National Income: Best Methods Measuring National Income

In this post you will learn about Methods Measuring National Income, national income is a measure of, methods to calculate national income, how many methods to calculate national income, national income by expenditure method, methods of national income etc.

Methods Measuring National Income

National Accounts Statistics (NAS) in India are compiled by the National Accounts Division in the Central Statistics Office, Ministry of Statistics and Programme Implementation (MOSPI). Annual as well as quarterly estimates are published. 

This publication is the key source material for all macroeconomic data of the country. As per the mandate of the Fiscal Responsibility and Budget Management Act 2003, the Ministry of Finance uses the GDP numbers (at current prices) to determine the fiscal targets.

The Ministry of Statistics and Programme Implementation has released a new series of national accounts, revising the base year from 2004-05 to 2011-12. In the revision of National Accounts statistics done by the Central Statistical Organization (CSO) in January 2015, it was decided that sector-wise estimates of Gross Value Added (GVA) will now be given at basic prices instead of at factor cost. 

In simple terms, for any commodity, the ‘basic price’ is the amount receivable by the producer from the purchaser for a unit of a product minus any tax on the product plus any subsidy on the product.

The Circular Flow of Income

Circular flow of income refers to the continuous circulation of production, income generation, and expenditure involving different sectors of the economy. There are three different interlinked phases in a circular flow of income, namely: production, distribution, and disposition 

Topic	National Income
Home	Click here

(1) In the production phase, firms produce goods and services with the help of factor services.

(ii) In the income or distribution phase, the flow of factor incomes in the form of rent, wages, interest, and profits from firms to the households occurs

(iii) In the expenditure or disposition phase, the income received by different factors of production is spent on consumption goods and services and investment goods. This expenditure leads to further production of goods and services and sustains the circular flow.

These processes of production, distribution, and disposition keep going on simultaneously and enable us to look at national income from three different angles namely: as a flow of production or value added, as a flow of income, and as a flow of expenditure. 

Each of these different ways of looking at national income suggests a different method of calculation and requires a different set of data. The details in respect of what is measured and what data are required for all three methods mentioned above are given in the following table.

Data Requirements and Outcomes of Different Methods of National Income

Method	Data Required	What is measured
Method Phase of Output: Value-added method (Product Method)	The sum of net values added by all the producing enterprises of the country	Contribution production units
The phase of disposition:  Expenditure method	Total generated in the production of goods and services	The flow of consumption and investment expenditures
Phase of disposition:  Expenditure method	The sum of expenditures of the three spending units in the economy, namely, government, consumer households, and producing enterprises	The phase of income: Income Method

Corresponding to the three phases, there are three methods of measuring national income. They are: Value Added Method (alternatively known as Product Method); Income Method; and Expenditure Method. 

Value Added Method or Product Method

The product Method or Value Added Method is also called Industrial Origin Method or Net Output Method. The national income by value-added method is the sum total of net value added at factor cost across all producing units of the economy. 

The value-added method measures the contribution of each producing enterprise in the domestic territory of the country in an accounting year and entails the consolidation of production of each industry less intermediate purchases from all other industries. This method of measurement shows the unduplicated contribution by each industry to the total output. This method involves the following steps:

Step 1. Identifying the producing enterprises and classifying them into different sectors according to the nature of their activities

All the producing enterprises are broadly classified into three main sectors namely:

(i) Primary sector,

(ii) Secondary sector, and

(iii) Tertiary sector or service sector

These sectors are further divided into sub-sectors and each sub-sector is further divided into a commodity group or service group.

Step 2. Estimating the gross value added (GVA) by each producing enterprise (This is the same as GDP)

Gross value added (GVA)= Value of output-Intermediate consumption 
                                                = (Sales + change in stock) - Intermediate consumption

While calculating the value added, we are actually finding the value of the production of the firm. Production of the firm = Value added + intermediate consumption. (Note that imports are included in the value of intermediate consumption if total purchases are given. If domestic purchases are specifically mentioned, then imports will also be added. Also, sales include exports, if domestic sales are separately mentioned, exports need to be added)

Step 3. Estimation of National income

For each individual unit, the Net value added is found.

Σ (GVA) - Depreciation = Net value added (NVA )

Adding the net value-added by all the units in one sub-sector, we get the net value-added by the sub-sector. By adding net value-added or net products of all the sub-sectors of a sector, we get the value-added or net product of that sector. For the economy as a whole, we add the net products contributed by each sector to get Net Domestic Product. We subtract net indirect taxes and add net factor income from abroad to get national income.

Net value added (NVA) - Net Indirect taxes = Net Domestic Product (NVA)
Net Domestic Product (NVA) + (NFIA) National Income (NNP)

The values of the following items are also included:

(1) Own account production of fixed assets by government, enterprises, and households. 

(ii) Imputed value of production of goods for self-consumption, and

(iii) Imputed rent of owner-occupied houses.

(iv) Change in stock(inventory)

Income Method

Production is carried out by the combined effort of all factors of production. The factors are paid factor incomes for the services rendered. In other words, whatever is produced by a producing unit is distributed among the factors of production for their services.

Under the Factor Income Method, also called Factor Payment Method or Distributed Share Method, national income is calculated by the summation of factor incomes paid out by all production units within the domestic territory of a country as wages and salaries, rent, interest, and profit. By definition, it includes factor payments to both residents and non-residents.

Thus,

NDP = Sum of factor incomes paid out by all production units within the domestic territory of a country

NNP For National Income = Compensation of Employees 
                                               +Operating Surplus (rent + interest+ profit)
                                               + Mixed Income of Self-employed
                                               +Net Factor Income from Abroad

Only incomes earned by owners of primary factors of production are included in national income. Thus, while wages of laborers will be included, pensions of retired workers will be excluded from national income. 

Compensation of employees includes, apart from wages and salaries, bonus, dearness allowance, commission, employers’ contribution to provident fund, and imputed value of compensation in kind. Non-labour income includes rent (actual and imputed), royalty, interest on loans availed for productive services, dividends, undistributed profits of corporations before taxes, and profits of unincorporated enterprises and of government enterprises.

(Note: Interest paid by the government on public debt, interest on consumption loans, and interest paid by one firm to another are excluded.

Profit =Corporate taxes+ dividend retained + earnings)

While using the income method, capital gains, windfall profits, transfer incomes and income from the sale of second-hand goods and financial assets, and payments out of past savings are not included. 

However, commissions, brokerages, and imputed value of services provided by owners of production units will be included as these add to the current flow of goods and services.

Usually, it is difficult to separate labor income from capital income because in many instances people provide both labor and capital services. 

Such is the case with self-employed people like lawyers, engineers, traders, proprietors, etc. In economies where subsistence production and small commodity production are dominant, most of the incomes of people would be of mixed type. In sectors such as agriculture, trade, transport, etc. in underdeveloped countries (including India). 

it is difficult to differentiate between the labor element and the capital element of the incomes of the people. In order to overcome this difficulty a new category of income, called ‘mixed income’ is introduced which includes all those incomes which are difficult to separate. 

Expenditure Method

In the expenditure approach, also called Income Disposal Approach, national income is the aggregate final expenditure in an economy during an accounting year.

GDP = Final Expenditure

In this approach to measuring GDP which considers the demand side of the products, we add up the value of the goods and services purchased by each type of final user mentioned below.

1. Final Consumption Expenditure

(a) Private Final Consumption Expenditure (PFCE)

To measure this, the volume of final sales of goods and services to consumer households and non-profit institutions serving households acquired for consumption (not for use in production) are multiplied by market prices and then summation is done. It also includes the value of

primary products which are produced for own consumption by the households, payments for domestic services that one household renders to another, the net expenditure on foreign financial assets, or net foreign investment. 

Land and residential buildings purchased or constructed by households are not part of PFCE. They are included in gross capital formation. Thus, only expenditure on final goods and services produced in the period for which national income is to be measured and net foreign investment are included in the expenditure method of calculating national income.

(b) Government Final Consumption Expenditure

Since the collective services provided by the governments such as defense, education, healthcare, etc. are not sold in the market, the only way they can be valued in monetary terms is by adding up the money spent by the government in the production of these services. This total expenditure is treated as the consumption expenditure of the government. Government expenditure on pensions, scholarships, unemployment allowance, etc. should be excluded because these are transfer payments.

2. Gross Domestic Capital Formation

Gross domestic fixed capital formation (Gross Investment) is that part of the country’s total expenditure which is not consumed but added to the nation’s fixed tangible assets and stocks. It consists of the acquisition of fixed assets and the accumulation of stocks. 

The stock accumulation is in the form of changes in the stock of raw materials, fuels, finished goods, and semi-finished goods awaiting completion. 

Thus, the gross investment includes final expenditure on machinery and equipment and own account production of machinery and equipment, expenditure on construction, expenditure on changes in inventories, and expenditure on the acquisition of valuables such as, jewelry and works of art.

3. Net Exports

Net exports are the difference between exports and imports of a country during the accounting year. It can be positive or negative.

How do we arrive at national income or NNP using the expenditure method? We first find the sum of final consumption expenditure, gross domestic capital formation, and net exports. The resulting figure is gross domestic product at market price (GDP). To this, we add the net factor income from abroad and obtain Gross National Product at market price (GNP). Subtracting net indirect

taxes from GNP, we get Gross National Product at factor cost (GNP). National income or NNPrc is obtained by subtracting depreciation from Gross national product at factor cost (GNP).

Ideally, all the three methods of national income computation should arrive at the same figure. When the national income of a country is measured separately using these methods, we get a three-dimensional view of the economy. Each method of measuring GDP is subject to measurement errors and each method provides a check on the accuracy of the other methods. 

By calculating total output in several different ways and then trying to resolve the differences, we will be able to arrive at a more accurate measure than would be possible with one method alone. Moreover, different ways of measuring total output give us different insights into the structure of our economy.

The income method may be most suitable for developed economies where people properly file their income tax returns. With the growing facility in the use of the commodity flow method of estimating expenditures, an increasing proportion of the national income is being estimated by the expenditure method. 

As a matter of fact, countries like India are unable to estimate their national income wholly by one method. Thus, in the agricultural sector, net value added is estimated by the production method, in the small-scale sector net value added is estimated by the income method and in the construction sector net value added is estimated by the expenditure method.

FAQ’s