BySudarshan Kadariya

JMC

National income measures the total value of goods and services produced within the economy over a period of time

It is the final outcome of all economic activities of a nation. In another words, it is the value of the final goods and service produced in the country in a year.

Production of goods and service generates income and income give rise to demand for goods and service, demand give rise to expenditure, and expenditure give further rise to production of goods and service. Hence, there is a circular flow of production, income and expenditure.

On the basis of these flows, national income can be analysed at (1) as a flow of goods and services, or (2) as a flow of incomes, or (3) as a flow of expenditure on goods and services.

(a) Final product approach

The final product approach involves estimation of the market value of final goods and services produced in the economy in a given period.

Steps in Final Product Approach

(i) The market value of all final goods and service produced within the country gives the estimate of Gross Domestic Product at Market Price (GDP at MP), or

GDP at MP=P1Q1+ P2Q2+P3Q3+ .......+ PnQn, Or = PiQi

(ii) The addition of net factor income from abroad in GDP at MP gives Gross National Product at Market Price (GNP at MP).

(iii) The deduction of depreciation from Gross National Product at market price (GNP at MP) MP provides Net National Product at market Price (NNP at MP).

(iv) The deduction of net indirect taxes from NNP at MP give Net National Product at Factor Cost (NNP at FC)

(v) Net National Product at factor cost equals National Income.

Problem of Double Counting

The calculation of national income through final product approach considers the market value of final goods and services.

The value of intermediate goods is not included. If the value of intermediate goods are considered, it will involve the problem of double counting.

Double counting means, consideration of certain item more than once which leads to over estimation of national income.

For example, bread is final goods while wheat and flour are considered as intermediate goods. The price of bread includes in Nation Income while cost of flour and wheat does not.

(b) Value Added Approach

This approach includes value added at different stages of production. This method considers national income as sum total of value added by different production units of a country.

In this method, the cost of intermediate products is deducted from the total value of the output.

Table: Estimation of Value Added

ProducersStages of Production

Value of Output (Rs.)

Cost of Intermediate Goods (Rs.)

Gross Value Added (Rs.)

Farmer Wheat 400 - 400

Miller Flour 700 400 300

Baker Bread 900 700 200

Total 2000 1000 900

Steps in Value Added Approach

The value added approach measures the contribution of production units of the country. This methods involves following steps.

1. All production units of the country are grouped into various industrial sectors according to their production activities

2. Obtain net value added by deducting depreciation.

3. Adding of net value added of all sector provides Net Domestic Product at factor Cost (NDP at FC)

4. Addition of net factor income from abroad gives Net National Product at Factor Cost or National income.

B. Income MethodIncome method measures national income from the side of factor incomes. It is the sum of all income derived from providing the factors of production.

It includes wages and salaries, rent, interest and profits within a country in a given year. This is also to note that the net value added in each production unit is equal to the factor income generated in that production unit.

The Net Domestic Product at factor cost is equal to the Domestic Factor Income.

Steps in Income Method

1. Obtain Net Domestic Product at Factor cost (NDP at FC) by summing up factors payment paid in form of wages & salary, rent, interest and profit by all production units of all sectors in the country.

2. Add Net factor income from abroad in Net Domestic Product at Factor Cost to obtain Net National Product at Factor Cost (NNP at FC) or national income.

The inclusion of incomes from the various sources to obtain national incomes should take precaution. The incomes from those sources which are productive and legal should only be included to derive national income

Incomes for Inclusion

Value of production for self employment, imputed rent, corporation tax should be included as factor income

Incomes for Exclusion

Transfer payment, illegal income, windfall gains (like lottery), gift tax/wealth tax and tax on windfall gain, money received from selling second hand goods, interest on national debts (considered as transfer payment) are to be excluded in estimating factor incomes.

C. Expenditure MethodExpenditure method measures national income as aggregate of all the final expenditure on gross domestic product in an economy during a year.

This is the sum of expenditure made for final consumer goods and investment demand, and for net export.

This method also known as "income disposal method", or "consumption and investment method" . The total income generated in the economy is spent either on consumption goods or on investment goods (capital goods).

Therefore, the sum of total income (Y) equals to the sum of final expenditure incurred on consumption goods (C) and the sum of investment goods (I). Symbolically, Y = C + I.

The final consumption expenditure includes (a) private household consumption expenditure and (b) government final consumption expenditure.

• Similarly, final investment expenditure comprises (a) gross final investment or gross fixed capital formation,

(b) changes in stock or inventory investment, and net export of goods and services or net foreign investment (X - M).

Steps in Expenditure Method

1. GDP at MP = Gross National Expenditure at Market Price (GNE at MP) which is obtained with the sum of Final private consumption expenditure (C), Government final consumption expenditure (G), Gross domestic private investment (I) which includes gross fixed capital formation plus changes in stocks, and Net export or export minus import (X- M)

Or, GDP at MP = GNE = C + G+ I +(X - M)

2. An addition of net factor income from abroad (NFIA) to GDP at MP provides Gross National Product at market price (GNP at MP).

Or, GNP at MP = GDP at MP + NFIA

3.The deduction of net indirect tax (tax - subsidy) from Gross

National Product at MP provides Gross National Product at Factor Cost (GNP at FC). Or,

GNP at FC = GNP at MP - Net Indirect Taxes.

4.The deduction of depreciation from Gross National Product

at Factor Cost provides Net National Product at Factor Cost

(NNP at FC) or National Income. Or,

NNP at FC = GNP at FC - Depreciation.

Factors to be taken care

1. Expenditure on second hand goods should be excluded It is because such expenditure on the goods is not considered to be expenditure on currently produced goods.

2. Expenditure on the purchase of new or old shares and bonds should be excluded because they are not payments for goods and services.

3. Government expenditure in the form of transfer payments should be excluded because these payments do not make any contribution to the flow of goods and services.

4. Expenditure on intermediate goods and services should be excluded, otherwise this will lead to the problem of double counting.

Measuring the level and rate of growth of national income is important to economists when they are considering:

◦ Economic growth and where a country is in the business cycle

◦ Changes to average living standards of the population

◦ Looking at the distribution of national income (i.e. measuring income and wealth inequalities)

There are problems of measuring NI, some of them are as follows:

1.Simon Kuznet’s difficulties (Definition of the term Nation, Method to be used, Stage of economic activity, Types of goods and services)

2.Problem of double counting3.Transfer payments4. Income generated by foreign firms5.Public services6.Calculation of depreciation

7. Inventory revaluation8. Capital gains or losses9. Changes in value of money10. Income from illegal activities11. Imputations (non-monetary activities)

In case of developing countries, there are special problems for measuring NI as follows:

a) Large non-monetized sectorb) Inadequate and unreliable statisticsc) Illiteracy and ignoranced) Less occupational specialization

Source: Joshi, S. (2066) Economic Policy Analysis, Taleju Prakashan, Kathmandu