Calculation of National Income and Difficulties while Calculation

Production of goods and services gives rise to income, income given rise to demand for goods and services, demand gives rise to expenditure, and expenditure gives rises 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 (i) as a flow of goods and services, or
(ii) as a flow of incomes, or (iii) as a flow of goods and services. Thus, there are three methods of measurement of national income.

i) Product/Output Method

Product method measures national income at the phase of production in the circular flow. This method is also called value added method. Data of all productive activities like agricultural products, industrial products, contribution of transport to production, service of lawyer, doctor, professors etc., are collected and measured their value at market prices. Under this method, there are two approaches to the estimation of national income.

a) Final Product Method: In this method, 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 final product of calculating national income are:

The market value of all final goods and services produced within the territorial limits of the country gives estimate of GDP at market price.

Thus, GDP at market price = market value of all goods and services produced within the country.

Hence, GDP = Total agricultural product + Total industrial product + Total contribution of tertiary sector.

GNP = GDP + Net foreign income

NNP = GNP – Depreciation

Further, by deducting indirect taxes from NNP at market price, that gives NNP at factor cost of national income.

Hence, NNP at Factor Cost or National Income = NNP at market price – Net indirect taxes.

While calculating national income using final product approach, problem of double counting may be appeared. In order to avoid the double counting problem, we use value added approach.

b) Value Added Method: In this method, instead of taking market value of final product, the value added 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. In order to calculate the value at a particular state of production, the cost of intermediate products is subtracted from the total value of output.

Hence, Value added = Value of capital – Cost of intermediate goods.

Produer
Stage of 
Production
Value of 
Output
Cost of 
Intermediate Goods
Gross 
Value Added
FarmerPaddy
100
50
50
MillerRice
150
100
50
WholesalerFlour
200
150
50
BankerBread
250
200
50
Total
700
500
200

The table is constructed on the supposition that the entire economy for purposes of total production consists of four sectors. The table below shows the contribution of different sectors to the GDP and computation of national income.

Measuring National Income by Output Method
($ in Million)
S.No.
Sector
Contribution of 
Different Sector
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
Agriculture, Forest and Fisheries
Transportation and Communication
Public Administration and Defense
Health and Education
Banking and Financial Institution
Irrigation, Electricity and Drinking Water
Construction Industry
Mine Industry
Industry, Trade and Commerce
Others
20
5
10
6
4
3
2
5
5
1
Gross Domestic Product (GDP)
61
11.
Net Income from abroad
+ 10
Gross National Product (GNP)
71
12.
Value of depreciation fund
- 6
Net National Product (NNP)
65
13.
Indirect Tax
- 4
Subsidies
+ 1
National Product (NP = NI = NE)
62

Despite the popularity gained in application, this method is not free from the problem of over estimation (double counting). To avoid the problem of double counting economists have suggested two alternative methods, viz., final product method and value added method. We should keep in mind that whichever the method is applied, the result will be the same.

ii) Income Method

Income method measures national income from side of factor incomes. It is also known as distributive share method of factor payment method. In this method, net incomes received by all factors of production are added to obtain the national income. It means national income comprises the net rents paid to land, net wages paid to labor, net interest paid to capital and net profit earned by entrepreneurs. It does not include transfer payments.

According to Income Method,

GDI = Rents + Wages and salaries + Interests + Dividends + Undistributed profits + Indirect taxes + Depreciation

Where, GDI = Gross Domestic Income

GNI = GDI + Net foreign income

NNI = GNI – Depreciation

The measurement process can be shown in the table as below:
Measuring National Income by Income Method
($ in Million)
S.No.
Headings
In Million $
1.
2.
3.
4.
5.
6.
7.
8.
9.
Wages and Salaries
Interest
Rent
Dividends
Undistributed corporate profit
Corporate profit tax
Social Security Contribution
Income from self employment
Depreciation
12
10
16
8
6
1
2
3
3
Gross Domestic Income (GDI)
61
10.
Net Income from abroad
+ 10
Gross National Income (GNI)
71
11.
Depreciation
- 6
Net National Income (NNI)
65
12.
Indirect Tax
- 4
Subsidies
+ 1
National Income (NI = NP = NE)
62

iii) Expenditure Method

Expenditure method measures national income as the aggregate of all final expenditure on Gross Domestic Product in an economy within a year. In other words, the expenditure method measures the disposal of GDP. Final expenditure means expenditure on final product. Total final expenditure or national expenditure (Y) represents the sum total of final expenditure incurred on consumption goods © and investment (I). Symbolically;

Y = C + I

Final consumption expenditure includes private household consumption and government final consumption expenditure. Similarly, final investment expenditure comprises (i) Gross final investment, or Gross fixed capital formation; (ii) Changes in stock or inventory investment; and (iii) Net export of goods and services or net foreign investment.

Hence, GDE = C + I + G

GNE = GDE + (X – M)

NNE = GNE – Depreciation

Where, GDE = Gross Domestic Expenditure
GNE = Gross National Expenditure
NNE = Net National Expenditure
C = Consumption Expenditure
I = Investment Expenditure
G = Government Expenditure
X = Export earning
M = Import expenses
X – M = Net income from abroad (net foreign investment)

The measurement process can be shown in the table as below:

Measuring National Income by Expenditure Method
($ in Million)
S.No.
Expenditure Head
Expenditure
1.
2.
3.
4.
5.
Individual consumption expenditure
Total internal investment expenditure
Expenditure on goods and services by government
Exports of goods in monetary value
Imports of goods in monetary value
25
15
11
16
- 6
Gross Domestic Expenditure (GDE)
61
6.
Net income from foreign investment
+ 10
Gross National Expenditure (GNE)
71
7.
Depreciation
- 6
Net National Expenditure (NNE)
65
8.
Indirect Tax
- 4
Subsidies
+ 1
National Expenditure (NE = NP = NI)
62


So, from the above table, it is clear that if the entire production of a country is purchased at market price, the amount will represents the GNE of the country.

Difficulties in the Measurement of National Income

There are, however, some theoretical and practical difficulties in the way of the exact measurement of national income. A clear understanding of these difficulties, therefore, becomes necessary to understand the concept of national income relation to any particular country.

  1. Lack of statistical data: We can’t easily take statistical data of national income. The available data are inadequate and unreliable. For example, statistics of agriculture in developing countries is not complete. We have no reliable estimates of production cost in developing countries. These are not also statistical value of small scale industry and middle scale industries production.
  2. Existence of non-monetized sectors: All agricultural outputs do not reach the market. Either it is consumed at home or exchanged for other goods in the village. This presents several in the calculation of national income.
  3. Illiteracy and ignorance: The majority of the small producers in the underdeveloped countries are illiterate and ignorant. And the producers are not able to keep any account of their productive activities. So, they can’t give the information about the value of their output.
  4. Lack of occupational specialization: There are little occupational specializations people in underdeveloped country. Many people take up more than one activity to earn money. It becomes difficult to collect information about their income. A farmer engaged in agriculture, industries and other sectors during off season.
  5. Frequent changes in price level: National income depends on monetary price of production. But the problem of changing prices is one of the major problems of national income accounting.
  6. Problem of double and multi-counting: It is very difficult in national income calculation only one time. The goods can be counted as intermediate goods and final goods. For example, orange produced by a farmer can be taken as final goods if they consume it and intermediate goods if they sell it to the wholesaler. Sometimes it is difficult to find the exact amount of consumption and sales.
  7. Illegal incomes: Such economic activities do not occur easily, for example, gambling, prostitution, black marketing, drug dealing etc. All their activities are not included in national income. So, due to the presence of illegal economic activities, national income underestimates the value of the output of an economy.
  8. Value of money may not be suitable measure of national income: Firstly, the value of money does not remain stable. It, therefore, cannot give a correct account of national income. Secondly, even though value of money may remain the same, the quality of goods may change. Lastly, there may be certain goods and services which may not have any money value at all, for example, services rendered in friendship or even in mercy (i.e., housewife’s work in the family).
  9. International transactions: National income determination in an economy having international economic relation would create a number of problems. Foreigners own a part of the output produced in the country, and the people of the country may receive income payments from aboard. How are these payments to be accounted for in the national income? Including in the national income produced within the country can solve this problem plus any income earned by the nationals of that country in other countries by way of interest, banking charges, etc., minus any payments of foreign countries by way of interest, bank charges etc.
In calculation of depreciation valuation is also another difficulty to the measurement of national income.

In underdeveloped countries, conceptual and statistical difficulties of national income calculations become more severe. Major difficulties are given below:

  • A large portion of produced, especially in the agriculture sector, is not bought to the market for sale. It is either directly consumed by the producers or exchanged for other goods.
  • People are socially backward. They are superstitious and do not disclose their incomes easily and correctly.
  • Most of producers do not keep accounts of their produced because of illiteracy.
  • Lack of occupational specialization; an individual is engaged in supplementary occupations too. Due to this, the income from supplementary activities is not included in the estimation of national income.
  • Adequate statistical data are not available, and; if available, they are not reliable.
  • There is a lack of trained and efficient statistical staff.
  • Problems of calculating national income also arise due to regional disparities of language, customers etc.
  • Mostly, people are indifferent and non-cooperative to the acquirement regarding the national income estimates.
  • A large number of producers are pretty producers, who do not have any accounts of their business. Hence it is difficult to include in national income.

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