Methods of Measuring National Income

Ø  GDP (Gross domestic product) 

•      The final products within the boundaries of India within that specific period of time are in the GDP of India. Further, the effect of inflation on these products is also calculated.
•       GDP includes government expenditures, consumption, exports, imports, and investment of India.
•      For example, if Honda decides to manufacture it’s parted in India than that will go into the GDP of India. But the revenues got through the sales are included in the GDP of Japan.

Ø  GNP (Gross national product 

•      GNP of the country is measured by the income which is collected due to the various factors of production that are owned by the residents or the citizens of India. The GNP of India is calculated by adding the net inflow coming from the abroad countries to the GDP of India while subtracting net outflow to the foreign countries from India.

As per the previous example, if Honda is an Indian company and it is selling its parted in other countries than that revenue becomes the GNP for India.

Ø  NET DOMESTIC PRODUCT (NDP)

The net domestic product (NDP) equals the gross domestic product (GDP) minus depreciation on a country's capital goods. Net domestic product accounts for capital that has been consumed over the year in the form of housing, vehicle, or machinery deterioration.

Ø  Net National Product (NNP)

"Net national Product or national income at market prices is the net market money value of all the final goods and services produced in a country during a year. It is found out by subtracting the amount of depreciation of the existing capital in a year from the market value of all final goods and services".

For a continuous flow of money payments, it is necessary that a certain amount of money should be set aside from the gross national income for meeting the necessary expenditure of wear and tear of all capital equipment so that there should not be any deterioration in the capital and it should remain intact. If we deduct depreciation allowance from gross national product, we get Net National Product at current market price.

Formula for Net National Product/National Income:

              NNP at Market Price = GNP at Market Price - Depreciation
 PER CAPITA INCOME (PCI)

It measures the average income earned per person in a given area (city, region, country, etc.) in a specified year. It is calculated by dividing the area's total income by its total population.

MEASURING NATIONAL INCOME

1.  Product/Production Method: It refers to the addition of value to the raw material (intermediate goods) by a firm due to its production activities.
2. It is also known as ‘Inventory method’ or ‘Commodity Service Method’. It consists in finding out the market value of all goods and services produced in a country during a given period.
3. We sum up the value of the gross product of all producers in an industry and from this total are deducted the value of the intermediate products consumed and depreciation of equipment during the process of production.

                      * Value added = Value of output – Intermediate consumption.

Q. What are the steps involved in value added method?

Ø  Classify all the production units located in the domestic territory into distinct industrial sectors: The units are classified into primary, secondary and tertiary sectors which are further classified into sub-sectors like agriculture, manufacturing, banking, etc.  

Ø  Estimate NVA_FC of each industrial sectors by taking the following sub-steps:

     1.Estimate the value of output and it can be estimated in two ways, firstly sum of sales and net addition stock.

      2.Deduct intermediate consumption from value of output to arrive at GVA_MP.

      3.Deduct consumption of fixed capital from GVA_MP to arrive at NVA_MP.

      4.Deduct net indirect tax from NVA_MP to arrive at NVA_FC of an industrial sector.

•      Take the sum of NVA_FC of all the industrial sectors of the economy. By doing so, we will arrive at net domestic product at factor cost (NDP_FC).

                           ∑ NVA_FC = NDP_FC

•        Add net factor income from abroad to NDP_FC arrive at national income.

                 NDP_FC + Net factor income from abroad = National Income

Q. Explain the problem of double counting?

    The term double counting refers to an output more than once while passing through various stages of production. It leads to over-estimation of national income or domestic income in the economy. It can be explained with the help of an example:

•       Stage1: Suppose a farmer produces 50kg wheat and sells is at Rs.5000 to the miller (flour mill). Therefore, final value of wheat for the farmer is Rs.5000.
•      Stage2: For miller, whet is an intermediate good. He converts it into flour and it for Rs.700 to a baker. Therefore, final value of the flour for the miller will be Rs.700.
•     Stage3: For baker, flour is an intermediate good. He manufactures bread from it and sells the bread to the final consumers for Rs.1000. Therefore, final value of bread for the baker is Rs.1000.
•      If adding all the values of final goods (output), the total value of output = 500 + 700 + 1000 = Rs.2200.

Each stage contains the value of intermediate goods. The value of wheat contains 3times and the value of flour is counted 2times. This means it creates the problem of double counting.

Q. How is the ways of avoiding double counting avoided?

     The two alternative ways of avoiding double counting:

•      Take value added instead of total output: It is necessary to identify intermediate consumption for this. From the above example, the intermediate consumption of farmer is nil. Whereas, that of baker and grocer is Rs.1000 and Rs.2000 respectively.

     Thus, the sum total of value added by farmer, baker and grocer is Rs.2200. Therefore, this is the value that should be added in the national income as it is free from double counting.

•      Take the value of only the final product (output): The final products are those products which are purchased for consumption and investment. In the above example, only the value of grocer i.e. Rs.2200, is the final product because only he sells the entire output to the consumers.
•      This value i.e. Rs.2200 includes the value added by all the three levels of production unit taken together which are Rs.1000 of farmer, Rs.1000 of baker and Rs.200 of the grocer.

So by taking only the value of final goods, the problem of double counting can be avoided and this method is used in the expenditure method of estimating national income.  

Production unit	Value of output – Intermediate consumption.	Value added
Farmer	500 – 0	500
Miller	700 – 500	200
Baker	1000 – 700	300
Total	2200 – 1200	1000

Q. Explain how income generated in the economy is equal to NVA_FC or domestic income?

Or

NVA_FC = Factor payment. Why?

Or

Sum of value added = Sum of Factor Income. Why?

     Value added is a measure of contribution of a product unit to the domestic product of a country. Production unit means owners of four factors of production (land, labour, capital and entrepreneur) producing goods and services together.

     So NVA_FC is nothing but contribution of the owner of these four factors of production and the income generated by them in the form of rent, interest, profit and wages. Therefore, NVA_FC must necessarily be equal to factor payments.

                               *NVA_FC = Rent + Interest + Wage + Profit + = Factor payments.

Q. Illustrate with the help of an example, the concept of mixed income.

        In the situation of a doctor running his clinic at his resident, he is performing the role of all four factors (land, labour, capital and entrepreneur) of production necessary to run a clinic and they are:

a)      When he treats the patient, he is a worker.

b)      He is the owner of the land on which the clinic is constructed.

c)      He is the owner of the capital because he has less supplied funds to the clinic.

d)      He is also the entrepreneur because he has taken initiative to start the clinic.

    Suppose, the doctor changes the consultation of Rs.100 from a patient, as such the fee should be demanded into four parts i.e. into four factor income. Apart of it is lie remuneration as a worker and another part is the rent of land on which the clinic is situated.

       Still another part is interest on funds invested by him and the remaining part is his profit as an entrepreneur.

2.      The Income Method:

This method consists in adding together all the income that accrued to the factors of production by way of wages, rents, interests and profits. This gives us national income classified by distributive shares. The factor owners are paid for the productive services rendered by them in money. The total money payments made to the factors of production in the economy represent the total money value at factor cost. What is factor payment (cost) for the producers is factor income (earning) for the factor owners. Thus, under income approach GNP is found by adding up the total factor incomes generated in producing the national product. 

Components of Income Method:

Ø  Compensation of employees: It refers to the amount paid to employees by employer for rendering productive services.

a)      Wages and salaries in cash: It includes all monetary benefits like wages, salaries, bonus, commission, etc.

b)      Wages and salaries in kind: It includes all non-monetary benefits like rent, free home, free car, free transport, imputed interest of interest free loans, etc.

c)      Employer’s contribution to social security schemes: It includes contribution made by the employer for the social security of employees such as contribution to provident funds, gratuity, retirement pension, insurance, etc.

Ø  Rent and Royalty: Rent is that part of national income which arises from ownership of land and building. Royalty refers to income received from granting leasing rights of sub-soil assets.

Ø  Interest: It refers to amount received from lending funds to a production unit.

Ø  Profit: It is the reward to the entrepreneur for his contributions to the production of goods and services. It includes:

a)      Corporate tax: It is direct tax paid by an enterprise to the government on the total profit earned by it.

b)      Dividend: It refers to that part of profit which is paid to the shareholders in the ratio of their shareholding.

c)      Retained earnings: It refers to that part of profit which is kept as reserve to meet unexpected contingencies or business expansion.

d)      Mixed Income: It is the income of the unorganized sector or the self-employed people. In this sector factors of production are not hired from factor market. Rather, own resources are used in the production. So the income generated in this sector will be mixture of rent, interest, profit and wages and they cannot be separated from each other. That’s why, it is called mixed income of self-employed.

For e.g.: Doctor running his own clinic, CA practicing from his house, etc.    

Q. What are the steps of income method in estimating national income?

     The steps of income method involved in estimating national income are as follows:

Step1: Identify and classify the production unit and all the producing enterprises employing various factors of production are identified and classified into primary, secondary and tertiary sectors.

Step2: Estimate the factor income paid by each sector. The factor incomes paid by each sector are classified under the following heads:

a)      Compensation of employees

b)      Rent and royalty

c)      Interests

d)      Profits

e)      Mixed Income.

Step3: Calculate domestic income (NDP_FC). When factor income of all the sectors are summed up, we get domestic income.

                     NDP_FC = Compensation of employees + Rent + Interest + Profit + Mixed Income.

Step4: Estimate net factor income from abroad (NFIA) to arrive at national income.

  In the final step, NFIA is added to domestic income to arrive at national income.

                     NNP_FC = NDP_FC + Net factor income from abroad. 

3. The Expenditure Method:

Under this method we add up personal consumption expenditures, the gross private domestic investment, the Government purchase of goods and services and the net foreign investment to obtain GNP at market prices. We deduct depreciation to obtain Net National Product (NNP) at market price, less Indirect Taxes give us net national income at factor cost. In this method of national product measurement, the GNP is regarded as a flow of total goods and services bought through the money payments by the community.

Components of Expenditure Method:

Ø  Private Final Consumption Expenditure (PFCE): It refers to expenditure incurred by the households and private non-profit institutions serving households of all types of consumer goods i.e. durable goods, non-durable goods, semi-durable goods and services.

Ø  Government Final Consumption Expenditure (GFCE): It refers to the expenditure incurred by general government on various administrative services like law and orders, defense, education, etc.

Ø  Gross Domestic Capital Formation (GDCF)/Gross Investment: It refers to the addition to capital stock of the economy.

Ø  Net Exports (X - M): It refers to the difference between export and imports of a country during a period of one year.  

Q. What are the steps of expenditure method in calculation of national income?
   The steps of expenditure method in calculation of national income are as follows:
Step1: Identify the economic units incurring final expenditure. These economic units are classified into four groups:

a)      Households

b)      Government

c)      Production unit

d)      Rest of the world.

Step2: Classification of final expenditure. The above economic units estimated as:

a)      Private final consumption expenditure (PFCE)

b)      Government final consumption expenditure (GFCE)

c)      Gross domestic capital formation (GDCF)

d)      X – M (export - import).

The sum total of these four component gives GDP_MP.

Step3: Calculate domestic income (NDP_FC). By subtracting the amount of depreciation and net indirect taxes from GDP_MP, we get domestic income.
                  NDP_FC = GDP_MP – Depreciation – Net Indirect taxes.
Step4: Estimate net factor income from abroad (NFIA) to arrive at national income. NFIA is added to domestic income to get National income.
                 NNP_FC = NDP_FC + NFIA.