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Question 2

There are generally three methods used to calculate national income:

(a) Expenditure (final value) methodThe expenditure (final value) method is a measure of the expenditure of local and foreign residents of a country on final goods and services within the period of one year.(b) Output (added value) methodThe product (added value) method is a measure of the value of the country's total production within the period of one year. The added value will cause an increase in the price of goods after going through the production process.(c) Income (factor cost) methodThe income (factor cost) method is a measure of the total factor income paid tovarious factors of production such as labour, capital, entrepreneurs, and land in the production of the country's products. This method also measures the totalincome generated by each sector in the economy within the period of one year.

Theoretically, all of the three methods will result in the same value of national income, because

National expenditure = National product = National income

Expenditure (Final Value) Method

1. Using the expenditure method, national income can be calculated from the total of all expenditures on final goods and services within a year.2. It is important to calculate national income through the sum of expenditure on final goods only, to avoid the problem of double counting.3. An economy will produce intermediate goods and final goods. Intermediate goods are goods that must be processed further before use by consumers. Examples ofintermediate goods are cocoa seeds, lumber, palm oil, and iron ore. Final goodsare goods that can be immediately used by consumers without having to be furtherprocesses, such as chocolate, furniture, cooking oil, and clothes.4. In the calculation of national income through the expenditure method, the value of final goods must not include the value of intermediate goods.5. In the calculation of national income using the expenditure method, expenditure is made by the following sectors:

(a) Expenditure by the household sector for final goods and services. This expenditure is known as personal or private consumption expenditure (C).(b) Expenditure by firms and governments to purchase capital for use in productio This expenditure is known as investment expenditure (I).(c) Expenditure by the government sector for final goods and services. This expenditure is known as government or public expenditure (G).(d) Expenditure made by residents of a country for goods and services produced by other countries. This expenditure is known as import expenditure (M). However,the sale of goods and services produced by residents of one country to abroad is know n as export expenditure (X). Net export is the net difference between export expenditure and import expenditure.

Net experts = Exports - ImportsOr

Net exports = X - M6. The sum of all types of expenditure made by households, governments, firms, and overseas sectors w ill result in gross domestic product at market price (GDPmp).

GDPmp = Household consumption expenditure (C) + Investment expenditure (I) + Government expenditure (G) + Net exports (X - M) + Changes in inventory

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7. Exports cause the inflow of money, while imports cause the outflow of money.Therefore, exports must be added to the GDP while imports must be subtracted from the GDP.8. Changes in inventory must be taken into account because inventories are stocks ot unsold goods that are included in the value of total production for the year.9. If the value of change in inventory is positive, this value must be added tothe GDP. However, if the value of change in inventory is negative, this value must be subtracted from the GDP.10. The GDP at factor cost (GDPfc) is calculated by subtracting indirect taxes and adding subsidies to the GDPmp.

GDPfc = GDPmp Subsidies - Indirect taxes11. The gross national product at factor cost (GDPfc) is obtained by adding thefactor income from abroad and subtracting the factor income spent abroad from the GDPfc.

GDPfc = GDPfc + Factor income from abroad - Factor income spentabroad12. The net national product at factor cost (NNPfc) is calculated by subtractingdepreciation from the GNPfc.

NNPfc = GNPfc - Depreciation13. An example of calculation of national income through the expenditure methodis depicted in Table 3.1

Product (Added Value) Method1. Using the product method, national product is calculated from the total valueof final products created by each sector in the economy using the added value method.2. Added value is the increased value of a product after undergoing the production process in an economic activity, for example, in the production of furniture.3. This calculation only involves the value of the final products, to avoid double counting. In the production process, each sector will use intermediate goods

produced by other sectors. Therefore, during the calculation of national production, the value of intermediate goods used in the production process is excluded.4. Therefore, using the product method, national product is the total value of final goods and services produced by all sectors of an economy within one year, or the total added value of products produced at every stage of the production process within one year. Table 3.2 depicts the calculation of added value within the production process of furniture.

5. In a logging activity, the value of logs is equal to the total factor incomepaid to factors of production to produce the logs, i.e. RM8000.6. When logs are processed into sawn logs, many other factors of production mustbe used. The total payment to these factors of production is RM2000 (RM10 000 -RM8000). This means that the added value to produce sawn logs is RM12000.7. Sawn logs will then be processed into timber. This process will create an added value of RM6000 (RM16 000 - RM10 000). Finally, timber is processed into furniture, which is a final good to be used by consumers. This process also createsan added x alue of RM600 (RM22 000 - RM 16 000).

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8. The total added value is equal to the value of the final good (furniture), i.e. RM22 000.9. The total added value for all goods and services produced in an economy is equal to the total value of final goods in the economy.10. If the added value method is not used in the calculation of national incomeusing the product method, the value of intermediate goods will be included in the calculation of the value of final goods, thus causing the national product tobe overvalued. Therefore, the added value method is used to prevent double counting in the calculation of national product (national income).11. Using the product method, economic sectors are divided into the following three main sectors:(a) Agriculture and mining sector; covering agriculture, forestry, fishery, andfarming, as well as mining and quarrying.(b) Industrial sector covering factories, construction, and utility supply suchelectricity, gas, and water.(c) Services sector; covering transportation, communication, trading, hotel andrestaurant, financial insurance, property, government services, and other services.

12. The total value of final goods and services created by the economic sectorsis equal to the gross domestic product at market price (GDPmp).13. The GDP at factor cost (GDPfc) is calculated by subtracting indirect taxes and adding subsidies to the GDPmp.

GNPfc = GDPmp+ Subsidies - Indirect taxes

14. The gross national product (GNP) is calculated by differentiating the products produced by factors of production owned by citizens of the country that are located abroad from the products produced by factors of production owned by foreign citizens that are located within this country. Therefore,

GNPfc = GNPmp + Factor income from abroad - Factor income paid abroad15. The net national product at factor cost (NNPfc) or national income is generated when depreciation is subtracted from the GNPfc. NNPfc = GNPfc - Depreciation16. An example of calculation of national income through the product method is shown in Table 3.3

Income (Factor Cost) Method1. Using the income method, the income of factors of production consists of:(a) Rent (from land )(b) Wages and salaries (from labour)(c) Interest (from capital)(d) Profit (from entrepreneurs).2. In the calculation of national income using the income method, the income offactors of production consists of:(a) Wages and salaries

(b) Net interest (Gross interest - Interest on consumer loans - Interest on government loans)(c) Rent(d) Private corporate income(e) Corporate profit.3. National income is generated from the total income of factors of production.4. Interest from consumer and government loans must be subtracted from nationalincome, because both these forms of interest are not considered to be income forcapital used for national production.5. Interest on consumer loans is charged on consumer loans for the purchase of g

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oods such as houses and cars (not for purposes of investment).6. Interest on government loans is charged to governments that borrow money to finance national expenditure, such as expenditure on defence and security.7. Income from transfer payments is not included in the calculation of nationalincome because this income is not income from productive factors. Examples of transfer payments are pensions to retirees, scholarships for students, and unemployment allowances.8. An example of calculation of national income using the income method is depicted in Table 3.4.