National Income – Concept, Types and Measurement (Managerial Economics)

Posted on Jun 5 2020 - 4:46pm by Preeti

Methods of Measuring National Income

For measuring national income, the economy through which people participate in economic activities, earn their livelihood, produce goods and services and share the national products is viewed from three different angles.

The national economy is considered as an aggregate of producing units combining different sectors such as agriculture, mining, manufacturing, trade and commerce etc.
The whole national economy is viewed as a combination of individuals and households owning different kinds of factors of production which they use themselves or sell factors-services to make their livelihood.
The national economy may also be viewed as a collection of consuming, saving and investing units (individuals, households and government).

Following these notions of a national economy, national income may be measured by three different corresponding methods:

1. Net product method – when the entire national economy is considered as an aggregate of producing units
2. Factor- income method- when national economy is considered as combination of factor-owners and users
3. Expenditure method – when national economy is viewed as a collection of spending units.

1. Net Output or Value Added Method

The net output method is also called the value added method. In its standard form, this method consists of three stages:

(i) estimating the gross value of domestic output in the various branches of production;

For measuring the gross value of domestic product, output is classified under various categories on the basis of the nature of activities from which they originate. The output classification varies from country to country depending on :

(a) the nature of domestic activities
(b) their significance in aggregate economic activities
(c) availability of requisite data.

After the output is classified under the various categories, the value of gross output is computed in two alternative ways:

(a)by multiplying the output of each category of sector by their respective market price and adding them together, or

(b) by collective data about the gross sales and changes in inventories form the account of the manufacturing enterprises and computing the value of GDP on the basis thereof. If there are gaps in data, some estimates are made thereof and gaps are filed.

(ii) determining the cost of material! and services used and also the depreciation of physical assets;

The next step in estimating the net national product is to estimate the cost of production including depreciation. Estimating cost of production is, however, a relatively more complicated and difficult task because of  non-availability of adequate and requisite dat. Much more difficult is the task of estimating depreciation since it involves both conceptual and statistical problems. For this reason, many countries adopt factor-income method for estimating their national income.

However, countries adopting net-product method find some ways and means to calculate the deductible cost. the costs are estimated either in absolute terms (where input data are adequately available) or as an overall ration of input to the total output. The general practice in estimating depreciation is to follow the usual business practice of depreciation accounting. Traditionally, depreciation is calculated at some percentage of capital, permissible under the tax-laws. In some estimates of national income, the estimators have deviated from the traditional practice and have instead estimated depreciation as some ration of the current output of final goods.

Following a suitable method, deductible costs including depreciation are esti­mated for each sector. The cost estimates are then deducted from the sectoral gross output to obtain the net sectoral products. The net sectoral products are then added together. The total thus obtained is taken to be the measure of net national products or national income by net product method.

(iii) deducting these- costs and depreciation from gross value to obtain the net value of domestic output…”. The net value of domestic product thus obtained is often called the value added or income product which is equal to the sum of wages, salaries, supplementary labour incomes, interest, profits, and net rent paid of accrued.

2. Factor-Income Method

This method is also known as income method and factor-share method. Under this method, the national income is calculated by adding up all the “incomes accruing to the basic factors of production used in producing the national product”. Factors of production are conventionally classified as land, labour, capital and organization. Accordingly the national income equals the sum total of the corresponding factor earning.
Thus, National income = Rent + Wages + Interest + Profit

Thus, the total factor-incomes are grouped under three categories:

(i) Labour incomes
(ii) capital incomes
(iii) mixed incomes

(i) Labour Incomes

Labour incomes included in the national income have three components:

(a) Wages and salaries paid to the residents of the country including bonus and commission, and social security payments;
(b) Supplementary labour incomes and including employer’s contribution to social security and employee’s welfare funds, and direct pension payments to retired employees.
(c) Supplementary labour incomes in kind, e.g. free health and education, food and clothing and accommodation etc. Compensation in kind in the form of domestic servants and such other free-of-cost services provided to all the employees are included in labour income. War bonuses, pensions, service grants are not included in labour income as they are regarded as ‘transfer payments’. Certain other categories of income e.g. incomes from incidental jobs, gratuities, tips etc., are ignored for lack of data.

(ii) Capital Incomes

According to Studenski, capital incomes include the following capital earning:

(a) Dividents excluding inter-corporate dividends
(b) undistributed before-tax profits of corporations;
(c) interest on bonds, mortgages, and saving deposits (excluding interests on war bonds, and on consumer-credit)
(d) interest earned by insurance companies and credited to the insurance policy reserves;
(e) not interest paid out by commercial banks;
(f) net rents from land, buildings, etc., including imputed net rents on owner- occupied dwellings;
(g) royalties; and
(h) profits of government enterprises.

The data for the first two items are obtained mostly from the firms’ accounts submitted for taxation purposes. But the definition of profit for national accounting purposes differs from that employed by taxation authorities. Some adjustments in the income tax data become, therefore, necessary. The data adjustments generally pertain to (i) excessive allowance of depreciation made by the firms; (ii) elimination of capital gains and losses since these do not reflect the changes in current income; and (iii) elimination of under or over-valuation of inventories on book-value.

(iii)  Mixed Income
Mixed incomes include-earnings from (a) farming enterprises, (b) sole proprietorship (not .included under profit or capital income); and (c) other pro­fessions, eg., legal and medical practices, consultancy services, trading and transport­ing etc. This category also includes the incomes of those who earn their living through various sources as wages, rent on own property, interest on own capital, etc.
All the three kinds of incomes, viz., labour incomes, capital incomes and mixed incomes added together give the measure of national income by factor-income method.

3. Expenditure Method

The expenditure method, also known as final product method, measures national income at the final expenditure stages. In estimating the total national expenditure, any of the two following methods are followed:

(i) all the money expenditures at market price are computed and added up together.

The items of expenditure which are taken into account under the first method are (a) private consumption expenditure; (b) direct tax payments; (c) payments to the non-profit-making institutions and charitable organizations like schools, hospitals, orphanages, etc.; and (d) private savings.

(ii) the value of all the products finally disposed of are computed and added up, to arrive at the total national expenditure. Under the second method, the following items are considered: (a) private consumer goods and services; (b) private investment goods; (c) public goods and services; and (d) net investment abroad. The second method is more extensively used because the data required in this method can be collected with-greater ease and accuracy.

The two main considerations on the basis of which a particular method is chosen are: (i) the purpose of national income analysis, and (ii) availability of necessary data. If the objective is to analyse the net output or value added, the net output method is more suitable. In case the objective is to analyse the factor- income distribution, the suitable method for measuring national income is the income method. If the objective at hand is to find out the expenditure pattern of the national income, the expenditure or final products method should be applied. However, availability of adequate and appropriate data is a relatively more important consideration is selecting a method of estimating national income.

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