Methods of Measuring National Income

Introducing the National Income:

National Income(NI) accounting is defined as a system used to estimate national income and its components, an approach to measuring an economy’s aggregate performance. NI refers to the total income or revenue of the nation in a particular period of time.

According to Wikipedia or encyclopedia; In national income accounting, net national income (NNI) is net national product (NNP) minus indirect taxes. Net national income encompasses the income of households, businesses, and the government.
And,
Dictionary meaning of NI; the total amount of money earned within a country.
It is calculated as:
NI= (Y1+Y2+Y3+….. … ..+Yn)

Methods of Measuring National Income (NI)

With Figure:  

We have altogether 3 approaches or methods to measure National Income; 

1.Expenditure Method also known as(aka) Spending Method
2.Income Method also know as (aka) Share Distributive Method
3.Product Methods also know as (aka) Inventory or Value added Method

Description on Each Methods:

Expenditure Approach:

Expenditure Method is also know as spending Method or Final product method. This approach measures GDP as the aggregate of all the Final expenditure on GDP in an economy during an accounting year.

In another sense, Final expenditure means Expenditure on final products.

Now symbolically, Lets analysis Expenditure method;

GDPmp =C+I+G+(X-M)

GNPmp =C+I+G=(X-M)+(R-P)

NNPmp =GNPmp-Depreciation 

Where,

C=Private Consumption Expenditure ; I=Gross Private Domestic Investment ; G=Govn Expenditure ; X=Export Earnings ; M=Import Expenses ; R=Receipts from abroad and P=Payments made to abroad

  

Components of Expenditure Methods

There are 5 Components of Spending Approach:

A. Private (or Personal) Consumption Expenditure(C):

It includes all the types of expenditure made on final goods and services, including those produced abroad by the individuals or households of the country. 

Expenditure on Durable(eg. Watch, Furniture, Vehicles) and Non-durable (eg. Milk, Rice) but not residential houses as they are classified under Investment.  

B. Gross Private Domestic Investment or Gross Capital(K) Formation(I):

It includes expenses incurred by Private enterprises on new investment and on replacement of old capital and also on inventory investment. It’s Categories are:

1. Non-Residential Investment: Meaning is Expenditures made by business firms on Machines, tools, Plants are added

2. Residential Investment: Meaning: Expenditure on Factories, Warehouse, business complex added

3. Changes on Business Inventories: Meaning: It is the difference in closing stock and opening stock. It is treated as goods which firms now produce and intend to sell later. 

4. Depreciation: Meaning: It is the Value of the value of the capital that wears out during the period over which economic activity is being measured.

C. Government Expenditure:

Expenditure made by Govnt (centre, State, Local) on the final goods or services, including thosed produced abroad are the part of GDE(GDP). Government expenditure refers to the purchase of goods and services, which include public consumption and public investment, and transfer payments consisting of income transfers (pensions, social benefits) and capital transfer.

D. Net Foreign Investment (X-M):

Net foreign investment (which is also referred to asnet capital outflow) is the total amount of investment overseas done by people in the domestic economy minus the investment from people overseas in the domestic economy.

E. Net Factor Income From Abroad (NFIA) or Net Receipt(R-P):

Net factor income from abroad is the difference between the factor income earned from abroad by normal residents of a country (say, India) and the factor incomeearned by non-residents (foreigners) in the domestic territory of that country

Income Approach:

Income Approach also known as Share Distributive Method. The Income Method measures national income from the side of payments made to the primary factors of production in the form of rent, wages, interest and profit for their productive services in an accounting year. ... Hence, value of national income method should be the same as the one calculated by value added method.

There are three ways of calculating GDP - all of which in theory should sum to the same amount:

National Output = National Expenditure (Aggregate Demand) = National Income.

(i) The Expenditure Method - Aggregate Demand (AD)

GDP = C + I + G + (X-M) where.

The Income Method – adding together factor incomes.

Components of Income Methods:

There are 5 Components of Share Distributive Approach:

A. Rents:

Rents includes the rent of Land, Shops, houses, Factories,etc. and the estimated rents of all such assets as are used by the owners themselves. Some miscellaneous types of income such as royalties income paid to authors, recording artists, patents etc are also included.

 Rents= Rent of Land, machines and buildings + Royalties

B. Compensation of Employees:

It includes sums received or deposited during a year in the form of wages and salaries paid to households or workers by private firms and the govn and employer’s contributions to social security or PF.

Compensation of Employees=Wages & Salaries+Employer’s Contribution to social security

C. Net Interest:

Interest is the payment paid by different productive agencies or business firms to the suppliers of the money capital.

D. Profits:

National income accountants put accounting profit into two categories:

1.Proprietor’s Net Income(Income received from sole proprietorship, partnerships and professional associations )and,  

2.Corporate Profits(Income received from Corporate Business)

E. Mixed Income of Self-employed:

It is where there is unorganized sector where people are self-employed and self-owned factors are used. In such setup, separate estimates of rent, interest, profits and wages are not available because factors are not hired from the factor market. Such income generated by sector is treated as mixed income. It is added to total rent, interest, profit etc..

According to Income Method,

NDPfc= Compensation of Employees+Operating Surplus+Mixed income

GDPfc= NDPfc+Depn

GDPmp= GDPfc+Net indirect taxes

NNPfc= NDPfc+Net factor income from abroad

NNPmp= NNPfc+Net indirect taxes

GNPfc= NNPfc+Depn

GNPmp= GNPfc+Net indirect taxes

Product Methods:

In this method, national income is measured as a flow of goods and services. We calculate money value of all final goods and services produced in an economy during a year. Final goods here refer to those goods which are directly consumed and not used in further production process.

Components of Product Methods

It have 4 components:

Primary Sectors:

It includes agro-products(foods crops, cash crops,  animal husbandry, etc ), fishery, forestry etc

Secondary Sectors:

It includes manufacturing, construction, electricity, gas, water supply etc..

Tertiary Sectors:

It includes banking and insurance, transport and communication, trade and commerce, health and educations..

Net Factor income from abroad:

It is the difference between receipts from foreign countries and payments to foreign countries.

According to product method,

GDPmp= Total product of primary sectors+Total product of Secondary Sectors+Total product of Tertiary Sectors

GNPmp= GDPmp+NFIA

NDPmp= GDPmp-Depn

NNPmp= GNPmp-Depn

NNPfc or NI= NNPmp-Net indirect tax

Summary:

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