Method of Measuring National Income
The national income of any country is the monetary value of its final services and goods which are produced by the residents of that country. The national income of every country includes the total investment expenditure, total consumption expenditure, net exports or imports, total government expenditure. Thus based on the consumption, expenditure, and trade data, there are three methods that you can use to measure the national income.
Methods of Measuring National Income
A. Expenditure Method (Spending Approach)
The expenditure method measures GDP as the aggregate of all the final expenditure on the gross domestic product at market price in an economy during the accounting year. People spend their income on capital goods or consumer goods. So, all types of expenditures are calculated in this method. Thus, expenditures can be from anyone from households and private individuals to government expenses or the various business enterprises. This method is used mainly to calculate the incomes in the construction sector.
GDPmp = C + I + G + (X-M)
GNPmp = C + I +G + (X-M) + (R-P)
NNPmp = GNPmp – Depreciation
Where;
C = private consumption expenditure
I = gross private domestic investment
G = government expenditure
X = exports earning
M = imports expenses
R = receipts from abroad
P = payments made to abroad
Components of Expenditure Method
1. Private (personal) Consumption Expenditure (C)
It includes all types of expenditure made on final goods and services, including those produced abroad by the individuals or households of a country. It comprises:
i. Expenses on durable goods.
ii. Expenditure on non-durable goods
iii. The expenditure incurred on services of all kinds.
2. Gross Private Domestic Investment or Gross Capital Formation (I)
It includes the expenditure incurred by private enterprises on new investment and on replacement of old capital and also on inventory investment. It comprises the following expenditure:
i. Non-residential investment.
ii. Residential investment.
iii. Changes in business inventories.
iv. Depreciation.
3. Government Expenditure (G)
Government expenditure refers to the purchase of goods and services, which include public consumption and public investment, and transfer payments consisting of income transfers (pensions, social benefits) and capital transfer. A government spends money on the supply of goods and services that are not provided by the private sector but are important for the nation’s welfare. Government spending goes to the nation’s defense, infrastructure, health and welfare benefits.
4. Net foreign Investment (X-M)
Net foreign investment is the difference between export earnings and import expenses. Every country exports to or imports from foreign countries. The imported goods are not produced with in the country and hence cannot be included in GDP, but the exported goods are manufactured within the country. Thus, net foreign investment, whether positive or negative, is included in GDE (GDP).
5. Net Factor Income from Abroad (NFIA) or Net Receipts (R-P)
Net factor income earned from abroad which is used to differentiate between national income and domestic income. Alternatively, NFIA is the difference between factor incomes received from abroad and factor income paid abroad. It is also called as net receipts.
Net factor income earned from abroad has three components:
i. Net compensation of employees.
ii. Net income from property (rent and interest and income from entrepreneurship).
iii. Net retained earnings of the resident companies working in foreign countries.
It must be noted that NFIA is zero in a closed economy as such an economy does not deal with the rest of the world sector.
B. Income Method (Share Distributive Approach)
The income method consists of adding together all the incomes that accrue to the factor of production by the way of compensation of employees, profits, rent, interest, and other values. This gives the national income classified by distributive shares.
1. Rent: Rent includes the rent of land, shops, houses, factories, etc. and the estimated rents of all such assets as are used by the owners themselves.
Rents = rent of land, machine, and buildings + loyalties
2. Compensation of Employees: Compensation of employees is defined as the total remuneration, in cash or in kind, payable by an employer to an employee in return for work done by the latter during an accounting period. Compensation of employees has three main components: wages and salaries in cash, wages, and salaries in kind, and employers’ social contributions. Compensation of Employees = wages and salaries + employer’s contribution to social security
3. Net Interest: Interest is the payment paid by different productive agencies or business firms to the suppliers of money capital. Net interest income is the difference between revenues generated by interest-bearing assets and the cost of servicing liabilities. For banks, the assets typically include commercial and personal loans, mortgages, construction loans, and investment securities.
4. Profits: National income accounts put accounting profit into two categories: proprietor’s net income and corporate profits.
5. Mixed-income of self-employed: Mixed-income of self-employed refers to the incomes of the self-employed persons who use their own land, labor, capital, and entrepreneurship to produce various goods and services. It comprises imputed factor incomes (rent, wages, profit, and capital).
6. Depreciation (Capital Consumption Allowance or Consumption of Fixed Capital): Depreciation is the gradual decrease in the economic value of the capital stock of a firm, nation or other entity, either through physical depreciation, obsolescence or changes in the demand for the services of the capital in question.
7. Net Factor Income from Abroad (Net receipts): It is the difference between income earned by our residents and the payments made to the foreign residents. Whether negative or positive, it is calculated in GNI.
8. Net Indirect Taxes: It is the difference between indirect taxes and subsidies. It is defined as the components of income method while converting factor cost values into market price values. And net indirect tax is the difference between indirect tax and subsidy.
C. Product Method (Inventory Approach)
The production method is also known as the value-added method, industrial origin method or net output method. This method measures the total value of the nation’s output by adding up the total value of final goods and services produced within the economy for one year. Also called as inventory method or commodity-service method or value-added method or net output method. Sum total of the value of final products produced by the primary sector, secondary sector and tertiary sector. Sum total of the value of final products produced by the primary sector, secondary sector and tertiary sector.
The main component of the production method is as follows:
1. Primary sector: It includes agro-products like food crops, cash crops, animal husbandry, etc. fishery, forestry, mining and so on.
2. Secondary sector: It includes manufacturing, construction, electricity, gas, water supply, and others.
3. Tertiary sector: It includes banking and insurance, transportation and communication, trade and commerce, health and education and other services.
4. Net factor income from abroad: It is the difference between receipts from foreign countries and payments to foreign countries.
According to the Product Method
GDPmp = Total product of primary sector + Total product of secondary sector + Total product of the tertiary sector
GNPmp = GDPmp + Net factor income from abroad
NDPmp = GDPmp –Depreciation
NNPmp = GDPmp – Depreciation
The problem of Double Counting
While calculating NI from product method, the value of intermediate goods and services may be included two or more times, it is called the problem of double counting. If the value of intermediate goods is included in NI accounting, the problem of double-counting will crop up. Double counting leads to an overestimation of National Income. There are two methods of avoiding the problem of double counting.
1. Final Product Method: By this method, we measure the value of all that is produced in the domestic economy. It is broadly called the Gross Domestic Product. GDP is defined as the gross market value of all the final goods and services produced by all producing units located m the domestic economy in an accounting year. It is estimated by multiplying the gross product with market prices. This gives us the value of Gross Domestic Product at market price (GDPmp).
2. Value Added Method: Value added is the value of the output of a firm minus all inputs that it buys from other firms. According to this method, domestic income is first calculated by totaling ‘net value added at FC by all the producing units during an accounting year within the domestic territory. This total is called Net Domestic Product at FC or Domestic Income. Then by adding net factor income from abroad to Domestic Income (NDP at FC), we get National Income (NNP at FC). Mind, in the value-added method, national income is measured at the stage of production (or addition of value). Clearly, the value-added method measures the contribution of each producing unit in the domestic economy avoiding any possibility of double counting.
|
Producer |
Output Produced | Value of Output | Cost of Intermediate Goods | Gross Value Added |
| Farmer | Wheat | 10,000 | 10,000 | |
| Flour Mill | Flour | 30,000 | 10,000 | 20,000 |
| Bread Industry | Bread | 40,000 | 30,000 | 10,000 |
| Total | 80,000 | 40,000 | 40,000 |
From the above Table,
The final product produced is Bread worth 40,000. i.e. NI from final product method = 40,000.
Total value of Output = 80,000
Cost of Intermediate Goods = 40, 000
Hence, Gross Value Added = 80,000 – 40,000 = 40,000
Or NI from value added method = 40,000
NI from Product method with double counting = 80,000
NI after avoiding double counting/ Actual NI = 40,000
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