPT), undistributed corporate profit (UCP), dividends etc..
3.5 Mixed income of self-employed
It includes the incomes from self-employment and use of self-owned factor of production in business firm. All these types of mixed income are added to calculate GDI.
3.6- Depreciation
The amount of depreciation is a part of income which is also included to GDI.
3.7 Net Factor Income.
It is also a component of income method. Net factor income is the difference between foreign receipts and payments. It is also included in GNI.
3.8 Net indirect taxes
Net factor income is also a component of income method. It is the difference between indirect taxes and subsidies.
1.3- Expenditure Method
According to expenditure method GDP is calculated by summing up consumption exp. (C), investment exp. (I) and govt. exp. (G) and other process is applies the same as in product method.
4-Components of expenditure method
Mainly there are four components which are used to compute GDE or GDP at market price.
4.1- Private Consumption Expenditure (C)
This component measures the money value of consumer goods and services which are purchased by households and non-profit institutions for current use during a period of account. These are classified into consumer durables, semi-durables, non-durables and services.
4.2- Investment Expenditure (I)
Investment means additions to the physical stock of capital during a period of time. It includes, business fixed investment, inventory investment, residential construction investment, public investment etc.
4.3- Government Purchases of Goods and Services (G)
This component consists of government spending on goods and services. It includes (i) purchase of intermediate goods and (ii) wages and salaries paid by the government. All government purchases and expenditure are Govt. expenditure.
4.4- Net Exports (X – M)
It shows the difference between domestic spending on foreign goods (i.e., imports) and foreign spending on domestic goods (i.e., exports). Thus, the difference between Exports (X) and Imports (M) of a country is called Net Exports (X- M).To sum up, Gross Domestic Product (GDP) is the total value of sum of Consumption Expenditure by households (C), Investment Expenditure by firms (1), Government Purchases (G) and Net Exports. (X- M). Symbolically:
GDP = C + I + G + (X-M)
5-Difficulties in Measurement of National Income
5.1-Conceptual Difficulties
5.2-Practical Difficulties
5.1-Conceptual Difficulties
5.1.1-Inclusion of Services:-There are different views about the inclusion of the value of services in NI. Marxism economists deny including the value of services while others are in favor of inclusion of services. So whether to include the value of services to NI or not is a conceptual problem.
5.1.2-Identifying intermediate goods:- National income includes only the value of final goods but in practice, it is difficult to make an appropriate distinction between final and intermediate goods because some goods are used as both final as well as intermediate goods.
5.1.3-Identifying factor incomes:- Only factor incomes are included in NI. Some incomes look like factor incomes but they are not in reality. For example interest received from loan for consumption, payments received from sale of old houses, cars etc. look like factor incomes but actually, they are non-factor incomes. They are received by a business man mixing with factor incomes. So sometimes it is difficult to separate and possible to be treated as factor income.
5.1.4- Services of Housewives:- Housewives are not paid for their services at home but housemaid is to be paid for doing same service. The payment made to housemaid is the part of NI but the values of services of housewives are not included in NI. So it is a matter of controversy of estimating correct size of NI.
5.1.5- valuation inventory:- The valuation of inventory is one more difficulty of estimating NI. While valuating inventory, whether it is to be valuate at its original cost prices or at current prices, should be decided. Both the prices give different results but which one is the correct one. Generally current cost prices are mostly used in practice.
5.1.6- Estimation of depreciation:- Estimation of depreciation is also known as one of the problem of NI. Depreciation of a piece of capital can be estimated at its original cost price or replacement cost price but Taking decision for which one is appropriate is one problem and both the prices give different results.
5.2- Practical difficulties
5.2.1-Possibily of double counting:- While estimating NI only the value of final goods are considered but some goods are used as final as well as intermediate goods. Therefore sometimes there is possibility of double counting.
5.2.2-lack of occupational specialization:- There is lack of occupational specialization mainly in developing countries. People are not found to be stuck to a special occupation. They adopt more than a single occupation at their leisure time mainly in agriculture. In such a condition, it is difficult to evaluate their occupation-wise income and real value of NI cannot be estimated.
5.2.3-Non-monetized sector:- In developing countries all goods and services are not monetarily evaluated. Some goods and services are exchanged with other goods and services. In such cases the value of produced goods and services are left to be included in NI and actual value of NI can't be estimated.
5.2.4-Inadequate Information:- To estimate NI, adequate information are required but in developing countries people are illiterate and they do not keep records of their income. So there is always lack of adequate information about income and expenditure and actual volume of NI can't be estimated.
5.2.5- Illegal Income:- Some people make incomes from illegal activities but they do not show their incomes. Such incomes are not likely to be included to NI. This is also an obstacle to estimate the actual volume of NI.
5.2.6-Lack of Reliable Data:- Lack of reliable data is also one of the problems of estimating NI. People hesitate to give reliable data of their production as well as incomes to refrain from tax burden. So reliable data are not available and real size of NI can't be estimated.
6- Importance of National Income
6.1- To compare standard of Living:- One of the importance of NI is that it is used to compare living standard of people in different years. Moreover, whether the living standard of people is increasing or decreasing in comparison of previous years can be easily viewed by estimation of NI.
6.2-To measure economic Growth:- Economic growth is measured in terms of per capita national income and these figures are used to measure the rate of growth of a countries.
6.3-To examine behavior of economic Sector:- NI helps to analyze the behavior of different sectors of the economy. It provides the detailed picture of change in production, consumption, investment etc.
6.4-To forecast Business Activities:- The Present size of NI helps to forecast the business activities to some extent in future dates. It is because NI reveals the trends of business in later dates.
6.5-Basis of Economic Planning:- To formulate economic planning in a country, past data of income as well as revenue are highly needed because they provide bases to formulate future planning. It is NI which helps to provide such data for formulation of future economic planning.
6.6-To evaluate the Structure of the Economy:- The national income figures are useful in providing a correct sense of proportion about the structure of the economy.
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